The relentless march of FPIs to the exit gate

The relentless march of FPIs to the exit gate

Subject: Economy

Context:

June 2022 witnessed the worst Foreign Portfolio Investment (FPI) sell-off since March 2020 — when India announced a nationwide lockdown — at ₹50,000 crore.

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

Concept:

• Foreign portfolio investors are those that invest funds in markets outside of their home country. Investments typically include equities, bonds and mutual funds.
• They are generally not active shareholders and do not exert any control over the companies whose shares they hold.
• 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.
• The US accounts for a major chunk of FPI investments, followed by Mauritius, Singapore and Luxembourg In India, according to data available from the National Securities Depository Ltd (NSDL).

Causes of FPI fluctuations:

• Higher relative rate of interest in the country- FPI inflow increases when there is a favourable 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.
• Better growth perspectives-increase certainty about profits and market conditions, thus increases FPI inflows.
• Stability– contingencies like Ukraine War, Covid 19 led FPI outflow to safer destinations. FPI thus tends to exit assets seen as ‘risky’ such as in emerging markets like India, Brazil or South Africa.
• Liberalised regulatory regime-increases ease of FPI inflows
• Depreciation-If the dollar strengthens against the rupee( rupee depreciates), then an investor is able to realise fewer dollars for a given quantum of rupee assets liquidated, leading to FPI outflows. This happens as FPIs sell rupees in exchange for their home market currency.
• Inflation-if inflation quickens in the market where the investor has placed funds in, then real returns decrease leading to FPI outflows.

Impact of FPI outflows:

• Currency depreciation-FPIs sell rupees in exchange for their home market currency. As supply of the rupee in the market rises, its value declines.
• Rupee depreciation is never good for the overall equity market, and foreign investors pulling out can result in a decline in stocks and equity mutual fund investments.
• Balance of Payments Deficit-a lower rupee against the dollar keeps import bills higher, pushing inflation even higher than it is now. A strong dollar is good for export-oriented companies, but bad for import-oriented industries such as oil, gas and chemicals and capital account.
• Inflation-With the dip in the rupee, oil imports and other imported components will get costlier, which will further lead to higher inflation.