A cut in equity LTCG tax could ease foreign outflows and support the rupee, says Jefferies

Foreign portfolio investors have been consistent sellers of Indian equities for much of the past year, and the resulting capital-account strain has kept the rupee under pressure. Herein, Jefferies argues that a reduction in the long-term capital gains tax on equities could meaningfully improve foreign investor sentiment and help stabilise portfolio flows.

The brokerage noted the substantial equity-related exits by foreign portfolio investors, foreign promoters and private equity funds. These outflows have contributed to the weakness in India’s capital account, leaving the currency more vulnerable at a time when global interest-rate differentials and competing investment destinations already make Indian markets less compelling for overseas capital.

Jefferies has identified three possible routes the government could take.

The first is an across-the-board cut in both long-term and short-term capital gains rates that would apply to all investors.

The second is a more targeted reduction specifically for foreign portfolio investors.

The third is a technical change that would allow FPIs to compute their capital gains in US dollar terms, effectively introducing an element of indexation against currency movement.

Any of these measures, the firm believes, would lower the effective tax friction that currently sits alongside high transaction costs and make Indian equities relatively more attractive.

Discussions around tax rationalisation have gathered pace in recent weeks, and the Securities and Exchange Board of India has itself recommended relief on long-term capital gains for foreign investors. While no decision has been announced, the fact that the issue is under active consideration has already begun to shape market expectations.

Jefferies suggests that a meaningful improvement in foreign flows would likely benefit large-cap stocks first, with financials among the more obvious candidates. Banks, in particular, tend to be preferred vehicles for foreign capital when sentiment turns. A sustained return of portfolio money would also ease one of the key external pressures on the rupee, though the brokerage is careful to note that tax changes alone cannot offset broader global factors such as US yields or relative growth differentials.

Among the policy levers available to improve the attractiveness of Indian equities to foreign capital, a recalibration of the capital gains tax regime ranks high. Whether the government chooses a broad cut, a targeted FPI measure, or a currency-linked computation, the brokerage sees scope for the move to support both flows and the currency at a time when both remain under strain.