FPIs pull out $64 bn from Indian equities in 25 months; can LTCG tax relief bring foreign investors back?
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Foreign portfolio investors (FPIs) have net-sold nearly $64 billion worth of Indian equities over the past 25 months, marking one of the longest and deepest spells of foreign capital withdrawal from the domestic market. While the government and market regulator are considering tax concessions to make Indian equities more attractive, experts caution that changes to the LTCG tax regime alone may not be enough to reverse foreign outflows. Earnings growth, valuations, crude oil prices and currency stability will remain the bigger determinants of foreign investor sentiment.
Recently, Finance Minister Nirmala Sitharaman indicated that the government was open to hearing suggestions on LTCG tax and the securities transaction tax (STT). The Securities and Exchange Board of India (Sebi) has also recommended scrapping LTCG tax for foreign portfolio investors and exempting mutual fund switches from the levy. The recommendations are reportedly part of Sebi's pre-Budget representation for 2027-28.
Speaking at Bloomberg's New Economy Forum last month, Sitharaman said investors, both domestic and overseas, had raised questions about LTCG and STT. "It's healthy to have this debate, and I will be keen to hear them," she said, while adding that she would "tread cautiously" on possible changes in the Budget.
Can LTCG tax cuts revive FPI interest?
For foreign investors, the proposed changes could improve post-tax returns from Indian equities and reduce the cost of investing in the market. However, tax efficiency alone may not be enough to reverse the sustained outflows, say market experts.
"Sebi's proposal is a step in the right direction, but tax efficiency alone will not bring foreign capital back to India. Lower capital gains taxes would improve post-tax returns, reduce friction and make Indian equities more competitive against other emerging markets," says Nirav Karkera, Head of Research and Fund Manager, W by Groww.
He also highlights the impact of rupee depreciation on dollar-denominated returns. According to Karkera, FPIs should ideally be taxed on their actual economic gains rather than gains arising from rupee movements that may disappear when returns are converted into dollars.
"However, the bigger drivers of foreign flows remain earnings growth, valuations, currency stability and India's relative attractiveness within emerging markets," he says.
For domestic mutual fund investors, the proposal to make scheme switches tax-neutral after a holding period of more than a year could also improve capital allocation by allowing portfolio rebalancing without an immediate tax liability.
Karkera believes tax reform can remove a deterrent to investment but cannot, by itself, create an incentive to invest. That conviction, he says, will have to come from earnings delivery, reasonable valuations and confidence in the rupee.
Axis Securities also believes that rationalisation of LTCG, short-term capital gains (STCG) and STT could improve India's investment proposition. However, a sustained revival in foreign flows would depend primarily on earnings growth and relative valuations.
The brokerage notes that Indian equities have underperformed US and other emerging markets during CY25 and CY26, bringing down India's relative valuation premium. The FTSE India index currently trades at a 47% price-to-earnings premium to the emerging-market index, compared with 97% in September 2024.
There is also a case for a broader rationalisation of the capital gains tax regime, says Punit Shah, Partner, Dhruva Advisors. Given the current economic environment, the government could consider abolishing LTCG tax on listed equity shares and reducing the holding period required for shares to qualify as long-term assets, he says.
"Currently, there is an additional incidence of taxes in the form of securities transaction tax (STT), which was introduced in lieu of capital gains tax. This makes transactions in equity shares expensive and less attractive, negatively impacting inflows of foreign capital," Shah says.
Rationalising LTCG taxes could also simplify processes and compliance requirements, he adds.
What is driving the foreign sell-off?
According to a JM Financial report, FIIs net-sold $59 billion worth of Indian equities in the 24 months to September 2026. Including October's month-to-date outflows, the figure rises to around $64 billion. Rolling 12-month outflows had already touched a record $40 billion in June 2026.
The brokerage analysed 20 years of monthly data to assess the relationship between foreign flows and key variables, including GDP growth, interest rates, earnings, valuations, the rupee, crude oil prices and capital gains taxation.
Its findings suggest that economic growth alone does not explain foreign investor behaviour. India recorded GDP growth of 7.8% in the first quarter of FY27, even as FIIs sold $13.4 billion worth of equities during the quarter. Similarly, an improvement in corporate earnings has not yet translated into a reversal in foreign flows.
Valuations, however, offer a more useful signal, although with a time lag. The brokerage found that the earnings yield of Indian equities has a stronger relationship with FII flows four to five months ahead than with flows in the same month. At a one-year forward P/E of 17.1 times and an earnings yield of 5.8%, current valuations appear supportive, but cheaper stocks alone may not be enough to trigger an immediate return of foreign money.
JM Financial estimates that removing LTCG tax could add around 2.2 percentage points to an average year's dollar returns for foreign investors. While meaningful, this is relatively small compared with the potential return from a valuation re-rating towards the market's 10-year average.
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