Government Makes G-Sec Returns Tax-Free for Foreign Investors: What It Means for India

On June 5, 2026, the Ministry of Law and Justice published the Income-Tax (Amendment) Ordinance, 2026 in the Gazette of India, amending the Income-tax Act, 2025. 

The ordinance does one specific thing: it grants complete tax exemption to Foreign Institutional Investors (FIIs) and the Bank for International Settlements (BIS) on all income earned from Indian Government Securities, both interest income and capital gains arising from their sale, transfer, redemption, or maturity. The exemption is effective retrospectively from April 1, 2026.

There is one compliance condition attached. The gazette specifies that "such exemption shall be subject to furnishing of information in such form and manner as may be prescribed." In plain terms, FIIs get the tax break but must report their G-Sec income to Indian tax authorities in a prescribed format. The exemption is not a blank cheque; it comes with a transparency requirement. 

The timing is not coincidental. The move comes on the same day the RBI held rates at 5.25% and just days after the government also expanded the Fully Accessible Route (FAR) to include all new issuances of 15-year, 30-year and 40-year G-Secs, making longer-duration bonds freely accessible to foreign investors. 

Together, these three moves form a coordinated policy package aimed at one objective: reverse the Rs 2.64 lakh crore of FPI outflows India has absorbed so far in 2026.

Before this ordinance, foreign investors in Indian government bonds faced one of the more friction-heavy tax regimes among major emerging markets. Here is what that looked like.

For context: FPIs registered with SEBI are treated as FIIs for this purpose, and they are eligible to invest in G-Secs through two routes: the General Route and the Fully Accessible Route (FAR). Transactions in government securities do not attract Securities Transaction Tax (STT), so the only friction that existed before this ordinance was the interest and capital gains tax. That friction is now gone.

For a pension fund or sovereign wealth fund deploying Rs 10,000 crore, the difference between 8.225% and 10% net yield is Rs 177.5 crore annually. That is not a rounding error. It is a decision-maker.

India's rupee has depreciated approximately 7% in 2026, making it one of the worst-performing emerging market currencies this year. 

The ordinance is partly a currency defence mechanism. Every time a foreign investor buys an Indian G-Sec, they must convert dollars into rupees. That conversion is a direct dollar sale in the forex market, which supports the rupee. If the exemption attracts even Rs 50,000-70,000 crore of net fresh FPI flows into G-Secs in FY27, the dollar inflow equivalent (approximately $6-8 billion) would be meaningful support for reserves and the exchange rate.

India's forex reserves stood at approximately Rs 696.99 billion for the week ending May 8, 2026, down from a peak of $728.5 billion. 

The Ministry of Finance was explicit about the objective: the tax relief aims to "ensure stable systematic inflow of durable, patient foreign capital and long-term investors such as pension funds, insurance companies, and Sovereign Wealth Funds."

Tax-free G-Sec returns for foreign investors could bring higher dollar inflows into India, deepen the bond market, lower borrowing costs for PSUs, support treasury gains for banks, and strengthen India's long-term economic growth prospects.

It is an ordinance promulgated by the Government of India on June 5, 2026 and published in the Gazette of India. It amends the Income-tax Act, 2025 to grant complete tax exemption to Foreign Institutional Investors (FIIs) and the Bank for International Settlements (BIS) on both interest income and capital gains earned from Indian Government Securities, effective April 1, 2026.

Three taxes have been eliminated: the 20% withholding tax on interest income from government securities, the 12.5% long-term capital gains tax on listed G-Secs held for more than 12 months, and the 30% tax on short-term capital gains. All income from G-Sec interest and capital gains is now fully exempt for eligible FIIs.

The Fully Accessible Route (FAR) is a channel through which Foreign Portfolio Investors (FPIs) can invest in designated Indian Government Securities without any investment limit. As of May 2026, FPIs hold Rs 3.24 lakh crore of FAR securities, representing only 6.8% of the total available limit. The government simultaneously expanded FAR to include all new 15-year, 30-year and 40-year G-Sec issuances.

When foreign investors buy Indian G-Secs, they convert dollars into rupees in the forex market, which directly supports the rupee. The exemption is a strategic move to attract dollar inflows at a time when the rupee has depreciated approximately 7% in 2026 and FPIs have pulled out a net Rs 2,63,784 crore from India year-to-date.

Direct beneficiaries include FIIs and BIS. Indirect beneficiaries include PSU bond issuers like PFC, REC, IRFC, and HUDCO (through lower borrowing costs as G-Sec yields compress), banks with large G-Sec portfolios (through treasury gains as bond prices rise), and the Government of India itself through reduced sovereign borrowing costs on new issuances.