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Foreign Portfolio Investment (FPI), Benefits and Challenges

Context: Foreign portfolio investors (FPIs) pulled out ₹14,800 crore from equity markets, driven by the outcomes of recent elections and the appealing valuations of Chinese stocks.

Foreign Portfolio Investment (FPI)

  • Foreign portfolio investment (FPI): It involves holding securities and other financial assets by foreign investors without direct control over the assets. It is generally more liquid and influenced by market volatility.
  • Types of FPIs: Includes various forms like stocks, bonds, mutual funds, exchange-traded funds, American Depositary Receipts (ADRs), and Global Depositary Receipts (GDRs).
  • Economic Impact: FPI is a component of a country’s capital account and appears on its Balance of Payments (BOP), which tracks monetary exchanges between countries over a fiscal year.
  • Regulation: In India, the Securities and Exchange Board of India (SEBI) updated its FPI Regulations in 2019, replacing the older 2014 regulations.
  • Characteristics: Often referred to as “hot money,” FPI is known for its liquidity and volatility, making it riskier and prone to rapid withdrawal from markets at the first hint of economic distress.
Note
Investments made by Non-Resident Indians (NRIs) are not classified as FPI.

Benefits of Foreign Portfolio Investment (FPI)

The benefits of Foreign Portfolio Investment (FPI) can be summarized in the following points.

Benefits Details
Diversification FPI allows investors to diversify their portfolios by accessing foreign markets and assets, reducing the risk associated with investing in a single country or region.
Higher Returns FPI provides opportunities for potentially higher returns, as investors can tap into the growth potential of foreign economies and take advantage of favourable market conditions.
Liquidity FPI offers greater liquidity as portfolio assets can be bought and sold more easily, allowing investors to react quickly to market changes and manage their investments more efficiently.
Access to Global Markets FPI enables investors to access a wider range of investment options and participate in global markets, expanding their investment opportunities beyond their home country.
Portfolio Optimization FPI allows investors to optimize their portfolios by including assets from different countries, industries, and sectors, thereby spreading risk and potentially enhancing overall portfolio performance.
Economic Development FPI contributes to the economic development of recipient countries by attracting foreign capital, stimulating investment, fostering competition, and supporting market efficiency.
Knowledge and Expertise Transfer FPI brings in foreign investors who bring with them knowledge, expertise, and best practices, which can have a positive impact on the local financial markets and industries.

Challenges Related to FPI

The challenges of Foreign Portfolio Investment (FPI) can be summarized in the following points. 

  • Volatility and Short-Termism: FPIs are highly liquid and can be quickly moved in and out of markets, which often leads to increased volatility.
    • Investors may pull out their investments at the first sign of trouble or better opportunities elsewhere, leading to sudden financial outflows that can destabilise markets.
  • Market Manipulation Risks: Large flows of FPIs can lead to significant price movements in the domestic markets, which might not necessarily reflect the underlying economic fundamentals. This can result in asset bubbles or exacerbate market crashes.
  • Limited Contribution to Real Economy: Unlike Foreign Direct Investment (FDI), FPI does not contribute directly to the real economy in terms of job creation, infrastructure development, or technological advancements since it mostly goes into purchasing existing securities.
  • Currency Risks: Large inflows and outflows of FPI can lead to significant currency fluctuations.
    • While inflows can lead to currency appreciation, making exports less competitive, outflows can result in depreciation, leading to inflationary pressures.

FPI and FDI

Compared to direct investments, FPI is a more accessible form of investment that requires less capital and due diligence. It allows investors to engage in global markets without the complexities and resource-intensive nature of direct investments. This accessibility broadens investment opportunities for individuals and institutions alike.

In India, FPI is regulated by the Securities and Exchange Board of India (SEBI), which ensures compliance with relevant rules and regulations. SEBI has established different categories and eligibility criteria for FPI registration, allowing for better oversight and management of foreign investments. These regulations help safeguard the interests of investors and maintain the stability of the Indian financial market.

FPI is an important aspect of a country’s Balance of Payments (BOP) as it falls under the capital account. The inflows and outflows of FPI are recorded in the BOP, reflecting the financial transactions between a country and the rest of the world. Monitoring FPI is crucial for policymakers to assess the overall health of the economy and make informed decisions related to capital flows.

Difference Between FDI and FPI

The following table comprehensively highlights the difference between the two related concepts of Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI).

Aspect Foreign Direct Investment (FDI) Foreign Portfolio Investment (FPI)
Definition Investment from foreign entities aimed at gaining significant influence in a company in another country. Investment in foreign financial assets like stocks or bonds on an exchange.
Type Direct investment in enterprises. Indirect investment in financial assets.
Market Capital is directed into the primary market. Capital flows into the secondary market.
Investor Role Investors play an active role in management and operations. Investors remain passive with no role in daily operations.
Control Level Substantial control and influence over business decisions. Minimal to no control over business operations.
Investment Term Typically aimed at long-term engagement. Usually short-term placements.
Investment Focus Targets physical assets in the host country. Focuses on financial assets like securities.
Market Entry/Exit Entry and exit are more complex due to larger investments and regulations. Entry and exit are relatively easier due to the nature of the assets involved.
Risk Profile Generally stable due to long-term involvement and tangible assets. Tends to be more volatile due to market fluctuations and shorter investment horizons.

Foreign Portfolio Investment UPSC 

Understanding foreign portfolio investment (FPI) is crucial for UPSC aspirants as it aligns with the UPSC Syllabus, particularly in topics related to the Indian economy, international trade, and finance. FPI is an essential aspect of India’s economic policies and its integration into the global economy. Aspirants preparing for UPSC examinations can expect questions on FPI in the Economics and International Relations sections. UPSC Online Coaching and mock tests can provide valuable resources for candidates to enhance their understanding of FPI, its implications, and its relationship with other economic factors, thus enabling them to approach related questions with confidence in the examination.

Other Important Articles
Gross National Product External Debt of India
Concept of GDP, GNP, NNP and NDP Circular Flow of Income
Gross Value Added

 

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Foreign Portfolio Investment FAQs

What is a foreign portfolio investment?

Foreign Portfolio Investment (FPI) refers to investing in financial assets such as stocks, bonds, and mutual funds in foreign markets.

What is difference between FDI and FPI?

The difference between Foreign Direct Investment (FDI) and FPI lies in the nature and purpose of investment, with FDI involving long-term investments in physical assets and FPI focusing on short-term investments in financial assets.

What is FII and FPI?

Foreign Institutional Investor (FII) and Foreign Portfolio Investor (FPI) are terms used interchangeably to refer to entities that invest in the Indian financial market, with FII being the older term.

What is an example of FPI in India?

An example of FPI in India could be a foreign investor buying stocks listed on the Indian stock exchange.

Who controls FPI in India?

The Securities and Exchange Board of India (SEBI) controls and regulates FPI in India.

About the Author

I, Sakshi Gupta, am a content writer to empower students aiming for UPSC, PSC, and other competitive exams. My objective is to provide clear, concise, and informative content that caters to your exam preparation needs. I strive to make my content not only informative but also engaging, keeping you motivated throughout your journey!

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