India weighs tax cut to win back foreign investors as stock outflows hit records

India is weighing whether to scrap a tax on long-term capital gains for foreign portfolio investors as policymakers look for ways to halt record outflows from the country's equity markets. Reuters reported on Monday that India's capital markets regulator has urged the government to abolish the levy, and Finance Minister Nirmala Sitharaman acknowledged the exit of foreign capital the same day, saying she would consider calls to review the tax, according to local media reports.

The push comes as foreign appetite for Indian equities sinks to unprecedented levels. Foreign holdings of Indian stocks stand at an all-time low of 14%, Nomura said in a report on Monday, and overseas investors have cashed out a net $18.9 billion in 2025 and more than $30 billion so far this year. India was the world's third worst-performing market after Indonesia and Turkey between January and October, and its benchmark Nifty 50 has lost nearly 9% this year.

Pressure for a repeal has been building. The PHD Chamber of Commerce and Industry, one of India's oldest and most prominent industry bodies, last week appealed to the government to abolish the tax, arguing it was raised in 2024 when the stock market was "near record highs" and that conditions have since changed enough to warrant a review.

Market watchers agree that removing the levy would lift sentiment by putting India's tax regime on par with other emerging markets, but they caution that a tax cut alone is unlikely to bring foreign investors back in droves.

"A tax cut helps at the margin, but allocators tend to buy expected returns, not tax breaks," said Amit Bhartia, a portfolio manager at Singapore-based Delorean Partners. He noted that foreign investors put about 570 billion rupees ($6 billion) into Indian equities in September 2024, then pulled out 940 billion rupees a month later to chase cheaper Chinese stocks. "The tax rate didn't change between those two months. The perceived relative return did," he said. Until a record exit in March this year, the October 2024 outflows were the highest recorded in a single month.

Several risks are weighing on Indian markets right now, including strained ties with the United States, higher energy prices, a depreciating currency and uncertainty over the impact of artificial intelligence. Nomura said a capital gains tax cut, a drop in global bond yields and expectations that the rupee will hold up on central bank intervention would lend support, though it warned that geopolitical and technological uncertainty persists over the longer term, "weighing on long-term growth expectations."

Global brokerage Bernstein said in a report on Monday that India now has "to fight for capital in a competition it could once afford to take for granted," arguing that multiple catalysts, including a tax cut and an easing of tensions in the Middle East, are needed to reverse the outflows. "India's valuations remain expensive, while earnings growth has been disappointing," the report said.

Bernstein's data shows India trading at a rolling 12-month forward price-to-earnings ratio of 18.6 times, higher than Taiwan's 16.8 times and Korea's 3.9 times, two markets that have outperformed on the back of strong artificial intelligence names. On earnings, emerging markets on average are expected to deliver a 45% improvement, while India's forecast is a much slower 11%.

Hanna Luchnikava-Schorsch, head of Asia-Pacific economics at S&P Global Market Intelligence, told CNBC that a tax cut by itself will not "trigger a major reallocation into Indian equities as the fundamental trade-off facing foreign investors remains unchanged." India has a strong structural growth story, she said, but investors still need earnings growth to justify the valuation premium.

There are tentative signs of a turn. As cracks emerge in the global AI rally, LSEG data shows Indian benchmark indexes have outperformed global peers over the past month, with some investors treating the market as a hedge against artificial intelligence. Foreign capital flows at the start of this month have been positive, though whether they will sustain remains an open question.