High equity taxes dampen market sentiment amid FII outflows, West Asia war: What should investors do?

Investor sentiment in Indian equities continues to be shaped by a combination of factors, including the current geopolitical turmoil in the Middle East, persistent foreign institutional investor (FII) outflows, and recent tax changes, experts say.

As of today, equity markets remain under immense pressure, even as domestic institutional investors have provided partial cushioning. Since the start of this year, the benchmark Nifty 50 index has delivered a return of -9.55%, whereas the BSE Sensex has lost about 11.59% of its value.

Experts note that since July 2024, taxation on equities in the country has witnessed an incremental boost. For example, the Long-Term Capital Gains (LTCG) on equities was hiked from 10% to 12.5%, with taxation on profits exceeding ₹1.25 lakh in a financial year. On similar lines, to curb speculation, the Short-Term Capital Gains (STCG) rate was increased from 15% to 20% under Section 111A of the Income Tax Act, with the change impacting all transactions after 23 July 2024. The Securities Transaction Tax (STT), particularly on derivatives, has been raised in recent policy measures aimed at curbing excessive speculation. The recent budget raised STT on equity futures by a massive 150% to 0.05% and on options by 50% to 0.15%.

These changes have reinforced the structural idea of longer holding periods, while ensuring that tax liability increases as the holding period is reduced. When a person trades frequently, the cost of such trading naturally rises. Now, with serious market underperformance relative to peers and the extended exodus of FIIs, these changes and periodic tax adjustments are beginning to tell on equity markets.

Market performance has been weak over the past year

Note: Data as of 18 May 2026, taken from official sources

Against this backdrop, where global equity markets have mostly outperformed Indian benchmarks, there are discussions around whether taxation levels could be influencing relative competitiveness and capital flows, along with a host of other factors such as weakening of the rupee, serious geopolitical turmoil and escalated prices of oil and commodities across the globe due to the US-Israel war against Iran.

Foreign institutional investors, for example, have continued to remain extremely bearish on Indian equities, resulting in sustained outflows since the start of 2026. A trend that has continued since late 2024. The outflows for just 2026 have exceeded ₹2.1 lakh crore, year-to-date, thus reflecting broader risk aversion towards emerging markets, especially India. According to recent market data, India has witnessed some of its sharpest monthly outflows in years, which have been driven by a mix of valuation concerns and global uncertainty.

US-Israel war on Iran continues to drag on

A serious headwind to market underperformance has been geopolitical tension linked to the US-Iran conflict, which has kept crude oil and commodity prices elevated. This has resulted in constant pressure on India’s import bill and currency stability.

These developments have also contributed towards a cautious stance among global investors, with flows increasingly rotating towards other emerging and developed markets perceived as less exposed to energy shocks.

Higher taxes hit trading volumes

Says CA Zubin Billimoria, President, Bombay Chartered Accountants' Society, “The recent STT increase is confined to derivatives and does not affect delivery-based cash trades, reflecting a policy intent to curb speculation. The LTCG changes were introduced to simplify and rationalise the capital gains structure, with some categories seeing the rate reduced from 20% to 12.5% without indexation. Active traders and F&O participants are the most affected, and higher transaction taxes can have some dampening effect on trading volumes.”

Akshat Garg, Head - Research & Product, Choice Wealth, explained how these developments have made investors rethink risk and investment horizon. “Rising equity taxes—from higher STT to expanded LTCG—are nudging investors to rethink risk and horizon. For retail clients, this means lower enthusiasm for shorter-term trading and greater demand for clear, tax-efficient advice. Policy changes don’t kill appetite for equities, but they make disciplined planning and cost-aware portfolio design essential,” says Garg.

How can you manage your personal finances in this environment?

To effectively manage your personal finances in this environment, you should:

Make sure that you don't borrow beyond your repayment capacity. Don't participate in trading on borrowed funds.

Ensure that you have a proper emergency fund.

Plan a monthly budget to keep your expenses under control. Understand SEBI regulations and notifications on how retail investors have suffered through excessive trading in F&O.

Cut down on avoidable expenses, such as luxuries and expensive items. When inflation trends higher, saving and cutting expenses become vital.

Try to repay the debt that comes with the highest interest rate. For example, first clear high-interest credit card debt, followed by other EMIs, to bring down your overall debt liability.

It can be argued that while tax policy continues to remain a tool for market regulation and balancing of revenue, the current phase of serious market underperformance and muted domestic returns, heavy FII outflows and elevated geopolitical uncertainty, is subtly reviving the debate on whether equity market taxation should evolve further, primarily to support long-term market depth and global competitiveness. That too without undermining fiscal priorities or structural safeguards.

As a sensible retail investor in this environment, you should plan your investments across different asset classes such as equities, fixed income, debt, mutual funds, gold, silver, and other similar investment options, cut down on unnecessary expenses, and seek professional guidance to plan your finances and successfully navigate this challenging period.

For all personal finance updates, visit here.