Why India’s capital gains tax may be doing more damage to the rupee than revenue to the exchequer.
The Indian rupee has slid from ₹83 to nearly ₹95 against the US dollar in under two years. The Reserve Bank of India is burning through forex reserves at almost $10 billion a month to slow the fall. And in the middle of all this sits a policy that rarely gets blamed: the Long-Term Capital Gains tax on equities.
LTCG was reintroduced in 2018 at 10%, and effectively raised to 12.5% in the Union Budget 2024. The timing of the rupee’s acceleration downward isn’t a coincidence. To understand why, we need to go back to 2004 to a quiet but important tax compact that has since been broken.
The 2004 Compact: STT Was Meant to Replace LTCG
When then Finance Minister P. Chidambaram introduced the Securities Transaction Tax (STT) in 2004, the design principle was simple and transparent. Instead of taxing investors at exit on their gains, a moment that could deter long-term participation, the government would collect a small tax on every equity transaction, at the point of trading.
The deal was straightforward:
- STT would be collected automatically, on every trade, in profit or loss.
- In exchange, long-term capital gains on equity would be exempt.
- Revenue would be reliable and continuous, without punishing patient capital.
That compact was held for fourteen years. Markets deepened, retail participation grew, foreign investors found India accessible and STT collected its revenue quietly. Then in 2018, LTCG was reimposed at 10% while STT was kept in place. In 2024, LTCG was raised further to an effective 12.5%, and STT itself was increased on futures and options. What was designed as a replacement for LTCG became an addition to it.
The Foreign Investor Math No Longer Works
In every major global shock of the past two decades 2008, 2013, the 2018 Fed cycle, the 2020 Covid collapse, the 2022 Fed supercycle foreign institutional investors (FIIs) exited India. In every single case, they returned. The rupee fell, then recovered. A natural floor formed each time.
That mechanism is now broken. Consider how a global fund manager evaluates India today:
- Indian equities, in a good year, deliver around 15% in rupee terms.
- LTCG of 12.5% takes a meaningful chunk of that gain.
- Rupee depreciation of about 4.5% a year eats further into the dollar return.
- After transaction costs, what looked like 15% becomes roughly 7% in dollars.
- Meanwhile, US Treasuries offer 4.4% risk-free, tax-free, and dollar-denominated.
The arithmetic does the deciding. The external triggers that drove FIIs out in previous cycles were temporary — yields, oil, risk appetite — and they eventually reversed. LTCG, by contrast, is a permanent, policy-imposed friction sitting on the re-entry calculation. It didn’t exist in 2008, 2013, 2020 or 2022. It exists now.
Revenue Earned vs Reserves Burned
The defence of LTCG is usually a revenue argument: the tax brings in thousands of crores. The numbers don’t support it once you look at both sides of the ledger.
- On one side: LTCG revenue: approximately ₹50,000 crore annually, and already declining after the 2024 rate hike.
- On the other side: RBI has sold over $100 billion in spot and forward currency markets in the current fiscal year alone. Forex reserves have fallen from a peak of $728 billion in early 2026 to around $690 billion by May — a drop of nearly $40 billion in three months. The burn rate is roughly $10 billion a month.
To call this a revenue-generating policy, you have to look only at the left side of the ledger and ignore the right. The government is collecting a few thousand crores while spending many times that, every single month, to defend the very currency LTCG is helping to weaken.
And there’s a feedback loop. A weaker rupee inflates India’s annual oil import bill of around $175 billion. It raises the cost of servicing India’s $746 billion external debt. Every percentage point of rupee depreciation adds thousands of crores to those bills — paid not by foreign funds, but by Indian households.
The Real Cost Is Paid by Indian Households
The political argument is that abolishing LTCG would be a gift to the wealthy. The economic reality is less flattering.
Consider who actually bears the cost when FIIs exit:
- Mutual fund investors and SIPs: When foreign funds pull out, NAVs of domestic equity mutual funds fall. The SIP portfolios of teachers, engineers, and middle-class savers in Pune, Jaipur, and Surat shrink — not the portfolios of the foreign manager who has already exited.
- Petrol and fuel costs: A weaker rupee directly raises the cost of crude oil, of which India imports 85%.
- Medicines and edible oil: Active pharmaceutical ingredients and edible oils are priced in dollars. Imported medication becomes less affordable; the monthly cooking oil bill goes up.
- Electronics and machinery: Almost every imported good — from electronic components to industrial equipment — becomes costlier as the rupee falls.
LTCG presents itself as a tax on the wealthy. Its actual cost is collected from every Indian household, every month, through the price of the goods they buy.
A Lesson from Argentina
Argentina’s repeated currency crises 2001, 2018, and beyond weren’t purely about global misfortune. They were about a structural condition (chronic dollar dependence) made worse by a policy response that kept repelling the capital the country needed. Each time Argentina raised taxes on capital, imposed restrictions, and burned reserves to defend its peso, the next crisis became more severe.
India’s trajectory is following a recognisable sequence. Over ₹2 lakh crore in foreign capital has already left in the first four months of 2026 more than the entirety of last year’s outflows. The RBI is burning reserves. The government is appealing for citizen austerity. None of this addresses the structural cause.
The critical difference and the reason this is still correctable is that India has structural advantages Argentina never had: a deep domestic investor base built through SIP culture, sovereign debt denominated in rupees, and reserves that, while declining, are not yet at crisis levels. But those advantages are being eroded month by month.
The Big Picture
A country that needs foreign capital cannot afford to make capital unwelcome. India runs a chronic trade deficit. It imports 85% of its oil. Its export share of global merchandise trade is under 2%. By every measure, it is a country that needs foreign flows to bridge its external gap.
The case for revisiting LTCG isn’t about giving up on taxing capital. STT already exists. It collects revenue from every equity transaction. It was strengthened again in the 2024 Budget. The instrument the government once chose to replace LTCG is functioning and growing. Layering LTCG on top of it isn’t filling a revenue gap it’s imposing a structural cost that the revenue cannot offset.
Currency stability won’t come from citizen austerity or from defending the rupee with reserves. It will come when the policies that broke the re-entry math for foreign capital are reconsidered. That window is still open. It won’t stay open indefinitely.
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