Tax moves aim to boost government securities market, not just rupee

NEW DELHI: Coordinated moves by government and Reserve Bank of India (RBI) on Friday are not just meant to improve foreign exchange inflows and boost the rupee but also meet a more long-term objective of deepening the government securities market with the entry of larger and stable players, widening the pool of investors beyond banks and financial institutions, which dominate the market currently.

Officials privy to the discussions said they had been taking place for months, but the intensity increased in the last eight to 10 weeks, with the central bank and Centre holding detailed deliberations based on investor feedback.

The need to review the tax framework was being discussed as the government has been pursuing inclusion of its bonds in major global bond indices, including the Bloomberg Emerging Market Local Currency Govt Bond Index. The earlier regime on interest and capital gains earned by foreign portfolio investors (FPIs) was reducing the effective post-tax yield relative to comparable sovereign instruments, investors had complained.

Officials are hoping Indian govt bonds will now be included in more bond indices.

Overseas investors faced a long-term capital gains tax of 12.5% on listed shares and bonds. A withholding tax of 20% also had to be paid on interest earned on government securities.

The government has also decided to exempt interest and capital gains of the Bank for International Settlements (BIS) from investments in government securities, as it is expected to facilitate investment from global central banks, which are seen to be long-term and stable investors.

"Deeper FII participation will, over time, improve liquidity and price discovery in the government securities market, benefiting market participants, including domestic banks, insurance companies and provident funds. A more liquid secondary market also reduces the cost of govt borrowing on a sustained basis," said an official. After the twin announcements on Friday, the rupee gained 0.9% to close at 94.95 against the US dollar, with banks expecting inflows of $25-30 billion, if not more, due to the steps.
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