Strategic Management and Corporate Finance · Foreign Funding - Instruments, Laws and Procedures

Foreign Portfolio Investment and Masala Bonds

Q: What is the difference between FDI and FPI?

FDI is a lasting investment with an element of control or management influence. FPI is a passive holding in listed securities for returns. If a single FPI reaches the 10% limit and does not divest the excess within five trading days, the whole holding is reclassified as FDI, subject to the sector's FDI policy.

Q: What are FPI categories?

SEBI groups FPIs into Category I, II and III by risk. Category I is the lowest risk, such as government-related investors. Category III covers the rest. Check the current regulations for exact lists.

Q: What are masala bonds?

They are bonds issued outside India but denominated in Indian rupees. The investor bears the currency risk. They are raised under the ECB framework.

Q: What is the FPI investment limit in an Indian company?

One FPI with its investor group must stay below 10% of the total paid-up equity capital, measured on a fully diluted basis. The excess must be divested within five trading days, or the holding is reclassified as FDI. All FPIs together are capped by the sectoral cap or the company's lower limit.

Updated 11 October 2026 · Fact-checked

Foreign Portfolio Investment (FPI) is investment by registered foreign investors in listed Indian securities without control of the company. Masala bonds are rupee-denominated bonds issued overseas, so the investor bears the currency risk. In answers, state the instrument, regulator, limits, and conclusion on who bears risk.

Understand Foreign Portfolio Investment and Masala Bonds

Foreign funding reaches an Indian company in two broad ways: equity-like investment and debt. FPI sits on the equity and debt market side. A foreign investor buys listed shares, bonds or units through the market. The aim is returns, not control or management.

FDI vs FPI. FDI is a long-term investment with a lasting interest and usually a say in management. FPI is a portfolio holding, often short or medium term, in listed securities. FPI money can enter and leave quickly, so it is called 'hot money'. FDI is more stable.

FPIs register with a Designated Depository Participant (DDP) under the SEBI (Foreign Portfolio Investors) Regulations. The regulations group FPIs into Category I, Category II and Category III by risk. Category I covers low-risk investors such as government and government-related bodies and regulated entities like central banks and sovereign funds. Category II covers regulated broad-based funds and similar entities. Category III is everyone else. Check the current regulations for the exact lists before you write them.

Investment limits come from FEMA rules, with SEBI regulations on top. The key idea: the combined holding of all FPIs in an Indian company is capped at a sectoral cap or the cap in the company's own approved limit. A single FPI, with its investor group, must also hold below 10% of the total paid-up equity capital of the company, measured on a fully diluted basis. If the holding reaches or crosses this limit, the excess must be divested within five trading days. If it is not, the entire holding is reclassified as FDI. That is allowed only if the sector permits it and the FDI conditions are met. Always state both limits, the fully diluted basis and the reclassification rule.

Masala bonds are bonds issued outside India but denominated in Indian rupees. The foreign investor funds in rupees and bears the exchange-rate risk, not the Indian issuer. This is the main selling point. Issuers raise them under the External Commercial Borrowings framework, so the end-use and eligibility rules of ECB apply. The issuer repays in rupees, so its foreign exchange exposure is removed.

In Indian exams, link the instrument to the company's need: a company that wants foreign capital without currency risk prefers masala bonds, while one that wants long-term stable funding prefers FDI.

Key rules to remember

Single FPI limit: One FPI (with its investor group) holding < 10% of the total paid-up equity capital of an Indian company, on a fully diluted basis; Divest the excess within five trading days. Otherwise the whole holding is reclassified as FDI, which is allowed only if the sector permits and FDI conditions are met. Check the current rule before writing the figure.
Aggregate FPI limit: Total FPI holding ≤ sectoral cap (or a lower limit set by the company); The cap depends on the sector. Name the rule, then apply the sector cap given in the question.
FPI categories: Category I (lowest risk) → Category II → Category III (highest risk); Classification is by risk and regulation status of the investor.
Masala bond currency risk: Currency risk = borne by the investor, not the Indian issuer; Issued overseas, denominated in ₹, and governed by the ECB framework.
FDI vs FPI test: Lasting interest and control → FDI; passive listed holding → FPI; Use this to classify any fact pattern.

How to solve Foreign Portfolio Investment and Masala Bonds questions

Use this method for any case-based question on FPI or masala bonds.

1Identify the instrument: shares or bonds bought by a foreign investor in the market (FPI) or a rupee bond issued overseas (masala bond).
2Name the governing law and regulator: FEMA for limits and ECB framework, and SEBI for FPI registration.
3State the investor category or issuer eligibility, and the registration route through a DDP for FPIs.
4Apply the limits: single FPI under 10% and the aggregate sectoral cap, with the figures given in the facts.
5Compute the holding as a percentage of paid-up capital and compare it with each limit.
6Decide the consequence: within limit, reclassification as FDI, or a breach that needs correction.
7For masala bonds, state who bears currency risk and check the ECB-type conditions.
8Write a clear conclusion in one sentence with a practical compliance point.

Quickest way: Three-check shortcut

When to use it: Use when time is short and the question gives numbers about a foreign holding.

Compute the holding as a percentage of total paid-up equity capital, on a fully diluted basis.
If one FPI group is below 10%, it stays FPI. If it is 10% or more, the limit is breached. The excess must be divested within five trading days, or the whole holding is reclassified as FDI (only if the sector permits and FDI conditions are met).
Compare the combined FPI holding with the sector cap. Then write the conclusion with the rule name.

Common mistakes in Foreign Portfolio Investment and Masala Bonds

Treating FPI and FDI as the same
Both bring foreign money into India.
Fix: Use the control and lasting-interest test, and the 10% line for a single FPI.
Saying the Indian issuer bears currency risk in masala bonds
Students assume foreign borrowing always carries exchange risk.
Fix: Remember the bond is in rupees, so the investor bears the risk.
Applying the 10% limit to all FPIs together
The single-FPI and aggregate limits are confused.
Fix: Write them separately: single FPI under 10%, aggregate up to the sectoral cap.
Calling masala bonds issued in India
The word 'rupee' suggests a domestic issue.
Fix: State that they are issued outside India but denominated in rupees.
Skipping the conclusion in case answers
Students stop after listing rules.
Fix: Always end with provision, analysis and a clear conclusion on the facts.

Worked examples

Example 1

Alpha Funds, a registered FPI, holds 6,00,000 shares of Bharat Foods Ltd, which has 80,00,000 paid-up equity shares. It buys 3,00,000 more shares. Is Alpha still within the single-FPI limit? Assume no other FPI in its investor group and that the fully diluted capital equals the paid-up capital.

Show the solution

Total holding after purchase = 6,00,000 + 3,00,000 = 9,00,000 shares.
Holding % = 9,00,000 ÷ 80,00,000 × 100 = 11.25%.
The single-FPI limit is below 10% of total paid-up equity capital on a fully diluted basis.
11.25% is above 10%, so the limit is breached.

Answer: Alpha holds 11.25%, which breaches the single-FPI limit. Alpha must divest the excess within five trading days. If it does not, the entire holding is reclassified as FDI. That is allowed only if the sector permits FDI and the FDI conditions are met.

Example 2

Sundaram Infra Ltd wants to raise ₹500 crore overseas by issuing bonds. The CFO wants the company to avoid exchange-rate risk. Which instrument suits, and who bears currency risk?

Show the solution

Identify the need: foreign funds with no currency risk for the company.
Masala bonds are issued outside India but denominated in rupees.
Principal and interest are paid in rupees, so the company's liability is fixed in ₹.
The foreign investor converts its currency into rupees, so the investor bears the exchange-rate risk.
The issue is made under the ECB framework, so eligibility and end-use conditions must be met.

Answer: Masala bonds suit Sundaram Infra. The investor bears the currency risk, and the company must comply with the ECB framework conditions.

Exam tips

Write the FPI vs FDI distinction as a short comparison in two or three lines.
Always show the percentage calculation when the question gives share numbers.
Verify current limits and category lists from the latest SEBI and FEMA text before the exam.
For masala bonds, mention three points: issued overseas, rupee-denominated, investor bears currency risk.
End with a conclusion and one compliance point such as DDP registration.

Practice questions from Foreign Funding - Instruments, Laws and Procedures