The Need to Revise Taxation Rules for Foreign Institutional Investors (FIIs) in India
The Indian stock markets have been experiencing volatility for the past two months. The benchmark Nifty 50 index has declined by 15.4% from its highest level in September 2024. According to market experts, the primary reason for this decline is the withdrawal of funds by FIIs. Most investors’ portfolios are in the red at the moment.
FIIs play a crucial role in maintaining liquidity in the stock market. When FIIs withdraw funds from any market, it creates volatility and exerts pressure on stock prices. To curb this relentless decline in the market, the Indian government should review the tax regulations imposed on foreign investors and provide some relaxation.
Recent Tax Changes for FIIs
The main culprit behind FIIs’ withdrawal is unfavouring Taxation Policies. Various complex taxes are imposed on the different types of income earned by FIIs in the current tax regime. For example, long-term capital gain from securities is taxed at different rates which depends on Securities Transaction Tax (STT) is applicable or not. In the Union Budget 2025 government changed the tax structure for FIIs and introduced a uniform rate of 12.5% for certain securities which take effect from 1 April 2026. However, this is not attractive enough to retain FIIs as compared to other global markets.
What can the policymakers do?
Attractive Tax Rates: To make India more attractive for investment, government should consider reducing LTCG tax rates and make them more competitive to international standards. It needs not be a dramatic cut, taxes from the earlier levels would be very helpful.
Simplified Tax Structure: There are so many compliances that shift the mood of FIIs. India needs to consolidate and streamline various taxes & Exemptions for FIIs so that they can comply and navigate with Indian tax laws.
Exemptions for Specific Investments: There must be targeted tax exemptions for investment in focused sectors such as renewable energy, technology etc. so that FIIs can incentivize on these areas.
Exchange Rates – Diminishing returns for FIIs
Exchange rates are also a major factor that significantly affects FIIs’ investments in India. A favourable exchange rate environment is needed to attract foreign capital. When the Indian National Rupee slumps against global currencies, it erodes returns of FIIs. It makes investment less attractive. We all know that the Rupee is trading around the highest levels against the USD.
Impact of Exchange Rates on FIIs
Risk of Depreciation: Depreciation of rupee increases the cost of imports that potentially affects profitability of any company thus impacts attractiveness of the stocks to FIIs. This leads FIIs to divest their investment.
Appreciation Benefits: On the other side of the coin, strong currency can increase foreign investment by increasing purchasing power of FIIs. However, this will also lead to higher imports and lower exports, affecting India’s trade balance.
Suggested Exchange Rate Strategies
Adjustment in Monetary Policy: The Reserve Bank of India (RBI) can help by altering the interest rates and foreign exchange interventions to stabilize rupee and create a predictable environment for FIIs.
Diversification of Investments: Government should encourage FIIs to invest in sectors that are less sensitive to exchange rates. Infrastructure and domestic consumption industries can be helpful to mitigate the risk associated with volatility in currency.
Conclusion
To stop the bloodbath in the Indian stock market, the government needs to address taxation and exchange rate challenges. When we implement competitive tax reforms and stabilize the exchange rates, we can create a more favourable investment environment. This will not only boost market liquidity but also support long-term economic growth.
The government should analyze Singapore as a case point, they established a well-grown market despite being a small country. Singapore offers a competitive tax environment by reducing certain types of taxes on investments. These efforts led Singapore to be an attractive destination for FIIs. India should analyze Singapore model to create a more healthy tax structure for FIIs.
In the past, the RBI has intervened in the foreign exchange market to stabilize the Rupee during high volatility. Such measures can reassure FIIs to invest in India.
In conclusion, a healthy and attractive tax and exchange rate environment can ensure FIIs that India is the best market for investing. These correction measures enhance India’s position as a global investment hub and it can create a more favorable environment for FIIs.
Written By : Anil Sharma
IPO Central
