The announcement late Sunday follows a year of large losses on the Sensex, India's benchmark index. The new regulations will come into effect Jan. 15.
So far, foreign individuals have been limited to investing in the country's stock markets indirectly through mutual funds.
A government statement said the change is intended to help combat market volatility and increase the flow of foreign funds into the country.
India's benchmark Sensex index fell more than 22 per cent in 2011, making it one of the worst performing in the region. The rupee also lost about 14 per cent this year and recently hit a lifetime low, breaching 54 rupees to the dollar.
This is the weakest the rupee has been since it was allowed to float against the dollar in the early 1990s.
After several years of 8 per cent growth, the Indian economy has slowed down. The Ministry of Finance last month trimmed its growth projection for the fiscal year through March to around 7.5 per cent, down from an earlier forecast of 9 per cent.
Growth in the September quarter slipped to a two-year low of 6.9 per cent and industrial production fell 5.1 per cent in October, its first contraction since June 2009.