Understanding FPI in India: A guide for investors

Foreign Portfolio Investment (FPI) plays a significant role in the Indian financial markets, driving liquidity and influencing stock prices. For investors seeking to understand the dynamics of the Indian market, grasping the fundamentals of FPI is essential. 

Let us explore the meaning of FPI, its significance in India, and the factors that attract foreign portfolio investors to the Indian market.

What is FPI?

The FPI full form, Foreign Portfolio Investment, indicates that it involves the buying and selling of securities as well as other financial assets by investors from outside the country. Unlike Foreign Direct Investment (FDI), which involves direct ownership and control, FPI entails passive holdings in assets such as bonds, stocks, and mutual funds. The primary aim is to diversify portfolios and achieve higher returns. Investors engaging in FPI are termed foreign portfolio investors.

Benefits of FPI

Engaging in FPI offers several advantages as follows:

• With diversification, investors can spread their investments across different markets, minimising the impact of adverse movements in any one market. 
• FPI enables investors to broaden their credit base internationally, which can be beneficial if domestic credit conditions are unfavourable. 
• Investing in foreign markets provides opportunities in less saturated environments, potentially offering higher returns. 
• High liquidity is another advantage, allowing investors to buy and sell with ease and respond swiftly to market changes.
• Fluctuations in currency exchange rates can present opportunities for additional gains.

What are the different categories of FPIs? 

The Securities and Exchange Board of India (SEBI) has divided FPIs into three distinct categories:

Category I

This segment includes entities that exert substantial control over market direction. Central banks, for example, shape monetary policy through interest rate adjustments, impacting borrowing costs and investment decisions. National wealth funds, backed by state reserves, deploy vast capital, influencing asset prices across sectors. 

Global financial institutions contribute through policy recommendations and financial aid. They typically operate with extended investment horizons and are driven by policy objectives alongside financial returns.

Category II

This category comprises institutions that facilitate fund flows within the financial system, operating under stringent regulatory frameworks. Banks, investment funds, and insurance providers are core examples. 

Their investment strategies are subject to regulatory mandates, risk management policies, and reporting requirements. Due to their substantial transaction volumes, their collective actions significantly impact market liquidity and price formation.

Category III

This group encompasses a broader range of entities, operating with less regulatory constraint than those in category II. University endowments, philanthropic organisations, and individual investors are included. Individual trading behaviours within this group can exhibit more significant variability, driven by personal preferences, market sentiment, and speculative motivations. 

While individual influence may be limited, their collective actions can contribute to market volatility, especially during periods of increased online trading activity.

The regulatory framework governing FPI in India

In India, FPIs are regulated by SEBI under the Foreign Portfolio Investors Regulations, 2019. Adherence to the Income Tax Act of 1961 and the Foreign Exchange Management Act (FEMA) of 1999 is required. These laws promote transparency and safeguard investors' interests.

To register as an FPI in India, applicants must meet specific criteria. They must not be classified as Non-Resident Indians (NRIs) under the Income Tax Act of 1961 or citizens of any country listed in the public statement issued by the Financial Action Task Force (FATF). 

They must also be eligible to invest in securities outside their home country and possess approval from their Memorandum of Association (MoA), Articles of Association (AoA), or equivalent agreements.

Factors influencing foreign portfolio investment

Several factors can affect FPI flows into a country:

• Economic growth prospects play a crucial role, as robust and growing economies tend to attract more FPI due to promising returns.
• Interest rates also influence investment decisions, with higher rates luring investors seeking better yields.
• Tax policies are another determinant, as favourable tax treatments enhance the attractiveness of a market to foreign investors. 
• Political stability is equally important, as uncertainty can discourage investment.
• Market liquidity impacts FPI flows, particularly in developing countries where lower liquidity can lead to higher price volatility.

Risks associated with FPIs

While FPI offers numerous benefits, it also carries certain risks:

• Political risk is a significant factor, as changes in a country's political environment can impact investment criteria and economic policies. 
• Market liquidity can pose challenges, especially in developing economies where liquidity constraints can lead to volatile price fluctuations. 
• Currency exchange rate fluctuations can result in unexpected losses if the local currency depreciates against the investor's home currency.

Recent developments in India's FPI

India has witnessed dynamic shifts in FPI trends. The RBI plans to double the investment limit for individual foreign investors in listed companies from 5% to 10%, aiming to boost capital inflows. The NIFTY50 index recently erased its year-to-date losses following a six-day winning streak, with foreign portfolio investors turning buyers and opportunistic bargain hunting boosting market sentiment. SEBI has also streamlined the registration process for FPIs, making it more accessible to investors across the globe.

Foreign investors have shown increased interest in pharmaceuticals and renewable energy sectors, aligning with India's long-term growth story. Recent government reforms, including corporate tax reductions and production-linked incentives, have further enhanced India's appeal as an investment destination. Additionally, SEBI is contemplating extending algorithmic trading to retail investors, which could lead to greater participation and liquidity in the stock market.

FAQs

1. Can retail investors participate in FPI?

No, retail investors cannot directly participate in FPI. It is primarily meant for institutional investors, such as asset management companies, pension funds, and sovereign funds.

2. How does FPI impact the Indian stock market?

FPI inflows can drive market liquidity and influence stock prices. A surge in FPI usually boosts market confidence, while outflows can lead to volatility.

3. Are there any restrictions on FPI investments in India?

Yes, FPIs must adhere to sectoral investment limits, restrictions on sensitive industries like defence, and compliance with SEBI and RBI regulations.

4. What are the tax implications for FPIs in India?

They are subject to capital gains tax, Securities Transaction Tax (STT), and withholding tax on dividends, which vary depending on the type of investment and double taxation treaties.

5. How do global events affect FPI in India?

Geopolitical tensions, US Federal Reserve policies, and global economic conditions significantly impact FPI inflows and outflows in India.