How FPI dumping impact the Indian market?

Foreign Portfolio Investors have been on a selling spree in India. May figures of about Rs. 44,000 crore forming the highest monthly quantum of sell-off since March 2020 when India announced nation-wide lockdown in the backdrop of covid pandemic.

• Capital account of India’s Balance of Payment constitutes foreign both foreign direct investments and foreign portfolio investment.
• Foreign investments are one of the major sources of foreign capital inflow for India.
• COVID pandemic has given a severe stress in the process of foreign currency inflow through foreign investment route.
• Along with covid, other several factors such as, middle-east crisis and rise in oil prices in the international market and inflationary stress as contributed to the sell-off of FPIs in the Indian economy.

What are FPIs?

• Foreign Portfolio Investments are investments in the market outside of the home turf.
• FPIs typically includes equities, bonds and mutual funds, with having an administrative control over the company.
• FPI, being a passive mode of investment, providing an easy way for entry and exit from the market.

• Consecutive COVID waves: Three consecutive Covid waves have disrupted the economic stability and declined the economic process led to increase in investment risk, leading to decline in investment.
• Demand side crunch in domestic economy: Nation- wide lockdown had led to increase in unemployment rate, severely impacting the demand side of the economy.
• Domestic inflation and supply chain bottlenecks: Disruption in supply chain has also contributed to the inflationary situation from the supply side.
• Imported inflation: Persisting Middle East crisis, continuing from USA’s strategic failure in Afghanistan to Russian attack on Ukraine led to increase in oil price and disrupted the world supply chain, bringing an inflationary impact in Indian economy.
• Liquidity tapering: Many of the central banks of the world has followed the tight money policy led to increase in cost of borrowing for the investors. Further leading to decline in foreign investments in the Indian market.

• Easy way of entry and exit: FPIs are volatile in nature, with a barrier free entry and exit method, creating a fluctuation in the Indian market.
• Short term investment: Due to negligible barrier for movement, there remains a scope for volatility in the investment.
• Hot money: Frequent inflow and out flow of dollar, increases the risk of currency volatility in the exchange rate market, further having a prolonged impact in the stock market and profitability of the domestic investors.
• Forex stress: Repayment of the investment money in dollar terms increases the burden on the forex reserve of the country.
• Depreciation of rupee: Sudden dumping of FPIs in the economy reduces the value of local currency with respect to dollars.
• Increase in Import bills: With a weaker rupee, India has to shell out more fund for the same amount of goods, widening the scope for imported inflation.
• Balance of Payment crisis: Increasing import bills and decline in foreign investment leads to outflow of dollars from the economy, creating a potential threat to the Balance of Payment.

• Tobin tax: Tax imposed on the frequent movement of foreign currency, i.e., Hot Money, is considered as Tobin Tax. This ensures stability in the exchange rate as well as stock market of the domestic economy.
• Convertibility of currency: Government of India has distinguished convertibility measure for capital and current account. A partial convertibility is allowed for capital investment, reducing the risk of currency market volatility and stock market shocks.
• Fiscal and monetary policy: A stabilization policy measure from both fiscal and monetary side, to control various sources of inflation in the economy.
• Differential investment routes: Government of India follows a policy measure of differential investment routes, few type of investments require government approval where others don’t.
• Limit on several sectors: Imposition of cap for foreign investment in several sectors is one of the preventive measure by the government.

Foreign Portfolio Investment has a significant share in the Balance of Payment of India, thus, becomes a deciding factor for India’s share in world economy. Sudden decline in FPIs provides a severe stress in the exchange rate market further creating a domino effect in the stock market and inflation in the economy.