Introduction to Foreign Portfolio Investment (FPI)
Foreign Portfolio Investment (FPI) refers to the investment by individuals, institutions, or funds in financial assets such as stocks, bonds, mutual funds, and exchange-traded (ETFs) of a foreign country. Unlike Foreign Direct Investment (FDI), FPI does not grant the investor direct ownership or control over a company’s operations or assets. FPI investments are typically more liquid and easily traded in foreign markets.
FPI significantly contributes to economic growth and financial stability in many developing economies by providing a steady inflow of foreign capital.
Understanding Foreign Portfolio Investment (FPI)
In FPI, investors take a passive role by investing in foreign financial securities to earn returns. This type of investment can involve:
- Equity securities: Stocks or shares in companies outside the investor’s home country.
- Debt instruments: Bonds issued by foreign governments or companies.
- Depositary receipts: American Depositary Receipts (ADRs) or Global Depositary Receipts (GDRs) representing shares of foreign companies.
- Mutual funds and ETFs: Funds that invest in assets from international markets.
Since FPIs do not involve active management or control of enterprises, they are less regulated than foreign direct investments.
Advantages of Foreign Portfolio Investment (FPI)
- Portfolio Diversification
FPI enables investors to diversify their portfolios internationally, thus reducing the risk of the domestic market. Investment in different foreign markets can result in better risk-adjusted returns and improve overall portfolio performance. - Access to International Credit
Investors in FPIs can access credit markets in foreign countries, allowing them to leverage investments and earn higher returns. - Increased Liquidity in Domestic Markets
FPI inflows increase the amount of capital available, thus enhancing local financial markets. Liquid markets also promote more investments and financing events that facilitate expansive economic growth. - Development of Local Equity Markets
Foreign Direct Investment increases domestic companies' quest for funding while encouraging better governance, transparency and performance. Consequently, the costs of equity are significantly improved, with fairer prices accruing to issuers and investors. - Boosts Economic Growth
FPI contributes in economic growth; it provides with much-needed funds for businesses, governments, helps fund infrastructure and business expansion developments, and can be used toward technology development.
Challenges of Foreign Portfolio Investment
- Volatility and Instability
Since FPI involves foreign capital that can be moved quickly in and out of markets, it introduces the risk of market volatility. A sudden outflow of FPI can destabilise domestic markets. - Currency Risk
FPI returns are affected by fluctuations in foreign exchange rates. Depreciation of the local currency against the investor’s home currency can reduce overall returns. - Economic Dependence
Over-reliance on FPI makes a country's economy susceptible to fluctuations in the global financial market. During global economic instability, countries highly dependent on FPI are badly struck by the economic impact of such a situation.
Policies for Managing FPI
To mitigate the inherent risks associated with FPI, countries implement several policies, such as:
- Regulating capital inflows and outflows to manage exchange rate volatility and prevent sudden market shocks.
- Strengthening financial institutions to ensure effective intermediation and proper allocation of foreign capital.
- Promoting transparency and corporate governance to attract stable and long-term foreign investment.
- Building foreign exchange reserves to cushion against abrupt FPI outflows.
Well-regulated financial systems and prudent macroeconomic policies help ensure that FPI inflows contribute positively to economic development.
Key Takeaways
- FPI Inflows Surge in Emerging Markets
Emerging markets have seen some big inflows of FPIs over the last few months, primarily driven by the lowering of interest rates by the developed countries and better growth prospects in the developing economies. - Changes in FPI Regulations
Countries, including India, have altered the regulations of FPIs in order to make the investment process simple and attractive for foreign capital inflows. For instance, limits on foreign ownership in key sectors have been softened and tax policies cleared out. - Increased Investment in ESG Funds
As sustainable investing is gaining more attention, FPIs in Environmental, Social, and Governance (ESG)-themed funds have increased manifold. This is a reflection of the global trend towards responsible investing.
