The Union Government and the Reserve Bank of India have introduced structural reforms to increase foreign institutional participation in Government Securities. Measures include retrospective tax exemptions for FPIs on G‑Sec interest and capital gains, expansion of the Fully Accessible Route, and simplification of the General Route to deepen the sovereign debt market and reduce borrowing costs.
What is current
The Income-tax (Amendment) Ordinance, 2026 grants full exemption from income tax on interest and capital gains for Foreign Portfolio Investors (FPIs) in government securities, effective retrospectively from 1 April 2026. The RBI has widened the Fully Accessible Route (FAR) to include long-tenor papers and sovereign green bonds. The General Route has been rationalised by removing micro-prudential caps while retaining aggregate macro ceilings.
Why it matters
Higher foreign participation can deepen the yield curve, lower sovereign borrowing costs, and attract long-term institutional capital such as pension funds and sovereign wealth funds. Policy changes affect balance of payments, rupee stability, domestic credit pricing and the financing of long-gestation infrastructure through bond markets.
Overhaul of the G‑Sec taxation regime
Tax treatment: FPIs in G‑Secs
| Income stream | Historic tax framework | Revised tax framework (post‑1 April 2026) |
| Interest income | 20% (plus applicable surcharge and 4% cess) | 0% (fully exempt) |
| Short‑term capital gains (STCG) | 30% (plus applicable surcharge and 4% cess) | 0% (fully exempt) |
| Long‑term capital gains (LTCG) | 12.5% (plus applicable surcharge and 4% cess) | 0% (fully exempt) |
Key caveats
- Asymmetry on capital losses: Capital losses from G‑Sec trades cannot be used or carried forward to offset other taxable incomes because gains are exempt.
- Corporate bond exclusion: Exemption applies only to sovereign instruments under Section 2(f) of the Government Securities Act, 2006; corporate bond income remains taxable.
- Extension to BIS: Identical tax treatment has been extended to the Bank for International Settlements to encourage reserve managers to invest in Indian sovereign debt.
Expansion of the Fully Accessible Route (FAR)
- Long‑tenor papers: FAR now covers all new issuances of 15‑year, 30‑year and 40‑year government bonds, enabling foreign investors to access long‑dated benchmarks.
- Sovereign Green Bonds (SGrBs): New issuances of SGrBs within FAR‑eligible tenors are accessible without volume restrictions to foreign investors, supporting market financing of sustainable public projects.
Rationalisation of the General Route
- Abolition of internal restrictions: Short‑term ceilings, concentration limits and security‑wise caps under the General Route have been removed.
- Category consolidation: Administrative sub‑categories for debt FPIs merged into a single slot to reduce operational complexity.
- Retention of macro ceilings: Aggregate limits remain at 6% of total outstanding Central Government Securities and 2% of State Government Securities to protect macro‑financial stability.
- VRR integration: Voluntary Retention Route limits have been subsumed into general investment limits to simplify portfolio accounting for foreign funds.
Macroeconomic impact analysis
Inflow stabilisation and currency protection
Long‑term institutional bond inflows are less prone to abrupt withdrawals than equity flows. Increased FPI presence provides a buffer in balance of payments and can ease episodes of rupee pressure during global risk aversion, provided inflows are broadly diversified across investor types and tenors.
Yield‑curve refinement and borrowing costs
Demand for 30‑year and 40‑year securities improves price discovery at long maturities. A smoother, liquid yield curve reduces term premia for corporate borrowers and the government, lowering average borrowing costs and enabling better pricing for infrastructure finance.
Index inclusion and passive flows
Reforms exploit India’s inclusion in major emerging‑market bond indices. Passive portfolio flows tied to indices will enter through FAR and General Route, raising base demand for local currency sovereign paper and improving secondary market liquidity.
Constitutional and governance aspects
The Income‑tax (Amendment) Ordinance, 2026 was promulgated under Article 123 when Parliament was not in session. Merits of ordinance use include speed and immediate market effect. Risks include reduced parliamentary scrutiny and the need for subsequent legislative approval within six weeks of reassembly to sustain the changes.
Constraints and implementation risks
- Loss asymmetry: Inability to offset capital losses may deter active trading strategies and limit participation by managers seeking tax‑efficient arbitrage.
- Partial market integration: Exemption limited to sovereign paper leaves corporate bond markets outside the preferential regime, slowing full fixed‑income market integration.
- Concentration and crowding: Large foreign holdings in specific maturities could raise rollover and liquidity risks if investor behaviour shifts rapidly.
- Operational issues: Clearing, settlement, custody arrangements and access to primary auctions require monitoring to ensure foreign inflows translate into durable market liquidity.
Practical indicators for policy monitoring
- FPI holding profile: As of mid‑May 2026 FPIs held about ₹3.75 lakh crore in G‑Secs, roughly 3.34% of a public debt stock of ₹112.42 lakh crore; FAR accounts for over 85% of foreign debt allocations.
- Yield and issuance metrics: Changes in yields across 10‑, 20‑ and 30‑year benchmarks, auction cut‑offs and bid‑to‑cover ratios indicate foreign demand strength.
- External sector indicators: Capital account flows, reserve accumulation and exchange rate volatility measure balance‑of‑payments impact.
- Banking and corporate spreads: Narrowing of corporate bond spreads and bank term lending rates will show transmission to domestic borrowing costs.
Model Questions
- Discuss the recent structural reforms aimed at enhancing Foreign Portfolio Investment (FPI) in Government Securities and analyse their expected macroeconomic impact on capital inflows and currency stability. [GS-III: Economic Development]
- Examine the constitutional provision used to enact the Income‑tax (Amendment) Ordinance, 2026 and critically evaluate merits and demerits of using ordinances for major economic policy changes. [GS-II: Constitution of India & Polity]
- Elaborate on the evolution and recent expansion of the Fully Accessible Route (FAR) and the rationalisation of the General Route for FPIs. How do these measures deepen the domestic G‑Sec market and aid global integration? [GS-III: Economic Development]
- Identify the remaining caveats and exclusions in the FPI G‑Sec reforms and discuss their implications for achieving full integration of Indian capital markets into global fixed‑income workflows. [GS-III: Economic Development]
Describe tax exemptions for FPIs in G‑Secs and RBI’s FAR expansion to long tenors and sovereign green bonds; outline General Route rationalisation and retained macro ceilings. Analyse how steady, long‑dated institutional inflows can stabilise capital flows, reduce rupee pressure during shocks, deepen the yield curve, lower government borrowing costs and affect balance‑of‑payments dynamics.
State Article 123 as the basis for presidential ordinance when Parliament is not in session. List merits: urgency, immediate market effect and administrative convenience. List demerits: limited parliamentary scrutiny, temporary validity needing subsequent approval, risk to democratic oversight and potential legal challenges. Apply these points to the G‑Sec reform context and note requirement for later legislative ratification.
Trace FAR’s origin and note its widening to include 15‑, 30‑ and 40‑year papers plus sovereign green bonds. Explain removal of micro‑prudential caps, category consolidation and VRR integration under the General Route. Connect these steps to increased long‑tenor liquidity, benchmark price discovery, easier index‑driven inflows and alignment with global fixed‑income investment practices.
List major caveats: inability to offset capital losses, exclusion of corporate bonds from tax exemption, retention of aggregate ceilings and operational settlement issues. Discuss implications: reduced trading flexibility, slower corporate bond integration, potential concentration risks and the need for complementary reforms in market infrastructure and regulation to complete global integration.