AsianFin -- China will begin taxing interest income on government and financial institution bonds, ending a decades-long exemption that has been a key pillar of its debt market appeal.

Starting August 8, Beijing will resume collecting value-added tax (VAT) on interest earnings from bonds issued by central and local governments, as well as financial institutions, the Ministry of Finance said in a statement Friday. Bonds issued before that date — including any subsequent reopenings of those notes — will remain exempt.

The surprise policy shift is poised to lift borrowing costs for new debt, reversing a tax-free status that has been in place since the 1990s. The move has already sent investors scrambling to lock in existing bond holdings before the tax kicks in, driving yields lower in the secondary market.

Analysts warn the measure could dampen demand for new sovereign and policy bank debt, particularly at a time when the government is ramping up bond issuance to fund infrastructure and economic stimulus.