India Considers Tax Relief Measures to Attract Foreign Capital

Following the recent increase in customs duty on gold imports, the Government of India and the Reserve Bank of India are evaluating a range of policy measures aimed at attracting greater foreign capital inflows. Among the options under consideration is a reduction in the withholding tax levied on interest earned by overseas investors on Indian government securities, with some discussions even exploring the possibility of removing the tax entirely.

Withholding tax, similar to tax deducted at source (TDS), is imposed on the interest income that non-resident investors receive from their investments in Indian bonds. Currently, foreign investors are subject to a tax rate of around 20% on such income, following the expiry of a concessional 5% rate in 2023. This makes India’s withholding tax burden relatively high compared with many other markets.

Over the past several weeks, policymakers have been deliberating on these proposals as part of a broader strategy to safeguard India’s foreign exchange reserves and maintain stability in the external sector amid heightened geopolitical tensions in West Asia.

Prime Minister Narendra Modi has also urged citizens to reduce discretionary foreign exchange outflows by limiting gold purchases, using public transport and carpooling to save fuel, and avoiding unnecessary overseas travel and destination weddings abroad.

According to sources, there has been considerable debate within policymaking circles regarding the likely effectiveness of these measures. Some officials have questioned whether a tax cut alone would be sufficient to attract meaningful inflows, especially in a global environment marked by elevated US interest rates and continued macroeconomic uncertainty.

Officials also examined the possibility of launching a special foreign currency deposit scheme similar to the Foreign Currency Non-Resident (Bank) [FCNR(B)] swap window introduced in 2013 during the rupee volatility caused by the US Federal Reserve’s “taper tantrum.” That initiative helped Indian banks mobilize approximately $26 billion in deposits and significantly strengthened the country’s forex reserves. However, sources indicate that the proposal for a similar scheme was ultimately set aside.

While eliminating withholding tax on government bonds remains under active consideration, policymakers are cautious about whether such a move would generate substantial incremental investment. In the meantime, the government appears focused on a broader approach centered on fiscal restraint and measures to conserve foreign exchange, including higher duties on gold and other precious metals.