Why capital gains tax is back in focus
Indian equity markets underperformed global peers in 2025. The Nifty rose only about 10-11% during the year, far below the returns investors had grown accustomed to in previous cycles. At the same time, foreign institutional investors pulled out more than Rs 1.5 lakh crore from Indian equities. This selling was driven by a mix of factors including a weaker rupee, relatively high valuations, rising US bond yields and a global shift of capital towards safer assets.
In this environment, capital gains tax has become an easy pressure point. At present, short-term capital gains on listed equities are taxed at 20%, while long-term capital gains are taxed at 12.5% on gains above Rs 1.25 lakh. For investors sitting on modest gains after a long period of volatility, these taxes feel more painful than they do during a roaring bull market.
Vinit Bolinjkar, Head of Research at Ventura, says the demand for relief is understandable. Lower capital gains taxes, he argues, could improve post-tax returns, discourage frequent selling and make long-term holding more attractive at a time when headline gains are limited. With markets delivering lower returns, taxes tend to become more visible in investors’ minds.
Will a tax cut bring FIIs back?
One of the key arguments in favour of cutting capital gains tax is that it could help stem foreign investor outflows and improve India’s attractiveness compared with other emerging markets. However, most strategists caution against overstating this link.
Ross Maxwell, Global Strategy Operations Lead at VT Markets, says foreign investors have not been exiting India because of capital gains tax. Instead, they have been reacting to global forces such as high US bond yields, a strong dollar and geopolitical risks. For large global funds, taxes are only one input in allocation decisions and often not the most important one.According to Maxwell, earnings visibility, macro stability and currency risk matter far more to foreign investors than a few percentage points of tax difference. A tax cut, by itself, will not reverse these global pressures. FIIs are more likely to return when global liquidity improves and when Indian corporate earnings show clear signs of acceleration.
Lessons from history
India’s market history also offers important clues. Changes in tax structures have influenced trading behaviour and short-term sentiment, but they have rarely created lasting bull markets on their own.
Bolinjkar points to the introduction of the securities transaction tax in 2004, which replaced long-term capital gains tax. Markets eventually went on to grow several times over, but that rally was driven by a powerful mix of economic growth, rising corporate profits and global liquidity — not by tax policy alone. Similarly, recent hikes in capital gains taxes caused temporary volatility but did not derail the broader market trend for long.
The government’s constraints
There is also the question of whether a tax cut is even feasible. Abhishek Jain, Head of Research at Arihant Capital Markets, believes expectations of a reduction may be unrealistic. From a fiscal perspective, capital gains tax has become a stable and predictable source of revenue for the government. With ongoing commitments to infrastructure spending and fiscal consolidation, there is limited room to sacrifice revenue.
Jain argues that maintaining the status quo may actually be the most market-friendly outcome. Sudden changes, whether cuts or hikes, tend to create uncertainty. Markets generally prefer stability, especially when global conditions are already fragile.
Sentiment versus reality
The growing call for tax relief, according to many market veterans, says more about investor psychology than policy failure. Sourav Choudhary, Managing Director at Raghunath Capital, describes the demand for lower capital gains tax as emotionally justified but economically overstretched.
When markets are rising sharply, taxes rarely dominate discussions. It is during phases of consolidation or disappointment that they become a focal point. “In reality, long-term wealth creation in equities has never depended on tax arbitrage. It has been driven by earnings growth, efficient capital allocation and the power of compounding.”
Choudhary also points out that domestic investors continue to invest steadily through SIPs despite market volatility. This suggests that long-term confidence in equities remains intact, even without tax incentives.
What a tax cut can and cannot do
Most experts agree that a reduction in capital gains tax could provide a short-term sentiment boost. It may encourage investors to rebalance portfolios more freely, reduce friction costs and improve after-tax returns, particularly for domestic investors who now account for a large share of daily market liquidity.
It could also support trading activity in mid and smallcap stocks, where sentiment has been more fragile. But expecting such a move to unleash a full-blown bull market is unrealistic.
Looking ahead to 2026, analysts believe the focus should remain on fundamentals. Corporate earnings growth, government capital expenditure, private investment recovery and global liquidity conditions will matter far more than marginal tax adjustments.
Bolinjkar notes that if earnings begin to recover meaningfully and global cues turn supportive, even a modest tax tweak could amplify positive sentiment. But without those drivers, a tax cut alone would struggle to sustain momentum.
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)