'AI-trade' bust will aid India only partially; don’t tweak LTCG, says Madhavi Arora of Emkay Global

Amid persistent foreign fund outflows, Madhavi Arora, chief economist at Emkay Global Financial Services, suggests rationalizing the effective transaction-tax burden rather than tweaking headline long-term capital gains (LTCG) rates. While she notes that a reversal of the global AI trade could improve India’s relative attractiveness, that alone won’t trigger a sustained return of foreign capital—just as new free-trade agreements (FTAs) can help cushion – but not fully offset – external demand shocks. Edited excerpts:

There is rising clamour for rationalization of LTCG tax and STT. If you had to give one suggestion to the finance minister on this matter, what would it be and why?

I would rationalize the effective transaction-tax burden rather than make another large change to the headline LTCG rate. Listed-equity LTCG is currently taxed at 12.5% on annual gains above ₹1.25 lakh, while delivery-based equity transactions also attract STT (securities transaction tax) of 0.1% on both the purchase and sale legs. The problem is, therefore, not simply the level of capital gains taxation, but the layering of a transaction tax on top of a capital gains regime.

STT was introduced in an era when listed-equity LTCG was exempt, whereas India today has both STT and LTCG tax. A calibrated reduction in STT, particularly for cash-market transactions, would lower friction, improve market liquidity and send a useful signal to global investors, without reopening the entire capital gains framework.

India’s anti-AI trade label is seen as another hurdle in attracting foreign capital. If the AI trade busts, will that be enough to regain foreign attention?

A reversal of the global AI trade would certainly improve India’s relative attractiveness, but I don't think it would be sufficient by itself to trigger a sustained return of foreign capital. India's ‘anti-AI’ label largely reflects the composition of its benchmark indices: financials account for roughly 36% of the Nifty, while direct exposure to the semiconductor and AI-hardware cycle is relatively limited. There are several ‘AI-enabler’ stocks in India which have seen spectacular returns over the past 12 months or so.

If the AI trade unwinds, some global capital could rotate back towards India. There is already evidence that periods of weakness in AI-heavy Asian markets have coincided with renewed foreign buying of Indian equities. But a durable return of foreign investors ultimately requires more than an AI correction. The relative valuation of India, earnings, the dollar and US yields, oil prices and domestic policy, all matter.

The IMF projects India will deliver 7% growth this year. China’s growth has been estimated at 4.5%. How realistic is India’s growth target? Are we better positioned than a tech-and-AI-driven Chinese economy?

The 7% figure is credible, but it sits at the optimistic end of what’s achievable and depends heavily on oil. Much of the strength came in Q1, when the public sector, led by the Centre and the OMCs (oil marketing companies), absorbed a large share of the oil shock on its balance sheet, largely insulating the private sector. That cushion cannot last indefinitely.

The IMF raised India’s forecast from 6.4% to 7%, citing resilient domestic demand and robust services. Notably, China wasn’t singled out for a downgrade; both countries were revised upward, with India getting the larger upgrade. Having grown 7.7% in FY26, India would only need a moderate slowdown to hit 7%. Our reliance on domestic consumption and services also shields us from tariff wars far better than an export-led model would.

Energy, however, remains our Achilles’ heel. The crude import bill rose over 24% YoY in H1FY27 despite slightly lower volumes, feeding directly into the rupee, inflation and the current account. If crude stays above $110/bbl for an extended period, growth will likely fall short of 7%.

On China, a faster growth rate is not the same as a stronger economy. China is four to five times our size, so its 4.5% adds more absolute output than our 7%. Lower-income economies are also expected to grow faster. The real test is whether 7% can absorb the millions joining our workforce each year. I’d argue we need closer to 8%, sustained, to meet our 2047 ambitions.

China’s problems are real, and AI isn’t solving them. Tech exports have surged, but weak household demand and a sagging property market weigh on growth, with retail sales up just 1.1% in September. Part of the AI export surge also reflects higher chip and server prices rather than broad-based output growth.

In short, India has the better cyclical position, with faster growth, a young population and no property crisis or deflation. China retains a stronger structural and technological base. Whether our advantage becomes a lasting catch-up depends on this decade’s choices in manufacturing, energy security and AI-ready skilling.

Your recent report argues that the RBI's tightening of forex rules and liquidity to curb rupee volatility amounts to a tactical fix rather than a structural solution. What alternative policy mix should the central bank have deployed to deliver lasting stability?

First, credit where it’s due. The RBI was handed an extraordinarily difficult situation. The West Asia crisis turned an already fragile balance of payments into an acute problem, and the central bank responded quickly. The FCNR+ scheme, which mobilized around $143 billion in a short period, was a remarkable success, and the latest measures will give the rupee some near-term support. But these measures redistribute currency pressure rather than remove it… The underlying dollar demand doesn’t go away. It simply shows up somewhere else.

I would have favoured a policy mix built on three pillars. Greater exchange rate flexibility. Allowing INR to adjust gradually, in line with fundamentals, is far less damaging than resisting and then suffering episodic, abrupt corrections.

The second is building reserves through durable inflows rather than borrowed money. FCNR deposits are a liability that must eventually be repaid, and forward positions of over $200 billion will need to be settled. Lasting stability requires stable capital such as FDI. Net FDI has improved to $13.8 billion so far this fiscal year, but with the FCNR window closed, the best of the durable inflows is likely behind us. India now competes for global capital against a US economy offering both high returns and an AI-led growth premium. Attracting that capital requires an investment climate and reform agenda credible enough to earn it, not just an attractive interest rate.

The third is reducing our structural dependence on imported oil. Our oil import bill is largely inelastic, and with Brent around $100 a barrel and costly electronics imports, I expect the current account deficit could widen to 1.6-1.7% of GDP in FY27. As long as that vulnerability exists, every oil shock becomes a currency shock. Energy diversification, faster EV adoption and domestic electronics manufacturing are ultimately exchange-rate policies too.

None of this is purely the RBI’s job. Lasting stability needs monetary policy, liquidity management, exchange-rate flexibility and government-led structural reform working together. Until that happens, regulatory curbs can buy time but cannot fix the underlying causes. My expectation is that depreciation pressure on the rupee will persist, and that RBI intervention will moderate the pace of the decline rather than reverse it.

Can FTAs offset demand shocks from the West and keep Indian exporters competitive? Among the EU, the UK and New Zealand deals, which is the most strategically beneficial?

FTAs can cushion an external demand shock, but they cannot fully offset one. They can diversify India’s export markets, reduce tariff disadvantages relative to competitors and make Indian exporters more competitive. But New Zealand is ultimately a relatively small market, so its strategic value is greater as part of a wider diversification strategy than as a substitute for demand from the US or Europe.

Of the three agreements, the EU deal is potentially the most strategically consequential, and the reason is scale. The EU gives India access to a much larger consumer and industrial market and offers significant opportunities in labour-intensive manufacturing, engineering and services. The EU already accounts for about 12% of India’s total bilateral goods trade, with about $40 billion of Indian services exports going to the EU annually.