Will tax-free status for FIIs boost India’s government bond market?

The Centre on Friday promulgated the Income tax (Amendment) Ordinance, 2026, which provides tax exemption to Foreign Institutional Investors (FIIs) on income earned from government securities. The ordinance has been issued while Parliament is not in session and will be deemed effective from April 1, 2026.

The amendment modifies Schedule IV of the Income-tax Act, 2025.

What the new tax exemption covers

Under the revised rules, FIIs will not be required to pay tax on:

• Interest earned from government securities
• Capital gains arising from sale, transfer or exchange of such securities

The exemption will also apply to the Bank for International Settlements (BIS). However, investors will be required to comply with prescribed disclosure and reporting norms.

Objective: attract long-term foreign capital

The government said the move is intended to attract stable, long-term foreign investment into India’s sovereign debt market. Officials believe stronger foreign participation will improve liquidity, deepen market efficiency and enhance price discovery in government securities.

Government bonds serve as benchmarks for pricing corporate loans, infrastructure financing and other financial instruments, making their stability crucial for the broader economy.

Expected impact on bond markets

The policy is expected to:

• Increase foreign participation in government securities
• Improve competition in bond auctions and secondary markets
• Reduce borrowing costs for the government over time
• Strengthen integration with global financial markets

Experts say higher overseas inflows could also help compress term premiums and support more efficient pricing of debt instruments across the economy.

Part of broader market reforms

The decision follows earlier reforms such as the Fully Accessible Route (FAR), which allowed easier foreign access to selected government securities. These steps have also supported the inclusion of Indian bonds in global indices, helping attract passive foreign investment.

Background and regulatory framework

The ordinance defines FIIs under the Income-tax Act and treats “government securities” in line with the Government Securities Act, 2006. The exemption will be applicable only if investors meet reporting requirements set by authorities.

India has been gradually opening its sovereign debt market to global investors as part of efforts to deepen financial markets and reduce borrowing costs. Government securities play a central role in determining interest rates across the economy, influencing corporate bonds, banking rates and infrastructure financing.

The latest tax exemption is expected to further strengthen India’s position in global capital markets by making its debt instruments more attractive compared to competing emerging markets. Analysts suggest that consistent foreign inflows could improve market stability and reduce volatility in bond yields.

The move also aligns with India’s broader strategy of integrating with global financial systems while ensuring stable funding for public expenditure in areas such as infrastructure development, urban expansion, climate transition and manufacturing growth.
(With ANI inputs)