Foreing Portfolio Investment

8/12/2019 Foreing Portfolio Investment

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CHAPTER 1

INTRODUCTION

Foreign portfolio investment typically involves short-term positions in

financial assets of international markets, and is similar to investing in domestic

securities. FPI allows investors to take part in the profitability of firms operating

abroad without having to directly manage their operations. This is a similar

concept to trading domestically: most investors do not have the capital or

expertise required to personally run the firms that they invest in.

Foreign portfolio investment differs from foreign direct investment (FDI),

in which a domestic company runs a foreign firm. While FDI allows a company to

maintain better control over the firm held abroad, it might make it more difficult

to later sell the firm at a premium price. This is due to information asymmetry:

the company that owns the firm has intimate knowledge of what might be wrong

with the firm, while potential investors (especially foreign investors) do not.

The share of FDI in foreign equity flows is greater than FPI in developing

countries compared to developed countries, but net FDI inflows tend to be more

volatile in developing countries because it is more difficult to sell a directly-

owned firm than a passively owned security.

For example, Ford Motor Company may invest in a manufacturing plant in

Mexico, yet not be in direct control of its affairs. Foreign Portfolio Investment

(FPI): passive holdings of securities and other financial assets, which do NOT

entail active management or control of the securities issuer. FPI is positively

influenced by high rates of return and reduction of risk through geographic

diversification. The return on FPI is normally in the form of interest payments or

non-voting dividends.


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DEFINITION

Securities and other financial assets passively held by foreign investors.Foreign portfolio investment (FPI) does not provide the investor with direct

ownership of financial assets, and thus no direct management of a company.

This type of investment is relatively liquid, depending on the volatility of the

market invested in. It is most commonly used by investors who do not want to

manage a firm abroad.

A hands-off or passive investment of securities in a portfolio. A portfolioinvestment is made with the expectation of earning a return on it. This expected

return is directly correlated with the investment's expected risk. Portfolio

investment is distinct from direct investment, which involves taking a sizeable

stake in a target company and possibly being involved with its day-to-day

management.

Portfolio investments can span a wide range of asset classes stocks,

government bonds, corporate bonds, Treasury bills, real estate investment

trusts, exchange-traded funds, mutual funds, certificates of deposit and so on.

Portfolio investments can also include options, warrants and other derivatives

such as futures, and physical investments like commodities, real estate, land and

timber. The composition of investments in a portfolio depends on a number of

factors, among the most important being the investors risk tolerance,

investment horizon and amount invested. For a young investor with limited

funds, mutual funds or exchange-traded funds may be appropriate portfolio

investments. For a high net worth (HNW) individual, portfolio investments may

include stocks, bonds, commodities and rental properties. Portfolio investments

for the largest institutional investors such as pension funds and sovereign funds

include a significant proportion of infrastructure assets like bridges and toll

roads. This is because their portfolio investments need to have very long lives,

so the duration of their assets and liabilities match.


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CHAPTER 2

BENEFITS OF FOREIGN PORTFOLIO INVESTMENT

Foreign portfolio investment increases the liquidity of domestic capital

markets, and can help develop market efficiency as well. As markets become

more liquid, as they become deeper and broader, a wider range of investments

can be financed. New enterprises, for example, have a greater chance of receiving

start-up financing. Savers have more opportunity to invest with the assurance

that they will be able to manage their portfolio, or sell their financial securities

quickly if they need access to their savings. In this way, liquid markets can also

make longer-term investment more attractive.

Foreign portfolio investment can also bring discipline and know-how into

the domestic capital markets. In a deeper, broader market, investors will have

greater incentives to expend resources in researching new or emerging

investment opportunities. As enterprises compete for financing, they will face

demands for better information, both in terms of quantity and quality. This press

for fuller disclosure will promote transparency, which can have positive spill-

over into other economic sectors. Foreign portfolio investors, without the

advantage of an insiders knowledge of the investment opportunities, are

especially likely to demand a higher level of information disclosure and

accounting standards, and bring with them experience utilizing these standards

and a knowledge of how they function.

Foreign portfolio investment can also help to promote development of

equity markets and the shareholders voice in corporate governance. As

companies compete for finance the market will reward better performance,

better prospects for future performance, and better corporate governance. As the

markets liquidity and functionality improves, equity prices will increasingly

reflect the underlying values of the firms, enhancing the more efficient allocation


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of capital flows. Well functioning equity markets will also facilitate takeovers, a

point where portfolio and direct investment overlap. Takeovers can turn a poorly

functioning firm into an efficient and more profitable firm, strengthening the

firm, the financial return to its investors, and the domestic economy.

Foreign portfolio investors may also help the domestic capital markets by

introducing more sophisticated instruments and technology for managing

portfolios. For instance, they may bring with them a facility in using futures,

options, swaps and other hedging instruments to manage portfolio risk.

Increased demand for these instruments would be conducive to developing this

function in domestic markets, improving risk management opportunities for both

foreign and domestic investors.

In the various ways outlined above, foreign portfolio investment can help

to strengthen domestic capital markets and improve their functioning. This will

lead to a better allocation of capital and resources in the domestic economy, and

thus a healthier economy. Open capital markets also contribute to worldwide

economic development by improving the worldwide allocation of savings and

resources. Open markets give foreign investors the opportunity to diversify their

portfolios, improving risk management and possibly fostering a higher level of

savings and investment.


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FPI FLOW CAN HELP AN ECONOMY

FPI benefit to the real sector of an economy in three broad ways

Inflow of FPI can provide a developing non debt creating source offoreign investment.

FPI can induce financial resources to flow from capital- abundantcountries, where expected returns are low, to capital scarce countries

where expected returns are high.

FPI affects the economy through its various linkage effects via thedomestic capital market.


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CHAPTER 3

FOREIGN DIRECT INVESTMENT

VS.

FOREIGN PORTFOLIO INVESTMENT

FDI- Foreign Direct Investmentrefers to international investment in

which the investor obtains a lasting interest in an enterprise in another country.

Most concretely, it may take the form of buying or constructing a factory in a

foreign country or adding improvements to such a facility, in the form of

property, plants, or equipment.

FDI is calculated to include all kinds of capital contributions, such as the

purchases of stocks, as well as the reinvestment of earnings by a wholly owned

company incorporated abroad (subsidiary), and the lending of funds to a foreign

subsidiary or branch. The reinvestment of earnings and transfer of assets

between a parent company and its subsidiary often constitutes a significant part

of FDI calculations.

FDI is more difficult to pull out or sell off. Consequently, direct investors

may be more committed to managing their international investments, and less

likely to pull out at the first sign of trouble.

On the other hand, FPI (Foreign Portfolio Investment)represents

passive holdings of securities such as foreign stocks, bonds, or other financial

assets, none of which entails active management or control of the securities'

issuer by the investor.

Unlike FDI, it is very easy to sell off the securities and pull out the foreign

portfolioinvestment. Hence, FPI can be much more volatile than FDI. For a

country on the rise, FPI can bring about rapid development, helping an emerging

economy move quickly to take advantage of economic opportunity, creating

many new jobs and significant wealth. However, when a country's economic

situation takes a downturn, sometimes just by failing to meet the expectations of
http://www.diffen.com/difference/ETF_vs_Mutual_Fundhttp://www.diffen.com/difference/ETF_vs_Mutual_Fundhttp://www.diffen.com/difference/ETF_vs_Mutual_Fund


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international investors, the large flow of money into a country can turn into a

stampede away from it.

Comparison chart

FDI FPI

Involvement

- direct or

indirect

Involved in management and ownership control;

long-term interest

No active involvement in management.

Investment instruments that are more easily

traded, less permanent and do not represent acontrolling stake in an enterprise.

Sell off It is more difficult to sell off or pull out. It is fairly easy to sell securities and pull out

because they are liquid.

Comes from Tends to be undertaken by Multinational

organizations

Comes from more diverse sources e.g.a small

company's pension fund or through mutual

funds held by individuals; investment via

equity instruments (stocks) or debt (bonds) of

a foreign enterprise.

What is

investedInvolves the transfer of non-financial assets e.g.

technology and intellectual capital, in addition to

financial assets.

Only investment of financial assets.

Stands for Foreign Direct Investment Foreign Portfolio Investment

Volatility Having smaller in net inflows Having larger net inflows

Management Projects are efficiently managed Projects are less efficiently managed


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CHAPTER 4

POSITIVE EFFECT OF FOREIGN PORTFOLIO INVESTMENTCapital Inflows

Over the past several decades, the hundreds of billions of dollars of foreign

capital that has been invested in the United States have been of tremendous

benefit to the U.S. economy, strengthening the dollar, and helping to bring down

interest rates by increasing the supply of capital for loans to business and

individuals. The decreased investment flows due to the Financial Crisis and the

Sovereign Debt Crisis certainly negatively impacted the flow of capital to the U.S.

and Europe.

In recent history the worlds largest recipient of foreign investment has

been the United States. In the first half of 2012 though, China surpassed the

United States and became the worlds largest recipient of foreign direct

investment, though by the end of 2012, the U.S. regained its number one spot. In

2003, China did beat out the United States for the number one position. One

reason might be the fact that the China is growing faster than the U.S. and most

developed countries, even though the growth rate in Asia is slowly down.

Another reason may be that China no longer seems to be a risky investment.

According to a 2012 IMF Working Paper, for developing countries:

Reductions in the global price of risk and in domestic borrowing costs were the

main contributors to the increase over time in net capital inflows and domestic

credit. However, the large cross-country differences in domestic and

international finance are best explained by fundamentals such as institutional

quality, access to international export markets, and an appropriate

macroeconomic policy. Both private capital inflows and domestic credit exert a


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positive effect on investment; they also mediate most of the investment impact of

the global price of risk and domestic borrowing costs. Surprisingly, neither

greater domestic credit nor greater institutional quality increase the extent to

which capital inflows translate into domestic investment. ( Luca, Spatfora, 2012)

This means that developing countries can strengthen their institutions and

better attract foreign investment though improved institutions do not always

translate into better domestic investment (domestic companies investing

locally).

Employment

Stated very simply, when a company builds a factory in a foreign country, it

generally creates new jobs. Foreign investment in the United States contributes

significantly to domestic employment. In 2010, roughly four percent of the U.S.


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labor force (six million Americans) was employed by foreign-owned enterprises

(Jackson, 2012). (Note: Because most foreign investment into the United States is

portfolio investment, rather than direct, as discussed above, one might assume

that foreign investment would account for more than four percent of the jobs in

the United States. Portfolio investment undoubtedly accounts for a large number

of jobs in the U.S., but is harder to quantify because it often involves ownership of

a portion of a company, making the numbers harder to disaggregate.)

Opponents of globalization often express concerns about jobs lost in the

domestic economy when a factory moves abroad, and about downward pressure

on wages at home due to the availability of cheaper labor abroad. Job losses can

mean that displaced domestic workers, though unlikely to remain unemployed

permanently, may be forced to take lower-paying jobs. But any downward

pressure on wages in general (for those in trade and non-trade related

industries) may be offset by lower prices for domestic consumers as a whole due

to the movement of the factory.

Consider the following process: a company moves its factory to a less

developed country to take advantage of lower labor costs and increase its profits.

The poorer country may be said to have a comparative advantagein the

production of low-skill, labor-intensive goods, such as textiles and apparel. Other

companies follow to gain the benefits of lower costs of labor, and are likely to cut

their prices to compete with the company already established in the poor

country. As competition increases, consumers in the home market as well as

those in the poor market will benefit from lower prices, while the less developed

country has all the benefits of new know-how, jobs, and related consumer

demand.

Globalization has raised numerous issues of concern about labor markets.

Foreign investment, trade, technology, and immigration, to name a few issues,


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are all disruptive to traditional means of productions. While most economists

believe that the changes brought about by these factors tend to work to promote

economic efficiency, and have great potential to improve the living standards of

people all over the world, a host of concerns remain. Numerous proposals have

been put forth to help mitigate the disruptions caused by globalization.

Bringing down the prices of goods and services has the same effect as giving a

pay raise to every worker who has access to these cheaper goods: their paycheck

can now buy more.

Production Advantages

Increased outward orientation: Foreign based affiliates tend to be moreoutward oriented. As multi-nationally based operations themselves, they are

often more aware of the opportunities of foreign markets and therefore more

likely to seek to export. This also helps improve a nations balance of payments.

In turn, this outward orientation often helps domestic firms become more aware

of international opportunities.

Technology transfers: When companies build plants in foreign countries,they tend to bring the same production techniques and technologies with them

that they use in domestic production. This helps raise the skill level of the

workers employed in the new plants. The economist Raymond Vernon has

observed that direct investment possesses a life cycle, starting with innovation

in a firms home market, successful application of that new knowledge or

technology, and ending with the replication of that innovation in foreign

affiliates.


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Productivity spillovers: Productivity spillovers can spur growth and raiseproductivity in industrialized countries as well as developing economies. For

example just in time manufacturing allows firms to minimize their needs for

inventory by receiving necessary inputs immediately before they are needed.

This reduces the need for warehousing and inventory costs. This innovation was

brought to the United States from Japanese firms. It was adopted by many

domestic firms and helped improve the productivity of many American

businesses.

Improved production processes: Companies can enjoy significantimprovements in productivity from economies of scale, which can be augmented

by participating in global operations. Foreign investment need not mean

duplicating production and distribution networks in new markets. Rather,

foreign investment can make production more efficient by purchasing elements

of a final product in the country with a comparative advantage in making that

product. Globalization has produced an integration of production and marketing

of goods across national borders.

Increased competitiveness in domestic industry: Competition from foreigncorporations often encourages domestic companies to become more efficient and

globally competitive. These improvements can result from the effect known as

backward linkages. Backward linkages are the long-term relationships that

develop between a foreign investor and other firms in the host country. For

example, when a firm decides to build a plant that assembles electrical

appliances in a foreign country, the firm not only provides a certain number of

people with new jobs, but the location of the plant is also likely to encourage the

development of new local industries that can supply it with electric motors, fans,

and other parts for its production.


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CHAPTER 5

POLICIES FOR FOREIGN PORTFOLIO INVESTMENT

For foreign portfolio investment, strong and well-regulated financialmarkets are necessary to deal with the inherent volatility. The financial system

must have the capacity to assess and manage risks if it is to prudently and

productively invest capital flows, foreign or domestic. Its central role of financial

intermediation and credit allocation is a key element of economic growth and

development. As has been shown above, foreign portfolio investment can be an

important player in this function, and bring additional strengths and benefits, but

those benefits will be most effective when working within a healthy financial

system.

For a financial system to maintain its health, the institutions within it must

be able to identify, monitor and manage business risks efficiently. The payments

system, through financial institutions and clearing houses, must be efficient and

reliable. The financial system must also have the ability to withstand economicshocks, such as a substantial shift in the exchange or interest rates, or a sudden

capital withdrawal. It must, as well, be able to withstand systemic shocks, such as

financial distress or bank failure. Systemic risk, from economic or systemic

shocks, is a central, and perhaps unique, element of capital markets. It demands

adequate capitalization and risk management capabilities.

Adequate and sound prudential supervision is necessary for a healthy

financial system. Financial institutions face a myriad of risks: from credit risk to

exchange rate risk, from liquidity risk to exposure concentration risk, from

various risks stemming from the institutions internal operations to risks

inherent in the payments system. Supervisors need to have a sound

understanding of all these types of risk and how they can be managed. They also

need to understand the environment in which the banks operate, and the variousways these risks can be transmitted. Adequate capital is a necessary element of


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prudential regulation, providing a safeguard against losses and a cushion in the

face of institutional or systemic problems. Financial institutions should also limit

their exposure to individual or associated counterparties, to related parties, to

market risk, to short-term debt or mismatches in liquidity. The IMF and World

Bank have developed effective banking supervision frameworks through

financial sector surveillance and assessment, carried out, at least in part, through

the Financial Sector Assessment Programme and through Reports on Observance

of Standards and Codes.

Although supervisors need to be able to verify that a financial institutions

exposure is balanced and capital is adequate, the extent of specificity in the

regulations should be a function of the overall soundness and structure of the

financial system. Regulation and regulators will be most effective when they

create incentives for sound behavior and when their application and practices

are able to evolve with the needs of the market. Supervisors need to be aware of

the risks and costs of excessive prudential regulation. The costs will be seen in

the time and resources required to comply with the regulations, which should be

balanced against the need for regulation, but they will also be seen in the effect

on innovation and evolution in the markets, which can bring benefits to both the

financial markets and the broader domestic economy. Excessive regulation and

supervision can put the onus for effective management of financial institutions

on the supervisory authorities, rather than the directors and managers of the

institutions. This will reduce the effectiveness of management and of market

disciplines, potentially the most practical and efficient regulators. The right

balance is essential.

Market discipline can provide the greatest incentives for effective risk

management. Therefore, it is important not to subvert it by excessive regulation,

but there are other factors to watch to ensure that market discipline is effective.

Market discipline depends on clear signals from the market. Government


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guarantees of financial institutions, or implicit government support, can keep the

market from signaling a growing problem, as can government ownership.

Financial safety nets and market failure response arrangements need to be able

to effectively resolve market distress situations, without creating unnecessary

moral hazard. If financial safety nets and market failure responses are not

appropriately designed, they can take away, or at least reduce, the financial

institutions incentive to manage its risks adequately, the first and best line of

defense against risks. Competition in the financial sector will also strengthen

market disciplines, and a financial sector open to foreign investment, which can

bring with it new and different outlooks and approaches to these problems, will

help attain the benefits of competition.

A sound financial system is best sustained when the broader legal, political

and economic environment is also marked by sound policies. As these boost the

benefits of both portfolio and direct investment, we will return to them below.

NON RESIDENT INDIANS

PORTFOLIO INVESTMENT SCHEME (PNB BANK)

NRIs can approach, PNBs any of the following branches RBI had allotted specific code to the banks dealing in PIS.

Sr. No. Name of the Branch Code allotted by RBI

1PNB House Fort, Mumbai 400 001. 4401

2ECE House, K.G.Marg, New Delhi 110 001. 4402

3 Brabourne Road, Kolkata 4403


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CHAPTER 6

FOREIGN PORTFOLIO INVESTMENT FLOWS TO INDIA

The international flow of capital is expected to benefit both the source as

well as the host country. However, the historical and recent financial crises have

also brought into focus the fact that these flows can expose the countries to new

risks. Hence it is important to understand the risks associated with these flows

and the factors that drive flows into India, so that policy reactions can be

formulated in advance to avoid any imbalances arising out of extremely high

capital inflows or sudden reversal of capital flows in future, whatever the case

may be.

The recent volatility in capital flows, especially when periods of high

capital inflows were followed by periods of huge reversal in these flows, has

posed macroeconomic challenges to countries across the world. India has not

remained untouched by the developments in the global financial markets due to

greater linkages of the Indian markets with the international markets. The recent

volatility in capital flows to India can mainly be attributed to volatility in foreign

portfolio investment flows and especially the foreign institutional investment

flows. Hence it is important to analyse the determinants of portfolio flows in this

uncertain global scenario.

Foreign portfolio investment (FPI) flows have been the most volatile

component of capital flows in India and play an important role in determining

the overall balance of payments. During the Asian crisis as well as during the

recent sub-prime crisis, it was the huge reversal of FPI flows that led to

deterioration in the overall balance of payments. This is because by their very

nature FPI flows do not involve a long lasting interest in the economy. The

ultimate aim of FPIs is to ensure profits and risk diversification.


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This study examines the determinants of portfolio flows to India in the

light of increasing volatility in FPI flows which is due to uncertainty in the global

scenario in recent times. This is done by using the determinants suggested by a

theoretical model, initially proposed by Fernandez- Arias (1996) and Fernandez-

Arias and Montiel (1995), where portfolio flows have been modeled using a zero

arbitrage condition. According to the model expected return from investing in the

host country, adjusted for credit worthiness of the country should be equal to the

opportunity cost i.e. returns from investing in home country. The model

therefore suggests that capital flows are a function of economic factors in the

host and the source country and also of the factors that influence

creditworthiness of host country.

These factors include domestic stock market performance, exchange rate,

foreign exchange reserves to imports ratio, volatility in exchange rate, interest

rate differential and domestic and foreign output growth. In addition to the

factors suggested by the theoretical model, other factors that are considered

important are also included in the empirical model. This includes the effect of the

stock market performance of emerging markets in general, on portfolio flows

received by India is captured by emerging market MSCI index.

The disaggregated components of FPI flows i.e. determinants of Foreign

Institutional Investment flows (FIIs) and American/Global Depository Receipts

(ADRs/ GDRs) which have been the major components of FPI flows to India are

also analyzed. It is important to do so in order to assess whether different

components of portfolio flows are driven by the same or different factors.

The results indicate that a well performing domestic stock market, an

appreciating exchange rate and strong domestic economic growth attracts

portfolio flows. Greater volatility in the exchange rate discourages these flows. If

the overall stock market performance of emerging markets in general is good


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then the flows received by India decline indicating that India competes with

other emerging economies in terms of receiving portfolio flows. A higher interest

rate differential between domestic and foreign interest rates attracts FPI flows.

The results relating to FII flows are same as that of aggregate FPI flows. For

ADR/GDRs, domestic stock market performance, exchange rate, domestic as well

as foreign output growth, are observed to be the most significant determinants. It

is observed that reserves to import ratio, which measures creditworthiness of

India, does not influence any component of portfolio flows, in time series

framework.

It makes an important contribution to the literature related to FPI flows to

India. Most of the literature that analyses the determinants of portfolio flows

(FPI) to India has concentrated on the FII component only. ADR/ GDR flows have

not received much attention despite the fact that the Indian corporate sector has

increasingly used ADR/GDR mechanism to raise foreign capital. This study thus

examines the macroeconomic determinants of not only FII but also ADR/GDR

flows to India in order to fill the existing gap in the literature.

Furthermore, this study examines a wider set of potential determinants of

FII flows to India compared to other studies pertaining to the Indian economy

such as Chakrabarti (2001), Kaur and Dhillon (2010), Rai and Bhanumurthy

(2004), Srinivasan and Kalaivani (2013). While the study by Gordon and Gupta

(2003) includes a wide range of determinants of portfolio flows, it uses the OLS

methodology that may yield biased and inconsistent estimates if the regressors

are endogenous. This study follows the ARDL approach to cointegration for

estimating the long-run coefficients which overcomes such problems. The long-

run coefficients are unbiased and the t-tests are also valid, even if the regressors

included in the specification are endogenous (Harris and Sollis 2003).


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CHAPTER 7

BIBLIOGRAPHY

http://www.investopedia.com/

www.google.com
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CHAPTER 8

CONCLUSION

To characterize portfolio investment as bad and direct investment as

good oversimplifies a muchmore complex situation. Both bring risks, and both

require their own policy approaches. There seems to be a certain fear attached to

foreign portfolio investment, due perhaps to its complexity and the central

economic role of the financial system. (At one time there was a fear of foreign

direct investment.) Doesforeign portfolio investment engender greater concern?

Certainly, financial disturbances have not been confined to foreign investors. If

you take foreign out of foreign portfolio or direct investment, most policy

makers would acknowledge that domestic portfolio and direct investment are

both necessary for healthy economic growth and development. Portfolio

investment and the financial system it is part of are central to any healthy

economy. Put foreign back in and you have effectively increased the quantity

and diversity of investment to even greater effect.

As shown above, both portfolio and direct investment can bring powerful

benefits to the economy, and together the benefits are increased. The best

answer is not to shut either type of investment out not to label one bad and

the other good. Instead, both should be welcomed within the proper regulatory

structure to maximize the benefits, and to manage the drawbacks and potential

negatives. Both portfolio and direct investment bring value for economic growth.

They are not intrinsically good or bad, but they are different. Liberalize both with

respect for their differences.

Beneficial if well functioning stock markets support the economic

development of the country. Impose significant fiscal cost on economy as has to

maintain the value of rupee in a very narrow band. Have to ensure the

attractiveness for the Investors

Documents

Foreing Portfolio Investment