Why are FPIs dumping Indian stocks?

06 Jun Why are FPIs dumping Indian stocks?

Why are FPIs dumping Indian stocks? Today Current Affairs

Context

Foreign portfolio investors (FPIs) have been on a selling spree in India. May figures of about ₹44,000 crore formed the highest monthly quantum of sell-off since March 2020 when India announced a nationwide lockdown. Last month was also the eighth on the trot that FPIs had sold net of their assets — i.e., sold more than they had purchased.

Their selling actions have triggered a significant decline in benchmark indices resulting in a drop in market capitalisation of companies.

Today Current Affairs

What are FPIs?

Foreign portfolio investors are those that invest funds in markets outside of their home turf. Their investments typically include equities, bonds and mutual funds exchange-traded funds. They are generally not active shareholders and do not exert any control over the companies whose shares they hold. The passive nature of their investment also allows them to enter or exit a stock at will and with ease.

What factors spur FPI moves? The Hindu Analysis

• Promise of attractive returns on the back of economic growth draws investors including FPIs into a country’s markets. For example, as per data from the National Securities Depositories Ltd. (NDSL), FPIs brought in about ₹3,682 crore in 2002. This grew to ₹1.79 lakh crore crore in 2010. This correlates with the concurrent expansion of economic output in that period, despite the 2008 global financial crisis. The year 2017 saw FPI inflows exceed ₹2 lakh crore.
• FPIs also show keenness to invest in bonds when there is a favorable differential between the real interest rates on offer in the country they aim to invest in, and other markets, but more specifically, compared with the largest economy in the world, the U.S.

Why have FPIs been selling India holdings? The Hindu Analysis

• Post-pandemic, recovery in the Indian economy has been uneven. The second wave of the COVID-19 pandemic in 2021 devastated lives and livelihoods. The economy stuttered again when a third, albeit less severe, wave saw the spread of the Omicron variant early this year.
• Add to this the return of pent-up demand in economies worldwide as the pandemic subsided. The pace of recovery caught suppliers off guard, contributing to supply-side shortages.
• Even as industry was grappling with this challenge, Russia launched an attack on Ukraine. Sunflower oil and wheat supplies, from these two nations were impacted, leading to a rise in global prices for these crops. As supplies in general tightened across the globe, commodity prices too rose and overall inflation accelerated.
• If inflation quickens in the overseas market where the investor has placed funds, then the real returns are even further impacted. They then tend to exit assets seen as ‘risky’ such as in emerging markets like India, Brazil or South Africa.
• With each of these factors contributing to a decline in confidence of robust economic performance, foreign portfolio investors have been reducing market investments over these past months. FPIs sold assets worth ₹44,000 crore in May 2022. This is the second highest sell-off in a month since 1993, after March 2020.

What impact does an FPI sell-off have? The Hindu Analysis

• When FPIs sell their holdings and repatriate funds back to their home markets, the local currency takes a beating. After all, they sell rupees in exchange for their home market currency. As supply of the rupee in the market rises, its value declines.
• With a weaker rupee, we have to shell out more funds to import the same unit of goods. The most telling impact is on the cost of our crude oil imports that contribute to 85% of our oil needs.

Categories of FPI (for investments in India) : The Hindu Analysis

Earlier, FPI was divided into three categories, on the basis of their risk profile.

• Category I or low-risk: This kind of FPI includes government/government-related establishments like central banks and international agencies among others. An example could be a sovereign wealth fund or an SWF which is a fund owned by the state or its divisions. The Hindu Analysis
• Category II or moderate-risk: This includes mutual funds, insurance firms, banks, and pension funds among others.
• Category III or high-risk: This type of foreign portfolio investment includes all other FPIs that don’t fall into the first two categories. They could include charitable organizations such as trusts or societies, endowments or trusts among others.

However, as per a new notification in the second half of 2019, SEBI has sought to reclassify the categories and simplify norms. Accordingly, FPIs would come under two categories. All those entities or funds that were earlier registered as Category III are now Category II, accordingly, and Category I is a mix of the earlier Category I and II.

What are the benefits of foreign portfolio investment? The Hindu Analysis

• Foreign portfolio investments boost demand for the stock of companies and help them when it comes to raising capital at low costs.
• The presence of FPI would mean a significant rise in the depth of the secondary market.
• From the investor’s perspective, it helps an investor add more diversity to their investments and benefit from such a diversification. The Hindu Analysis
• Investors can also gain benefits from exchange rate changes.
• Overseas markets provide investors a chance to a bigger market that may also sometimes not be as competitive as their home market. This means they benefit from the lower competition in a foreign country.
• A huge advantage of FPI is that it is liquid, ensuring that the investor is empowered and can move fast when there are good opportunities.

What are the disadvantages of foreign portfolio investment? The Hindu Analysis

• To the country receiving FPI, i.e., the host, the host, the unpredictability of such investments would mean a constant shift between markets over short periods. This gives rise to some amount of volatility. The Hindu Analysis
• A sudden withdrawal of FPI could make an impact on the exchange rate. FPI may be risky at certain occasions, i.e., when there is political instability in a country.

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