FOREIGN PORTFOLIO INVESTMENT (FPI)
- Foreign Portfolio Investors (FPIs) are overseas entities or individuals who invest in the financial assets of a country, such as shares, bonds, debentures, mutual funds, or other securities, without having direct control over the businesses they invest in.
- Unlike Foreign Direct Investment (FDI), which involves establishing a lasting interest in an enterprise, setting up facilities, or acquiring a controlling stake, FPIs are primarily concerned with earning returns from the movement of capital markets.
- Essentially, FPIs put their money into a country’s stock market or debt market to benefit from short- or medium-term price changes, dividends, or interest income.
- Their investment is often guided by considerations like the stability of the economy, growth prospects, interest rates, and global liquidity conditions.
- Because the money can be moved in and out relatively quickly, FPIs are often described as “hot money,” highlighting the fact that such investments can be highly volatile.
- In India, FPIs are regulated by the Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI), which set the rules regarding eligibility, permissible investment limits, and reporting requirements
- These investors can include foreign institutional investors such as pension funds, insurance companies, hedge funds, asset management companies, or even individual investors from abroad.
- Their participation is significant because it not only provides additional capital for companies and governments but also increases liquidity and depth in the financial markets.
- However, large-scale entry or exit of FPIs can impact stock prices, exchange rates, and overall financial stability
- That’s a very relevant follow-up. The key difference between Foreign Portfolio Investment (FPI) and Foreign Direct Investment (FDI) lies in the nature, purpose, and level of control over the assets being invested in.
- Foreign Portfolio Investment (FPI) refers to investment in a country’s financial markets—such as equities, bonds, or other securities—without seeking management control or a lasting interest in the company.
- An FPI is more like buying shares on the stock exchange: the investor becomes a shareholder but has little or no say in how the company is run.
- The intention is usually to earn returns from dividends, interest, or capital gains, and the money can move in and out relatively quickly depending on market conditions. Because of this, FPIs are generally considered more volatile and speculative in nature.
- On the other hand, Foreign Direct Investment (FDI) involves investing directly in productive assets of another country, such as setting up factories, infrastructure projects, offices, or acquiring a significant stake in a company to gain management influence.
- The idea here is to establish a long-term business presence and contribute to the host country’s economic activities.
- FDI is more stable because it ties the investor to physical assets and operational responsibilities, making it less prone to sudden withdrawal compared to FPI.
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In short:
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- FPI brings in foreign capital into a country’s stock and debt markets, which increases the liquidity and depth of those markets. This makes it easier for domestic companies and governments to raise funds, since more investors are available to buy their securities.
- It also improves market efficiency, as the entry of sophisticated foreign investors often brings in better practices in valuation, analysis, and corporate governance.
- For the broader economy, FPIs are an important source of foreign exchange inflow. This helps strengthen the balance of payments, stabilizes the currency in times of pressure, and gives policymakers more room to finance trade deficits.
- For emerging economies like India, FPIs signal international confidence in the domestic economy. When foreign investors channel funds into Indian markets, it reflects their positive outlook on India’s growth potential, macroeconomic stability, and regulatory environment.
- However, FPIs are equally significant because of their volatility. Since FPI money can be withdrawn at short notice—depending on global interest rates, risk perception, or geopolitical conditions—large inflows or sudden outflows can cause swings in stock markets and currency values.
- For example, massive withdrawals of FPI funds may lead to a depreciation of the rupee and stock market instability, affecting both investors and the wider economy.
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The Foreign Capital Paradox refers to the puzzling observation that capital (money for investment) does not always flow from rich countries to poor countries, even though economic theory suggests it should.
In theory, poorer countries, being capital-scarce, should offer higher returns on investment compared to rich countries where capital is already abundant and returns are relatively lower. Based on this logic, one would expect foreign capital—through FDI, FPI, or loans—to flow heavily into developing or low-income nations, helping them grow faster. This is consistent with the predictions of the neoclassical growth model.
However, in reality, the flow of capital is often the opposite. A large share of global investment moves among already rich, developed nations rather than toward poorer countries. Many developing countries actually see capital outflows instead of inflows, despite their greater need for funds. This mismatch between theory and reality is what economists call the “foreign capital paradox.”
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One of the best-known explanations for this paradox comes from Robert Lucas (1990), often referred to as the Lucas Paradox. He argued that capital doesn’t flow as expected due to several factors:
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For Prelims: Balance of payments (BOP), foreign portfolio investors (FPI), foreign direct investment(FDI)
For Prelims: GS III - Economy
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Previous Year Questions
1.Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of the Indian stock market without registering themselves directly? (UPSC CSE 2019) (a) Certificate of Deposit (b) Commercial Paper (c) Promissory Note (d) Participatory Note Answer (d)
Participatory Notes (P-notes) are financial instruments issued by registered Foreign Portfolio Investors (FPIs) to overseas investors who wish to invest in Indian stock markets without directly registering with SEBI. They are essentially offshore derivative instruments, linked to Indian securities. For example, if an FPI buys shares of Infosys in India, it can issue a P-note to an overseas investor. That overseas investor will gain the benefits (returns) from Infosys’ shares without directly owning them in India. This route is often used by investors who want to save time and avoid the regulatory process of registration, though SEBI keeps a close watch on P-notes due to concerns about transparency and misuse |
