Govt considers raising debt limits for FIIs: source

An employee uses an electronic machine to check a currency note inside a bank in Allahabad December 16, 2011.

NEW DELHI/MUMBAI (Reuters) - The government is considering a proposal to raise the ceiling on foreign investments in government and corporate bonds by $5 billion each, a senior finance ministry official said, as the country looks to increase vital capital flows.

The official did not specify which debt categories would be affected, and whether the proposal involved raising the overall debt limits for foreign investors or entail reshuffling limits between the different debt categories. The official declined to be identified as they are not authorised to speak to media.

India caps the amount that foreign institutional investors (FIIs) can buy into domestic debt at $66.5 billion, which is distributed through a number of categories across government, corporate and infrastructure debt, some of which impose tenor or lock-in restrictions.

Easing India's complicated rules on debt investments for foreign institutional investors (FIIs) has been one of the measures expected by markets, as the country looks to boost capital inflows to fund a wide current account deficit (CAD) that poses a key vulnerability.

"An increase in FII debt limit will help finance CAD somewhat," said Shubhada Rao, chief economist at Yes Bank said, adding that markets would need to see details about which tenors and sectors are affected.

As a result of the different rules, foreign investors have traditionally steered towards the unrestricted categories of government and corporate debts.

Debt limits in government bond and corporate bonds without any investment restrictions, called the old category bond limits, have seen strong demand from FIIs.

However, some other categories attract little demand, including the $25 billion limit allocated for infrastructure corporate bonds which impose an unpopular lock-in restriction.

The Reserve Bank of India has previously opposed raising the debt limits, given its reluctance to have foreign investors hold excessive domestic debt as it looks to maintain macro economic stability.

The government has already started the process of simplifying the process of buying into Indian debt, including earlier this month allowing foreign investors to re-invest up to 50 percent of their debt holdings from the previous calendar year.

India needs to increase its capital flows to plug a current account deficit that widened to a record high of $21.76 billion in the January-March quarter, and was cited as key reason behind the rupee currency's fall to a record low in mid-June.

Although the gap narrowed to $16.55 billion in the June quarter, allowing the country to run a small balance of payments surplus, it still remains above analysts' comfort levels.

The government has also sought to attract sturdier foreign direct investments, opening up the multi-brand retail and aviation sectors earlier this year.

(Reporting by Rajesh Kumar Singh and Archana Narayanan; Writing by Rafael Nam; Editing by Jacqueline Wong)