Foreign Portfolio Investment (FPI) is a kind of investment in which the investors can group their financial securities as well as assets in any foreign country.
The financial securities they hold can include bonds, stocks, exchange-traded funds (ETFs), mutual funds, etc. FPI is a factor that effectively enhances the stock market efficiency and strikes a balance between the price and value of the stock in the market.
The Securities & Exchange Board of India (SEBI) regulates the functioning of Foreign Portfolio Investment in India. FPI is also known as Foreign Institutional Investors (FII)/ investment groups or Qualified Foreign Investors (QFI).
Types of FPI in India
There are multiple categories into which FPI is classified based on the risk level.
Category 1 – This category is low-risk and includes investment in establishments that are associated with the government, such as the central bank and other agencies.
Category 2 – The second category is a moderate-risk type which includes investment in financial intermediaries like banks, mutual funds, insurance firms and many more.
Category 3 – This category is a high-risk type and specifically includes all the FPIs that aren’t included in the first two categories.. This includes FPIs in charitable organisations such as NGOs, trusts or others.
Advantages of FPI
Foreign Portfolio Investment yields several benefits including a surge in demand for stocks of companies, aids in diversifying investments of investors, helps investors gain the benefit of exchange rate changes, its nature of liquidity and many more.
Portfolio diversification – This is a key advantage of an FPI. Through FPI, the investors become capable of diversifying their portfolio’s assets as they buy or sell stocks not only in the domestic market but also from foreign countries. During underperformance of a country’s stock market, it wouldn’t impact the investors heavily who have undertaken FPI as they own stocks from various countries. Accordingly, the degree of volatility in their portfolio reduces.
International Credit – FPI also gives the investors an advantage to widen their credit base over the global market, thus giving access to international credit. Any investor with an FPI will be able to borrow in foreign countries where they have made investments. This advantage allows the investor to secure their line of credit and aids in remaining steady.
Liquidity – The FPIs are known to be highly liquid in nature and provide the investors with the required amount of liquidity in the market. Accordingly, any investor can buy or sell stocks quickly and very easily. It also enhances the buying power of the investors and thus is capable of responding rapidly to any potential purchase opportunities.
Exchange rate benefit – The exchange rates of international currencies are volatile in nature. The changes in the exchange rates are extremely unpredictable. Sometimes, the domestic currency remains strong and other times it depreciates. So, investment in the foreign portfolios helps the investors benefit from a comparatively stronger currency.
Disadvantages of FPI
Despite the advantages, there are some disadvantages of FPIs as well. Firstly, the country that receives the FPI experiences becomes more prone to volatility given the unpredictability of investments as well as market shifts.
Secondly, investors are allowed to withdraw their FPI at their convenience. Such withdrawals impact the exchange rates in the market and lead to the development of heavy risks in the host country.
However, the FPI implies an investment of foreign investors in the financial instruments such as stocks, bonds and mutual funds, etc. It can be traded from time to time and leads to heavy liquidity. As a result, this causes heavy volatility as traders enter and exit the market swiftly.