Foreign Portfolio Investment (FPI) (2024)

What is Foreign Portfolio Investment (FPI)?

Foreign Portfolio Investment (FPI) involves investing in securities and financial assets in another country than a home country. The securities include stocks or American Depository Receipts (ADR) of companies in an overseas country. Also, it includes bonds or debts issued by companies or governments, mutual funds, and exchange traded funds (ETFs). Furthermore, it does not provide direct ownership or control over the company’s assets. In other words, all these investments are held passively by foreign portfolio investors.

The foreign portfolio is subject to volatility which in turn increases the risk. Also, the intent of investing in overseas markets is to diversify their portfolio and earn significant returns by giving them an edge in international markets. Individuals, companies or government agencies invest in foreign portfolios.

While on a macro level, foreign portfolio investments become a part of the country’s capital account and are seen on its balance of payments (BOP). BOP measures the amount of money flowing from one country to another over a financial year.

Categories of FPI

On the basis of the risk profile of investments, the following are the three categories of FPI in India –

• Category I (or low risk): It comprises financial assets backed by the Indian Government. It includes government bonds, any fund the Indian state owns, a sovereign wealth fund, etc.
• Category II (or moderate risk): It comprises regulated broad-based funds like mutual funds, pension funds, insurance policies, bank deposits, etc.
• Category III (or high risk): It comprises all FPI that are not eligible for the first two categories. It includes charitable trusts, endowments, charitable societies or foundations, etc.

Who Invests Through FPI?

The FPI involves several types of investors. However, the common investors are –

• Individuals
• Companies
• Foreign Governments

Policies for Foreign Portfolio Investment

The Government of India has made a well-designed FPI policy. It includes defining the FPI, identifying the types of investors under FPI, setting investment limits and classifying them in terms of risk profile. All these put together is the FPI policy.

The most common investment by FPI is in equities or shares. However, it is essential to differentiate between FDI and FPI. According to the present FPI policy, investment of up to 10% shareholding from a single foreign investor in an Indian firm is FPI, and anything above 10% is considered as FDI. This differentiation is required for regulatory purposes.

Additionally, all FPIs together cannot acquire more than 24% of the paid capital in an Indian company. But this condition has been modified and elaborated in the foreign investment cap policy by the government. Besides setting the investment limit for FPI, SEBI also introduced an investment group known as Foreign Portfolio Investors.

FPIs are a combination of various portfolio investment groups. Also, a different class of investors, like FIIs, their sub-accounts, and Qualified Foreign Investors, are combined into a new category to place a uniform set of entry norms for them.

Advantages of Foreign Portfolio Investment

The following are the advantages of FPI –

• Portfolio Diversification: FPIs give investors an opportunity to diversify their portfolios internationally. This will help them to generate higher risk-adjusted returns where they can cushion losses due to market volatility.
• International Credit: Investors can access increased credit in other countries, which boosts their credit base. For instance, investors with low domestic credit score can compensate using their higher foreign credit score. Thus giving higher leverage to investors and helping them generate better returns on their investments.
• Access to Bigger Markets: Through FPI, investors no longer need to invest only in domestic financial markets. They can increase their reach to the global market and earn better returns. For instance, emerging markets or unsaturated markets can provide increasing returns on investments.
• Improves Liquidity: FPI improves liquidity for individual investors as well as for domestic capital markets. With the increase in liquidity, the financial market grows and provides a wide range of investment opportunities. At the same time, investors also have control over their portfolio and sell their assets quickly at the right opportunities or foresee any significant risk.
• Exchange Rate Benefit: Investors can benefit from the fluctuating exchange rate among nations. They can invest when the exchange rate has fallen and sell the holdings when the exchange rate rises. This results in dual benefits in investment returns, further boosted by the exchange rate.

Risks Involved in Foreign Portfolio Investment

The following are the risks involved in FPIs –

• Political Risk: Any sudden change in the political situation or government policies can create uncertainty for investors, including foreign investors. For instance, changes in the government can result in changes in economic or investment policies, which can impact 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 index.
• Liquidity: Sometimes, in developing countries, the capital market liquidity is low, which results in higher volatility.

Factors Affecting Foreign Portfolio Investment

The following are some factors affecting the FPI –

• Growth Prospects: A country’s economy plays a crucial role in foreign investments. If the economy is robust and growing, then investors prefer investing in the financial assets of that country. In contrast, investors tend to withdraw their investments if the economy is experiencing financial turmoil or recession.
• Interest Rates: Any investor would prefer a high return on investment. Therefore, investors look for countries whose interest rates are high.
• Tax Rates: There are taxes levied on capital gains, and a higher tax rate can reduce the overall return on investment. Hence, investors prefer investing in countries with lower tax rates.

Difference Between FPI and FDI

The following table shows the difference between FPI and FDI

Frequently Asked Questions

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