Can LTCG, STCG Tax Cuts Revive FPI Flows? Analysts Weigh In

Tax Relief May Help India’s Pitch to Foreign Investors, but Valuations Still Lead

A lower tax bill could improve returns at the margin; a durable revival in foreign flows will likely require stronger earnings and more compelling valuations.

Tax changes may improve returns, not repair the investment case

The discussion around capital gains tax for foreign portfolio investors (FPIs) is about whether a lower tax burden can help restore overseas appetite for Indian equities. FPIs currently pay tax on realised gains from listed Indian shares calculated in rupees: long-term capital gains (LTCG) are taxed at 12.5% and short-term capital gains (STCG) at 20%, excluding applicable surcharge and cess.

JM Financial and Bernstein agree that a cut could raise post-tax returns and signal a more welcoming policy environment. But they caution that taxation is not the main determinant of foreign flows. Investors also weigh valuations, currency movements, earnings prospects and the opportunities available in other emerging markets. That leaves tax relief as a potential support, rather than a substitute for a stronger investment case.

Valuation changes could outweigh the tax benefit

JM Financial estimates that scrapping LTCG tax could add about 2.2 percentage points to an average year’s dollar returns for foreign investors, broadly offsetting the annual drag from rupee depreciation. That would be meaningful at the margin, but the brokerage’s comparisons underline why investors may focus more on the market’s valuation and earnings trajectory.

A one-time increase of one turn in the market’s price-to-earnings multiple could lift returns by 5.8%, JM Financial estimates. A re-rating from 17.1 times to the 10-year average of 21.3 times would imply a potential gain of 24.3%. These are analytical comparisons, not forecasts: they illustrate how valuation changes can have a larger effect on returns than the estimated tax benefit.

A policy signal comes with a fiscal trade-off

The government would also need to weigh any relief against lost revenue. Equity LTCG tax collections stood at ₹1.29 trillion in FY25, equivalent to around 2.9% of the Centre’s budgeted gross tax receipts for FY27. JM Financial sets that figure against the government’s fiscal deficit target of 4.3% of GDP, highlighting the budgetary cost a full exemption could carry.

The historical relationship between tax rates and foreign flows is mixed, the brokerage said. Small rate adjustments have had limited influence, while larger changes in the effective tax burden have produced more visible responses. JM Financial sees a credible announcement in the February 2027 Budget as potentially improving perceptions of India’s investment climate, though a short-lived rally could also give existing investors an opportunity to sell, Bernstein’s Venugopal Garre warned.

JM Financial’s bull-case assessment suggests relief could add $3 billion to $5 billion to foreign inflows in FY28. The brokerage stressed that this is an analytical assessment, not a formal model output, and said investors with greater flexibility in how they allocate to India could be more responsive. The Securities and Exchange Board of India has recommended that the government remove LTCG tax for foreign investors; the source does not indicate that a change has been enacted.

Alternatives could target the rupee-tax mismatch

Rather than abolishing the tax, JM Financial has proposed calculating gains in dollars or indexing acquisition costs to account for rupee depreciation. The rationale is that a foreign investor may face tax on a gain measured in rupees despite making little or no return in dollars. Other options include bringing the STCG rate closer to the LTCG rate or shortening the 12-month holding period for long-term treatment.

These proposals would address different parts of the tax burden, and their effect on flows would depend on the final design and investor response. For markets, the central question is whether any policy change comes alongside improving earnings and valuations that can support a sustained allocation to Indian equities.

Key Highlights

• Current FPI tax rates on listed-equity gains are 12.5% for LTCG and 20% for STCG, before surcharge and cess.
• Analysts say tax relief could help post-tax returns, but is unlikely to revive foreign inflows by itself.
• JM Financial estimates an LTCG exemption could add 2.2 percentage points to average annual dollar returns.
• Equity LTCG tax collections were ₹1.29 trillion in FY25, bringing the fiscal cost of a full exemption into focus.
• Dollar-based taxation or inflation of acquisition costs are among the alternatives proposed to address rupee-related tax distortions.

Investor Note: Any tax cut should be viewed as one factor in the foreign-flow outlook, not a standalone signal to buy equities. Earnings momentum, valuations, currency movements and the final policy design remain important considerations.