Bangalore: Indian Firms would attract additional inflows of $2 billion a year in the medium term, after the government has reduced the withholding tax on foreign loans to 5 percent from 20 percent. This will help to lower the foreign loans for Indian firms.

According to Barclays Capital, the government's decision to decrease the withholding tax on foreign borrowings could generate an additional $.2 billion per year inflow in the medium term - a significant input against annual balance of payments forecasts (around $.15 billion deficit).

However, the bigger and immediate impact of such kind of initiative would be the revival of the investor sentiment towards India, as the move will be seen as an indication of the government's resolve to continue to take positive steps to revive investor sentiment, Barclays Capital said in a note.

Continuing with the slew of reforms initiated by the UPA government, finance minister P Chidambaram last week cut the withholding tax on overseas borrowings to 5 percent  from 20 percent and approved the Rajiv Gandhi Equity Scheme to attract more investment and supress demand for gold.

"While the political stalemate continues, the recent developments indicate that the government is unlikely to face near term threats, given the support of

the Samajwadi Party," Barclays Capital said.

The report further noted that the government is "unlikely" to completely roll-back its recent measures.

While announcing the reduction of withholding tax on overseas borrowings, Chidambaram had said that appropriate amendments would be made in the Income Tax Act, 1961, under which the interest income of a non-resident investor will be taxed at reduced rate of 5 percent instead of 20 percent.

The reduced tax will apply to funds borrowed between July 1, 2012 and June 30, 2015, Chidambaram had said, adding this would enable domestic companies to access cheaper funds from abroad as the tax on overseas borrowings has been lowered.

"It is to encourage overseas borrowings. Interest rates are low abroad and these low cost funds can come to India," Chidambaram had said.

According to Barclays Capital, the cut in withholding tax could reduce the cost of external borrowing by 75-100 basis points for companies, assuming current borrowing costs at Libor + 500 basis points).

(With Agency Inputs)