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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
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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