Which of the following types of foreign investment is generally considered comparatively unsafe because it can be withdrawn quickly?

Introduction / Context:

This question relates to international capital flows and macroeconomic stability. Different forms of foreign investment have different risk levels for the host economy. Policy makers are particularly cautious about flows that can be reversed suddenly, causing volatility in exchange rates and stock markets. Understanding why portfolio investment is considered relatively unsafe compared to more stable forms of capital is important for exams on economics and public policy.

Given Data / Assumptions:

Concept / Approach:

Foreign Direct Investment involves long term investment in productive assets such as factories and infrastructure and is relatively stable. Portfolio investment, on the other hand, involves foreign investors buying financial assets such as shares and bonds without taking managerial control. These investors can move their funds quickly across borders in response to interest rates, exchange rates, or market sentiment, leading to sudden inflows and outflows known as hot money. Because of this high mobility and volatility, portfolio investment is considered comparatively unsafe from the macroeconomic stability perspective.

Step-by-Step Solution:

Verification / Alternative check:

An alternative check is to think of financial crises where sudden exits of foreign institutional investors from stock markets and bond markets have created sharp falls in asset prices and currency values. These episodes are described as capital flight or portfolio outflows. In contrast, FDI tends to remain even during turbulence because it is tied to physical projects. This association of volatility with portfolio flows confirms that portfolio investment is considered more unsafe.

Why Other Options Are Wrong:

Foreign Direct Investment (FDI): It usually represents stable, long term commitment to the host country and is therefore regarded as relatively safe and desirable.

NRI deposits: These are deposits by non resident Indians in domestic banks and are governed by maturity periods and regulations, making them less instantly volatile than portfolio flows.

External commercial borrowing: These are loans raised abroad by firms or the government. While they carry repayment and currency risks, they are not as quickly reversible as portfolio investments in securities.

Common Pitfalls:

Some candidates think of external commercial borrowing as unsafe because of debt repayment risks and therefore choose it. Others may see the word deposits and incorrectly assume that NRI deposits are risky. The key is to focus on the speed and ease with which funds can move in and out. Portfolio investment stands out as the form of capital that can be withdrawn very quickly, making it the comparatively unsafe option in this context.

Final Answer:

The correct answer is Portfolio investment.