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How FPI dumping impacts the Indian market?

  • Category
    Economy
  • Published
    14th Jun, 2022

Overview:

  • What are FPIs
  • How it benefits India
  • Concerned Risks
  • Reasons behind FPIs sell-off
  • Preventive measures

Context

Foreign Portfolio Investors have been on a selling spree in India. May figures of about Rs. 44,000 crore forming the highest monthly quantum of sell-off since March 2020 when India announced nation-wide lockdown in the backdrop of covid pandemic.

Background

  • Capital account of India’s Balance of Payment constitutes foreign both foreign direct investments and foreign portfolio investment.
  • Foreign investments are one of the major sources of foreign capital inflow for India.
  • COVID pandemic has given a severe stress in the process of foreign currency inflow through foreign investment route.
  • Along with covid, other several factors such as, middle-east crisis and rise in oil prices in the international market and inflationary stress as contributed to the sell-off of FPIs in the Indian economy.

Analysis

What are FPIs?

  • Foreign Portfolio Investments are investments in the market outside of the home turf.
  • FPIs typically includes equities, bonds and mutual funds, with having an administrative control over the company.
  • FPI, being a passive mode of investment, providing a easy way for entry and exit from the market.

What are benefits of FPIs?

  • Inflow of foreign currency: More FPIs increases the inflow of foreign currencies in the country, positively impacting the balance of Payment of the nation.
  • Surplus Balance of Payment: More dollar in the forex reserve increase strengthens the balance of payment situation.
  • Appreciation of currency: Supply of dollar in the economy limits the downfall of rupee and increases the value of rupee with respect to foreign currency.
  • Increase in Import cover: Availability of forex reserve at surplus position makes the country’s import cover stronger, essential for import dependent country like India.
  • Reduction in Import Bill: Appreciated currency or a stronger rupee reduces the burden of out shelling of funds on imports.

What are the risk associated with the FPI?

  • Easy way of entry and exit: FPIs are volatile in nature, with a barrier free entry and exit method, creating a fluctuation in the Indian market.
  • Short term investment: Due to negligible barrier for movement, there remains a scope for volatility in the investment.
  • Hot money: Frequent inflow and out flow of dollar, increases the risk of currency volatility in the exchange rate market, further having a prolonged impact in the stock market and profitability of the domestic investors.
  • Forex stress: Repayment of the investment money in dollar terms increases the burden on the forex reserve of the country.
  • Depreciation of rupee: Sudden dumping of FPIs in the economy reduces the value of local currency with respect to dollars.
  • Increase in Import bills: With a weaker rupee, India has to shell out more fund for the same amount of goods, widening the scope for imported inflation.
  • Balance of Payment crisis: Increasing import bills and decline in foreign investment leads to outflow of dollars from the economy, creating a potential threat to the Balance of Payment.

What are the risk associated with the FPI?

  • Easy way of entry and exit: FPIs are volatile in nature, with a barrier free entry and exit method, creating a fluctuation in the Indian market.
  • Short term investment: Due to negligible barrier for movement, there remains a scope for volatility in the investment.
  • Hot money: Frequent inflow and out flow of dollar, increases the risk of currency volatility in the exchange rate market, further having a prolonged impact in the stock market and profitability of the domestic investors.
  • Forex stress: Repayment of the investment money in dollar terms increases the burden on the forex reserve of the country.
  • Depreciation of rupee: Sudden dumping of FPIs in the economy reduces the value of local currency with respect to dollars.
  • Increase in Import bills: With a weaker rupee, India has to shell out more fund for the same amount of goods, widening the scope for imported inflation.
  • Balance of Payment crisis: Increasing import bills and decline in foreign investment leads to outflow of dollars from the economy, creating a potential threat to the Balance of Payment.

What are the available preventive measures?

  • Tobin tax: Tax imposed on the frequent movement of foreign currency, i.e., Hot Money, is considered as Tobin Tax. This ensures stability in the exchange rate as well as stock market of the domestic economy.
  • Convertibility of currency: Government of India has distinguished convertibility measure for capital and current account. A partial convertibility is allowed for capital investment, reducing the risk of currency market volatility and stock market shocks.
  • Fiscal and monetary policy: A stabilization policy measure from both fiscal and monetary side, to control various sources of inflation in the economy.
  • Differential investment routes: Government of India follows a policy measure of differential investment routes, few type of investments require government approval where others don’t.
  • Limit on several sectors: Imposition of cap for foreign investment in several sectors is one of the preventive measures by the government.

Conclusion

Foreign Portfolio Investment has a significant share in the Balance of Payment of India, thus, becomes a deciding factor for India’s share in world economy. Sudden decline in FPIs provides a severe stress in the exchange rate market further creating a domino effect in the stock market and inflation in the economy.

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