Vivek Kaul: Is capital gains tax to blame for the exodus of foreign investors?

Villainy in today’s stock market story has been ascribed to foreign institutional investors (FIIs) who have been selling Indian stocks lock, stock and barrel, having net sold shares worth ₹2.4 trillion from October to 13 March.

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In fact, we are now being told by those in the business of managing other people’s money (OPM)—individuals who thrive on selling different stock market stories at different points of time—that this selling is taking place primarily because of the long-term capital gains (LTCG) tax that FIIs need to pay. As far as backstories and explanations go, this is a clever one. But it’s weak as an argument.

First, the tax came into effect from April 2018, with FIIs having to pay 10% on their LTCG. So, why come up with this story now when the tax has been around for nearly seven years?

Second, the investment behaviour of FIIs since 2018-19 is worth looking at. In 2018-19, they net sold stocks worth ₹88 crore. In 2019-20, they net bought stocks worth ₹6,153 crore. In 2020-21, a year when domestic institutional investors (DIIs) net sold stocks worth ₹1.34 trillion, they net bought stocks worth ₹2.74 trillion. DIIs comprise insurance companies, mutual funds and pension as well as provident funds, and they primarily invest money collected from retail investors.

In 2021-22 and 2022-23, FIIs net sold stocks worth ₹1.4 trillion and ₹37,632 crore, respectively. In 2023-24, they net bought stocks worth ₹2.1 trillion. And in 2024-25, as of 13 March, they had net sold stocks worth ₹1.53 trillion. The point being that FIIs have behaved differently in different years since 2018. So, why attribute their recent selling to the tax?

Third, it has been argued that the recent depreciation of the Indian rupee, combined with the LTCG tax—which lowers the dollar returns for FIIs—is compelling them to sell more than they otherwise would.

Now, the value of the rupee was more or less pegged to the dollar through much of 2024, moving in the ₹83-84 range. Even during this period, there were months when FIIs sold Indian stocks—worth ₹25,744 crore in January, ₹25,586 crore in May and ₹94,017 crore in October.

Fourth, in the latest Union budget, the rate of the LTCG tax for FIIs was increased to 12.5%. This is another reason being offered for FII selling. The trouble is that this higher rate will come into effect only from 1 April 2026.

So, the LTCG tax hike can’t be the main reason behind FIIs selling out of Indian stocks. The OPM wallahs are basically being disingenuous here. But then, what are their reasons?

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First, the valuations of Indian stocks were out of whack. In September 2024, when the stock market peaked, the price-to-earnings ratio of the BSE 100 index was 25.2. This index is a good representation of the large-cap stocks that FIIs like to invest in.

The average price-to-earnings ratio of this index from April 1998 to March 2025 has been 20.2. Of course, there have been periods during which this ratio has been higher than in September. Still, it’s worth noting what Aswath Damodaran, a professor of finance at New York University, recently said: “The most expensive market in the world is India.” In that sense, FIIs have been taking some profits off the table.

Second, in October, the US stock market was betting on Donald Trump winning the presidential election and Trumponomics benefitting American stocks. So, money started moving out of Indian stocks. Also, October onwards, US interest rates started to go up, which made investing in fixed-income assets in the US more attractive.

Third, the aggregate net sales of the BSE 100 companies have been growing in single digits since the quarter ended June 2023, implying that any increase in sales has been because of rising prices and that volumes are not growing.

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All these reasons are more important than the LTCG explanation that OPM wallahs have been offering. Indeed, the trouble is that over the last few years, many OPM guys have played up a nationalism story to get more people to invest in stocks. Several of them have also proclaimed that stock prices will only keep going up. And now that these stories are unravelling, newer stories are needed.

Some of them have talked up investment in stocks so much that they can’t get their heads around the fact that stock markets can also fall. They have bought the same stories that they had been telling retail investors.

Given this, a new story has to be told and sold. A villain has to be found to provide mental closure and an explanation to both retail investors and OPM wallahs themselves. The trouble is that every bull market has a theory behind it and every bear market has an explanation, and very few understand that in both cases, it’s usually the OPM wallahs marketing stocks.

The author is the author of ‘Bad Money’.