The conventional cure for a falling currency is painful but familiar: raise interest rates, make the currency more expensive to short, and wait for capital to flow back in. India has decided it doesn't want to take that medicine right now. Instead, it's trying something more ambitious — and considerably riskier.
The Problem Piling Up on India's External Accounts
Since the start of 2026, foreign investors have been steadily pulling money out of Indian securities. FPIs have sold Indian equities worth $27.6 billion — more than the entire outflow recorded in all of 2025 — and this relentless exit, combined with elevated global oil prices, has put the rupee among Asia's worst-performing currencies.
The structural picture is no prettier. Net FDI flows, which used to contribute around $40 billion annually, have slipped to essentially zero on a rolling basis. That combination — a wider current account deficit and a vanishing cushion from direct investment — is precisely why India's external accounts look unbalanced heading into FY27.
Policymakers are staring at a projected $40–50 billion balance-of-payments gap for FY27. Raising rates to close it would slow a growth engine that's already running below earlier forecasts. So the government and the RBI have chosen a different lever entirely.
The Seduction Strategy
The government scrapped taxes on foreign investor earnings from government securities, while the RBI expanded bond market access, eased investment caps, and offered incentives for foreign currency deposits.
The specifics matter. From April 1, 2026, FPIs will no longer pay tax on interest income or capital gains earned from government securities — the exemption covers both short-term and long-term gains. Previously, foreign investors faced a 12.5% long-term capital gains tax on listed bonds held for over 12 months and a 20% withholding tax on interest earned from government bonds.
On the market-access front, the RBI brought all new 15-year, 30-year and 40-year sovereign bond issuances under the Fully Accessible Route — a move aimed at attracting overseas capital into India's debt market amid pressure on the rupee. The RBI also scrapped several sub-limits that previously governed FPI investments through the general route, including restrictions linked to short-term holdings, concentration levels, and exposure to individual securities.
The initial market signal was encouraging: the rupee gained about 50 paise against the dollar after the announcements, reflecting improved investor sentiment.
Why This Isn't a Sure Thing
The appeal of this approach is obvious: attract patient, yield-seeking capital without choking domestic growth. But the risk is equally clear.
The extent of currency stability will also hinge on developments in global oil prices, interest rates, and geopolitical conditions — forces India cannot control by rewriting its tax code. And while debt flows can help bridge the current account deficit and reduce pressure on the rupee, analysts note this works only if the capital account pressure from weak equity FPI flows and FDI outflows doesn't deepen further.
RBI Governor Sanjay Malhotra said these measures, along with trade deals India has entered into, will allow for a "much better balance of payments this year" than would otherwise have been possible. That's a reasonable bet — but it's still a bet. India is wagering that foreign capital responds more to carrots than to rate hikes. The rupee's next move will be the verdict.
Sources
- India scraps tax on overseas bond investors in bid to attract foreign capital and shore up the rupee
- Why the Rupee Crossed 90: India’s Balance-of-Payments Story | Wright Blogs
- India rolls out tax breaks, RBI steps to woo foreign capital
- Are Tax Tweaks Enough to Stem the Foreign Investment Outflows? – Outlook Business
- RBI Opens Long-Term Government Bonds To Foreign Investors, Announces Additional Inflow Measures | 5paisa