Why in News?

The Reserve Bank of India (RBI) recently issued guidelines for Foreign Portfolio Investors (FPIs) intending to reclassify their investments in Indian companies as Foreign Direct Investment (FDI) if their holdings exceed specified thresholds.

The RBI mandates FPIs to secure government approvals and consent from the investee companies to ensure alignment with FDI norms.

What’s in Today’s Article?

• What is Foreign Portfolio Investment (FPI)?
• What is Foreign Direct Investment (FDI)?
• How is FPI Different from FDI?
• Guidelines on Investment Limits for FPIs

What is Foreign Portfolio Investment (FPI)?

• FPI is when investors from a foreign country invest in a country's financial markets or assets for a short term.
• It does not give investors direct ownership of a company's assets and includes securities and financial assets held by investors in another country.
  • Securities include stocks of companies in nations other than the investor's nation.
  • Financial assets include bonds or other debt issued by these companies or foreign governments, mutual funds or exchange-traded funds (ETFs) that invest in assets abroad or overseas.
• FPI is relatively liquid depending on market volatility and is part of a country’s capital account and shown on its balance of payments (BOP).
  • BOP calculates the amount of money flowing from one country to other countries over a financial year.
• In India, FPIs are an important source of investment capital that helps the country's financial markets grow.

What is Foreign Direct Investment (FDI)?

• FDI is an investment in the form of controlling ownership in a business in one country by an entity based in another country.
• FDIs are commonly made in open economies that have skilled workforce and growth prospects.
• It usually involves participation in management, joint-venture, transfer of technology and expertise, and not only brings money with them but also skills, technology and knowledge.
• Broadly, FDI includes mergers and acquisitions, building new facilities, reinvesting profits earned from overseas operations and intra company loans.
• Stock of FDI is the net (outward FDI minus inward FDI) cumulative FDI for any given period.

How is FPI Different from FDI?

• A FDI is distinguished from a FPI by a notion of direct control (or ownership in a business).
• In 2014, the Government of India constituted the Arvind Mayaram Committee and approved its recommendation for further rationalising FPI and FDI definitions.
• Recommendations of the committee:
  • An integrated definition of FPI: Investor classes currently regulated as Foreign Institutional Investment (FIIs) and Qualified Foreign Investors (QFIs) are included.
  • What constitutes FDI and FPI? Direct investment excludes investment that results in an investor controlling less than 10% of the shares of the company (less than 10% is FPI).

Guidelines on Investment Limits for FPIs:

• Regulatory framework and investment caps:
  • As per the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019, an FPI’s investment in an Indian company must remain below 10% of the total paid-up equity capital on a fully diluted basis.
  • If an FPI breaches this limit, they must either divest or reclassify the excess holdings as FDI within five trading days after the trade settlement.
• Approval requirements for reclassification:
  • To reclassify FPI holdings as FDI, the concerned investor must obtain necessary approvals from the government.
  • This includes compliance with guidelines, particularly for investments from countries sharing land borders with India.
  • The acquisition must follow the prescribed norms under the FDI regulations, including entry routes, sectoral caps, and investment limits.
• Role of the investee company:
  • FPIs are also required to secure consent from the investee company to ensure adherence to sectoral caps and FDI prohibitions.
  • This compliance enables the investee company to verify that the reclassified investment aligns with sectoral restrictions and approvals under the existing FDI rules.
• Sectoral restrictions on reclassification:
  • In cases where the reclassification to FDI is prohibited in specific sectors, the RBI guidelines restrict the FPI from pursuing reclassification.
  • FPIs must clearly state their intent to reclassify and provide necessary approvals to their Custodian.
• Significance of the guidelines:
  • The RBI’s directive aims to streamline FPI investments breaching specified limits and ensure compliance with FDI norms.
  • These guidelines seek to maintain regulatory consistency in foreign investments, upholding India’s sectoral and governmental regulations.