At a time when all eyes are on foreign portfolio investor (FPI) flows into equities, inflows into India's debt market have quietly gathered momentum. Since FY25, FPIs have pumped about $19.3 billion into Indian debt securities, highlighting the growing role of bond markets as a source of foreign capital amid volatile equity flows and pressure on foreign direct investment (FDI).

In sharp contrast, FPIs have pulled out about $44.6 billion from Indian equities since FY25, marking one of the largest foreign capital exoduses in the country's market history.

According to an analysis by DSP Mutual Fund, the bulk of these debt inflows - around $11.8 billion - has come through the fully accessible route (FAR), which allows overseas investors unrestricted access to specified government securities. The route has emerged as the dominant channel for debt investments following India's inclusion in global bond indices.

"The Debt-FAR route, which allows FPIs fully open access to specified government securities, has become the dominant channel. Since FY25, India has received around $19.3 billion of FPI debt inflows, of which $11.8 billion came through Debt-FAR," DSP Mutual Fund said in a report.

The report noted that debt inflows have historically been a significant component of foreign capital entering India. Since FY99, India has attracted $154.4 billion in FPI equity flows and $95.5 billion in debt flows, with debt accounting for 62% of cumulative equity inflows and nearly 38% of total FPI flows.

March 2025 marked the strongest month for debt inflows, with FPIs investing $4.3 billion in Indian debt securities, including $3.3 billion through the FAR route.

Tax relief on capital gains could further boost debt inflows

DSP Mutual Fund said the government's reported proposal to remove capital gains tax on investments in government securities could further enhance the attractiveness of Indian debt for global investors while supporting the Centre's borrowing programme.

"If capital gains tax on government securities is removed, FAR can evolve into a quasi-open, tax-efficient avenue for global investors to access Indian debt markets," the report said.

Historically, the strongest phase for debt inflows occurred between March 2010 and February 2015, when India received $46.5 billion in FPI debt investments. The report found that foreign investors tend to favour periods when high nominal bond yields are accompanied by positive real returns.

While periods when 10-year government bond yields were above 8% attracted $35.8 billion of inflows, phases in which real yields exceeded 2% generated a much larger $51.6 billion in debt investments. India's current real bond yields remain comfortably above that threshold, the report noted.

Between March 2023 and February 2026, India attracted $34.5 billion in FPI debt inflows at an average 10-year government bond yield of 6.8% and a real yield of 2.8%.

Debt inflows key to stabilising India's external account

The mutual fund house believes debt inflows can play an increasingly important role in stabilising India's external account. Apart from helping finance the current account deficit, sustained debt inflows can ease pressure on the rupee and provide policymakers with an additional buffer during periods of global uncertainty.

The report highlighted four key factors that drive foreign debt investments: positive real yields, stable currency expectations, easy market access, and supportive global risk sentiment. India currently scores well on the first three parameters, with attractive real yields, improved rupee valuation metrics, and an established FAR framework.

"Debt flows may not fully substitute for long-term equity and FDI inflows, but they can serve as an important ancillary source of capital in a challenging global environment," the report said.