Tax Exemptions, Expanded Market Access and Global Index Ambitions Highlight New Phase of India's Bond Market Reforms

India has unveiled a fresh set of measures aimed at attracting foreign investors to its government securities (G-Sec) market, signalling a strategic shift in the country's efforts to deepen its debt markets and strengthen integration with global capital flows.

The government recently removed withholding tax on interest income and exempted foreign portfolio investors (FPIs) from capital gains tax on eligible government securities. Simultaneously, authorities expanded the list of securities available under the Fully Accessible Route (FAR), allowing overseas investors easier access to Indian sovereign debt.

The reforms come at a time when India's bond market is already among the largest in the emerging world. Yet policymakers believe that increasing foreign participation can bring benefits that extend well beyond funding government borrowing.

A ₹123.5 Trillion Market Still Dominated by Domestic Investors

India's government securities market has expanded rapidly over the past decade and currently stands at approximately ₹123.5 trillion, according to Reserve Bank of India (RBI) data.

Despite the market's size, ownership remains heavily concentrated among domestic institutions. Commercial banks are the largest holders of government securities, accounting for more than one-third of the market. Insurance companies hold another significant share, while the RBI itself owns a sizeable portion through its monetary operations.

Combined, these institutions control nearly three-fourths of all outstanding government securities. In contrast, foreign portfolio investors account for less than 3 per cent of the market, highlighting the limited role international capital currently plays in India's sovereign debt ecosystem.

This ownership structure has helped India maintain stability during periods of global financial turbulence. However, policymakers increasingly believe that a broader and more diversified investor base can further strengthen the market.

Why the Government Wants More Foreign Investors

At first glance, attracting foreign investors may appear unnecessary. India's borrowing programme has traditionally been well supported by domestic banks, insurance firms, provident funds and pension funds.

However, experts argue that the objective is not simply to raise money but to improve the overall quality and efficiency of the bond market.

Government bond yields serve as the benchmark for pricing almost every financial asset in the economy, from corporate bonds and infrastructure financing to home loans and business credit. A deeper and more liquid bond market leads to more efficient pricing and a stronger benchmark yield curve.

Foreign investors bring different investment strategies, risk models and trading behaviour, which can enhance market depth and improve price discovery. Their participation also increases trading activity in secondary markets, helping create a more dynamic and resilient financial system.

Tax Reforms Remove a Major Roadblock

One of the biggest barriers preventing foreign investors from increasing exposure to Indian bonds has been taxation.

Until recently, overseas investors faced a withholding tax on interest income earned from government securities. They were also subject to taxes on capital gains, reducing the overall attractiveness of Indian debt compared with competing markets.

For fixed-income investors, where returns are generally lower than equities, taxation can significantly affect investment decisions.

The government's decision to eliminate these taxes effectively increases the net yield available to foreign investors and aligns India more closely with global bond market practices.

Market participants believe the move addresses one of the most frequently cited concerns among global investors and could substantially improve India's attractiveness as a debt-market destination.

Global Bond Index Inclusion Remains a Key Objective

India's policy reforms are closely linked to its ambition of securing a larger presence in major global bond indices.

The country achieved a significant milestone in 2024 when Indian government bonds were included in the JPMorgan Government Bond Index-Emerging Markets. This was followed by inclusion in the FTSE Russell Emerging Markets Government Bond Index.

Attention has now shifted to potential inclusion in Bloomberg's Global Aggregate Index, one of the world's most influential fixed-income benchmarks.

Market estimates suggest that inclusion in Bloomberg's flagship index could attract approximately $20 billion to $25 billion of additional foreign capital into Indian government bonds over time.

Such inflows would not transform India's massive debt market overnight, but they could provide a meaningful boost to liquidity and investor participation.

Early Signs Show Foreign Investors Are Responding

Recent market data indicates that foreign investors have welcomed the government's latest reforms.

Holdings of government securities under the Fully Accessible Route have risen noticeably following the announcement of tax exemptions and expanded market access measures.

The increase suggests that investors are beginning to reassess the attractiveness of Indian bonds, particularly as the country offers relatively high real yields compared with many developed markets.

Analysts believe further inflows could materialise if global investors become more confident about India's policy stability and market accessibility.

Currency Risk Remains the Biggest Challenge

Despite the reforms, significant hurdles remain.

The most important concern for foreign investors continues to be currency risk. While Indian government bonds offer attractive yields, returns ultimately need to be converted back into dollars, euros or other foreign currencies.

Any depreciation in the rupee can substantially reduce investment gains.

This challenge has become more pronounced amid periods of volatility in global currency markets. Even a high-yielding bond can generate disappointing returns for foreign investors if exchange-rate movements move against them.

As a result, many overseas investors continue to evaluate Indian bonds not only on the basis of yield but also on expectations for currency stability.

Market Infrastructure Still Under Scrutiny

Beyond taxation and currency concerns, operational issues have also influenced investor decisions.

Global index providers have previously highlighted settlement procedures, registration requirements, post-trade processes and market infrastructure as areas requiring further development.

While India has made considerable progress in modernising its financial markets, policymakers recognise that continued reforms are necessary to meet international standards and facilitate smoother participation by global investors.

The latest measures represent another step in that direction.

How Much Foreign Ownership Is Ideal?

Experts generally agree that India does not need foreign investors to dominate its government bond market.

The country's large domestic savings pool remains a key strength and provides a stable funding base for government borrowing requirements.

Instead, policymakers appear focused on achieving a balanced ownership structure that combines domestic stability with international participation.

Many market observers believe foreign ownership in the range of 8 to 15 per cent over the next decade would provide meaningful benefits without exposing the market to excessive volatility from global capital flows.

The Bottom Line

India's latest tax exemptions and market-access reforms represent more than a simple effort to attract foreign money. They are part of a broader strategy to transform the country's bond market into a deeper, more liquid and globally integrated financial ecosystem.

While domestic institutions will continue to dominate government bond ownership, greater participation from foreign investors can improve liquidity, strengthen price discovery and support India's ambitions of becoming a larger player in global debt markets.

As the country pursues inclusion in major international bond indices and continues to modernise its market infrastructure, the latest reforms could mark an important turning point in the evolution of India's sovereign debt market.