- You’ll miss the next rally if you ignore the LTCG debate.
- FPI outflows have erased ₹16 lakh crore of market cap in a single week.
- A 1.5‑point LTCG cut could lift post‑tax returns, but won’t fix earnings gaps.
- Corporate earnings recovery and a US‑India trade deal are the true catalysts.
- Historical tax‑cut rallies were short‑lived without macro support.
You’ve been betting on sentiment alone—that was a mistake.
Budget 2026 is shaping up to be a turning point for Indian equities, but the headline‑grabbing proposal to lower the long‑term capital gains (LTCG) tax may be more of a band‑aid than a cure. While a reduced tax rate promises a modest boost to after‑tax returns, the deeper problem remains the relentless outflow of foreign portfolio investment (FPI) that has dragged the Nifty down 2.5% in just one week, wiping out roughly ₹16 lakh crore in market capitalisation.
Budget 2026’s LTCG Tax Proposal: Market Shockwaves
The government re‑introduced LTCG tax on equities in 2018 at 10% with a ₹1 lakh exemption. In 2024 the rate was nudged up to 12.5% and the exemption raised to ₹1.25 lakh, while short‑term capital gains (STCG) rose from 15% to 20%. The upcoming budget is rumored to trim the LTCG rate back to 10% and possibly restore the Securities Transaction Tax (STT) to a lower slab. For a typical retail investor, this translates into a few extra basis points of return on a ₹10 lakh portfolio – attractive, but not a game‑changer.
Why does the proposal matter? First, it directly influences the marginal tax cost of holding equities for longer than one year, a horizon that aligns with the investment style of many institutional and pension funds. Second, a lower LTCG rate signals a pro‑equity stance, which could improve market sentiment and encourage fresh capital inflows.
Why FPI Outflows Are the Real Deal‑Breaker
Foreign portfolio investors have been the engine behind India’s decade‑long bull run, accounting for roughly 30‑40% of daily turnover. Yet in 2025 they turned net sellers in eight out of twelve months, dumping ₹166,286 crore and continuing the trend with a fresh ₹33,598 crore sell‑off in January 2026 – the biggest monthly outflow since August 2025.
The drivers are macro‑centric: a weakening rupee, an elusive US‑India trade pact, and slowing earnings growth across sectors. FPI decisions are largely governed by three criteria – growth durability, liquidity depth, and macro‑economic stability. A marginal LTCG cut does not address any of these pillars. As Harshal Dasani of INVasset PMS notes, “Even a modest cut in LTCG would improve post‑tax returns at the margin, but it does not materially change the risk‑reward equation for large offshore funds.”
Sector‑Wide Ripple Effects: From IT to Pharma
Lower LTCG taxes could benefit high‑growth sectors that rely on foreign capital for scaling, such as information technology services, pharmaceuticals, and renewable energy. These industries have seen earnings momentum slow, partly due to currency headwinds and global demand fluctuations. If the tax cut entices even a modest uptick in foreign buying, the resultant liquidity could narrow bid‑ask spreads, lower financing costs, and support valuation multiples.
However, the effect will be uneven. Defensive sectors like FMCG and utilities, which attract more domestic retail money, are less sensitive to FPI sentiment. Consequently, investors should re‑balance portfolios with a tilt toward earnings‑driven champions rather than chasing a tax‑only rally.
Historical Playbook: Past Tax Cuts and Market Moves
The most cited precedent is the 2004 LTCG exemption era, when the government removed the tax entirely for gains up to ₹1 lakh. That move sparked a sharp short‑term rally, with the Sensex climbing over 15% in the subsequent six months. Yet the rally faded as macro fundamentals – global growth, oil prices, and corporate earnings – reverted to pre‑boom levels.
Similarly, the 2018 reinstatement of LTCG at 10% saw a muted response because foreign inflows were already constrained by global risk aversion. The pattern is clear: tax incentives can act as a catalyst for sentiment but cannot sustain a bull market without concurrent earnings acceleration and macro‑policy support.
Investor Playbook: Bull vs Bear Scenarios
Bull case: The budget trims LTCG to 10% and rolls back STT, providing a clean signal that the government is pro‑equity. Coupled with a tentative improvement in corporate earnings projected for Q4 FY26 and a breakthrough in the US‑India trade talks, FPI flows could reverse, injecting fresh capital. In this environment, high‑growth stocks with solid balance sheets could see 12‑15% upside over the next 12 months.
Bear case: If the trade deal stalls and earnings remain flat, the LTCG cut will merely soften the tax bite for domestic investors. FPI outflows would likely persist, keeping the Nifty in a 2‑3% correction range. Defensive stocks and dividend‑paying blue chips would outperform, while high‑beta names could underperform by 8‑10%.
Actionable steps for investors:
- Prioritise companies with earnings visibility into FY26 – look for EBIT margin expansion and strong cash conversion.
- Maintain a diversified core of low‑beta, dividend‑rich stocks to weather FPI volatility.
- Allocate a modest satellite portion (10‑15% of the portfolio) to high‑growth, foreign‑fund‑attractive sectors, but set tight stop‑losses.
- Monitor macro indicators – rupee strength, US‑India trade negotiations, and global risk sentiment – as they will dictate FPI behavior more than tax policy.
In short, Budget 2026’s LTCG tweak is a welcome gesture for retail investors, but it won’t be the silver bullet to revive India’s equity market. The true catalyst will be a confluence of earnings recovery and macro‑policy clarity that convinces offshore capital that the risk‑reward balance has finally tipped back in India’s favour.