After discussions, RBI will formulate a framework to raise the investment limit for such investors in government debt securities, which will be pegged to the rupee against the current practise of linking it to the dollar, he said.
"The overall goal of this medium-term framework will be to enlist FPIs in market development within prudential limits which we set even as they are attracted by the rates available in domestic bonds," Rajan told reporters at the customary post-policy press conference here today.
The proposed framework, expected by next month, will include a target for what fraction of the sovereign bond market will be constituted by FPIs in the medium-term.
It will also consist of an announcement of staggered changes in limits every six months, with limits being released on a monthly or quarterly basis on which the decision is yet to be taken, the Governor said.
"Limits will be specified in rupees so that they do not vary with exchange rate movements," Rajan added.
The framework will create space for participation of different kinds of investors which include long-term investors such as pension funds and sovereign wealth funds, as well as more usual medium investors and importantly those coming through international central security depositories such as Euroclear and Clearstream, he added.
The Governor said once the framework with higher caps is decided, the RBI will wait for suitable market conditions including possibly greater certainty about the US Fed actions and appropriate liquidity conditions in the domestic markets before making a public announcement on the framework.
Currently FPIs can invest up to USD 31 billion in government bonds and an additional USD 20 billion in other debt instruments. Both these caps are almost fully exhausted and foreign investors have been calling for a higher limits.
The government had earlier said the cap on government bond holdings by FPIs could be increased in the first half of the current fiscal. RBI has barred FIIs from investing in short-term debt to encourage long-term flows and reduce dependence on hot money.
It hasn't allowed fresh foreign investment in government bonds since raising the ceiling to USD 30 billion in 2013. The US Fed is expected to begin raising its near zero interest rates after nine years as early as in September or latest by December this year, which may lead to a flight of capital from the country destabilising the external accounts.
Expecting turbulence, the RBI has been shoring up the forex reserves which currently stands at around USD 354 billion. Since March 2014 alone, the RBI had ramped up the forex reserves by USD 105.8 billion.