Foreign Portfolio Investment in India

Foreign Portfolio Investment (FPI) is when foreign investors invest capital in India's stock and bond markets by buying securities but not gaining control of companies. FPIs have to register with SEBI and adhere to India's FEMA regulations. Today, FPIs play a very important role in bringing in foreign capital to Indian markets and complement Foreign Direct Investment (FDIs) by improving market liquidity and making India a part of global financial systems. 

Regulatory Framework for FPI in India

FPIs are primarily governed by SEBI and RBI. SEBI's FPI Regulations, 2019 (which replaced the 2014 regime) lay down detailed rules for registration, permissible investments, and compliance. Under these rules, foreign entities must register through SEBI-appointed Depository Participants to invest in Indian securities. The RBI oversees foreign exchange aspects, emphasises foreign investment limits, and reports capital flows. Together, SEBI and RBI ensure liberalisation in India's regulatory framework and maintain detailed reporting of FPI inflows and holdings.

Eligibility Criteria for FPIs

SEBI classifies FPIs into categories reflecting their risk profiles. Broadly:

1. Category I FPIs: Low-risk, highly regulated investors such as sovereign governments and agencies, pension funds, multilateral institutions, and well-regulated funds. Unregulated funds can qualify only if their investment manager is from a Financial Action Task Force (FATF) compliant jurisdiction.
   Example: Government of Singapore Investment Corporation (GIC), Canada Pension Plan Investment Board, etc.
2. Category II FPIs: Includes regulated financial institutions and corporate bodies, family offices, limited partnerships, and other entities not qualifying as Category I.
   Example: Metropolitan Lifespace Real Estate Developers Pvt. Ltd.
3. Category III FPIs: Primarily unregulated entities like corporate bodies, foundations, trusts, etc., that do not meet Category I/II criteria are category III FPIs. 

All FPIs must meet KYC/AML norms. FPIs also require a PAN (tax ID) and must disclose the ultimate beneficial owners of the investment. SEBI recently tightened disclosure rules, requiring FPIs to report ownership down to the natural-person level.

Routes and Modes of Investment

FPIs may invest via primary or secondary markets in eligible instruments. Key routes/modes include:

1. Equity: Purchase of listed shares or instruments on Indian stock exchanges. FPIs can subscribe to IPOs and Follow-on Public Offerings (FPOs) under the automatic route.
2. Debt: Investment in Indian debt markets through designated channels like RBI’s Negotiated Dealing System -Order Matching (NDS-OM) platform or the Fully-Accessible Routes (FAR) and Voluntary Retention Routes (VRR) for government bonds. 
3. Units of Funds: FPIs can invest in units of domestic mutual funds, including equity- or debt-oriented schemes, and in units of REITs and InvITs.
4. Derivatives: Category I FPIs may invest in exchange-traded derivatives approved by SEBI.
5. Depository Receipts: Foreign investors can hold Indian stocks indirectly via American Depository Receipts or Global Depository Receipts issued abroad.
6. Participatory Notes (Offshore Derivatives): Unregistered foreign investors may access India by investing through Overseas Direct Investments issued by Category I FPIs.
7. Other Instruments: Any security that SEBI permits for FPIs.

Importantly, FPIs operate largely on the automatic route. Once registered, they can freely deploy funds within prescribed limits without case-by-case approval. They must invest in “eligible investment products,” as mentioned above. FPIs must also comply with settlement rules and tax withholding by custodians.

Sectoral Caps and Restrictions

FPIs face both company-specific and sector-specific limits:

1. Single-company stake limits: Under SEBI rules, an FPI may hold up to 10% of a listed company's paid-up equity on a fully diluted basis. Exceeding this threshold triggers mandatory re-classification of the excess investment as FDI under FEMA.
2. Industry-sector rules: FPIs are generally subject to the same sectoral restrictions as FDI, but with some relaxations. Notably, FPIs can invest in companies operating in sectors where FDI is normally prohibited, but only up to 24% in such firms. 
3. Aggregate foreign cap: Total foreign investment (FDI + FPI) in all companies cannot exceed the ceiling prescribed for that sector. The RBI has also notified that the aggregate FPI in any company is limited.

Taxation on FPI in India

FPIs are taxed under Indian income tax law on capital gains and income from Indian securities. Key provisions are:

1. Equity Long-Term Capital Gains (LTCG): 10% (without indexation) on gains above ₹1 lakh per financial year. 
2. Equity Short-Term Gains (STCG): 15% on gains from equity sold within 12 months. Securities Transaction Tax (STT) applies to trades, so no benefit of indexation for LTCG.
3. Debt and Other Securities (including derivatives): LTCG on debt was earlier taxed at 10% for FPIs, STCG at 30%. The Union Budget 2024 proposed taxing all gains on unlisted bonds or debentures at 30% (as short-term) irrespective of holding period. For listed debt mutual funds and security receipts, similar 10%/30% provisions apply.
4. Interest/Dividend: Interest from fixed-income or dividend payments to FPIs are subject to withholding tax, generally 20% plus surcharge.
5. Withholding (TDS): Indian companies and customers pay TDS on interest/dividends to FPIs as per domestic law, with no lower treaty rate unless specified.

Benefits of FPI for India

FPIs bring several benefits to India’s economy and markets. 

• FPI flows provide substantial foreign capital, deepening India’s capital markets. Increased inflows improve market liquidity and allow more efficient price discovery in stocks and bonds. 
• By supplementing domestic savings, FPIs help finance infrastructure and corporate growth. For example, foreign demand for government bonds helps fund the fiscal deficit at lower cost. 
• A larger investor base can reduce borrowing costs for companies and the government.
• Enhanced competition among investors tends to narrow credit spreads. 
• FPI participation signals confidence in India’s economy. 
• Inclusion of India in global indices has further integrated Indian markets into the world system. Access to FPIs also encourages international best practices in corporate governance and disclosures. 
• Large and stable FPI inflows can help stabilise the rupee, although sudden outflows can have the opposite effect.

Risks and Challenges Associated with FPI

Despite the benefits, FPIs pose some risks.  

• FPI investments are highly sensitive to global market shifts. Investors may withdraw rapidly in response to foreign rate changes or risk-off events. 
• Significant FPI inflows have the potential to harm exporters by strengthening the rupee and inflating asset prices. On the other hand, abrupt withdrawals may put pressure on bond yields and the rupee. 
• Markets with high FPI participation can exhibit higher volatility. 
• Frequent changes in investment or tax rules can deter FPIs. FPIs may view complex compliance as a hurdle. 
• Indirect investment vehicles allow non-resident ownership without registration, raising concerns about opacity and speculative trades. 
• FPIs exceeding the 10% stake limit must convert to FDI, which involves lock-in and reporting under FEMA. 
• Accidental breaches can create legal and liquidity challenges.

Government Initiatives and Reforms

In recent years, India has undertaken several policy measures to liberalise and streamline FPI investment:

1. SEBI Reforms (2019): SEBI overhauled the FPI regime, replacing multiple categories with a unified FPI framework. The 2019 regulations removed redundant restrictions and eased KYC requirements for FPIs from FATF-compliant jurisdictions.
2. Simplified Onboarding: SEBI introduced a Common Application Form (CAF) overhaul, allowing certain FPIs to use an abridged registration form. It also set up an FPI Outreach Cell to engage directly with investors and resolve issues.
3. Relaxed Limits: The Reserve Bank and government have considered higher foreign ownership caps. In 2025, the RBI proposed doubling the single foreign investor limit in a company from 5% to 10% and raising the combined foreign limit to 24%.
4. IFSC (GIFT City) Initiatives: To attract global FPIs, India’s IFSC at GIFT City offers tax and regulatory incentives. In 2024, SEBI allowed up to 100% investment in IFSC-registered FPIs by NRIs/OCIs/RIIs.
5. Bond Market Inclusion: Starting in mid-2024, the government facilitated the inclusion of Indian government securities in global indices, which is expected to attract substantial FPI debt flows.
6. Disclosure Enhancements: SEBI issued new norms requiring FPIs to disclose beneficial ownership on a look-through basis. While stricter, these are meant to improve monitoring of large investors and prevent opaque control structures.
7. Macro Stability Measures: To support FPI inflows, the government continued to liberalise external borrowing by the private sector and maintained RBI’s commitment to fiscal prudence. These measures aim to create a stable investment climate for foreign investors.

The Future of FPI in India

Looking ahead, FPI flows will depend on both India’s fundamentals and global dynamics. Analysts note that India’s relatively high growth rates and strong corporate earnings could continue to attract FPIs. The expected bilateral trade liberalisations and index inclusions may further bolster foreign interest. On the policy side, the proposed easing of investment limits and the success of GIFT City in attracting foreign fund managers are positive signs.

However, FPIs will remain sensitive to global rate differentials and risk sentiment. India’s ability to sustain reforms and to manage inflation/currency volatility will influence FPI confidence. The future holds gradual liberalisation, but flows are likely to remain cyclical. India’s challenge is to continue improving market infrastructure so as to capitalise on its growth story and attract stable portfolio investment inflows.