Brief overview of Foreign Portfolio Investments - impact on the economy and impact by the economic variables, with special statistics & focus on India.

1. FPIs & Macroeconomic
Variables
Tarang Gupta

2. What are FPIs?
In economics, foreign portfolio investment is the entry of funds into a country
where foreigners deposit money in a country's bank or make purchases in the
country’s stock and bond markets, sometimes for speculation.
For example: Purchase of stocks by Ram in Barcelona.
1. Highly Liquid
2. No Managerial Hold
3. Foreign portfolio investment typically involves short-term positions in financial
assets of international markets, and is similar to investing in domestic securities.
FPI allows investors to take part in the profitability of firms operating abroad
without having to directly manage their operations. This is a similar concept to
trading domestically: most investors do not have the capital or expertise required
to personally run the firms that they invest in.
FPIs- About

3. FPI Rules & Regulations (in India)
 In order to harmonize the various available routes for foreign portfolio investment
in India, the Indian securities market regulator i.e. Securities Exchange Board of
India ("SEBI") has introduced a new class of foreign investors in India known as
the Foreign Portfolio Investors ("FPIs"). This class has been formed by merging the
existing classes of investors through which portfolio investments were previously
made in India namely
 1. Foreign Institutional Investors ("FIIs"),
 2. Qualified Foreign Investors ("QFIs")
 3. Sub-accounts of the FIIs.

4.  Previously portfolio investment was governed under different laws i.e. the
SEBI (Foreign Institutional Investors) Regulations, 1995 for FIIs and their
sub-accounts and SEBI circulars dated August 09, 2011 and January 13,
2012 governing QFIs, which are now repealed under the SEBI (Foreign
Portfolio Investors) Regulations ("FPI Regulations") that govern FPIs.
 SEBI has, thus, intended to simplify the overall operation of making foreign
portfolio investments in India. To govern FPIs, SEBI introduced the FPI
Regulations by a notification dated January 7, 2014.

5. Classification based registration of
investors
 Under FPI Regulation 5 the following three categories of FPIs have been
created on the basis of associated risks -
 (a). Category I - Includes foreign investors related with the government
such as central banks, government agencies, sovereign wealth funds.
 (b). Category II - Includes regulated entities like banks, assets
management companies, investment managers etc. and broad-based
funds, which may be regulated such as mutual funds, investment trusts
etc. or non-regulated.
 (c). Category III - Includes investors, which are not covered under
categories I and II.

6.  The registration requirements are progressively difficult depending
on the category under which the investor falls with easiest formalities
for category I investors.
 Unlike the previous situation wherein the QFIs, FIIs and their sub-
accounts were required to register with SEBI for 1-5 years initially to
operate, FPIs registration is carried out by SEBI designated
depository participants ("DDPs") on permanent basis unless
suspended or cancelled.

7. Eligibility criteria for FPIs
 FPI Regulation prescribes the mandatory eligible criteria for registration as
FPI.
 1. The applicant must be a non-resident in India but non-resident Indians
("NRIs") are specifically prohibited. However, a fund having NRIs as its
investors can operate as a FPI as stated by SEBI.
 2. The applicant is required to be a resident of a country which meets the
following criteria- 1.Its securities market regulator is a signatory to the
International Organization of Securities Commission's Multilateral
Memorandum of Understanding or party to an MOU with SEBI. 2.Whose
central bank is a member of the Bank for International Settlements in case if
the applicant is a bank. 3.Not mentioned in the public statement of Financial
Action Task Force as a country having issues related to combating financing of
terrorism or money laundering.

8. Instruments available for investment
and prescribed limits
 FPIs can invest in instruments-
1. Listed or to be listed shares,
2. Government securities,
3. Units of mutual funds or collective investment schemes,
4. Treasury bills,
5. Corporate debts.
6. Indian depository receipts.
 For foreign corporates and foreign individuals, the investment limit now stands
increased from 5 to 10% of a company's total issued capital. Also, investment in
equity shares which was previously permissible up to 10% of a company's total
issued capital is now restricted to below 10%.

9.  FPI Regulation 22 has brought a major change relating to issuance of
Offshore Derivative Instruments ("ODIs"). ODIs are significant because
they allow foreign investors, such as high net worth individuals and
hedge funds based overseas, to invest in the Indian market without being
registered with the SEBI. Now, only FPIs, which are regulated and also
fall under Category I or II can issue ODIs.
 With the ease in registration requirements and clarity on taxation being
brought in for FPIs, the new FPI regime is likely to boost portfolio
investments in India by foreign investors. Granting of permanent
registrations to FPIs shall not require them to approach the DDPs time
and again for the same, thus, providing them a more supportive
environment for investment in India. Meanwhile, with the delegation of
work to DDPs, SEBI can now focus on more important issues at hand
requiring its attention and perform its regulatory role more effectively.

10. .
.
The inflow of FPI can provide a
developing country non-debt
creating source of foreign investment.
FPI gives an upward thrust to the
domestic stock market prices.
Increased inflow of foreign
capital increases the allocative
efficiency of capital in a country.
How Foreign Portfolio Flow
can help an Economy?

11.  The advent of portfolio investment can supplement domestic
saving for improving the investment rate.
 By providing foreign exchange to the developing countries, FPI
also reduces the pressure of foreign exchange gap for the LDCs,
thus making imports of necessary investment goods easy for
them.
How does FPI develop non debt
creating source of foreign investment?

12.  FPI induces financial resources to flow from capital-abundant countries,
where expected returns are low, to capital-scarce countries, where expected
returns are high.
 The flow of resources into the capital-scarce countries reduces their cost of
capital, increases investment, and raises output.
 It is also sometimes believed that portfolio investment does not result in a
more efficient allocation of capital, because international capital flows have
little or no connection to real economic activity. Consequently portfolio
investment has no effect on investment, output, or any other real variable with
nontrivial welfare implications.
How does inflow of foreign capital
increase the allocative efficiency of
capital in a country?

13.  FPI gives an upward thrust to the domestic stock market prices. This has an
impact on the price-earning ratios of the firms. A higher P/E ratio leads to a
lower cost of finance, which in turn can lead to a higher amount of
investment. The lower cost of capital and a booming share market can
encourage new equity issues.
 The equity investment may not always lead to an increase in real investment
in the private sector. This is simply because most stock purchases are on the
secondary market rather than the purchase of newly issued shares. The first
impact is to increase the price of the shares rather than the flow of funds to the
companies that wish to increase investment. Increased wealth of local
investors may actually increase consumption.
How does FPI affect the domestic
stock market prices?

14.  FPI also has the virtue of stimulating the development of the domestic stock
market. The catalyst for this development is competition from foreign
financial institutions. This competition necessitates the importation of more
sophisticated financial technology, adaptation of the technology to local
environment and greater investment in information processing and financial
services. The results are greater efficiencies in allocating capital, risk sharing
and monitoring the issue of capital.
 This enhancement of efficiency due to internationalization makes the market
more liquid, which leads to a lower cost of capital.
 A well-developed stock market has its impact on the demand side also. It
provides investors with an array of assets with varying degree of risk, return
and liquidity. This increased choice of assets and the existence of a vibrant
stock market provide savers with more liquidity and options, thereby
inducing more savings.

15. Macroeconomic Variables –
Impact on FPIs (Indian
Perspective)

16.  The movement of Foreign Portfolio Investments in an economy is determined by
a host of macroeconomic factors which include prices, interest yields, economic
growth etc.
 However the impact of these factors is not absolute, a lot of external events also
have a considerable influence on these movements. A change in government
policies, a major event in the world economy, a social unrest in the domestic
country and similar disturbances have the potential to re-route the FPI inflows
and outflows of a country even when all its macroeconomic variables are
satisfactory.

17. Exchange Rate
 Exchange rate refers to the value of domestic currency in terms of a
foreign currency. Such as rupee per dollar or rupee per euro or dollar per
euro.
 A change in the exchange rate is inversely proportional to the change in
FPI inflows. This happens because an increase in the foreign exchange
rate or depreciation in the domestic currency leads to a reduction in the
returns of the foreign investors & vice-versa.
 Example – Jack a foreign investor invests $100 in India when the
rupee/dollar exchange rate is 60 i.e Rs.6000. Due to some emergency he
decides to withdraw this $100 but he receives only $92. This happened
because in the meantime the rupee/dollar exchange rate went up by 5 to
65, thereby eroding the value of his investments.

19. Gross Domestic Product
 Change in real GDP is directly proportional to Foreign Portfolio
Investments inflows.
 A stable and sustained growth in GDP shows an overall growth in
the country’s industries. This indicates adequate demand level in the
economy and willingness of people to spend which incentivises
producers to think of increasing production & expanding production
capacity.
 This has a bearing on the individual firms involved in various
industries with many of them witnessing increased profits & stock
price appreciation.

20. Stock Indices
 Stock Indices like BSE Sensex, Nifty, DOW Jones are representative of the
general condition of a country’s stock/financial markets.
 An increase in the value of these indices signals a strong financial market. A
sustained rise in the stock indices of a country attracts FPIs as it represents strong
demand and liquidity in the financial markets generally accompanied by high
volumes.
 FPI inflows further give a boost to these markets as they create demand in the
market. However, if the markets start falling due to some external factors the
capital flight in the form of FPIs can cause the markets to fall further due to
creation of excess supply.

21. • Foreign Portfolio Investors (FPIs) hold a larger stake in listed Indian companies (10.45%)
than the combined stake of Indian Mutual Funds (2.68%) and Indian Financial
Institutions/Insurance Companies (5.32%).

22. Inflation
 Inflation is defined as a sustained increase in the general price of goods &
services in an economy.
 An increasing rate of inflation is likely to drive out foreign investors from the
economy because the return on their investments decreases with an increase in
the general price level. If the inflation rate in the country is increasing, then the
value of the foreign investments is dwindling because the domestic currency is
depreciating in real value.
 However a controlled rate of inflation is desirable as it promotes growth in the
economy & acts as a safeguard for the economy against depression.

23. Government Treasury Yields
 Government treasury yields refer to the interest being paid by the
government on government debt instruments such as bonds.
 These have a direct relationship with FPI inflows as a higher interest
rate is attractive for foreign investors & so they are more likely to
invest in these debt instruments compared to the debt instruments of
their or other countries with a lower interest rate.
 However the real return on these debt instruments depend on their
market prices, with an increase in market price leading to a fall in
the real return and vice-versa.

25. Major Events Impacting FPIs
 January-March – No major external influences but decrease in monthly net
inflows due to strong performance by other Asian economies, especially China.
 April-May – Uncertainty over the imposition of MAT on foreign investors.
 May-June – Government decides against charging MAT on profits of foreign
investors.
 July-August – China devalues Yuan. Economic growth revealed to be lower than
the previous quarter. Manufacturing sector growth slows in August.
 September – Uncertainty over US rate cut clears. RBI announces repo rate cut.
Chinese economy struggles.

27. THANK YOU