India’s capital gains tax regime is a significant constraint driving the exclusion of Indian government bonds (IGBs) from global bond indexes, according to a report by S&P Global titled Unlocking India’s Capital Market Potential.
At a time when the international norm is to waive withholding tax on payment on sale, India’s taxation norms that levy capital gains tax on profits made on government bonds is proving to be a major hurdle in listing its securities in global bond indexes, the report published on August 3 said.What the report by S&P Global has termed as a “major constraint” has been a bone of contention between India and index providers — the tax treatment for gains made by foreign investors from the sale of Indian government bonds once they have been listed on the indices.
India has been reportedly opposed to providing any favourable tax terms as waiving capital gains on foreign investors would put domestic investors at a disadvantage. This has led to the proposal not taking off so far.
But in July, a report by Reserve Bank of India (RBI) staff articulating that gains from adding IGBs to global indices are greater than the risks generated speculation about potential headway on the proposal even as media reports said the government is sticking to its stance of not offering tax concessions.
The RBI's interdepartmental group on internationalisation of the rupee, headed by executive director Radha Shyam Ratho, in a report released on July 5 recommended that the RBI "may step up measures to engage with index providers for the inclusion of IGBs in global bond indices".
S&P Global’s take on the inclusion of IGBs in global indexes comes close on the heels of this report by the RBI staff.
The report by the data, research and analytics firm further said that foreign funds that allocate local currency investments based on major global bond index ratings lack incentives to invest in Indian government debt.
JPMorgan’s reference index for global government bonds excluded India in 2022 due to concerns over the potential inadequacy of domestic bond settlement systems, rules on fund repatriation and that the country's capital gains tax regime was not aligned with international standards.
“Despite India’s sizable economy and its substantial domestic government bond market, the country is excluded from major global government bond debt indexes, so it fails to generate the sizable portfolio inflows associated with inclusion,” the report said.
Major gains
The inclusion of Indian government securities in major bond indexes could attract an initial inflow of $20-40 billion, increasing to $180 billion over the next decade, the S&P Global report said, citing market estimates.
Wider index inclusion could increase foreign participation in India’s government bond market to 10 percent from the current 0.9 percent, the report said, citing data from Institute of International Finance. S&P Global analysts expect available funds for corporates to nearly triple if foreign ownership of Indian government securities rises to this level.
Higher foreign participation in India’s domestic government debt market would not only increase demand and subsequently lower the cost of new government debt issuance, it would also free up resources for the private sector, the report added.
The report by S&P Global pointed out that foreign ownership of IGBs is lower than of peers, including China, Brazil and Indonesia, adding that foreign investors collectively held less than 1 percent of outstanding IGBs as of 2022-end.
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