Foreign Portfolio Investment (FPI) is an important conduit for capital in and out of an economy. It represents foreign investment in shares, bonds, and other financial instruments, with no direct control over the firms in which they invest.

While an emerging market like India stands to benefit considerably from FPI in terms of capital and liquidity, there is also the danger of outflows on a large scale triggered by changes in global conditions or sentiments. Thus, FPI, like all other forms of foreign investment, has its own set of implications for the economy.

What Is Foreign Portfolio Investment?

Foreign Portfolio Investment (FPI) refers to the investment made by foreign investors in the financial assets of another country or its marketable securities.

Its main distinguishing feature from other forms of investment is its passive nature. In other words, foreign portfolio investors do not seek to establish control over the firm in which they invest. Rather, they invest with the hope of deriving benefits from the rise in value of the asset or regular income from the investment.

The objectives of portfolio investment are:

• Capital appreciation
• Income generation
• Portfolio diversification

In short, FPI facilitates the flow of capital from one economy to another. It provides foreign investors with an avenue to invest in the financial assets of another economy. As a result, FPI enriches the financial markets of the host country with additional capital.

In India, FPI works with certain limits and regulations. For instance, an FPI in India is restricted to 10%, beyond which it qualifies as FDI.

FII and FPI: What Is the Difference?

Foreign Institutional Investors (FIIs) was the designation given to foreign institutional entities such as mutual funds, pension funds, insurance companies, hedge funds, etc., investing in the Indian financial market.

FPI has replaced the old FII and sub-account regime with SEBI.

Why Is FPI Important for India?

FPI is important for India because it provides an alternate route for bringing foreign capital into the domestic financial market. Apart from that, the benefits of FPI include:

1. Bringing Foreign Capital into the Domestic Financial Markets

FPI provides an additional channel for foreign capital to enter the domestic financial market. This, in turn, creates liquidity in the financial market.

In addition, it provides an alternative investment avenue for overseas investors.

2. Developing Capital Markets

With increased liquidity and the entry of global investors, the capital markets in India become more robust and sophisticated.

In short, the presence of FPI enhances the depth and breadth of the financial markets.

3. Encouraging Economic Activity

The additional capital brought in by FPI can be utilised to finance economic activity.

4. Creating Foreign Exchange Inflows

Since FPI is a foreign capital inflow, it aids in improving the foreign exchange position of the country.

In other words, FPI helps in supplementing the foreign exchange reserves of the country.

5. Hedging Risk

FPI enables international investors to hedge their risk by diversifying their portfolios across different geographies and markets.

In other words, FPI allows investors to reduce their exposure to one market and balance it out with their exposure to another market or asset.

6. Enabling Emerging Markets

FPI allows emerging market economies to participate in global capital markets.

In other words, FPI helps economies such as India and Brazil to connect with the global financial markets.

7. Sign of Confidence

A high and consistent level of FPI inflows is an indicator of the confidence that international investors have in the Indian financial markets and, by extension, the Indian economy.

What Are the Major Problems Associated with FPI?

While FPI is indeed beneficial for the capital markets, there are certain problems associated with it.

The most prominent among them is the fact that it is extremely volatile. In other words, FPI can enter and exit the domestic financial market quickly at a much larger scale compared to other forms of investment.

Some of the problems associated with FPI are:

1. Volatility

The inflow and outflow of FPI can lead to significant fluctuations in the value of domestic financial assets.

Thus, it has the potential to trigger financial crises in the domestic market.

2. Exposure to External Shocks

The economies in which FPI originate can expose the domestic market to:

• Financial crises
• Political and geopolitical tensions
• Fluctuations in monetary policy

3. Oversupply of Foreign Currency

A surge in FPI can lead to an increase in the foreign currency in the domestic foreign exchange market.

This can lead to depreciation of the domestic currency.

4. Speculation-Driven

Some FPIs are speculative in nature. Thus, these investors do not intend to hold onto their investments for the long term.

Rather, they invest in anticipation of short-term gains.

5. Flight of Capital

Similar to speculation, in times of crisis, FPI can lead to a rapid withdrawal of capital from the domestic financial market.

This can create liquidity issues in the domestic financial market.

6. Taxation, Regulation, and Disclosure

Differences in tax policies, regulations, and disclosure requirements can undermine FPI.

7. Dependence on Foreign Capital

The domestic financial market becomes extremely vulnerable to the whims and fancies of foreign investors in case of a heavy influx of FPI.

FPI vs FDI: Key Differences

The most basic difference between FPI and FDI is provided below:

Why Does the FPI–FDI Difference Matter?

The difference between FPI and FDI, as explained above, highlights the varying impacts that the two have on the host economy.

In other words, while FDI has a direct and long-term impact on the host economy, FPI tends to affect the financial markets more.

It is important to note that while FPI facilitates liquidity in the financial markets, it can also make the host country vulnerable to a rapid and large-scale withdrawal of capital by foreign investors.

Thus, in order to realise the benefits of both FPI and FDI, it is necessary to encourage both forms of investment while minimising their costs.

FPI in the Indian Economy

India has become a preferred destination for foreign portfolio investors. The presence of vast financial markets and investment opportunities makes India a tempting prospect for any global investor.

Thus, FPI plays a significant role in India’s financial markets, especially in the stock and bond markets.

Consequently, FPI has a major impact on the prices of these financial assets. Moreover, changes in FPI influence the liquidity in these markets.

Since the Indian Rupee is directly dependent on the demand and supply of this financial asset, FPI exerts indirect pressure on the value of the Rupee.

Thus, the policy objective should not be to encourage maximum FPI, but to utilise it to build depth in India’s financial markets without exposing them to volatility and sudden fluctuations.

FAQs

What is Foreign Portfolio Investment?

FPI is the investment made by foreign investors in the financial assets of another country, with no direct control over the firm in which they invest.

What is the Main Objective of FPI?

The main objectives of FPI are capital appreciation, income generation, and portfolio diversification.

How Is FPI Different from FDI?

FPI mainly focuses on financial securities, while FDI focuses on direct foreign business ownership and control.

Also, FPI is passive in nature while FDI is active.

Why Is FPI Important for India?

FPI helps in enhancing capital-market liquidity, depth, and international investment.

It also has an impact on the financial markets as well as the foreign exchange market.

Why Can FPI Create Volatility?

Since FPI is passive in nature, any changes in the global financial scenario, interest rates, political situation, etc., prompt foreign investors to rapidly buy or sell financial assets.

Thus, in case of any global geopolitical or economic changes, there is a high possibility that foreign portfolio investors will withdraw their investments suddenly, thereby creating volatility in the financial markets.

What Are FIIs?

Foreign Institutional Investors (FIIs) is the term used for those foreign institutional entities that invest in the Indian financial market.

However, now, the term FPI has replaced FII with SEBI.