Budget 2026: Markets cautiously eye FII returns amid STT hike

Budget 2026 STT Hike Sparks Market Jitters

The Union Budget 2026, presented by Finance Minister Nirmala Sitharaman, has left stock markets in a state of cautious anticipation, particularly over the sharp increase in Securities Transaction Tax (STT) on futures and options trading. The STT on futures jumped from 0.02 percent to 0.05 percent, while rates on options premium and exercise rose to 0.15 percent from previous levels. This move, aimed at curbing speculative trading, immediately triggered a market downturn, with benchmark indices closing lower on the budget day. Foreign institutional investors (FIIs) offloaded equities worth hundreds of crores, adding to the bearish sentiment that had already been brewing due to global factors like rising US yields.

On February 1, FIIs sold shares amounting to Rs 588 crore, while domestic players also trimmed positions by Rs 682 crore. Traders now face higher costs—for instance, selling Rs 1 lakh worth of futures incurs Rs 20 in STT instead of Rs 12.50 earlier, and a Rs 10,000 options contract sale now carries a Rs 10 tax up from Rs 6.25. This has raised concerns about India's appeal compared to other Asian markets, especially with Rs 41,000 crore in FII outflows already recorded in January alone.

Government's Rationale and Investor Reactions

The government defends the STT hike as a tool to manage systemic risks in the booming derivatives market and discourage high-risk speculation by retail traders. Officials described it as a "course correction" to promote sustainable investing over short-term churning. STT collections from derivatives have surged, estimated at Rs 44,867 crore from April 2025 to mid-January 2026, with projections hitting Rs 73,700 crore in FY27. Yet, investors worry this could reduce market depth and liquidity, potentially spilling over to cash equities.

Analysts point out that the budget missed chances to ease capital gains taxes or offer direct incentives for foreign inflows, compounding pressures from elevated gross market borrowings set at Rs 17 lakh crore—higher than the anticipated Rs 16-16.5 lakh crore. This has fueled fears of rising bond yields, further straining sentiment. "The increase in STT on derivatives will raise trading costs, acting as a short-term deterrent for FIIs, especially derivative-focused funds. With existing outflows due to global pressures, this diminishes post-tax profits and India's edge over peers," said Nitant Darekar, Research Analyst at Bonanza.|quote|

Glimmers of Hope Amid Cautious Outlook

Not all news is grim. The budget includes market-friendly steps like expanding access for non-resident Indians (NRIs) to Indian equities, raising individual investment limits to 10 percent from 5 percent and the overall cap to 24 percent from 10 percent. This could attract stable, long-term capital and boost liquidity. Capital expenditure plans, at Rs 12.2 lakh crore with an 18 percent rise in defence spending, align with expectations, signaling continued infrastructure push.

Experts like Siddharth Maurya note that while the initial reaction was negative due to higher taxes and no big reliefs, medium-term stability could emerge from fiscal discipline and potential reforms. Markets have historically shrugged off budget surprises, with domestic flows providing a buffer. However, reversing FII exits will hinge on earnings growth, valuation corrections, and broader economic momentum. India's premium valuations—still 55-60 percent over emerging market peers—add to the caution.

In summary, Budget 2026's STT hike has heightened trading costs and spooked investors, prompting watchful eyes on FII behavior. Balancing speculation curbs with NRI access expansions and capex continuity offers some optimism, but sustained foreign returns depend on global cues and policy follow-through.