An Indian monetary policy has hardly ever generated as much lead-up debate as the one unveiled on Friday (5 June 2026). Trump’s mercurial wars and tariffs had plunged the global economy into crisis. India’s rupee was hurtling towards the economically/psychologically maiming 100-to-the-dollar mark. Energy and other critical supply shocks were causing inflation to rise globally, especially in Asia. It was much beyond a price shock, with severe dislocations caused by shortages and rationing. Interest rates were spiking, led by a searing 5 percent on the 30-year US treasury. India’s 10-year was dangerously above the 7 percent threshold.
So, the key questions were: will India increase interest rates to stem the rupee’s free fall and rein inflation before it jumped out of control? Would we have the gumption to boldly cut tax rates and reverse the rampaging exit of foreign capital?
I was clear about what would happen, and had said so on WhatsApp groups where these intense debates took place:
The government should abolish Long Term Capital Gains (LTCG) tax on equities, as was solemnly promised in 2004 before we reneged on that commitment by reimposing LTCG in 2018—but I was clear that the regime was simply too risk averse to do this!
A specially incentivised Foreign Currency Non-Resident (FCNR) bond scheme would be introduced at high interest rates to suck about $ 50 bn of inflows. As they had done in 2013, wealthy NRIs would use extreme leverage—up to 19 times—to borrow at cheaper dollar rates overseas and invest in this bond. This arbitrage could give them nearly 15 percent dollar returns on a AAA credit instrument underwritten by India’s sovereign risk! It’s a bonanza that no high-net-worth NRI would pass up on!
Some other tiny tweaks would be made—for example, the withholding tax on interest income earned on government bonds would be abolished. Here I proved to be totally off the mark because the government almost “recklessly” abolished all taxes—income, LTCG, and STCG – on foreign investments in Indian treasuries. I simply did not see that coming and will dwell on it a little later.
Finally, I was sure that there would be no rate hike. I was spot on!
The Magical Tax Policies of 2004
Even though I was sceptical, I really did want the government to rediscover the “magic policy of 8 July 2004”. On that day, India abolished LTCG on all securities transactions, replacing it with a minuscule 0.15 percent Securities Transaction Tax (STT) on the buyer. It was an audacious move, but it ignited hope. What followed was the “golden age” of India’s forex, capital, FDI, and private equity markets, an arc from 2004 through 2008:
Believe it or not, the rupee appreciated, climbing from 46/dollar to 39/dollar. Contrast that with what happened once we repudiated our tax assurance and re-slapped LTCG and increased STT after 2018. Clearly, foreign investors saw that as a betrayal, with the rupee careening downhill, from about 70/dollar to 97/dollar a few days ago.
Net capital inflows touched an astonishing high of $ 108 bn, or ten percent of GDP, in 2007-8. Contrast that with the relatively poor inflow of barely $ 100 bn, or a meagre two to three percent of GDP, last year!
Foreign Direct Investment had peaked at $ 34 bn, or 2.8 percent of GDP in 2007-8. It’s now fallen by nearly half, to less than 1.4 percent of GDP.
Foreign capital inflows into listed equities were at about 1.4 percent of GDP in 2007-8; they plummeted to less than half, around 0.7 percent of GDP last year.
Private equity and venture capital infusion was at $ 17 bn, or about 1.5 percent of GDP in 2007-8; that’s cooled off to about $ 35 bn, or about 0.7 percent of GDP.
Finally, the Sensex leapt from 4500 in 2004 to 21000 in 2008, an astonishing 5X move!
Clearly, India’s best forex, stock market, FDI, and private equity performance was captured in those go-go years from 2004-7. While several global and external factors had created the tailwinds, a good part of the credit must be given to the ringing tax policies, ie no LTCG, and only a marginal STT, on equities. Conversely, after we weaselled out on our commitment and brought back LTCG—to add insult to injury, we also increased STT—it’s been a downhill trudge for the rupee and net foreign capital inflows.
Why Miss the Goldilocks Moment Now?
I am mystified by what we’ve done now. Instead of giving incentives to equities by reverting to the “goldilocks tax architecture of 2004”, we’ve swung to the other extreme. By abolishing all taxes on foreign investments in government bonds, we’ve created a goldilocks tax regime for foreign debt! When we should have bolstered the economy with a thick buffer of foreign risk capital, we’ve loaded tonnes of higher debt on it! The arithmetic is a tad perverse:
We expect to get $ 50 bn of additional foreign investment in treasuries; by abolishing income tax on this instrument, we’ve perhaps given up about $ 1 bn, or about Rs 10,000 cr of tax revenues. Add to this the Rs 4000 cr of taxes on the current block of foreign investments in government bonds, and the total giveaway adds up to Rs 14,000 cr.
As against this, an intelligent estimate (by ChatGPT) indicates that the government could have earned about Rs 12-15,000 cr via LTCG on foreign equity investments in FY 26.
So, we gave a bounty of Rs 14,000 cr to strap on $ 50 bn or Rs 5 lakh crore of additional debt, when we could have given roughly the same quantity of largesse to stock up on hundreds of billions of dollars of foreign equity or risk capital. Isn’t that perverse?
Clearly, the government’s primary objectives were as follows:
First and foremost, reduce the cost of its own borrowing.
Secondly, shore up the value of the rupee against the dollar.
And thirdly (if at all), benefit the broader private economy.
I ask you, in all honesty—shouldn’t the above ranking be reversed? Shouldn’t government policy be made to create the best conditions across the economy, as opposed to fulfil a relatively narrow objective, of lowering its own interest cost?