Current Affairs 2024 - Foreign Portfolio Investment

Why in News?

Foreign Portfolio Investors (FPIs) withdrew a record ₹94,000 crore from Indian equities in October due to attractive valuations in Chinese markets.

The Role of FPI in India’s Financial Markets

Foreign Portfolio Investment (FPI) refers to investments made by non-residents in a country’s financial assets such as stocks and bonds, without direct involvement in the management or control of the invested entities. FPIs play a pivotal role in enhancing market liquidity and driving economic growth but are also highly susceptible to global economic and geopolitical dynamics. The record withdrawal of ₹94,000 crore from Indian equities in October highlights the challenges associated with FPI, including its speculative and volatile nature.

Key Features of FPI

1. Capital Inflows
   • FPIs contribute significantly to the liquidity of capital markets, enabling smooth functioning and funding of businesses.
   • For example, FPIs provided liquidity support during the post-COVID recovery phase in Indian equity markets.
2. Market Efficiency
   • FPIs encourage better corporate governance as firms aim to attract foreign investments by adhering to global standards.
   • They also contribute to price discovery, leading to more efficient markets.
3. Economic Growth
   • FPI inflows provide funds for sectors like infrastructure, real estate, and technology, contributing to overall GDP growth.
   • In 2021-22, FPIs accounted for approximately 19% of total investments in Indian markets.
4. Foreign Exchange Reserves
   • FPI inflows bolster forex reserves, strengthening the economy’s ability to manage external shocks like trade imbalances or currency depreciation.
5. Risk Diversification for Investors
   • FPIs allow global investors to spread their risks across emerging economies like India, where growth prospects are higher.

Challenges Associated with FPI

1. Volatility in Capital Markets
   • FPIs are highly sensitive to global events, such as interest rate changes in the US or geopolitical conflicts, often leading to sudden outflows.
   • The record ₹94,000 crore outflow in October 2023 underscores the vulnerability of markets to external factors.
2. Speculative Nature
   • Short-term capital inflows can lead to speculative bubbles, with rapid buying inflating asset prices followed by abrupt crashes.
3. Impact on Exchange Rates
   • Large FPI outflows can depreciate the domestic currency, affecting export competitiveness.
   • For instance, during the October withdrawals, the Indian rupee witnessed increased pressure against the dollar.
4. Regulatory Challenges
   • Ensuring robust frameworks to prevent market manipulation and safeguard investor interests is essential, but often complex.
   • Misuse of participatory notes (P-notes) by FPIs has been a recurring issue.
5. Limited Long-Term Benefits
   • Unlike Foreign Direct Investment (FDI), which creates infrastructure and jobs, FPIs primarily target short-term gains, offering limited tangible benefits to the economy.

FPI vs. FII: A Comparative Analysis

Way Forward for Regulating and Harnessing FPI in India

1. Strengthen Regulatory Frameworks
   • The Securities and Exchange Board of India (SEBI) must enforce stringent monitoring mechanisms to prevent speculative manipulation and enhance transparency.
2. Promote Stable Macroeconomic Policies
   • A stable policy environment can attract sustained FPI inflows by reducing uncertainty in the financial markets.
3. Focus on Diversifying Investor Base
   • Encouraging investments from diverse regions can reduce dependence on a single market and mitigate risks of abrupt withdrawals.
4. Encourage Long-Term Investments
   • Policies incentivizing long-term FPI can help align foreign investments with national growth priorities.
5. Coordinate with Global Markets
   • Engaging with global economies for bilateral or multilateral agreements can provide stable investment opportunities for FPIs, reducing their tendency to shift funds during crises.

Conclusion

FPIs play a vital role in deepening India’s capital markets, enhancing liquidity, and contributing to economic growth. However, their volatile and speculative nature poses significant challenges. Balancing the benefits and risks of FPI requires a robust regulatory framework, stable policies, and focused measures to ensure that foreign investments align with India’s long-term growth objectives. While the record withdrawals in October are concerning, they underscore the importance of fostering resilience in Indian financial markets.

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