Structural Disadvantage
Foreign investors are finding India a less attractive destination, largely due to ongoing structural tax disadvantages. The recent increase in long-term capital gains (LTCG) tax to 12.5% and the removal of indexation benefits—which adjust for inflation—have significantly changed the after-tax returns for foreign investments. For many international investors, particularly those unable to claim double taxation relief in their home countries, this means a higher effective tax burden. Market commentator Samir Arora has called the policy a potential 'big mistake' that could harm India's investment image.
Currency depreciation is another major challenge. The Indian Rupee has historically fallen against the US Dollar, averaging a 3.95% annual depreciation over the last decade. This erodes dollar-denominated returns, making investments riskier and lowering profits for international funds when money is sent back home. These tax policies combined with currency volatility make it difficult for foreign funds to invest.
Global Context and Peer Analysis
India's new tax rules make it less competitive compared to major Asian rivals. Taiwan and South Korea, for example, reportedly have no capital gains tax on equities for foreign investors, making them much more attractive. These markets are currently drawing significant foreign investment, boosted by the artificial intelligence (AI) boom and strong tech exports, while India faces outflows. These rival markets collectively attracted about $25.7 billion in the three months ending July 2025, whereas India saw outflows of over $2 billion in July 2025 alone.
Although India's 12.5% LTCG rate is globally competitive against countries like the US, UK, or Thailand, the loss of indexation benefits and a move to a 20% STCG rate for FIIs has reduced its appeal. Countries like Singapore and the UAE, which impose no capital gains tax, remain key destinations. These factors have collectively driven substantial outflows from foreign portfolio investors (FPIs). In fiscal year 2025-26, FPIs sold Indian equities worth an estimated ₹1.76 trillion, up from ₹1.27 trillion in FY25. This trend signals India's weakening attractiveness for global capital as markets increasingly favor those with better tax structures and growth stories, like AI-focused economies.
Persistent Headwinds
Foreign investor selling, which has been ongoing since October 2024, isn't just due to tax changes. A falling rupee, slower corporate earnings growth compared to rivals, and rising US market yields have also prompted foreign capital to leave. These outflows are increasing stock market volatility and reducing liquidity, making trading harder for everyone.
Regulatory uncertainty is also a concern. Although SEBI has worked to simplify processes, new disclosure requirements for FPIs (introduced August 2023, amended March 2024) have reportedly contributed to sell-offs. Such policy shifts can raise perceived risks for foreign investors, potentially leading to more capital flight or fewer inflows if clarity and consistency aren't maintained. This suggests that India, which relies on foreign capital for economic growth, is becoming less competitive globally regarding its capital gains tax approach.
Future Outlook
Looking ahead, some market strategists expect foreign investor flows to recover in 2026. A report from Antique Stock Broking Limited suggests that conditions driving outflows in 2025 are easing, with earnings prospects, valuations, and market stability expected to improve. They noted that FPI equity outflows in 2025 hit a record USD 17.5 billion, but predict a revival in 2026 as global interest rates potentially fall and India's nominal growth accelerates.
India's debt markets, boosted by their inclusion in global bond indices, are also anticipated to attract steady foreign demand, providing more stable capital. However, the ongoing preference for AI-focused emerging markets over India could continue to pose a risk.