RBI Ex-Director Warns: Tax Policy Risks Economy

Experts are urging the government to reconsider India's capital gains tax structure ahead of Budget 2026, warning that current policies create significant macroeconomic risks. The existing tax framework provides substantial advantages to equity investments compared to fixed-income instruments, encouraging a flow of funds away from bank deposits and bonds. This trend is particularly concerning as banks, traditionally the primary lenders to lower-rated borrowers and MSMEs, face challenges in mobilizing deposits.

G Mahalingam, formerly of the RBI and SEBI, highlighted that while tax incentives for equity align with encouraging savings in financial markets, equity's inherent risk far outweighs that of deposits and bonds. The wide disparity in taxation, with long-term equity gains taxed at 12.5% and interest income at higher slab rates, incentivizes excessive risk-taking purely for post-tax returns.

Ananth Narayan, also an ex-SEBI member, noted that tax has become a dominant factor in asset allocation, even pushing retirees towards higher equity exposure to protect savings from inflation. He argued that taxing entire interest income for fixed-income investors, whose real returns are already slim after considering inflation and taxes, is unfair. Narayan advocates for uniform, low capital gains tax across asset classes, enabling risk-based allocation.

Banking veteran Srinivasan Varadarajan pointed out that India's past capital scarcity no longer justifies the current tax treatment, as equity participation has surged. Mahalingam further warned that a deposit shortage could cripple credit access for MSMEs, hindering production and overall economic growth.