What is Foreign Portfolio Investment?

Last Updated on September 27, 2023 by BFSLTeam BFSLTeam

Foreign Portfolio Investment Meaning

Foreign Portfolio Investment (FPI) is a type of cross-border investment that involves buying and holding various foreign financial assets by investors who want to diversify their portfolios and access new markets. Foreign portfolio investors can choose from a wide range of financial instruments, such as stocks, bonds, mutual funds, derivatives, fixed deposits, etc. These instruments offer different levels of risk and return, depending on the characteristics of the foreign market and the exchange rate fluctuations. FPI investors do not have any control or ownership over the foreign entities that issue these assets, unlike Foreign Direct Investment (FDI) investors who invest in foreign businesses or projects to influence their management or operations.

Advantages of FPI in Share Market 

FPI has several advantages for both the investors and the host countries. For the investors, FPI allows them to:

• Diversify their portfolio and reduce their exposure to domestic market risks.
• Access larger and more developed markets that offer higher returns and growth potential.
• Benefit from favourable exchange rate movements that can increase their profits when they convert their foreign currency earnings into their domestic currency.
• Improve their international credit rating by holding more foreign assets and increasing their creditworthiness

For the host countries, FPI can:

• Increase the availability of capital and liquidity in their financial markets.
• Enhance the efficiency and competitiveness of their financial sector by introducing more sophisticated products and practices.
• Promote the development and integration of their economy with the global market
• Attract more FDI by signalling a positive image and confidence in their business environment

Challenges of Foreign Portfolio Investment

However, FPI also has some drawbacks and challenges. For the investors, FPI involves:

• Higher risk due to the volatility and uncertainty of foreign markets.
• Higher transaction costs due to the fees and taxes involved in buying and selling foreign assets.
• Higher information costs due to the difficulty of obtaining reliable and timely data on foreign markets.
• Higher regulatory risks due to the possibility of changes in foreign policies or laws that can affect their investments.

For the host countries, FPI can:

• Increase the vulnerability of their financial markets to external shocks and speculative attacks.
• Create instability and inflationary pressures in their economy due to the inflow and outflow of foreign capital.
• Cause exchange rate appreciation or depreciation can affect their trade balance and competitiveness.
• Erode their sovereignty and autonomy by exposing them to external influences and pressures.

Also Read: Bollinger Bands: An Introduction to the Indicator that Helps Predict Market Volatility

What are The Eligibility Criteria for FPI in Share Market 

To qualify and register as an FPI, an individual must meet certain criteria that vary from country to country. Some of the common criteria are:

• The applicant must not be a resident or a citizen of the host country or any country that is blacklisted by international organisations such as FATF.
• The applicant must be eligible and authorised to invest in securities in their home country and abroad.
• The applicant must have a genuine interest in contributing to the development of the securities market in the host country.
• The applicant must comply with the rules and regulations of the host country regarding FPIs, such as disclosure requirements, investment limits, taxation, etc.
• The applicant must obtain a certificate or a licence from a designated authority or agency in the host country that verifies their identity and eligibility as an FPI.

Also Read: Minimum and Maximum Limit for Investment in Bonds

Categories of Foreign Portfolio Investment in India

Previously, SEBI had classified FPIs into three categories, as follows:

• Category I or low-risk: This category consists of government or government-related entities, such as central banks, sovereign wealth funds, international organisations, etc. These entities were considered to have a low risk of money laundering or market manipulation, and hence they enjoyed the most relaxed norms and benefits in terms of documentation, KYC, investment limits, etc.
• Category II or moderate-risk: This category included regulated entities, such as mutual funds, insurance companies, banks, pension funds, etc. These entities were considered to have a moderate risk of money laundering or market manipulation, and hence they had to comply with some additional norms and restrictions in terms of documentation, KYC, investment limits, etc.
• Category III or high-risk: This category comprised all other FPIs that did not fall into the first two categories, such as trusts, societies, endowments, individuals, etc. These entities were considered to have a high risk of money laundering or market manipulation, and hence they had to comply with the most stringent norms and limitations in terms of documentation, KYC, investment limits, etc.

However, in 2019, SEBI revised the categorization of FPIs and simplified the norms for them. According to the new notification, FPIs are now classified into two categories, as follows:

• Category I: This category includes all those entities that were previously classified as Category I or II. These entities are considered to have a low or moderate risk of money laundering or market manipulation, and hence they enjoy the most relaxed norms and benefits in terms of documentation, KYC, investment limits, etc.
• Category II: This category includes all those entities that were previously classified as Category III. These entities are considered to have a high risk of money laundering or market manipulation, and hence they have to comply with some additional norms and restrictions in terms of documentation, KYC, investment limits, etc.

The new categorisation of FPIs aims to make the FPI registration process easier and faster for foreign investors and to attract more capital inflows into the Indian securities market.

Conclusion 

Now when you understand the complete concept of foreign portfolio investment meaning, FPI in share market is a significant source of capital flows and financial integration in the global economy. It offers many opportunities and challenges for both investors and host countries. FPI in India has been liberalised and simplified by SEBI in 2014, making it easier for foreign investors to participate in the Indian securities market. According to recent data, the top three countries that have invested in India through FPI are the United States, Mauritius, and Luxembourg.