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India Introduces Tax Exemption on FII Investment in Government Securities - A defense against currency depreciation
The Income Tax (Amendment) Ordinance, 2026 (No. 2 of 2026) was promulgated on 5 June 2026 to amend Schedule IV of the Income Tax Act, 2025. The Ordinance provides an exemption from income tax for specified income earned by eligible foreign institutional investors (FIIs) and the Bank for International Settlement (BIS) from investments in Indian Government Securities.
| What Does the Ordinance Provide?
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The Ordinance grants a full exemption from income tax on both interest income and capital gains arising from investments in Indian Government Securities held by eligible FIIs and the BIS. Importantly, the amendment has been made effective retrospectively from 1 April 2026, thereby applying to income earned during the current financial year.
| Pre-Ordinance vs. Post-Ordinance Position
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| Aspect |
Pre-Ordinance position |
Post-Ordinance position1 |
| Interest on Government securities
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20%*
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0% - Fully exempt from total income
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| STCG on Government securities (STCG) <12 months
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30%*
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0% - Fully exempt from total income
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| LTCG on Government securities (LTCG) >12 months
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12.5%*
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0% - Fully exempt from total income
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* Plus applicable surcharge and cess
The measure comes against a backdrop of high macroeconomic volatility, due to the West Asia conflict and increased strength in the US dollar, which have placed pressure on the Indian Rupee in 2026. The Rupee has fallen to a record low this year, depreciating by more than 6% year to date. Historically, such depreciation in emerging-market currencies has often eroded, or even entirely offset the nominal returns generated by global-fixed income investments.
The Ordinance would enhance post-tax yields for FIIs and BIS , helping mitigate the impact of currency fluctuations. This is significant given that the interest rate differential between India and many developed economies has narrowed in recent years. When combined with taxation and currency depreciation, the net risk-adjusted returns on Indian fixed income have become comparatively less attractive, contributing to portfolio reallocation by foreign investors. These capital outflows have, to some extent, contributed to pressure on India's balance of payments, resulting in a current account deficit. This Ordinance ensures that even if the Rupee encounters volatility, the post-tax USD-denominated returns remain insulated and highly competitive.
- 7.20% Gross Yield - Less 20% Tax: Net returns - 5.76%
- 7.20% Gross Yield - Less 0% Tax: Net returns - 7.20%
On account of the above, the post-tax returns would increase by ~1.5%, which may make India an attractive jurisdiction for foreign investments, and help strengthen the rupee.
Complementing the tax waiver, Reserve Bank of India (RBI) Governor Sanjay Malhotra announced some changes to India's cross-border investment routes to lower entry barriers by expanding access to long-term sovereign debt, dismantling operational limits, and creating immediate parity for global individual capital pools.
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