Foreign portfolio investment

Also called: FII, Foreign institutional investors, Foreign institutional investment, Portfolio investment, FPI · Topic: Balance of Payments and Exchange Rates · NCERT: Class 10, Ch 4 "Globalisation and the Indian Economy"; Class 11, Ch 3 "Liberalisation, Privatisation and Globalisation: An Appraisal"; Class 12, Ch 6 "Open Economy Macroeconomics"

Meaning

Foreign portfolio investment (FPI) is money that non-residents (people or funds based outside India) put into Indian financial securities, such as shares and bonds, without taking a controlling stake. In India, a foreign investor who holds below 10% of a listed company's equity is treated as an FPI.

FPI matters because it is "hot money": it can come in fast and leave in days. That makes it a big source of swings in India's balance of payments, the rupee and the stock market.

Explanation

How it works

• A foreign investor buys shares or bonds of Indian companies, or Indian government debt, through the stock and bond markets.
• The investor wants returns (dividends, interest, a rise in price). The investor does not want to run the company.
• The 10% line:
• Below 10% of a listed company's equity → FPI.
• 10% or more → FDI (foreign direct investment, where the investor has a "lasting interest", meaning long-term control or influence over management).

• Crossing the line: if an FPI's holding goes above 10%, it must either sell down below 10% or have the holding reclassified as FDI under the RBI/SEBI framework.

• FII (foreign institutional investor) is simply the older name for FPI.

Where it sits in the balance of payments

• The balance of payments (BoP) is the record of all money flows between India and the rest of the world.
• Sign rule: follow the foreign exchange.
• A foreigner buys Indian shares → dollars come in → credit (+).

• A foreigner sells Indian shares and takes the money home → dollars go out → debit (−).

• Old format (NCERT Table 6.1, RBI Statement II): FPI is shown under "Foreign investment" in the capital account, next to FDI.

• BPM6 format (the IMF's Balance of Payments and International Investment Position Manual, 6th edition, 2009):
• The old capital account was renamed the "capital and financial account" [2].
• FPI now sits in the financial account, together with FDI, loans, other investment and reserve assets.
• The narrow BPM6 capital account only covers capital transfers and non-produced, non-financial assets (land for embassies, patents, spectrum licences, brands).

Worked example 1: NCERT Table 6.1 (illustrative, US$ million)

• Foreign investment (net) = FDI 13 + portfolio 6 = 19.
• This is the largest item in a capital account balance of 41.15.
• Reading it: FDI (13) is bigger than portfolio (6). This is a healthier mix, because FDI stays for a long time and portfolio money can leave quickly.

Worked example 2: India, 2021-22 (real data)

• BoP identity: Current account balance + Capital account balance + Errors and omissions = Change in foreign exchange reserves.
• CAD (current account deficit) = US$ 38.7 bn. Reserves rose by US$ 47.5 bn [3].
• So capital account + errors ≈ 47.5 − (−38.7) = US$ 86.2 bn net inflow.
• Inside this:
• Net FDI = +US$ 38.6 bn (money came in) [3].

• Net FPI = −US$ 16.8 bn (foreign portfolio investors took money out) [3].

• Lesson: in the same year, FDI helped pay for the CAD, while FPI worked against it.

What makes FPI rise or fall

• Interest rate gap:
• Interest rates rise in the US → safe US bonds pay more → foreign funds sell Indian assets → FPI outflow.

• Indian rates are high compared with the rest of the world → Indian bonds look attractive → FPI inflow.

• Stock market returns: a strong Indian market and good company profits pull money in.

• Exchange rate expectations:
• Investors expect the rupee to fall → their dollar returns will shrink → they sell and leave.

• Their selling raises the demand for dollars → the rupee falls more. This loop can feed on itself.

• Global risk mood: in a global crisis, investors rush to "safe" places and pull money out of emerging markets like India, even if nothing has changed inside India.

• Domestic policy: stable tax rules, clear regulation and growth prospects attract FPI. Sudden tax changes push it away.

In India

• Regulator: SEBI (Securities and Exchange Board of India) regulates FPIs. The RBI records FPI flows in the balance of payments.
• Data: the RBI publishes quarterly BoP data in two formats: Statement I (BPM6 format) and Statement II (the old "major items" format that NCERT Table 6.1 follows) [3][4].
• Volatility in real numbers:
• 2021-22: net FPI was −US$ 16.8 bn, while net FDI was +US$ 38.6 bn [3].
• April–September 2023: net FPI was US$ 20.7 bn, while net FDI was only US$ 4.8 bn [4].

• So FPI can flip from a large outflow to a large inflow within a short time. FDI moves much less.

• Long-term trend (NCERT Class 11): foreign investment (FDI + FII together) rose from about US$ 100 mn in 1990-91 to US$ 23 bn in 2022-23.

• Checks on misuse (round-tripping): round-tripping means Indian money is sent abroad, often through Mauritius or Singapore, and brought back as "foreign" investment to save tax. India has closed this route in three ways:
• DTAA (Double Taxation Avoidance Agreement) amendments with Mauritius (2016) and Singapore (2017), so capital gains are now taxed in India.
• GAAR (General Anti-Avoidance Rules), in force from April 2017: tax officers can deny benefits to deals whose main purpose is to avoid tax.

• SEBI beneficial-ownership disclosure rules (2023): FPIs with concentrated holdings must disclose who really owns them.

• Link to 1991: that crisis showed how quickly foreign money can dry up. Foreign lenders and NRIs pulled money out, and reserves fell to about two weeks of imports.

Don't confuse with

• FDI (foreign direct investment): holding of 10% or more of a listed company's equity, with a lasting interest in management. It brings factories, technology and jobs, and is hard to pull out. FPI is below 10%, gives no control, and can leave in days.
• FII (foreign institutional investors): this is not a different thing. It is the older name for FPI. A question that treats them as two separate categories is a trap.
• ECB (external commercial borrowing): a loan that an Indian resident raises from non-residents. It is debt that has to be repaid, and RBI rules govern it. FPI is the purchase of securities in the market. The investor carries the market risk, and nothing has to be "repaid".
• Capital account (BPM6) vs financial account: under BPM6, FPI is in the financial account. It is not in the narrow capital account, which is tiny for India.

Prelims Hooks

• FPI: below 10% of a listed company's equity. FDI: 10% or more. If an FPI crosses 10%, it must sell down or have the holding reclassified as FDI.
• FII is the old name for FPI. SEBI regulates FPIs.
• Sign rule: a foreigner buying Indian shares is a credit (foreign exchange comes in). A foreigner selling and leaving is a debit.
• BPM6 (IMF, 2009): FPI is recorded in the financial account, not the narrow capital account. The RBI publishes both the BPM6 format (Statement I) and the old format (Statement II) [3].
• 2021-22: net FPI −US$ 16.8 bn vs net FDI +US$ 38.6 bn [3]. April–September 2023: net FPI US$ 20.7 bn vs net FDI US$ 4.8 bn [4].
• Trap: "a capital account surplus built on FPI shows a strong economy" is false. FPI is hot money and can reverse quickly.

Mains Points

• Quality of capital matters more than quantity.
• FDI is sticky and brings technology. FPI can reverse in days, as the swing from −US$ 16.8 bn in 2021-22 [3] to US$ 20.7 bn in April–September 2023 [4] shows.
• If the CAD is paid for mainly by FPI, a sudden outflow can hit the rupee and reserves together, as in 1991.

• So India's policy prefers equity over debt and long-term over short-term flows, and moves slowly towards full capital account convertibility (the freedom to move money in and out of the country without limits).

• FPI still does useful work.

• It makes Indian stock and bond markets deeper and cheaper to use for raising money.
• When net FDI falls because foreign investors cash out through IPOs and secondary sales [5], the CAD depends more on volatile FPI.

• The answer is to build buffers (enough foreign exchange reserves) and to attract stable FDI through ease of doing business, stable tax rules and PLI-type incentives.

• Openness vs integrity.

• DTAA changes with Mauritius (2016) and Singapore (2017), GAAR (April 2017) and SEBI's beneficial-ownership disclosure rules (2023) give up some easy inflows.
• In return, India gets tax fairness, stops round-tripping, and knows who really owns its listed companies.

Related concepts

• Capital account
• BPM6
• Capital flows
• Foreign Direct Investment
• Greenfield and brownfield investment
• Automatic route and government route
• Overseas direct investment
• Round-tripping
• External commercial borrowings
• Non-resident deposits

Read more

• Balance of payments II: the capital (financial) account and BPM6