India's recent policy package to exempt non-resident investors from taxes on government bonds and to broaden foreign access to domestic debt is already reshaping investor behaviour and could improve the country's candidacy for inclusion in global bond benchmarks.
Announced on Friday, the set of measures was designed to draw foreign capital while supporting the rupee and external balances, which policymakers said had been strained by higher oil prices. Officials removed withholding and capital gains taxes on foreign investments in government securities, expanded the list of bonds available to overseas investors without investment limits, and introduced incentives aimed at encouraging banks to attract foreign currency deposits from non-resident Indians and at making it easier for companies to issue debt overseas.
Market reaction was swift. In the three trading sessions following the announcement, overseas investors bought more than $1 billion of Indian government debt. For perspective, in the year-to-date period before these moves, foreign purchases of government bonds totaled $1.6 billion. Yields fell across the curve, dropping between 10 and 30 basis points, with the steepest declines observed at shorter maturities.
Asset managers and portfolio specialists said the tax changes improve the relative appeal of Indian government securities and could expand foreign participation along the yield curve. "We believe that these changes are a game-changer for debt flows," said Jennifer Taylor, head of emerging market debt and systematic fixed income at State Street Investment Management, which manages about $5.6 trillion of assets.
Some market participants suggested the implications extend beyond near-term flows. By reducing tax frictions and increasing access, the reforms are viewed as strengthening India’s bid for inclusion in major global benchmarks, a step that would likely generate more sustained and predictable capital inflows. Niel Clement, portfolio manager for emerging market fixed income at BNP Paribas Asset Management, which manages more than €1.6 trillion in assets, said the measures would broaden opportunities for overseas investors, redirect flows to the onshore market and provide a constructive boost to India’s case for inclusion in the Bloomberg Global Aggregate Index.
Bloomberg Index Services is expected to seek investor feedback later this month on whether Indian government bonds should be added to its flagship global bond index. M&G Investments, which manages about £376 billion of assets, noted that the tax exemptions have increased the near-term attractiveness of Indian government securities but added that actual inclusion in the Bloomberg index would be a larger catalyst for inflows, similar to the effects seen when India entered JPMorgan's emerging market debt index.
Officials engaged in discussions in the weeks prior to the tax changes, with the finance minister meeting central bank officials to press the case for index entry, according to a government official. Market strategists interpreted the coordinated moves as signaling a renewed policy emphasis on stabilising capital account pressures.
Investors and asset managers described the measures as restoring policy levers to address capital-account strains. "We view the measures announced aimed at addressing pressures on the capital account as having effectively restored policy control," said Low Guan Yi, head of Asia fixed income at M&G Investments. He added that with steps taken to support macroeconomic stability, India could stand out from other emerging bond markets that have less policy flexibility.
UBS Asset Management, which currently holds a neutral to underweight stance on Indian fixed income, said the Reserve Bank of India’s actions signalled a constructive approach to broadening market access and would encourage more foreign inflows over time. "India is an important part of EM local index so we are always reviewing it as an investment option," said Shamaila Khan, head of fixed income emerging markets and Asia-Pacific at UBS Asset Management.
Yet, investors stressed that currency dynamics will remain central to allocation decisions. The rupee's direction was identified as the primary concern for offshore buyers. "The bigger issue for offshore investors is still the currency," said Rong Ren Goh, head of macro and thematics for Asian fixed income at Eastspring Investments, which manages about $250 billion. He noted that investors are likely to wait for clearer signs of rupee stability before materially increasing allocations.
The rupee has depreciated 5.86% so far this year, ranking among Asia’s weakest performers, and was last reported at 95.16 per dollar. The recent slide has weakened the carry advantage of Indian debt, and rising energy prices have amplified pressures on the currency and on inflation expectations.
Some forecasters revised balance-of-payments outlooks in light of the policy adjustments. Economists at Citi sharply revised their forecast for India’s external position for the current fiscal year, projecting a $5 billion surplus compared with an earlier projection of a $60 billion deficit. That revision was cited by some market participants as a factor that should underpin the rupee in coming months.
Nonetheless, other investors warned that the broader fixed-income backdrop is still challenged by heightened global interest-rate volatility and by inflationary pressures linked to energy and food prices. "The broader investment backdrop for bonds remains challenging, given the pickup in interest-rate volatility across many markets and the shift from monetary easing to tightening in response to inflationary pressures from energy and food prices," said Low of M&G Investments.
For now, the policy package appears to have delivered both immediate market relief and a potentially important structural change to how foreign investors access and are taxed on Indian government debt. Whether those effects translate into durable, large-scale inflows will depend on the evolution of the rupee, the path of global rate volatility, and the outcomes of index-provider consultations later this month.
Additional analytical note: The measures explicitly remove withholding and capital gains taxes on foreign holdings of government bonds, expand the pool of securities available without limits, and include incentives to attract foreign currency deposits from non-resident Indians and to facilitate corporate overseas borrowing. These steps were taken in the context of pressures from higher oil prices and a desire to stabilise external balances.