The Centre is considering a major overhaul of tax rules to attract more foreign investment into India's bond market. The move comes at a time when the rupee remains under pressure and foreign investors continue to withdraw money from domestic equities, according to a report by The Economic Times.

The government is working on a package of measures aimed at making Indian government bonds more attractive to Foreign Portfolio Investors (FPIs). Among the key proposals being discussed are the removal of capital gains tax on investments in government securities and the relaxation of ownership restrictions on selected sovereign bonds.

The proposed changes come as India faces record foreign outflows from the equity market, a weakening rupee and rising crude oil prices linked to the prolonged Iran conflict. Policymakers believe that encouraging greater foreign participation in the bond market could help ease some of these pressures.

Foreign investors have remained net buyers of Indian government bonds this year, investing around $1.4 billion in sovereign debt. However, they have pulled nearly $28 billion from Indian equities. The sharp outflow from stocks has increased pressure on financial markets and added to concerns over the rupee's performance.

The Indian currency recently touched a record low of 96.9650 against the US dollar before recovering slightly. Authorities are now exploring ways to attract fresh capital inflows and limit further weakness in the rupee.

Several factors have contributed to the rupee's decline this year. Rising oil import costs, sustained foreign investor withdrawals and uncertainty in global trade have all weighed on the currency. According to the report, the rupee has fallen more than 6% against the US dollar this year, making it one of Asia's weakest-performing currencies.

To improve the appeal of government bonds for overseas investors, the government is considering significant tax relief. Reuters, citing an Economic Times report, said that the Union Cabinet approved a proposal on Wednesday to eliminate capital gains tax on foreign portfolio investments in government bonds.

At present, foreign investors are required to pay a 12.5% long-term capital gains tax on listed shares and bonds held for more than 12 months. Removing this tax would increase the returns investors can earn from Indian government securities.

In addition to this, officials are examining the possibility of removing or sharply reducing the 20% withholding tax imposed on interest income earned from government securities. People familiar with the discussions said the proposal is being actively considered as part of a broader effort to attract foreign capital.

The government is expected to implement the changes through an ordinance that would amend relevant provisions of the Income Tax Act. If approved, the measures would significantly improve post-tax returns for foreign investors and strengthen the attractiveness of Indian debt instruments.

The Reserve Bank of India may also take additional steps to support the effort. According to the report, the central bank is considering including more long-term government securities under the Fully Accessible Route (FAR). This framework allows foreign investors to buy eligible government bonds without being subject to investment limits.

The RBI last revised the list of securities eligible under the FAR framework in 2024. Expanding the list further would provide foreign investors with greater access to India's sovereign debt market and could help deepen market participation.

Market experts believe the proposed reforms could help India attract a larger share of global fixed-income investments. Increased foreign participation in government bonds would generate additional foreign exchange inflows and provide support to the rupee.

Higher inflows into debt markets could also reduce pressure on India's external accounts at a time when the country is dealing with elevated energy prices and persistent foreign selling in equities. Stronger demand for government securities may further strengthen confidence in India's financial markets.

The proposed measures could also improve India's competitiveness against other emerging markets. Lower taxes and easier market access would make Indian government bonds more appealing to global investors seeking stable returns.

The report further stated that the government is likely to notify plans allowing Persons Resident Outside India (PROIs) to invest in shares of listed Indian companies through the portfolio investment scheme. Such a move would expand investment opportunities for overseas investors and could help improve overall capital inflows into the country.

Neither the Finance Ministry nor the Reserve Bank of India has officially commented on the proposals so far. However, investors are expected to closely monitor any formal announcements in the coming days.

If implemented, the proposed reforms would represent one of the government's most significant efforts in recent years to draw foreign capital into India's bond market. The measures are also expected to provide additional support to the rupee while helping strengthen the country's financial position amid ongoing global economic challenges.