Foreign Portfolio Investment (UPSC Economics)

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Foreign Portfolio Investment

What is FPI? Why and when is it used? Who does it? What are the characteristics of  Foreign portfolio investment? And what are the advantages of it? Does it  have disadvantages too? If yes then what are they? Let’s know more about this topic reading this article.

Well this article is aiming to solve all your queries regarding the Foreign portfolio investment

Foreign portfolio investment represents International investments in financial assets /instruments which are traded on stock exchanges . such investments are by intention short-term in nature and do not represent any intention to participate in the management of the target company. Such investments are made to exploit short-term trading opportunities to make quick capital gains/profits in foreign countries.

Characteristics of Foreign Portfolio Investment:

  1. The primary intention is not to control a foreign business enterprise but to gain from profit-making opportunities available in foreign markets.
  2. Foreign Portfolio investment is represented by monetary flows from  individuals , mutual funds portfolio management companies, pension funds,equity funds etc.
  3. Due to the short terms of nature of such investment, the fund flows are less predictable. this may result in volatility in both the foreign exchange and capital markets.
  4. There is no interface between the management and the foreign investor . the transaction represents a change in ownership of existing equity from one investor to another. It has no impact on the balance sheet of the company.
  5. Conventionally , all such investments represent secondary market transactions . however , regulations may permit investments through the primary market with quantitative restrictions.
  6. Foreign Portfolio investment  transactions result in the replacement of an existing investor. Thus, they do not directly contribute to economic growth. However, the greater demand for shares of the target company increases. Their market price leading to a higher PE ratio. This helps the target company to raise capital at lower cost.

What are the Advantages of Foreign portfolio investment? Following are the advantages of the FPI:

  1. There is a substantial increase in the secondary market depth and breadth due to the presence of such investors.
  2. The capital market acquires an institutional character since global liquidity is channelized into local markets in a planned manner through research and analytical studies. These funds translate into diversified investments against predefined risk parameters.
  3. These investments increase demand for the shares of target companies thereby increasing their PE ratios. This helps such components to raise the capital lower cost.
  4. International investors are provided with an avenue for investments diversification, wealth protection and at a macro level an opportunity for cross country hedging in terms of currencies , industries, and geographical locations.
  5. The growth in FPI in recent years can be attributed to better investor protection regulations in developing countries, liberalisation in the terms of access to such markets and better macroeconomics fundamentals of emerging economies.
  6. They provide a buffer for financing the balance of payments deficit thereby helping to preserve the foreign currency reserves of the host country.

To the question of it having disadvantages well yes, it does have disadvantages too

Following are the Disadvantages of Foreign Portfolio Investment:
  1. Political risk represented by the possibility of change in the political environment resulting in changes in investment norms and repatriation regulations.
  2. Emerging markets which are the beneficiaries of most FPI Traditionally suffer from low retail participation which results in inadequate liquidity which results in price volatility.
  3. Due to the unpredictable nature of such funds, there is a tendency to shift from one market to another at short intervals volatility arising out of FPI inflows and outflows has adverse effects on the host country economy.
  4. Emerging economies tend to have depreciation prone currencies this expose the foreign investor to exchange rate risk on both principal and returns.

This is all about foreign portfolio management one should know.

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