Foreign Portfolio Investment (FPI) refers to the investment by an individual or an entity based in another country into the financial assets of an emerging economy like India. But before we dig deep on how it impacts the economic health, we must understand what is foreign portfolio investment.
The Role of FPI in Economic Growth:
Foreign Portfolio Investment (FPI) comprises of securities and other financial assets passively held by foreign investors. It does not provide the investor with direct ownership of financial assets and is relatively liquid depending on the volatility of the market. The primary purpose of FPI is for quick and short-term gain, compared to Foreign Direct Investment (FDI) which allows investors to have a direct stake in the business.
Many emerging economies see FPI as a crucial source of economic growth. FPI allows investors to participate in another country’s growth while fostering development in that nation.
In the ambit of international finance, an increase in foreign portfolio investment is often taken as a signal of a booming economy. For example, after the introduction of economic liberalisation in India in 1991, the country attracted significant FPI, which led to the rapid growth of the economy.
The role of foreign portfolio investment in shaping the economic fortunes of countries like India is essential for a few reasons. To start with, it leads to the strengthening of the domestic capital market. Let’s assume if the FPI in India equals to 500 crore INR in a year, and if this money is invested in the equities segment, it increases the demand for stocks of the companies thus boosting the overall market sentiment.
How to Invest in Foreign Stocks:
While FPI involves foreign entities investing in India’s markets, individuals can also explore how to invest in foreign stocks to diversify their portfolios. Investing in foreign stocks can offer significant growth potential, especially in developed markets like the U.S. or Europe, where established companies often offer long-term stability and returns. Many brokerage firms in India now offer access to international markets, allowing Indian investors to buy stocks of companies like Apple, Amazon, or Tesla. This option provides an opportunity to benefit from global economic growth while spreading risk across various markets.
Impact on Currency and Exchange Rates:
An increase in demand for domestic securities by foreign investors is followed by an appreciation in the value of the rupee. This aids in stabilising the exchange rate system to a large extent. To be precise, if the FPI is 500 crore, and one dollar equals 75 INR, then approximately 67 million USD has entered the Indian economy gesturing a stronger economy.
Risks Associated with FPI:
However, Foreign Portfolio Investment also comes with its share of drawbacks for emerging economies like India. The fickle nature of FPI, given that it can be quickly withdrawn, may lead to a sudden capital flight leading to a financial crisis in an economy. Moreover, FPI can lead to the overvaluation of the currency leading to a rise in inflation rates. Therefore, the domestic economy should not be overly dependent on FPI.
Another risk factor comes with the volatility of international finance. If global events lead to a downturn in the global economy, foreign investors may decide to withdraw their investments, leading to a financial crisis.
Therefore, it is essential to have strong regulatory mechanisms in place to manage the flow of foreign portfolio investment in the economy.
conclusion
Foreign Portfolio Investment plays a significant role in shaping the economic trajectory of emerging economies like India. While it has a plethora of advantages like enhancement of capital markets and stabilization of exchange rates, the downsides like possible capital flight and currency overvaluation require attention through robust financial governance. Similarly, understanding of invest in foreign stocks provides individual investors with a unique opportunity to diversify their portfolios and tap into the growth of international markets. However, it’s essential to grasp the nuances of FPI and foreign stock investments to fully reap the benefits while mitigating associated risks.
DISCLAIMER:
This article aims to provide information on Foreign Portfolio Investment and should not be construed as a recommendation. Investors should make their own independent evaluation and should consider discussing their specific requirements with a professional financial advisor.
Summary:
Foreign Portfolio Investment (FPI), an investment strategy by foreign entities or individual in an emerging market’s financial assets, plays a critical role in shaping the economic trajectory of the emerging economies like India. While FPI can lead to enhanced capital markets and exchange rate stabilization, it can also lead to possible capital flight and currency overvaluation. In the context of the Indian market, a significant boost in FPI signals an economically healthy and growing nation, but on the flip side, its sudden withdrawal can lead to a financial crisis. Therefore, understanding the ins and outs of foreign portfolio investments and having strong regulations to manage the flow of FPI is essential. However, investors must gauge all the pros and cons of trading in the Indian financial market before making any investment decisions.
