Context: The rupee rose nearly two percent to 73.40 against the US dollar last week as foreign portfolio investors (FPIs) pumped more money into Indian markets and the Reserve Bank of India refrained from intervening in the foreign exchange market.
US Fed policy shift and implications on FPIs
- The shift in managing inflation in the US:
- The US Federal Reserve recently signaled a major shift in its approach to managing inflation in a bid to aid the country’s economy’s recovery.
- It will now target an “average” of two percent inflation, rather than making a fixed two percent target.
- The new policy will allow the bank to keep interest rates lower for longer, stimulating growth to help tackle unemployment.
- The new policy will lead to more capital flows to emerging markets like India.
- Pumping money by FPIs
- FPIs have recently bought Rs 46,602 crore worth of shares so far in August, the highest monthly inflow in the calendar year 2020.
- FPIs are making use of the interest rate differential to bring in dollars. It is being said that the dollar inflows into the stock market and gains in other Asian currencies boosted the rupee’s value.
- Worldwide, risk sentiments have strengthened on aggressive stimulus by the US Fed and there have been sharp inflows into the stock market.
No intervention by RBI
- The RBI which bought $ 59.74 billion of forex reserves since April 1 this year to boost the country’s reserves did not intervene in the market to prevent the rupee appreciation in that particular week.
- When the RBI buys dollars, it releases an equivalent amount in rupees into the system which, in turn, could increase inflation and yields.
- However, the sharp fall in the USD-rupee spot has been unexpected and traders are in shock. Initially, the RBI was protecting the 74.50 zones but its absence has led to a free fall.
About Foreign Portfolio Investors (FPIs)
- Foreign portfolio investment (FPI) involves holding financial assets from a country outside of the investor's own.
- FPI holdings can include stocks, ADRs, bonds, mutual funds, and exchange-traded funds.
- Along with foreign direct investment (FDI), FPI is one of the common ways for investors to participate in an overseas economy, especially retail investors.
- Unlike FDI, FPI consists of passive ownership; investors have no control over ventures or direct ownership of property or
- In the case of accounting for the balance of payment(bop):
- The balance of payments (BOP) is a statement of all transactions made between entities in one country and the rest of the world over a defined period of time.