India is the world’s fourth-largest economy by GDP and among the fastest-growing developing economies. Considering its performance over the past few years, the Indian economy has consistently attracted significant foreign investments from Foreign Portfolio Investors (FPIs) and Foreign Direct Investors (FDIs). FPIs, overseen by Sebi, predominantly engage in India’s listed markets across various sectors, while FDI remains the preferred avenue for long-term investments in unlisted sectors subject to sectoral caps.

Current foreign investment landscape in India

Despite the inflows from FPIs and FDIs, the net foreign investment landscape in India during the year has turned negative. Calendar Year 2025 closed at a net outflow of FPI proceeds of approximately USD 11,838 mn, lower than its preceding calendar year 2024, which closed at a net inflow of approximately USD 19,937mn. The calendar year 2023 had higher net inflows of approximately USD 28,703mn.

Notwithstanding the robust headline returns in Indian markets, the effective returns to foreign investors, once adjusted for applicable taxes and depreciation of the rupee via inflation, are materially lower than the returns on risk-free securities offered in foreign markets. Consequently, while capital appreciation in Indian markets contributes to fiscal revenues through applicable tax mechanisms, the subsequent repatriation of such gains by foreign investors exerts adverse pressures on domestic financial markets. It also impacts our currency, which has been struggling to keep its falling trend in recent times. The FDI inflows (equity) also show a similar trend in the range of USD 51bn to USD 53bn in Calendar Years 2021 to 2024.

Expectations from Budget 2026

Regulators and policy-makers have ensured that India maintains its preferred investment destination status not only in Asia but also on the global map. As the Indian economy matures, the next phase would be to retain the foreign investments from various sectors globally. While the US keeps playing its ‘Trump’ card of federal rates to attract foreign investors, the Indian policymakers can incentivise foreign investors with competitive tax rates on their investments in India. The Indian tax law provides for a separate tax regime to tax the FPIs investing in India. This regime can be strengthened by lowering the tax rates for long-term foreign investors.

The erstwhile tax provisions granted an exemption on long-term gains derived from listed equity instruments. However, the tax rates scaled up from discontinuing the exemption to taxing the long-term gains @ 12.50%, followed by surcharge and cess. To retain foreign capital within the Indian economy, Budget 2026 can consider lowering the existing tax rate of 12.50% for foreign investors if the gains are derived from their investments after two to three years.

As an additional safeguard, from a regulatory perspective, for incentivising the large and stable investors, this lower tax regime can be offered only to the Category I FPIs that comprise foreign banks and insurance companies, pension and sovereign funds, etc. The longer the tenure of investment, the lower the applicable tax rate on gains from such investments. Similarly, investments under the FDI route could be liable to tax at a lower tax rate if the investment is in specific sectors and the investment is exited after a specified period, say three to five years. This will provide stable capital to start-ups and business houses and strengthen our foreign currency reserves.

The tax rate on dividends, which were previously exempt from tax, is now 20%. Lowering the tax dividends will motivate the FPIs and FDIs to stay invested and can ensure steady inflows throughout their investment tenure.

Today, a large chunk of corporate bonds and government securities remains unutilised by the FPIs. While there are various reasons for the overall reduction in debt inflows, policymakers can make the Indian debt market more lucrative by making certain regulatory and fundamental changes. To begin with, Budget 2026 can provide tax incentives like bringing back the lower tax rates of 5% on the interest income earned by foreign investors, thereby opening the taps for steady, long-term debt inflows.

The upcoming Budget 2026 must take a step forward to stabilise and retain the erratic foreign inflows by providing a transparent and lower tax regime to the foreign investors. The domestic tax law should provide robust mechanisms and clarity to all foreign investors, such that the reliance on tax treaties is reduced, thereby providing a feeling of assurance to the foreign investors and ruling out the possibility of prolonged litigations for availing beneficial tax treatment under the tax treaties that India shares with various countries.

(The article is authored by Manoj Purohit, Partner, Financial Services Tax, Tax & Regulatory Advisory, BDO India. Assisted by CA Pranav Sakhadeo)