Sovereign Debt vs Corporate Debt: SEBI’s New FPI Rules and the Emerging Investment Landscape

Introduction

In the ever-changing economic scenario where global capital movements dictate the pace of economic growth, the Securities and Exchange Board of India (SEBI) has geared itself up to lay down the lines on which foreign portfolio investment should take place in India. A paradigm change is in the process- SEBI has suggested ease in compliance standards for foreign investors who want to invest in government securities.[i] The proposal is a strategic step to bring in inflows into the sovereign debt market of India and to get the financial system in shape and par with the best global practices and expectations of the investors.

Although enabling a few to traditionally regard it as a riskier asset than sovereign debt with better returns and almost no governmental support, corporate debt has now carved for itself the identity of a rival asset class. The comparative study of the two worlds of sovereign debt and corporate debt becomes significant when the changes to the regulation being offered by SEBI are proposed, in view of institutional and foreign investors who are dealing with issues and regulations of compliance, returns, and contractual ramifications.

Understanding Sovereign and Corporate Debt

1. What do you mean by Sovereign Debt?

Sovereign debt enters the market whenever a national government issues bonds. They are more commonly known as Government Securities (G-Secs), Treasury Bills, and State Development Loans (SDLs) in India.[ii] They are guaranteed by the full faith and credit of the government and thus are quite a low-risk investment.

Features:

• Government supported.
• A low interest rate since there is less risk.
• Usually, they are denominated in local currency (but there are those in foreign currency).
• Targeted by traders on open markets, and usually, they are targets of other interest rates.

2. What is the Corporate Debt?

Corporate debt is debt issued by private or publicly-traded corporations to finance their different business operations, including expansion, acquisition or re-structuring. Some instruments are Debentures, commercial papers and corporate bonds.

Features:

• More than the yields of the sovereign debts.
• Are at default risk according to the credit worthiness of the issuer.
• Needs ratings and disclosures of credit.
• It may either be secured (by assets) or unsecured.

Comparative Analysis: Sovereign vs Corporate Debt

SEBI’s New Proposal: Relaxed FPI Norms for Sovereign Debt

India has been trying to attract long-term foreign capital into its debt markets.  Although equity markets were always the leaders in the FPI inflow, recently, the government is promoting more and greater activity in the bond market, particularly sovereign bonds.[iii]

Important Recommendations of SEBI:

1. Lighter Compliance System of Sovereign Bond Investors:

• SEBI has suggested softening the KYC and registration requirements of the FPIs investing only in G-Secs, T-Bills and SDLs.[iv]
• This manifests itself in the form of limited documentation and a faster onboarding process.

2. Environment to Set up Alternate FPI Category:

• An additional sub-category of FPI norms so that the definition of sovereign-only investors is clear and allows simplification of regulation and reporting.

3. Case in favour of India’s inclusion in the Global Bond Index:

• Convergence of the rules that drive the bonds in the country and those of the global economy is also a contributing factor that causes India to be included in certain global index rankings, such as JPMorgan-EM global aggregate bond index and Bloomberg global aggregate bond index.[v]

4. Increasing the Liquidity and Depth of the Market:

• The move will deepen market liquidity, and market yield volatility is expected because it will make access for foreign investors easier.

Implications of SEBI’s Proposal

For Investors:

• Fewer Barriers to Entry: At least as far as pension funds, sovereign wealth funds and long-term institutional investors are concerned.
• Improved Risk Management: It also comes with improved risk management, whose level of clarity and transparency in the sovereign debt instruments is high.
• Increased Participation: The proposal will attract billions of foreign funds, which will improve the level of height and liquidity in the market.

For Economy:

• Fiscal Policy: A Greater fiscal policy will enable the government to manage deficits a lot more as funds will be more available.
• Currency stability: Long-term FPI inflow enhances the stability of the Indian Rupee because of lesser reliance on hot money.
• Capital Market Development: The capital market of the country will have an effective sovereign bond capital market to enable it to have a better price and monetary transmission.

Impact on Corporate Debt Market

Whereas the sovereign debt will be able to enjoy the relaxed norms, high scrutiny, and relatively low inflow can be put on the corporate debt, especially by the risk-averse and foreign investors. This deviation can bode a number of consequences:

• Yield Differentials Can Increase: With the rising demand for sovereign debt, the corporate bonds might have to pay heavier yields.
• Corporate Funding Limits: Corporates might have a problem raising money unless it is kept in check by local investors.
• Improved Corporate Governance: This will introduce competition on funding that may encourage corporates to become more transparent and creditworthy.

Why the Emphasis on Sovereign Debt Now?

Some of the reasons behind the present regulatory trend include:

• Macro Stability: India’s economy has remained strong since the outbreak of the pandemic, but it has been having stability in growing GDP, stable inflation rate and improving fiscal indicators.[vi]
• Currency Confidence: What has helped the rupee is that, despite being the most volatile, it has had unsteady strength when viewed in comparison to the other currencies in the emerging economies.
• World Bond Index goals: In the event of its inclusion, India could attract more than $20-30 billion in passive flows alone.[vii]
• Geopolitical Neutrality: the neutral stance of India, as a non-aligned state, appeals to global money leaders in an environment where the international economy operates along ideological lines.[viii]

Risk Assessment in Light of SEBI’s Proposal

The proposed move of SEBI to relax the compliance regime on FPIs with regard to sovereign debt has set new contours of risk analysis in Indian debt markets. There will be a comparative framework as well to judge the differences of these proposals with regard to the areas of sovereign and corporate debt in terms of risks and compliance.

Sovereign Debt:

The framework proposed by SEBI reduces the entry barrier to FPIs significantly by making the compliance procedures and KYC norms less restrictive, thus enabling a faster mode of getting access to government securities. Nevertheless, the sovereign instruments are not devoid of risks that are related to the macroeconomics of the issuer, like fiscal slippage, interest rates, and inflation volatility.[ix] The currency risk is very serious, and those investors who transfer foreign returns to India in a foreign currency are particularly vulnerable to the fluctuation of rupee.

Corporate Debt:

Conversely, the corporate bonds still seem to exist at the higher compliance grounds requiring compulsory credit ratings, sectoral limits, and investment limits. FPI concerns over credit risk in the category have increased due to high public profile defaults such as the IL&FS and DHFL defaults.[x] SEBI has not submitted similar types of relaxations in case of corporate debt investments to keep the regulations more stringent.

Commercial Contracts: How They Will Evolve

The new measures, which SEBI is proposing, will restructure the drafting of commercial contracts to govern their cross-border investment. Legal documents such as investment mandates, fund management agreements, and subscription documents will be modified to capture the difference between sovereign and corporate debts as announced in the new FPI regime.

1. Investment Mandates and Allocation Agreements (IMAs)

The current situation will be that contracts will specify the investment limits of various categories of sovereign and corporate debts. It will have a part to fulfil the regulatory requirements of the FPI investors, which will comprise only sovereign conditions, e.g. the condition of eligibility and information standards to be generated.[xi]

2. Provisions of Risk Management

Hedging provisions against foreign exchange (FX) will further include provisions on sovereign risks of exposures. The contracts can also have improved definitions of counterparty risk and exit rights, especially as a response to liquidity differentials within government and corporate bonds.[xii]

3. KYC and the Due Diligence

Sovereign-only portfolios will carry less onerous documentation, whilst internal fund arrangements will pool different investors to suit the SEBI classification. This separation would most likely be institutionalized as independent annexures or side letters.[xiii]

4. Dispute Resolution and Jurisdiction

Since there will be a higher exposure to Indian sovereign debt, arbitration and dispute resolution clauses might create an India-centric bias, including relevant jurisdiction, in the form of the Mumbai Centre of International Arbitration (MCIA).

How Will the Indian Debt Market Transform?

The proposed changes to the FPIs by SEBI may be a structural transformation to India in terms of its debt market, as it shifts towards the approach to the global capital markets. The major transformation effects attained are:

1. Creation of a Better Yield Curve

More FPI involvement in assets such as sovereign bonds will enhance yield discovery, which establishes a stable yardstick to pricing the corporate debt in addition to the transmission of policies carried out by policymakers.

2. The new enhanced infrastructure financing

As the foreign capital enters the government securities, the domestic banks and NBFCs have an opportunity to reshape their capital towards long-term lending in infrastructure and corporate banking, thereby alleviating the shortage of funds.

3. Market Discipline and Pricing Efficiency

The increased participation of FPI will promote deeper liquidity, proper price-setting of risks, and reduce the proportion of government issuance in overall debt issuance, shifting to a comparatively market-based debt environment.

4. Growth of Passive Debt Products

Regulatory clarity and reduced risk in sovereign debt could lead to the launch of ETFs, REITs and InvITs on debt to allow passive bond investors a pleasantly simple entry into Indian bond markets.[xiv]

Challenges Ahead

Though the idea appears to be good, it will be executed so that it will distinguish itself as a successful proposal.

Operating Risks: Hiring, monitoring of compliance, and off-boarding should be effective even with the relaxation of norms.

Regulatory Arbitrage: When a similar situation occurs between sovereign and corporate FPI regulations, an overallocation or distortion may occur.[xv]

Investor awareness: FPIs need to be sensitised on the tax, compliance and dynamics of risk-return of sovereign exposure and corporate exposure.

Strategic Recommendations to Stakeholders

In order to make the best out of the transforming FPI structure of SEBI, major stakeholders need to act separately:

For Investors

Rebalancing Portfolios: Take advantage of the regulatory incentives by diverting to the increased allocation of the instruments of the sovereign debt.

Lawful Measures in the Area: Liaise with local strategic advisors in the clarification of tax, repatriation, and regulatory peculiarities.

For Corporates

Increasing the transparency: This will include better disclosures of credit as well as enhancing financial reporting to ensure that risk-averse FPIs invest.

Funding Sources: Introduce experimentation on sources of funds such as equity offerings and External Commercial Borrowings (ECBs) such that there is reduced reliance on the domestic debt markets.

For Policymakers

Secure Policy Certainty: Policy should be consistent and clear, so that this will increase the level of investor confidence.[xvi]

Promote Corporate Debt Markets: Back off the imbalances by encouraging the reforms to increase the attractiveness of corporate bonds.

Reform Credit Ratings: The systems of reforming credit ratings should be more potent in credibility to the private debtors.[xvii]

Conclusion: A New Beginning to Indian Capital Markets

The FPI in the sovereign debt is a critical regulatory shift presented by SEBI. It is regarded as an indication of the fact that India is ready to take a larger role in the global capital markets and present a secure route towards achieving long-term foreign investments.

Despite the fact that securitizing and entering into sovereign debt is safer and simpler to incorporate into a portfolio, corporate debt plays a significant role in high-yielding portfolios. Among the investors, regulators, and the issuers, there ought to be a balance between compliance and the risk and returns.

The moment India puts in full drive on the path of greater economic globalization, the differentiation between sovereign debt and corporative debt would cease to matter as far as risk and reward are concerned and would instead become a calculative trade-off for the immediate investment objective, macroeconomic stability, and the higher framework of what laws demands.

Reference(S):

Primary Sources

1. Securities and Exchange Board of India, Discussion Paper on Ease of Doing Business for FPIs in Government Securities (Apr. 2025), https://www.sebi.gov.in/reports-and-statistics/reports/apr-2025.
2. Securities and Exchange Board of India, Master Circular for Foreign Portfolio Investors on KYC, AML, and UBO Requirements (Mar. 2024), https://www.sebi.gov.in.
3. Reserve Bank of India, Annual Report 2024–25 (June 2025), https://www.rbi.org.in.
4. Reserve Bank of India, Financial Markets Report Q1 2025 (2025), https://www.rbi.org.in.

Secondary Sources

1. International Monetary Fund, Capital Markets and Fiscal Risk in Emerging Market Economies, IMF Working Paper WP/24/118 (2024), https://www.imf.org/en/Publications/WP.
2. International Monetary Fund, Sovereign Debt and FPI Flows in Emerging Markets, IMF Working Paper WP/24/019 (2024), https://www.imf.org/en/Publications/WP.
3. World Bank, Currency Risk and Sovereign Bonds in EMEs, Policy Note No. 58 (2023), https://www.worldbank.org.
4. National Institute of Public Finance and Policy (NIPFP), Policy Brief on Regulatory Consistency and Arbitrage in Debt Instruments (Jan. 2025), https://www.nipfp.org.in/publications/policy-briefs.

[i] Securities and Exchange Board of India, Discussion Paper on Ease of Doing Business for FPIs in Government Securities (2025), https://www.sebi.gov.in.

[ii] Reserve Bank of India, Handbook of Statistics on Indian Economy,

https://www.rbi.org.in/scripts/AnnualPublications.aspx?head=Handbook%20of%20Statistics%20on%20Indian%20Economy.

[iii] JP Morgan, Emerging Markets Bond Index Inclusion Report (2025), https://www.jpmorgan.com.

[iv] SEBI, Operational Guidelines for FPIs (2025), https://www.sebi.gov.in/legal.

[v] Bloomberg, Global Aggregate Bond Index Methodology, https://www.bloomberg.com/professional/product/indices.

[vi] Reserve Bank of India, Monthly Bulletin (2025), https://www.rbi.org.in.

[vii] CLSA, India FPI Strategy Note (Apr. 2025).

[viii] Int’l Monetary Fund, Sovereign Debt and FPI Flows in Emerging Markets, WP/24/019 (2024),

https://www.imf.org/en/Publications/WP.

[ix] SEBI, Master Circular on Investment by FPIs, (2024), https://www.sebi.gov.in.

[x] India Ratings & Research, Corporate Bond Defaults in India: 2023–2025, (Apr. 2025), https://www.indiaratings.co.in.

[xi] Securities and Exchange Board of India, Discussion Paper on Ease of Doing Business for FPIs in Government Securities (2025), https://www.sebi.gov.in.

[xii] Int’l Monetary Fund, Sovereign Debt and FPI Flows in Emerging Markets, WP/24/019 (2024),

https://www.imf.org/en/Publications/WP.

[xiii] Baker McKenzie, Global FPI Compliance Guide (2024), https://www.bakermckenzie.com.

[xiv] Morningstar India, Passive Fixed Income Product Growth in Asia-Pacific, 2024, https://www.morningstar.in.

[xv] Securities and Exchange Board of India, Discussion Paper on Ease of Doing Business for FPIs in Government Securities (2025), https://www.sebi.gov.in.

[xvi] National Institute of Public Finance and Policy (NIPFP), Fiscal Policy and Capital Market Stability, Policy Brief (2024).

[xvii] Ministry of Finance, Report of the Committee on Strengthening the Credit Rating Framework in India (2024), https://dea.gov.in.