Jefferies Cautious On IT: TCS Rated Underperform, Infosys Hold After $10 Billion FPI Outflow

Foreign investors have pulled around $10 billion from India's information technology sector since October 2024, making it one of the worst-hit sectors in the prolonged foreign portfolio investor (FPI) sell-off, according to Jefferies. The brokerage has maintained a cautious stance on the sector, rating Infosys a 'Hold' and Tata Consultancy Services (TCS) 'Underperform'.

In its latest assessment of foreign flows and India's equity taxation framework, Jefferies said a potential cut in long-term capital gains (LTCG) tax could improve foreign investor sentiment and support both equities and the rupee. However, no decision on such a tax change has been announced. Financials, IT and consumer staples have seen the largest net FPI outflows since October 2024. Financials have recorded net outflows of $16 billion, while IT and consumer staples have each seen about $10 billion withdrawn.

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Jefferies said sectors that have faced heavy foreign selling could benefit if FPI flows reverse. Within these oversold sectors, the brokerage prefers banks, while also favouring energy stocks such as Reliance Industries, utilities and real estate. It prefers large-cap stocks over mid-caps.

Why Jefferies Sees Scope For A Change In FPI Flows

Market speculation about a potential reduction in equity LTCG tax has gathered pace, although the government has not announced any decision. Jefferies said this could be followed by changes to taxation for foreign investors in debt and relief on goods and services tax (GST) applicable to brokerage services.

The government would need to weigh the potential fiscal impact of any tax relief against its broader objective of gradually converging taxation across asset classes, the brokerage said.

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A more favourable tax regime could improve India's appeal to foreign investors, particularly as their positioning in the market remains light. Jefferies' analysis of 70 large emerging-market funds with combined assets under management of $380 billion showed that India was underweight by 0.3 percentage points, compared with its 10-year average overweight position of 2.2 percentage points.

The brokerage said improved foreign flows could support both the domestic equity market and the rupee, which has faced pressure from weakness in capital-account flows.

Since April 2025, equity-market-related outflows, including those from FPIs, foreign promoters and foreign private equity investors, have totalled $110 billion, according to Jefferies.

How India's Equity Tax Regime Has Changed

India's equity taxation framework has undergone several changes over the past two decades. In 2004, the government abolished LTCG tax on listed equities held for at least one year, reduced short-term capital gains (STCG) tax to 10% and introduced securities transaction tax (STT). The measures were intended to simplify taxation and curb tax avoidance.

The government reintroduced LTCG tax in 2018 at 10%, while retaining STT. In 2024, the rates were increased further, with LTCG tax raised to 12.5% and STCG tax to 20%.

Foreign portfolio investors generally face the same equity capital gains tax rates as other investors in India. In several emerging markets, LTCG on equities is exempt for FPIs, Jefferies noted.

Foreign investors had previously benefited in some cases from tax-favourable jurisdictions through double taxation avoidance agreements. However, routes that enabled such benefits have been largely closed since April 2019, according to the brokerage.

Jefferies said differential treatment for FPIs on equity taxation cannot be ruled out.

Three Options For Equity Tax Relief

Jefferies outlined three potential approaches to rationalising equity taxes: an across-the-board reduction in LTCG and STCG rates, an FPI-specific cut in LTCG tax, or calculating capital gains for FPIs in US dollar terms to provide some indexation benefit. The brokerage said an out-of-budget change in capital gains tax could be implemented through an ordinance, pointing to recent tax relief granted to certain foreign investors in Indian government bonds as a precedent for action outside the annual Budget process.

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However, it also noted that an excessive gap between long-term and short-term capital gains tax rates could be suboptimal.

Fiscal Impact Could Limit Scope For Tax Cuts

Any reduction in equity taxes would have to be assessed against its potential impact on government revenue. LTCG collections from equities stood at Rs 1.3 lakh crore in FY25, the latest available data point cited by Jefferies. The brokerage noted that collections coincided with Indian markets peaking during that period and could be lower now.

STT collections for fiscal 2027 were annualising at around Rs 85,000 crore, according to the report.

Combined equity LTCG tax and STT accounted for 8% of direct tax collections and 5% of total gross tax revenue in FY25. Given fiscal pressures, the government may need to identify ways to offset any revenue loss arising from a reduction in LTCG tax.

Large-Caps Preferred Over Mid-Caps

Jefferies said large-cap stocks offered a relatively attractive opportunity if foreign flows improve. Large-caps have underperformed mid-caps by five percentage points in 2026, while trading at a 23% valuation discount to their 10-year average, compared with a historical discount of 20%. This comes even as the earnings-growth gap between large-cap and mid-cap companies is expected to narrow, according to the brokerage.

Within sectors that have faced heavy foreign selling, banks remain Jefferies' preferred exposure. The brokerage also favours energy, utilities and real estate, with Reliance Industries among its preferred energy stocks.

The report also highlighted a recent improvement in foreign investment in Indian government bonds after tax relief was granted to certain foreign investors. Debt FPIs recorded $9 billion in inflows during June and July 2026.

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