As of Friday, foreign investors owned R886 billion worth of government debt, or 89% of the full available allocation, following a surge in inflows due to improving government finances and optimism about Narendra Modi's recent election as Prime Minister.
Once the limit reaches 90%, foreign investors are only allowed to buy debt under a more cumbersome auction bidding system.
"We will certainly look to raise the limit once it is closer to exhaustion," said one of the officials involved in the process, adding the government could allow foreign investors to invest another $5 billion in the local debt.
The finance ministry will decide on the matter after consultations with the Reserve Bank of India and capital markets regulator Securities And Exchange Board of India, the sources said, without providing a specific timeline.
The sources declined to be identified as they were not authorised to talk to the media about the plans.
Finance secretary Arvind Mayaram told domestic news agency Cogencis that the government had no plan to raise investment limits for now. "Why would we hike the limit just because they have reached the limit...The limits are set because of due considerations. At the moment there is no thought in changing the limits," Mayaram was quoted as saying to Cogencis.
Mayaram did not reply to requests for comments from Reuters.
India's 10-year benchmark bond yield fell 3 basis points to 8.49% after the Reuters news, but the yield then rose to 8.57% on the Mayaram comments to Cogencis. It closed at 8.51% on Friday.
Foreign investors bought a net $425.43 million worth of debt on Friday, their biggest daily purchase since May 23 and bringing their total this year to $8.6 billion.
Under current rules, India allows all types of foreign investors to buy up to $20 billion of government debt, although the dollar amount depends on the exchange rate.
The total foreign investment limit is $30 billion, with the remaining $10 billion for investors such as foreign central banks, sovereign wealth funds, insurance funds and pension funds.
Investors have been expecting the government would raise the allocation for foreign investors once the 90% mark was reached.
Last year, New Delhi had said it would increase the foreign investment cap in government bonds, depending on demand and economic requirements. However, it said the annual enhancement would be within 5% of the gross annual borrowing of the federal government, excluding buybacks.
But the government is still reluctant to fully free up limits for its debt markets, an objection that has slowed down the process of inclusion into global benchmark indices such as those run by JP Morgan.
The current limit means foreign investors own only about 5% of the total Indian government bond market.
The country last raised the amount of government debt that foreign investors can buy by $5 billion in June last year.
The renewed interest comes on the back of hopes that Modi will unveil big reforms, such as accelerating investments and clearing infrastructure projects, to boost an economy that posted two consecutive years of below 5% growth the worst slowdown in more than a quarter century.