UPSC Mains – What is the difference between FDI and FPI? What is the impact of Foreign Portfolio Investment (FPI) outflows on the Indian market and the value of the rupee?

Introduction:    

Foreign institutional investor (FII) is a designation used by certain countries for international investors in their stock markets. The term is typically associated with fast-developing economies, like India and China, that have strict rules regarding foreign investors.

Body:     

Difference Between FDI and FPI:

The influence of Foreign Portfolio Investment (FPI) outflows on the Indian market and the rupee encompasses various facets:

1. Market Volatility: FPI outflows escalate volatility in the Indian stock market. The sale of financial assets by foreign investors triggers abrupt fluctuations in stock prices, fostering overall market instability.
2. Currency Depreciation: FPI sell-offs and currency conversions intensify the demand for foreign exchange, resulting in the depreciation of the Indian rupee against other currencies. This, in turn, affects the country’s trade balance.
3. Interest Rate Adjustments: Responding to FPI outflows, the Reserve Bank of India (RBI) may make interest rate adjustments. This could involve raising interest rates to attract foreign capital, stabilize the currency, and address disruptions in the market.
4. Risk of Capital Flight: Significant FPI outflows may raise concerns about capital flight, where substantial amounts of capital exit the country rapidly. Policymakers may intervene with measures to prevent excessive fund outflows and maintain financial stability.

Measures Required:

1. Monetary Measures: The RBI employs strategies such as forex reserve accumulation and restricting FPI investments in short-term debts to counter exchange rate volatility during FPI inflows. In FY 2020-21, the RBI net purchased $68.315 billion to counter rupee appreciation.
2. Diversification of the Economy: Encouraging investment in less vulnerable sectors, such as manufacturing (Made in India) and agriculture, can help mitigate the impact of FPI inflows on the domestic economy.
3. Fiscal and Regulatory Measures: Crucial government policies, including the Tobin tax, Mutual Legal Assistance Treaties (MLATs), and Double Taxation Avoidance Agreements (DTAA), play a crucial role in influencing the impact of FPI inflows.
4. Developing Domestic Financial Markets: Initiatives like PMJDY and APY promote domestic savings, reducing reliance on foreign capital. Improving corporate governance and transparency, as observed in the Insolvency and Bankruptcy Code, helps prevent capital flight.

Conclusion:

In conclusion, both Foreign Portfolio Investment (FPI) and Foreign Direct Investment (FDI) are vital sources of funding for many economies. By harnessing foreign capital, countries can develop infrastructure, establish manufacturing and service facilities, and invest in productive assets. These actions contribute to economic growth and create employment opportunities.

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