Foreign Portfolio Investment

Any economy that wants to grow needs investment, which can come from both domestic and foreign sources.

 The economy benefits from foreign investment because it increases the amount of foreign currency entering the country and strengthens the local currency. A nation, organization or individual investing abroad is called "making a foreign investment." 

The two most popular channels through which foreign investment is made are 

1. Foreign Portfolio Investment (FPI) 
2. Foreign Direct Investment (FDI). 

The expansion of FDI and FPI can also benefit the economy's expansion. 

The increase in foreign portfolio investment (FPI) in India, according to a report included in the Indian Union Budget, caused the Sensex to rise by 11.36% during the fiscal year 2021–2022.

Foreign Portfolio Investment (FPI) – what is it?

An investment made by an individual, business, or nation in another country as a security, financial asset, or bond listed on that country's stock exchange is referred to as a foreign portfolio investment" (FPI). Instead of giving investors ownership of a company's assets, these investments allow them to profit from market volatility. Because it is easy to quickly buy and sell portfolio investments, enabling you to make sizable gains immediately, FPIs are frequently thought of as short-term investments.

Compared to direct investments, portfolio investment has higher liquidity due to its extensive trading, making it easier to buy and sell securities. Bonds, stocks, mutual funds, American depository receipts (ADRs), and exchange-traded funds (ETFs) can all be considered FPIs. 

The FPI is one of the most convenient markets for investors to trade stocks and securities from other countries. It plays a significant role in a country's capital structure and affects the country's BOP (Balance of Payments). Instead of influencing a specific company to invest, unlike Foreign Direct Investment (FDI), FPI enables you to trade shares of any company listed on the stock exchange. 

Risks Involved in Foreign Portfolio Investment

The risks associated with FPIs are as follows:

• Political Risk: Foreign investors, in particular, may experience uncertainty due to abrupt changes in the political environment or governmental policies. For instance, if the government changes, the economy or investment policies may also change, affecting foreign investors. 
• Volatile Asset Pricing: The volatility or fluctuations in asset price can be a major risk factor. For instance, the Germany-based DAX index is historically more volatile than the USA S&P 500 index. 
• Investing abroad can expose you to jurisdictional risk. For instance, the returns on your investment could be materially affected if a foreign nation in which you had investments drastically changed its laws.

Liquidity: Low capital market liquidity can occasionally be found in developing nations, which raises volatility. 

The Influences on Foreign Portfolio Investment

A few elements influencing the FPI  are as follows

• Growth Prospects: Foreign investments heavily depend on a nation's economy. Investors prefer to invest in a country's financial assets if its economy is strong and expanding. In contrast, investors often sell their holdings when there is financial instability or a recession. 
• Interest Rates: A high return on investment is desired by all investors. Since interest rates are high, investors seek out those nations. 
• Tax Rates: Taxes are charged on capital gains, and a higher tax rate can result in a lower overall rate of return. As a result, investors favor making investments in nations with lower tax rates. 

FPI versus FDI distinction:

The benefits and drawbacks of foreign portfolio investment (FPI) include the following:

FPI advantages:

• An individual investor may trade domestic and international bonds and securities through a foreign portfolio investment (FPI).
• It enables small-scale investors to exploit market volatility by investing in foreign firms.
• A country's economy can benefit from the difference in currency exchange rates. For instance, if an investor invests in a company with operations in a country where the currency is more valuable than the investor's own, both the investor and that country will profit. 
• Foreign Portfolio Investment (FPI), as opposed to FDI, enables investors to trade securities and bonds of foreign companies and invest even a small amount.
• Thanks to FPI, governments, businesses and retail investors can invest abroad. 

FPI's drawbacks include the following:

• The FPI is not regarded as a stable investment because it is heavily influenced by market volatility, carries a high risk of loss, and has a high potential for loss.
• Massive losses may be experienced if the nation in which the FPI investment was made experiences economic disruption or a decline in GDP.
• In contrast to FDI, foreign portfolio investment (FPI) does not grant ownership of the company's asset in which the investment has been made.

FPI's effect on India's economy:

Foreign portfolio investment (FPI) is crucial for India's economy to grow favourably. Due to a significant increase in foreign portfolio investors, India's economy has grown to rank as the sixth largest in the world. The Indian economy recovered more quickly and expanded after the Foreign Portfolio Investment (FPI) of Rs. 8381 crores was recorded in November 2020. 

Foreign Portfolio Investment (FPI), which is very similar to FDI, plays a significant role in fostering economic growth throughout a country, particularly in developing nations like India. An FPI helps to diversify external financing sources, fosters the growth of regional markets, and lowers capital expenditures.