Just like private companies, every country needs money for its growth. While the private firms and individuals turn to banks for it or take some other routes, nations look forward to foreign investors. So, the two most common routes through which the capital comes into any country are FDI or Foreign Direct Investment and FPI or Foreign Portfolio Investment.
Foreign investors take the FDI route when they have a long-term interest in mind. In FDI, an investor usually acquires foreign business assets, establishing ownership or controlling interest in a company. With FDI, foreign companies are directly involved with day-to-day operations in the other country. This means they are not just bringing money with them, but also knowledge, skills and technology.
Under such circumstances, the investor company has at least 10 per cent stake in the company, thus commanding a substantial amount of influence and control over the investee company. For example, Walmart acquiring 77 per cent stake in India’s biggest online retailer, Flipkart, is an FDI investment.
Now, let us explore the ways through which the FDI comes into India. According to the rules prescribed by the Indian government, FDI can either come via automatic route or via government route.
In the automatic route, non-resident or Indian companies do not need prior nod of RBI or the government for FDI. It is for the sectors where the FDI is not restricted and doesn’t need government scrutiny. And the second is the government route. For this, the company will have to file an application through Foreign Investment Facilitation Portal, which facilitates single-window clearance. So, if FDIs get ownership in a company, what do FPIs get? Let us find out.
Unlike the FDI, Foreign Portfolio Investment or FPI is meant for short-term profit booking. Through this route, foreign investors put capital in financial assets, such as stocks and bonds. In other words, FPI involves the purchase of securities that can be easily bought or sold. Such an investment is made with the aim of making short term financial gain and not for obtaining significant control over managerial operations of the enterprise.
In a nutshell, FDIs own controlling stake in a company by investing in its physical assets while FPIs invest only in financial assets. While FDI is a more stable long-term investment, FPI money is usually considered ‘hot money’.
Now, let us understand which one is a better investment route? FDI and FPI are both important sources of funding for most economies. However, FDI is preferred by most countries for attracting foreign investment, since it is much more stable than FPI and signals long-lasting commitment.
FPIs, on the other hand, have a higher degree of volatility because of its tendency to flee at the first signs of trouble in an economy. These massive portfolio flows can exacerbate economic problems during periods of uncertainty.
When investors from some other country buy securities or some other financial assets, this is referred to as a foreign portfolio investment (FPI). Stocks, bonds, mutual funds, exchange traded funds, American depositary receipts (ADRs), as well as global depositary receipts (GDRs) are a few examples of overseas portfolio investments.
Following the presentation of the Union Budget for 2021-2022, it was reported that the Sensex showed an 11.36% increase due to Foreign Portfolio Investments in India.
This article will give details about Foreign Portfolio Investment within the context of the UPSC Exams.
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About Foreign Portfolio Investments
Investment in financial assets of a foreign nation, such as stocks or bonds listed on an exchange, is known as foreign portfolio investment (FPI). Since portfolio investments can be easily sold off and are therefore perceived as a short-term effort to make money instead of a long-term investment in the economy, this sort of investment is sometimes viewed less positively than direct investment. Compared to direct investments, portfolio investments often have a shorter time to maturity. Foreign portfolio investors typically anticipate seeing a return on their assets quite fast, just like with any stock investment. The liquidity of portfolio assets makes them simpler to sell compared to direct investments because securities are widely traded. Because they demand significantly less investment cash and due diligence than direct investments, portfolio investments are much more affordable for the typical investor. The investor does not have an influence on the business firm in which the investment is made, in contrast to direct investments.
Making and keeping a hands-off, or passive, investment in a portfolio of assets is done with the hope of getting a return. These securities can be equities or global depositary receipts of corporations with headquarters from outside the investor’s country in foreign portfolio investment. Holding also comprises mutual funds or exchange traded funds (ETFs) that invest in foreign or international assets, as well as bonds or other debt issued by these businesses or foreign governments. The likelihood of an individual investor using an FPI to invest in possibilities located outside of their home nation is high. On a larger scale, a country’s foreign portfolio investment is reflected on its balance of payments as part of its capital account (BOP). The BOP calculates the amount of money that moves from one nation to another throughout a single fiscal year.
Foreign portfolio investments can be done by individuals, companies or even government agencies. Such investments help entrepreneurs in diversifying their portfolios, giving them an edge in international markets. An FPI will be featured in a country’s capital account and is part of the balance of payments which takes stock of money flowing in and out of the country over a specific period of time.
Pros of Foreign Portfolio Investments are as follows:
- Portfolio diversification: FPI enables investors to diversify their portfolios on the international stage.
- International Credit: FPI can give creditors a large crest base as it provides access to credit in foreign nations.
- Benefits from the Exchange rates: If an investor has an FPI in a foreign country with a stronger currency than their own country, the difference in exchange rates between the two countries can benefit the investor.
- Feasibility: Foreign Portfolio Investment option is feasible with retail investors as the amount of money is much less than that of the FDI and involves simpler legalities in general.
- Returns: Foreign Portfolio Investments give quicker returns as compared to that FDI. basically, the investor can sell his or her portfolio investments as and when he/she wants on the prevailing prices of that asset.
Cons of Foreign Portfolio Investments are as follows:
- Control: In contrast to FDI, in FPI the investor has no control over the management or functioning of the firm or business entity whose asset is bought.
- Volatile: Foreign Portfolio Investments are much more volatile to adverse shocks and thus their asset prices fluctuate every second.
- Economic Disruption: Foreign Portfolio Investments are not a dependable option as it is prone to panic sell or whale/shark selloffs thereby reducing the asset price and leading to money crunch on a large scale which may disrupt the economy.
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Foreign Portfolio Investment vs Foreign Direct Investment
In a foreign portfolio investment, it is not necessary for an investor to actively manage the investment or the companies that issue the investment. In other words, they don’t have direct control over the assets.
Through foreign direct investment, an investor is allowed to purchase a direct business interest in a foreign country. For example, an investor based in Bangalore purchases a restaurant chain in Tokyo to lease to n American company that needs space to expand its operations. The investor’s goal is to create a long-term income stream while helping the company increase its profits.
This Foreign Direct Investment (FDI) investor controls their investments directly and plays an active role in deciding where the company puts the money. The investor helps in setting up the business and nurtures it to the point where he/she can ascertain there is a viable return on investment (ROI). Since the investor money is fully committed to the business, they will face liquidity and more risk when selling the interest.
A brief info about the differences between FPI and FDI is given in the table below:
| Difference between Foreign Portfolio Investment and Foreign Direct Investment | |
| Foreign Portfolio Investment | Foreign Direct Investment |
| Foreign Portfolio Investment or FPI refers to the investment made in the financial assets of an enterprise, based in one country, by the foreign investors | Foreign direct investment or FDI pertains to international investment in which the investor obtains a lasting interest in an enterprise in another country |
| An investor is inactive | An investor is active |
| Indirect investments in assets are made | Direct investments in assets are made |
| Investments made are short term in nature | Investments made are long term in nature |
| FPI are volatile in nature | FDI are stable in nature. |
Frequently Asked Questions about the Foreign Portfolio Investment:
Foreign portfolio investment gives investors an opportunity to engage in international diversification of portfolio assets, which in turn helps achieve a higher risk-adjusted return. In FPI the investor
does not have direct control over the securities or businesses. This means that FPI tends to be more liquid and less risky than FDI. Foreign portfolio investment increases the liquidity of domestic capital markets, and can help develop
market efficiency as well. As markets become more liquid, as they become deeper and broader, a wider range of investments can be financed. Foreign portfolio investment provides investors with an easy opportunity to diversify
their portfolio internationally. An investor would diversify their investment portfolio to achieve a higher risk-adjusted return. Types of Foreign InvestmentsWhat is the benefit of foreign portfolio investment?
Why is FPI less risky than FDI?
Is foreign portfolio investment good?
Why foreign portfolio investment is important?
What are the different types of foreign investment?
- Foreign Direct Investment (FDI)
- Foreign Portfolio Investment (FPI)
- Foreign Institutional Investment (FII)
What is the riskiest type of investment?
High-risk investments include currency trading, REITs, and initial public offerings (IPOs). There are other forms of high-risk investments such as venture capital investments and investing in cryptocurrency market.
What is a lazy portfolio?
A lazy portfolio is a collection of investments that more or less runs on autopilot. Lazy portfolios are designed to weather changing market conditions without requiring investors to make significant changes to their asset allocation or goals.
Why are FPIs dumping Indian stocks?
FPIs sold assets worth ₹44,000 crores in May 2022. This is the second highest sell-off in a month since 1993, after March 2020. Uneven economic recovery in the post-pandemic India, quick price rise of many vital commodities due to supply shock created by Russia-Ukraine war, and weak consumption expenditure are some of the major factors for FPI sell-offs in the past few months.
What impact does an FPI sell-off have?
When FPIs sell their holdings, and repatriate funds back to their home markets, the local currency takes a beating. After all, they sell rupees in exchange for their home market currency. As supply of the rupee in the market rises, its value declines. In this instance, the rupee has recently been seeing all-time lows. About a year ago, it was trading in the region of 73 to a U.S. dollar; it is now flirting with the 78 level. With a weaker rupee, we have to shell out more funds to import the same unit of goods. The most telling impact is on the cost of our crude oil imports that contribute to 85% of our oil needs.
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