Indian government bonds: FPI tax break boosts 2026 odds

What changed and why bond markets are watching

India has moved to exempt foreign portfolio investors (FPIs) from income tax on interest and capital gains earned from government securities. The step has improved the prospects of Indian sovereign papers being included in Bloomberg Index Services’ flagship Global Aggregate Index, with a review scheduled by the middle of this month.

The policy change matters because global bond index inclusion can drive large, automatic inflows from passive funds that track benchmark indices. Market participants have estimated potential passive inflows of $10 billion to $15 billion if Indian debt is included in Bloomberg’s flagship index.

Bloomberg’s Global Aggregate Index review remains open

Bloomberg Index Services has deferred the much anticipated inclusion of Indian bonds in its Global Aggregate Bond Index (often referenced as BGAI). But the review has not been closed. Bloomberg has indicated the review is ongoing and investor feedback is being sought.

A formal update is expected by mid-2026. Bloomberg has cited the need for further clarity on operational aspects such as market accessibility, settlement mechanisms, and taxation. The latest FPI tax exemption directly addresses one of those cited issues.

How the FPI tax exemption changes the investment case

People involved in deliberations between the central bank and the government said the reforms were initiated to create a more competitive and investor-friendly framework for foreign investment in Indian government securities. The stated objectives also include deepening the sovereign bond market and strengthening the eligibility case for inclusion in global indices.

The earlier tax treatment was described as a structural disadvantage for Indian sovereign papers in global markets. Removing it is expected to improve the post-tax attractiveness of Indian government securities for global investors.

Officials also expect the exemption to support secondary market liquidity and price discovery, while signalling a stable, long-term policy commitment to opening India’s sovereign bond market to international capital.

What India’s potential weight could mean for flows

For the Bloomberg Global Aggregate Index, India has been evaluated for a potential weight of around 1%. That allocation has been linked to estimates of about $15 billion of inflows, spread over roughly 10 months, starting from April 2027, if admitted.

Another Bloomberg-related assessment outlines a possible initial weight of 0.7% if India is included through its Fully Accessible Route (FAR) eligible securities. Under that scenario, India would contribute 41 FAR securities worth approximately $102 billion in market value, and rank as the ninth-largest market by value among the 26 currencies represented in the index.

Why global bond index inclusion is a structural shift

Global bond index inclusion refers to a country’s government securities being added to widely tracked international bond indices maintained by providers such as JP Morgan or Bloomberg. These indices serve as benchmarks for global institutional investors, including mutual funds, pension funds, and passive investment vehicles.

Passive bond funds allocate based on index weightings rather than discretionary views. Once a market is included, funds that track the index are required to allocate a portion of portfolios to that country’s bonds. That mechanism can bring steady capital inflows and can change how bonds are priced and traded over time.

Beyond flows, higher foreign participation can improve market liquidity, deepen the investor base, and enhance price discovery. As demand for government securities rises, bond yields tend to soften, which can lower government borrowing costs and indirectly influence borrowing conditions for corporates.

Market-opening measures already in play

The Centre has pointed to “market-opening measures” such as the Fully Accessible Route as steps that have aided the inclusion of Indian gilts in global bond indices previously. The stated effect has been improved capital flows and credibility for India’s bond market.

Separately, Bloomberg announced India’s inclusion into its EM Local Currency Government indices in March 2024. Those inclusions were set to occur in a phased manner. Indian government bonds were expected to start climbing index share from June 2024, reaching a 10% share of the JP Morgan index by March 2025. For the Bloomberg index, a similar process was outlined to start in January 2025 and run until October 2025.

What Bloomberg says it needs from eligible markets

Bloomberg’s documentation indicates that inclusion in the Global Aggregate Bond Index is determined by alignment with its benchmark design principles. It is not based on the size of the economy, reform intent, or a discretionary assessment.

To qualify, a market must consistently meet requirements for replicability, operational stability, and transparency. Bloomberg has emphasised the need for clarity on market accessibility, settlement mechanisms, and taxation, making the latest tax exemption relevant to the assessment.

Market impact: liquidity, yields, and index-driven sensitivity

The episode has underlined how sensitive bond markets can be to global index-related flows. Index inclusion matters more for structural capital flows than for near-term yield expectations, because passive funds can deliver demand that is relatively steady and rules-based.

Market commentary linked the importance of inclusion to multiple channels: foreign inflows, stronger demand for government paper, potential easing in borrowing costs, and better long-term liquidity. With inclusion deferred, the estimated $10 billion to $15 billion of passive flows remain on hold until the decision is revisited.

Key facts at a glance

Why the tax step fits into the broader index push

India’s government bond market has grown rapidly in recent years, and policymakers have been trying to attract more foreign capital. Index inclusion is positioned as a route to bringing sustained foreign participation, rather than episodic portfolio flows.

The FPI tax exemption is framed as removing a clear structural disadvantage for foreign investors and aligning India’s market framework more closely with global expectations. The remaining focus, based on Bloomberg’s stated concerns, will be on operational readiness, including accessibility and settlement.

Conclusion

India’s decision to exempt FPIs from tax on interest and capital gains in government securities strengthens the case for Indian bonds in Bloomberg’s Global Aggregate Index review. With Bloomberg’s assessment still open and a formal update expected by mid-2026, the next set of signals will come from how quickly operational and replicability concerns are addressed.