India’s FPI reforms open doors, but will foreign capital follow?

The Reserve Bank of India (RBI) relaxed investment limits for corporate bonds, and the Securities and Exchange Board of India (Sebi) has proposed easing access to government securities. Once implemented, these measures will potentially enhance foreign investors’ ability to access India’s corporate and sovereign debt markets.

“I would look at it more as a part of the series of reforms, which both RBI and Sebi are trying to bring in, to make sure that doing business in India is easier," said Madan Sabnavis, chief economist, Bank of Baroda.

A number of bonds are part of those global indices and a large amount of money was supposed to come in but hasn’t in the way “we had forecasted earlier," he said. “This is to tell foreign investors that if you want to come to India, there should not be any concern of regulatory hurdles."

Read this | Sebi plans regulatory breather for FPIs investing in sovereign bonds

The Indian government bonds were included in the JPMorgan Emerging Market Global Diversified Bond Index in June last year and Bloomberg’s emerging market bond index in January under the Fully Accessible Route (FAR), which allows unrestricted investments without caps. The securities will also be added to the $4.7 trillion FTSE Emerging Markets Government Bond Index in September this year. 

The inclusions were supposed to bring about $22 billion between June 2024 and April 2025. However, foreign investors have put in around $12 billion through the FAR route during the period.

Regulatory push for FPI flows

On 8 May, the RBI removed short-term investment and concentration limits from its rules governing foreign investments in corporate bonds. Five days later, on 13 May, Sebi proposed streamlining KYC norms and expanding the Fully Accessible Route (FAR), allowing easier access to government securities.

Foreign investors currently have three routes for investing in Indian bonds: the general route, the voluntary retention route (VRR), and the FAR. The primary difference in these three routes are around the relative flexibility available to foreign investors.

Read this | RBI gives foreigners more flexibility to invest in corporate bonds

FPIs have utilized 19.6% of their general investment limit for government bonds and 14.4% of their corporate bond investment limit as of 13 May, according to data from National Securities Depository Ltd (NSDL). That’s lower than 24.7% and 15.7% a year earlier, respectively, for government and corporate bonds.

Around ₹1.75 trillion has been allotted through the VRR of the total limit of ₹2.5 trillion.

FAR has emerged as a preferred entry route, with FPIs ploughing in net ₹45,323 crore through this route since January compared with ₹28,962 crore in entire 2024.

Attracting foreign capital into India’s debt markets has been a policy priority since 2020, according to Mayank Mundhra, vice-president-financial risk management and head of research at FPI-focused Abans Financial Services Ltd. “Currently, we are seeing a shift in debt allocation from developing to developed markets."

Yield gap

It currently does not make sense for FPIs to invest in Indian government bonds on a fully hedged basis as the dollar returns aren’t attractive, according to Suresh Darak, founder of financial platform Bondbazaar. Yield differentials between Indian and US 10-year bonds would need to widen for FPIs to see value, he said.

To be sure, the cumulative stock of FPI investments through the FAR route has nearly doubled to ₹2.9 trillion year-on-year as of 13 May, according to NSDL data.

The capital market regulator has promised to be proactive in easing market access.

In his first public address after taking over as Sebi chief, Tuhin Kanta Pandey emphasized the need for domestic and foreign capital to support India’s growth, saying, “We will be happy to engage with FPIs and AIF industry participants to address their difficulties and further rationalise regulations to promote ease of operation."

Read this | Opportunity knocks: India Inc should warm up to corporate bond issuances

Challenges persist

The corporate debt market continues to face issues, including limited secondary trading and the dominance of top-rated issuers. High currency hedging costs, often exceeding 4%, and inconsistent tax treatments across investor categories are significant deterrents. Large forex reserves, however, give regulators the confidence to liberalize access.

“This move by both Sebi and RBI seemed to be a part of a broader strategy to deepen the debt market and attract long-term foreign capital for infrastructure and fiscal needs," said Swatantra Bhatia, partner, accounting and outsourcing services at financial auditing and tax firm Forvis Mazars in India. "It aligns with India’s macro goals like rupee internationalisation, GIFT IFSC development, and reducing reliance on banks for long-term funding."

Bhatia, however, is cautious about the Indian debt market’s readiness for large-scale foreign participation. While government bonds are more mature, challenges remain in corporate bond liquidity, infrastructure, and trading depth; progress is evident, but further reforms are needed to support large-scale FPI inflows, he said.

Also read | Will lower tariffs lure back FPIs from other emerging markets?

According to Meeta Kurpad, partner at law firm Cyril Amarchand Mangaldas, dispute resolution needs to also to be strengthened to draw more FPIs. “Focus on the certainty of outcome and a time-bound approach to resolution of disputes and recovery is going to be a critical area of focus and interest for foreign investors," Kurpad said. “We will need to strengthen our judiciary to support this growth."