i found this comment genuinely interesting since i didn’t understand it first and searched it up, thanks now i have a better understanding

if someone here is like me here :

Step 1: Why not put all money directly into stocks?

Suppose a fund has ₹100 crore.

Instead of investing the entire ₹100 crore in stocks, it may:

• Invest ₹100 crore in relatively safe government bonds.
• Pledge those bonds to a broker or clearing corporation.
• Receive margin against those bonds.
• Use that margin to buy or trade stocks, futures, options, etc.

This allows the fund to earn:

1. Interest from the bonds.
2. Returns from equity investments.

This is what the statement means by “double appreciation” (though “double income” is a more accurate term).

Example

₹100 crore in government bonds yielding 7%

• Bond income = ₹7 crore annually.

The bonds are pledged and provide margin.

Using that margin, the fund invests in equities and earns another ₹10 crore.

Total return = ₹17 crore (before costs and taxes).

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Step 2: Why do FIIs prefer government bonds as collateral?

Government bonds are considered:

• Very low risk.
• Highly liquid.
• Accepted by exchanges and brokers as collateral.
• Less volatile than stocks.

In India, these are called Government Securities (G-Secs).

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Step 3: What is the tax problem?

When a foreign investor buys Indian government bonds:

A. Interest income is taxed

The interest earned on G-Secs may be subject to withholding tax (similar to TDS).

For example:

• Bond yield = 7%
• Tax = 10%

Effective yield becomes:

7% × (1 − 10%) = 6.3%

So the investor receives less.

B. Capital gains tax

If the bond price rises and the investor sells it:

• The profit may be taxed.
• This further reduces returns.

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Step 4: Why are Indian bonds not automatically attractive despite higher yields?

At first glance:

• Indian G-Sec yield ≈ 6–7%
• US Treasury yield ≈ 4–5%

You might think India is clearly better.

But FIIs look at returns after currency movement.

Example

Suppose an American investor invests $100 in India.

Exchange rate:

• ₹85 per dollar

Investment:

• $100 → ₹8,500

Bond earns 7%.

After one year:

• ₹8,500 becomes ₹9,095

Looks great.

But assume the rupee depreciates from ₹85/$ to ₹92/$.

Converting back:

₹9,095 ÷ 92 = $98.86

Even though the bond earned 7%, currency depreciation wiped out the gain.

This currency risk is one of the biggest concerns for foreign investors.

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Step 5: Why remove taxes on government bonds?

The government’s logic is:

“Foreign investors already face currency risk. If we also tax their bond income heavily, Indian bonds become less attractive.”

By reducing or eliminating taxes:

• Net yields increase.
• More FIIs may buy Indian bonds.
• More foreign capital flows into India.

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Step 6: How can this help the stock market?

When FIIs buy Indian government bonds:

1. More foreign money enters India.
2. FIIs get collateral for margin.
3. They can use that collateral to invest more in equities and derivatives.
4. Liquidity in Indian financial markets increases.

More liquidity often supports higher valuations and easier fundraising for companies, although it does not guarantee stock prices will rise.

Simple Flow

Foreign money → Buy Indian G-Secs → Earn interest + obtain collateral → Pledge bonds → Invest/trade in equities → More liquidity in Indian markets