Exit of Foreign Portfolio Investors

Context:   

June 2022 witnessed the worst Exit of Foreign Portfolio Investor (FPI) selloff since March 2020 when India announced a nationwide lockdown at Rs. 50,000 crore.

• June was also the ninth on the trot that FPIs had sold net of their assets i.e. sold more than they had purchased.

Relevance:

GS III- Indian Economy (Capital Market)

Dimensions of the Article:

1. What is FPI?
2. What are the categories of FPIs?
3. Significance of FPI
4. How Big are FPI In India?
5. Why have FPIs been selling India holdings?
6. What Impact Does an FPI Selloff Have?

What is FPI?

• Foreign portfolio investors are those that invest funds in markets outside of their home turf.
  • Examples of FPIs include stocks, bonds, mutual funds, exchange traded funds, American Depositary Receipts (ADRs), and Global Depositary Receipts (GDRs).
• FPI is part of a country’s capital account and is shown on its Balance of Payments (BOP).
• The FPI system is regulated by SEBI.
• The Foreign Institutional Investor (‘FII’) and Qualified Foreign Investor (‘QFI’) regimes were merged into the FPI regime as a standardised path for foreign investment in India.
• FPI is often referred to as “hot money” because of its tendency to flee at the first signs of trouble in an economy. FPI is more liquid, volatile and therefore riskier than FDI.

Regulations

• Permitted Instruments: Shares of listed Indian companies, non-convertible debt, units of domestic mutual funds, government securities, derivatives.
• A single FPI’s investment must be less than 10% of the Indian investee company’s post-issue paid-up share capital, and a collective investment must be less than 24%.
• An FPI’s (including linked FPIs) investment in a corporate bond issue must be less than 50%.
• Minimum residual maturity of more than one year for corporate bonds, subject to the condition that short-term corporate bond investments (less than one year residual maturity) do not exceed 20% of that FPI’s total corporate bond investment.

What are the categories of FPIs?

Cat I: Government and government related foreign investors such as Central Banks, Sovereign Wealth Funds.

Cat II: Funds, which are broad based and (i) appropriately regulated, or (ii) whose investment manager is appropriately regulated. Includes mutual funds (‘MF’), investment trusts, insurance / reinsurance companies. Also includes banks, Asset Management Companies, investment managers / advisors, portfolio managers, broker dealers and swap dealers, University funds, and Pension funds.

Cat III: Endowments, Charitable societies, Corporate bodies, Trusts, Family offices, Individuals**

** Non-resident Indians (NRIs) are not permitted to register as FPIs, however they can invest in FPIs, subject to conditions

Significance of FPI:

• Investors may be able to reach an increased amount of credit in foreign countries, enabling the investor to utilize more leverage and generate a higher return on their equity investment.
• As markets become more liquid, they become more profound and broader, and a more comprehensive range of investments can be financed.
• As a result, investors can invest with confidence knowing that they can promptly manage their portfolios or sell their financial securities if access to their savings is required.
• Increased competition for financing leads to rewarding superior performance, prospects, and corporate governance.
• As the market’s liquidity and functionality evolve, equity prices will become value-relevant for investors, ultimately driving market efficiency.

How Big are FPI In India?

• FPIs are the largest non-promoter shareholders in the Indian market and their investment decisions have a huge bearing on the stock prices and overall direction of the market.
• Holding of FPIs (in value terms) in companies listed on National Stock Exchange stood at Rs. 51.99 lakh crore as on 31st March 2022, a decrease of 3.36% from Rs. 53.80 lakh crore as on 31st December 2021 due to the sustained sell-off since October 2021.
• FPIs hold sizeable stakes in private banks, tech companies and big caps like Reliance Industries.
• The US accounts for a major chunk of FPI investments at Rs. 17.57 lakh crore as of May 2022, followed by Mauritius Rs. 5.24 lakh crore, Singapore Rs. 4.25 lakh crore and Luxembourg Rs. 3.58 lakh crore, according to data available from the National Securities Depository Ltd (NSDL).

Why have FPIs been selling India holdings?

Effects of the Pandemic:

• The recovery of the Indian economy following the Pandemic has been uneven.
• In 2021, the second Covid-19 pandemic wave wreaked havoc on people’s lives and livelihoods.
• When a third, albeit less severe, wave began to spread early in 2021, the economy stumbled once more.
• As the pandemic abated, pent-up demand began to surface in economies all over the world, which caused problems as the speed of recovery caught suppliers off guard and led to supply-side shortages.
  • Pent-up demand is the term used to describe a sudden rise in demand for a good or service, usually after a period of slow expenditure.

Russia Ukraine Conflict:

• The availability of sunflower and wheat in these two countries was affected, which increased the price of these products globally.
• Globally constricted supply led to an increase in commodity prices and a quickening of inflation overall.
• The Reserve Bank’s upper comfort level of 6 percent was consistently exceeded by the rate of price growth in India for five consecutive months, reaching a peak of 7.8 percent in April before declining to a somewhat less aggressive 7.04 percent the following month.
• The S&P Global India Manufacturing Purchasing Managers’ Index (PMI) dropped from 54.6 in May to 53.9 in June, the lowest reading in nine months. According to survey data, this was caused by inflation pressures, which also caused business confidence to decline to its lowest level in 27 months in June.

US Federal Reserve:

• In its fight against surging inflation, the US Federal Reserve recently announced the most aggressive interest rate rise in in 30 years, raising the benchmark borrowing rate by 0.75 percentage points.
• The capacity of investors to obtain healthy returns is damaged when the difference between interest rates in the U.S. and other markets narrows, especially if such a development is accompanied by a strengthening of the dollar.
• An investor can earn fewer Dollars for a given amount of Rupee assets sold if the Dollar appreciates against the Rupee.
• Investors frequently sell off assets that are viewed as “risky,” such those in developing nations like South Africa, India, or Brazil.
• The rupee has been falling in value against the dollar.
  • The rupee touched its record low of 79.33 against the greenback in July 2022.

What Impact Does an FPI Selloff Have?

Local Currency:

• The local currency suffers when FPIs sell their assets and repatriate money to their home markets.
• Investors exchange their home market currency for the sale of rupees.
• The rupee’s value decreases as the amount available on the market increases.
• We have to spend more money to import the same amount of goods as a result.

Regarding exports and imports:

• India is one of the world’s major consumers of crude oil.
• Crude oil imports become more expensive when the rupee depreciates against the dollar, which may cause cost-driven inflation to spread throughout the entire economy, particularly in sectors that are particularly vulnerable to changes in the price of crude oil.
• On the other hand, India’s exports, particularly those related to IT and IT-enabled services, may somewhat gain from a stronger dollar relative to the rupee.
• Due to intense competition in the export industry, exporters might not completely benefit from the same thing.

Reserves:

• India’s foreign exchange reserves have fallen USD46 billion in the last nine months to USD596.45 billion as on 10th June 2022, mainly due to the dollar appreciation and FPI withdrawals.
• Other Effects:
• Foreign investors pulling out can result in a decline in stocks and equity mutual fund investments.
• Lowering the value of the rupee relative to the dollar keeps import costs higher, driving inflation even higher than it already is.
• Increased inflation is bad for the market as a whole. Another drawback is that FPI outflows would persist if the rupee does not rise.
• It will cost more rupees for travellers and students studying abroad to purchase dollars from banks.

-Source: The Hindu