What Is Foreign Portfolio Investment? FPI Meaning and Benefits

Foreign Portfolio Investment

Foreign Portfolio Investment Trends FPI refers to the purchase of financial assets in a country by foreign investors. These assets can include stocks, bonds, and other securities. FPI can be a significant source of capital for developing countries, as it can help to finance infrastructure projects, boost economic growth, and attract foreign talent.

In recent years, FPI has been on the rise in India. In 2022, India received a record $84.8 billion in FPI inflows. This was driven by a number of factors, including the country's strong economic growth, its attractive investment opportunities, and its relatively stable political environment.

However, FPI inflows have been volatile in recent years. In 2021, FPI inflows fell by 12%, as investors became concerned about the impact of the COVID-19 pandemic on the Indian economy. In 2022, FPI inflows rebounded, but they remained volatile.

Managing Currency Risk

One of the challenges of investing in foreign markets is the risk of currency fluctuations. When the value of a currency changes, the value of the investment in that currency can also change. This can be a significant risk for investors, as it can erode their returns.

There are a number of ways to manage currency risk. One way is to use hedging strategies. Hedging involves taking steps to offset the risk of currency fluctuations. For example, an investor might buy a currency future or option to protect their investment against a decline in the value of the currency.

Another way to manage currency risk is to invest in financial instruments that are denominated in multiple currencies. This can help to reduce the risk of currency fluctuations, as the value of the investment will not be as sensitive to changes in a single currency.

FPI can be a valuable source of capital for developing countries. However, investors need to be aware of the risks associated with investing in foreign markets, such as currency fluctuations. There are a number of ways to manage currency risk, such as using hedging strategies or investing in financial instruments that are denominated in multiple currencies.
 

The FPI full form is "Foreign Portfolio Investment." The popularity of Foreign Portfolio Investment has reached unprecedented heights on the back of a rapidly globalizing world and integrating economies.  Technological innovations have made cross-border investing much more easier and cost-effective than it was a few decades ago. Today investing in foreign securities is almost as easy as investing in domestic securities. Investors can track real-time stock prices and foreign exchange rates with the help of online applications. As more advanced technologies are developed and stock exchanges throughout the world adopt convergent regulations and compliances, the popularity of Foreign Portfolio Investment is likely to grow. 

FPI vs FDI

Foreign Direct Investment and Foreign Portfolio Investment are very similar yet very different terms.  Foreign direct investment takes place when a foreign entity or foreign individual establishes and conducts a business in India while foreign portfolio investment is said to take place when a foreign entity or a foreign investor invests in the security of an Indian company or purchases securities issued by a company from India. 

For example, if an entity or investor in the United States of America purchases security issued by the State Bank of India, then it will be the case of Foreign Portfolio Investment.  However, if the same investor was to establish a new bank in India and start the business of banking in India then it would be a case of foreign direct investment. 

Both Foreign Direct Investment (FDI) and Foreign Portfolio Investment have their advantages and disadvantages. While foreign direct investment brings more economic development for the host country it also involves more compliance and is costly.  On the other hand foreign portfolio investment also promotes growth and economic development of the host country but it is more convenient and cost-effective. 

Benefits of FPI (Foreign Portfolio Investment)

• Capital Generation

The increase in the popularity of Foreign Portfolio Investment vastly enhanced the market for the securities of companies such as their shares, debentures, etc. Companies are now finding it easier to sell their securities at higher and more competitive prices as compared to when they were able to sell their securities only to domestic customers or investors. 

• Risk Diversification

Foreign Portfolio Investment helps investors to diversify their portfolios by investing in the shares of different companies located in different countries. This way, even if the microeconomic conditions of one country go into crisis, the investors will be able to make good the loss incurred on the investment made in the companies of that country with the profits made on investments in companies located in other geographies. Moreover, where two countries are competing against each other to gain dominance in a particular industry, an investor can hedge the risk by investing in both countries. 

• Global Peace and Stability

Foreign Portfolio Investment creates a much more integrated world where citizens of each country have financial interests in the well-being and probability of companies across the world. In this way,  any instability or war which causes economic upheaval for any country will hurt the interest of people across the world. Thus, FPI creates a deterrence against war for every country. 

Challenges in FPI (Foreign Portfolio Investment)

• Exchange Rate Fluctuations

Purchasing securities of another country involves converting domestic currency into either the currency of that other country or into dollars. This conversion occurs both at the time of purchasing the security as well as at the time of selling it. Any appreciation of domestic currency or depreciation of the currency of that other country is likely to adversely affect the interests of the investor. 

For example, an American investor purchases a share of an Indian company "X" at a price of ₹80 today. Assuming an exchange rate of $1 = Rs 80, he would have to spend $1 to make this purchase. Now let us assume that he sells this share after 1 year at a price of 100 rupees.  If the American dollar appreciates or the Rupee depreciates and the exchange rate becomes $1 = Rs 100, the investor will get back only one dollar and will end up making no profit despite the fact that the value of the share has gone up by Rs 20. 

• The Danger of Double Taxation

Foreign Portfolio Investment (FPI) transactions are usually subject to Capital Gains Tax. An issue with such transactions has always been the possibility of the application of double taxation on capital gains. 

Double taxation implies tax levied by both the destination country and the domestic country. For example, if a person from France transacts in shares of an India Company, he will have to pay Capital Gains tax in India as the profits have been earned in India. Additionally, he may also be required to pay tax in France if he remits the amount earned to France. To avoid such double taxation, the Indian government has entered into Double Tax Avoidance Agreements, or DTAAs with various governments. Such DTAAs give the investor a choice to decide whether he wants to pay tax in India or his home country. Such agreement can help investors escape double taxation and make more profits

Foreign Portfolio Investment is a lucrative financial investment method for investors to minimize risk and maximize return. They can use a to diversify the portfolio and hedge risks. It opens the global market of financial assets for them where they can choose from a fast range of securities to maximize the return.

Despite its challenges foreign portfolio investment continues to grow because of the lucrative returns that it has a potential to investors. However, picking the right security from this vast ocean of financial assets can be a bit challenging. Keeping track of foreign exchange rates and bilateral agreements can create an additional workload. This is where experts come in. With our advanced algorithms and highly experienced team, we can help you earn sky-high returns on your portfolio. To know more, reach us at info@mastersindia.co.

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