Can India afford tax cuts right now?

With just about three months to the budget, Finance Minister Nirmala Sitharaman is likely to be swamped with demands for more funds or tax relief. One of the loudest is the clamour for a cut in long-term capital gains tax (LTCG) and securities transaction tax (STT). Stock investors argue that a tax cut will bring back foreign portfolio investors (FPIs) who have yanked out a staggering $32.5 billion from Indian equities this year.

The big question for Sitharaman is whether the exchequer can afford tax cuts amidst rising expenses and ballooning debt.

There’s an estimated ₹2.85 lakh crore fiscal hole as subsidy bills surge and tax collections slide, according to ICRA, a Mumbai-based ratings agency. That’s more than double the revenue from LTCG in the financial year ended March 2025.

How bad could India’s balance of payments get? 

Meanwhile, the dollar exodus from the share market has worsened the country’s balance of payments (BoP), the difference between money coming into the country and the sum that leaves. A net outflow of money of $50 billion to $55 billion in the second half of the year could keep the rupee under pressure, says Madhavi Arora, chief economist at Emkay Global, a Mumbai broking firm.

The Reserve Bank of India has already spent $67 billion over the last 8 weeks to keep the rupee afloat. That’s nearly half of the $144 billion ammunition parked with Indian banks, and subsidised by the regulator, which would be due for repayment in less than three years.

“Excluding FCNR(B), you would be looking at, you know, multiple years of a BOP deficit, which becomes a source of, let’s say, financial stability risks and all of that,” Dhiraj Nim said.

“Unlike the last time this happened around 2013, this is not so much a homegrown problem. This is happening because of certain global factors which have weighed on flows into India.”DHIRAJ NIM, ECONOMIST, ANZ

If the FPI selling continues, and the government remains intent on not letting the currency slide to ₹100/dollar, the RBI will have to spend even more of its forex reserves.

LTCG hike didn’t start the FPI sell-off, a cut may not stop it

Indeed, the sell-off in Indian stocks started in the fall of 2024 because Indian stocks had run up too much, too fast, and global investors found them expensive. There were juicy profits to be taken out of India, and the AI trade in other countries offered the investors a relatively lucrative opportunity to put their capital to work. Then came the US-Iran war, which drove up oil prices past the $100 mark, squeezing vulnerable economies like India.

Stock valuations have corrected enough already, and an LTCG cut in India will not stop the US-Iran war, nor will it birth large language models or memory chip makers overnight.

Pain relief for a few, austerity for many 

It may offer some pain relief to bleeding portfolios, but the government has other responsibilities too. “The government is cutting expenses elsewhere. For example, some of the water scheme, some of the housing scheme, and so on and so forth,” HSBC’s Pranjul Bhandari said. These cuts affect the poorer sections of society, most of whom may not have a stake in the stock market.

Cutting spending on essentials when inflation is rising may be politically costly. Prime Minister Narendra Modi’s rivals would have more material to escalate their attacks on the administration.

The country has less than 63 million unique people with investments in mutual funds, according to the August data released by the Association of Mutual Funds in India (AMFI). A much larger base of voters with no investable surplus is reeling from the high cost of food, fuel, and fertilisers.

The government has already seen its tax revenue dip 23% in the first five months of this fiscal year due to duty cuts in petrol and diesel. ICRA expects the fiscal deficit (the difference between the government’s expenses and revenue) to be at least ₹1.3 lakh more than what it had budgeted for in February this year. That’s as much as the LTCG collected in FY25.

A tax cut may bring some dollars back, for a while. It may help some portfolios, but as a result, the fiscal deficit would look bad, which is, again, not something FPIs like.

The end of the war in West Asia would be enough to spur a sharp correction in oil prices, which would in turn reduce inflation, cap the cost of capital, and improve earnings growth for Indian companies, making them attractive again for FPIs. That’s a tide the Indian government can’t turn.

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