02 Jun FOREIGN PORTFOLIO INVESTMENT (FPI)
This article covers “Daily Current Affairs” and the topic details “Foreign Portfolio Investment”. The topic “Foreign Portfolio Investment” has relevance in the Economy section of the UPSC CSE exam.
Relevance:
For Prelims:
What is Foreign Portfolio Investment?
For Mains:
GS 3: Economy
Impact of FPI on Indian Economy?
How is FPI Misused?
Measures to curb FPI misuse?
Why in the News?
The Securities and Exchange Board of India (Sebi) has proposed that foreign portfolio investors (FPIs) with investments concentrated in a single stock or stocks of a business group should provide granular information on beneficial ownership to custodians.India’s markets regulator proposed tightening of disclosure requirements for offshore funds in a consultation paper released on Wednesday. The move is intended to prevent promoters of Indian companies from abusing the FPI route to circumvent minimum public shareholding norms.
What is Foreign Portfolio Investment?
It refers to the investment made by foreign individuals, institutions, or funds into the financial markets of a country. FPI typically involves the purchase of stocks, bonds, and other financial assets in the foreign market. It is a passive form of investment, where investors do not actively participate in the management or control of the invested company or entity. FPI plays a significant role in attracting capital, promoting liquidity, and supporting the growth of financial markets in a country. Governments and regulatory bodies often monitor and regulate FPI to maintain stability in the economy and protect national interests.
Impact of FPI on Indian Economy?
- Capital Inflows: FPI has been a significant source of capital inflows for India. It has provided the country with much-needed foreign exchange reserves, which contribute to the stability of the Indian economy. These inflows help finance infrastructure development, investment in various sectors, and overall economic growth.
- Market Liquidity: FPI has played a crucial role in increasing liquidity in Indian financial markets, particularly in the stock and bond markets. The influx of foreign funds has enhanced market depth and facilitated smoother trading activities.
- Increased Investment Options: FPI has expanded the investment opportunities available to Indian investors. It has introduced foreign securities, such as stocks and bonds, enabling domestic investors to diversify their portfolios and potentially earn higher returns.
- Volatility and Market Risk: FPI can also contribute to market volatility and risk. Sudden outflows of foreign funds can lead to market downturns and fluctuations in asset prices. This volatility can pose challenges for policymakers and investors in managing risks and maintaining stability.
- Exchange Rate Fluctuations: Large FPI inflows or outflows can impact the value of the Indian rupee against other currencies. Rapid capital inflows can appreciate the currency, making Indian exports relatively more expensive and potentially affecting the competitiveness of domestic industries.
- Policy Challenges: FPI flows require effective regulation and policy management to ensure that they align with national interests and financial stability. Governments and regulatory authorities need to monitor and manage FPI to prevent excessive volatility, safeguard investor interests, and maintain macroeconomic balance.
How is FPI Misused?
- Round-Tripping: Round-tripping refers to the practice of routing domestic funds through offshore entities to bring them back into the country as FPI. This can be done to take advantage of tax benefits, regulatory loopholes, or to inflate investment figures. Round-tripping can artificially inflate FPI numbers, giving a misleading impression of actual foreign investments.
- Market Manipulation: FPI can be misused for market manipulation purposes. Large-scale investors or groups of investors may collude to manipulate stock prices or engage in insider trading, taking advantage of their positions and the liquidity they bring to the market.
- Tax Evasion: Some investors may use FPI to evade taxes. By routing their investments through tax havens or jurisdictions with favorable tax treatment, they can minimize their tax liabilities and avoid reporting their true income.
- Money Laundering: FPI can be misused as a means to launder illicit funds. Money launderers may use complex structures and transactions through FPI channels to obscure the origin and destination of their funds, making it difficult for authorities to trace and detect the illicit activities.
- Front-Running: Front-running involves taking advantage of advance knowledge of large FPI transactions. Individuals or entities with access to such information may trade ahead of the FPI transaction, thereby benefiting from the subsequent market movements caused by the large investment.
- Speculative Activities: Excessive speculative FPI flows can disrupt financial markets and destabilize economies. Speculators may engage in short-term trading or aggressive investment strategies solely for profit, without considering the long-term consequences or the underlying fundamentals of the market.
Measures to FPI curb misuse?
- Robust Regulatory Framework: Establishing a strong and comprehensive regulatory framework is crucial. This includes regulations and guidelines governing FPI, such as eligibility criteria, registration processes, disclosure requirements, and compliance standards. These regulations should be regularly updated to address emerging risks and loopholes.
- Anti-Money Laundering (AML) and Know Your Customer (KYC) Policies: Implementing stringent AML and KYC policies helps in verifying the identity of investors and ensuring the legitimacy of their funds. Robust due diligence procedures should be in place to identify and prevent money laundering and illicit activities associated with FPI.
- Enhanced Transparency and Reporting: Requiring regular reporting and disclosures from FPI participants can increase transparency in the market. This includes reporting of holdings, transactions, beneficial ownership, and any changes in investment patterns. Timely and accurate information helps identify any suspicious activities and promotes market integrity.
- Monitoring and Surveillance: Establishing dedicated monitoring and surveillance systems is essential to detect any market manipulation, insider trading, or unusual trading patterns related to FPI. This can involve the use of technology, data analytics, and cooperation between regulatory bodies and market participants to identify potential risks and take timely action.
- Cooperation and Information Sharing: Promoting international cooperation and information sharing among regulatory authorities is crucial. Collaboration with foreign counterparts helps in detecting cross-border illicit activities, tracking round-tripping, and sharing best practices in regulating FPI.
- Strict Penalties and Enforcement: Implementing strict penalties and enforcing them effectively acts as a deterrent against FPI misuse. Heavy fines, legal actions, license revocation, and criminal prosecution can discourage individuals or entities from engaging in fraudulent activities related to FPI.
- Continuous Monitoring and Evaluation: Regular monitoring, evaluation, and assessment of the effectiveness of regulatory measures are necessary. This ensures that regulations and policies remain up-to-date, relevant, and effective in addressing emerging risks and challenges in the FPI space.
Source:https://www.livemint.com/market/stock-market-news/sebi-moves-to-deter-promoters-from-misusing-fpi-route-11685556803980.html
Q.1 Which of the following statements regarding the misuse of Foreign Portfolio Investment (FPI) is correct?
(a) Round-tripping involves routing domestic funds through offshore entities to bring them back into the country as FPI.
(b) FPI is not susceptible to market manipulation as it involves passive investments.
(c) Money laundering through FPI is easily traceable due to strict regulatory measures.
(d) Front-running in FPI refers to investors colluding to manipulate stock prices.
Answer:(a)
Q.2 Which of the following statements regarding the impact of Foreign Portfolio Investment (FPI) in India is/are correct?
1.FPI inflows contribute to the stability of the Indian economy by increasing foreign exchange reserves.
2.FPI can lead to market volatility and fluctuations in asset prices.
3.FPI has no impact on the competitiveness of domestic industries.
4.FPI primarily benefits large-scale investors and does not provide opportunities for small investors.
Select the correct statement(s) from the options given below:
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1, 2, and 4 only
(d) 2 and 4 only
Answer:(c)
Q.3 “Discuss the impact of Foreign Portfolio Investment (FPI) on the Indian economy and financial markets. Examine the positive contributions of FPI in terms of capital inflows and market liquidity, and analyze the potential challenges and risks associated with FPI. Evaluate the role of regulatory measures in ensuring transparency, stability, and preventing misuse of FPI. Provide examples and relevant data to support your arguments.”
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