Potential Equity LTCG Tax Reduction Could Improve Foreign Inflows and Support Rupee, Says Jefferies Report

A potential reduction in India's equity long-term capital gains (LTCG) tax could improve foreign portfolio investor (FPI) sentiment, support the rupee, and benefit large-cap stocks, particularly in the financial sector, according to a recent report by brokerage firm Jefferies.

The report highlighted that discussions around a possible tax cut have gained momentum, although no formal decision has been announced by authorities. Capital-account weakness has put pressure on the rupee, driven by equity-market-related exits totaling $110 billion from FPIs, foreign promoters, and foreign private equity investors since April 2025.

An analysis of 70 large emerging-market funds managing $380 billion indicated that India was underweight by 0.3 percentage points, compared to a 10-year average overweight position of 2.2 percentage points. This indicates relatively light foreign investor positioning in the market.

A recovery in foreign capital flows could benefit sectors that have experienced substantial selling pressure. Financials recorded net FPI outflows of $16 billion between October 2024 and September 2026, followed by information technology and consumer staples at $10 billion each. Within these oversold sectors, the report noted that banks remain a key preference, alongside energy, utilities, and real estate.

Jefferies expressed a preference for large-caps over mid-caps, noting that large-caps trade at a 23 per cent valuation discount to mid-caps, compared to a 10-year average discount of 20 per cent, while the earnings-growth gap is expected to narrow.

Potential policy options being discussed include an across-the-board reduction in long-term and short-term capital gains taxes, an FPI-specific LTCG cut, or calculating foreign investors' gains in US dollar terms.

However, revenue considerations could influence any official decision. Equity LTCG tax and securities transaction tax (STT) combined accounted for 8 per cent of direct taxes and 5 per cent of gross tax revenue in FY25. Given fiscal pressures, the government may need to weigh potential revenue losses from any tax reduction.

India's equity taxation framework has undergone several modifications over the years. In 2004, LTCG tax on qualifying listed equity transactions was abolished, STT was introduced, and short-term capital gains tax was set at 10 per cent before rising to 15 per cent in 2008. In 2018, LTCG tax was reintroduced at 10 per cent on qualifying annual gains exceeding ₹1 lakh alongside STT. In July 2024, the LTCG rate was increased to 12.5 per cent, the short-term rate to 20 per cent, and the annual LTCG exemption threshold was raised to ₹1.25 lakh.

"A potential adjustment in capital gains tax can significantly alter foreign portfolio flows and shore up currency stability. However, policymakers face a delicate balancing act between attracting foreign institutional investment and managing fiscal revenue needs, especially given the contribution of direct taxes and securities transaction taxes to government revenues. Investors should closely monitor fiscal policy developments alongside sector valuations." — Dr. Shishir Gupta, Founder & CEO, StartupLanes