What are the Advantages and Disadvantages of FPI?

Advantages of FPI :
1. There is a substantial increase in the secondary market depth and breadth due to the
presence of such investors.
2. The Capital Market acquires an institutional character since global liquidity is
channelled into local markets in a planned manner through research and analytical
studies. These funds transiate into diversified investments against predefined risk
parameters.
3. These investments increase demand for the shares of target companies thereby
increasing their PE Ratios. This helps such companies to raise capital at lower cost.
4. International investors are provided with an avenue for investment diversification,
wealth protection and at a macro level an opportunity for cross country hedging in
terms of currencies, industries and geographical locations.
5. The growth in FPI in recent years can be attributed to better investor protection
regulations in developing countries, liberalisation in the terms of access to such
markets and better macro-economic fundamentals of emerging economies.
6. They provide a buffer for financing the Balance of Payments deficits thereby helping
to preserve the foreign currency reserves of the host entry.
Disadvantages of FPI :
1. Political Risk represented by the possibility of change in the political environment
resulting in change in investment norms and repatriation regulations.
2. Emerging markets which are the beneficiaries of most FPI traditionally suffer from low
retail participation which results in inadequate liquidity which results in price volatility.
3. Due to the unpredictable nature of such funds there is a tendency to shift from one
market to another at short intervals. Volatility arising out of FPI inflows and outflows
has adverse effects on the host country economy.
4. Emerging economics tend to have depreciation prone currencies. This exposes the
foreign investor to exchange rate risk on both principal and returns.