When it comes to economic growth, capital is a vital ingredient. As most nations cannot meet their total capital requirements through their internal resources only, they turn towards foreign investors. These investors use two means to invest in the overseas economy: foreign direct investment [FDI] and foreign portfolio investments
[FPI]. These are the two most common ways for investors to put their money into international portfolios. But what is the difference between FDI vs FPI? When it comes to what is implied by FDI vs portfolio investments in foreign assets, there are many differences. Let’s clarify these differences by defining FDI vs FPI. FDI implies that foreign investors are directly investing in the productive assets of
another nation. On the other hand, FPI implies investing in financial assets like the bonds and stocks of another country. While there are commonalities between FDI vs portfolio investments, they are also different in many ways. Since retail investors have started investing in both these types of foreign investments, they should be clearly
aware of the difference between FDI vs FPI. Nations with a higher level of FPI can easily encounter are higher market volatility and turmoil with respect to currency during uncertain times. Although both FPI and FDI are foreign investments at their heart, there
are fundamental differences between the two that should be taken into account before investing. 1. Degree of Control for FDI vs FPI The primary difference is the degree of control the foreign investor can exercise. Investors who look into FDI can usually exercise a higher degree of control than those who invest in FPI. FDI investors take controlling positions in two ways: either through joint ventures or in domestic firms. In general, FDI investors are
actively involved in the management of their investments. On the other hand, FPI investors are not as involved. They tend to take on more passive positions in their investments. They are considered passive investors as they are not involved in the day-to-day functioning and operation as well as strategic planning required by any domestic companies. Even if the investor has a controlling interest in the company, a foreign portfolio investment will lend them passive
shares. Hence, the degree of control is an important difference between FDI vs portfolio investments. 2. Investment Horizon of FDI vs FPI Another key difference to point out is that foreign direct investors tend to take a longer-term approach to their FDI investments. It can take anywhere between 6 months to a couple of
years to advance from the planning stage to the project implementation stage. The difference with respect to foreign portfolio investments is that the investors for these types of foreign investments have a much shorter investment horizon to worry about. They may be invested for the long haul however, the investment horizon continues to remain small, especially when one’s local economy is turbulent. The second point of difference between FDI vs FPI is closely tied to
the third difference. 3. Liquidity of FDI vs FPI investments FDI investments are carried out with a longer horizon in mind as investors usually do not liquidate their assets and depart from the nation. FDI assets can even be considered larger and definitely less liquid than FPI assets. Lack of liquidity reduces the buying power of an investor and increases the risk somewhat. This is why investors plan so much before investing in these types of
illiquid assets. FPI assets are both widely traded and highly liquid. An FPI investor has the luxury of exiting their investment with a few clicks of their mouse. Hence, these types of investments do not require as much planning and may also be considered more volatile due to being highly liquid. 4. Volatility of FDI vs FPI investmentsDifference between FDI vs FPI
The liquidity of an asset is a factor of how widely traded it is and also how volatile it is. FDI can prove to be a more stable investment than FPI, especially for a nation to attract foreign investment. This is because foreign direct investments require a longer investment horizon. An investor is somewhat locked into their investment for the long haul due to the lack of liquidity. FPI can be traded away in a day’s time and so can prove to be more volatile due to traders constantly entering and leaving their positions with the option of liquidity available to them.
Every country requires capital for its economic growth, and the funds cannot be raised from its domestic sources alone.
Foreign Portfolio Investment [FPI] and Foreign Direct Investment [FDI] are the two essential and well-sought type of foreign capital by the countries, especially by the developing world. Post Union Budget FY 2019-20, most of you surely would have heard the words “FPIs” being used, in the context of the stock markets crash through financial news channels or social media platforms.
While most people know that FPI and FDI pertain to foreign investment, but fewer know that they are not interchangeable.
This blog is to look at the two terms individually to understand them better and then go on to understanding the differences which make them unique and distinctive.
Foreign Direct Investment [FDI]
FDI pertains to foreign investment in which the investor obtains a lasting interest in an enterprise in another country.
It involves establishing a direct business interest in a foreign country, such as buying or establishing a manufacturing business, building warehouses, or buying buildings. Also, it tends to involve creating more of a substantial, long-term interest in the economy of a foreign country.
Due to the significantly higher level of investment required, FDIs are usually undertaken by MNCs, large institutions, or venture capital firms. FDI tends to be viewed more favorably since they are considered long-term investments, as well as investments in the well-being of the foreign country itself.
This kind of investment may result in the transfers of funds, resources, technical know-how, strategies, etc.
There are several ways of making FDI like:
- creating a joint venture
- through merger and acquisition
- by establishing a subsidiary company.
Examples
Some of the recent significant FDI announcements in India are as follows:
- In May 2018, Walmart acquired a 77% stake in India’s biggest online retailer, Flipkart is an FDI investment.
- In October 2018, VMware, a leading software innovating enterprise of US, announced an investment of USD 2 billion in India between by 2023.
- In June 2018, an appeal from Idea for 100% FDI was approved by Department of Telecommunication [DoT] followed by its Indian merger with Vodafone making Vodafone Idea the largest telecom operator in India.
- The investment arm of the World Bank Group, i.e., International Finance Corporation [IFC], is planning to invest around USD 6 billion in several sustainable and renewable energy programs in India by 2022.
Latest FDI Trends In India
The Modi Government’s favorable investment policy regime and robust business environment have ensured that foreign capital keeps flowing into the country.
The Government of India [GOI] has taken many initiatives in recent years such as relaxing FDI norms across sectors such as defense sector, PSU especially in the oil refineries sector, telecom sector, power exchanges, and stock exchanges, among others.
According to Department for Promotion of Industry and Internal Trade [DPIIT], India received the highest-ever FDI inflow of USD 64.37 billion during the FY 2018-19, indicating that government’s effort to improve ease of doing business and relaxation in FDI norms is yielding results.
During FY 2018-19, India received the maximum FDI equity inflows from Singapore [USD 16.23 billion], followed by Mauritius [USD 8.08 billion], Netherlands [USD 3.87 billion], USA [USD 3.14 billion], and Japan [USD 2.97 billion].
As of February 2019, the GOI is working on a road map to achieve its goal of USD 100 billion worth of FDI inflows.
Foreign Portfolio Investment [FPI]
FPI, on the other hand, refers to investing in the financial assets of a foreign country, such as stocks or bonds available on an exchange.
In simple words, FPI involves the purchase of securities that can be easily bought or sold.
The intent with FPI is generally to invest money into the foreign country’s stock market with the hope of generating a quick return.
Hence, this type of investment is at times viewed less favorably than direct investment because portfolio investments can be sold off quickly and are at times seen as short-term attempts to make money, rather than a long-term investment in the economy.
In India, FPIs includes investment groups of Foreign Institutional Investors [FIIs], Qualified Foreign Investors [QFIs] and subaccounts, etc. NRIs doesn’t come under FPI.
Latest FPI Trends in India
As per data from National Securities Depository Ltd [NSDL], FPI turned net sellers in July, withdrawing around Rs. 12,400 crores from the Indian stock market.
This is the highest outflow since October 2018, when foreign investors pulled out Rs. 27,622 crore from the Indian stock market.
Also, July’s FPI outflow from India is the highest among emerging markets, which indicates that investors have started shifting to other developing economies in their hunt for higher returns.
The FPI exodus was driven mainly by the Centre’s proposal to impose a higher tax surcharge on the super-rich in the Union Budget of FY 2019-20.
Along with that, weak monsoon and a slowing economy added to the problem.
Critical Differences Between FDI and FPI
While both FDI and FPI involve putting money into a foreign country, the two investment options differ considerably. Following are some of the key differences between these two:
| Parameters | FDI | FPI |
| Definition | FDI refers to the investment made by foreign investors to obtain a substantial interest in the enterprise located in a different country. | FPI refers to investing in the financial assets of a foreign country, such as stocks or bonds available on an exchange. |
| Role of investors | Active Investor | Passive Investor |
| Type | Direct Investment | Indirect Investment |
| Degree of control | High Control | Very low control |
| Term | Long term investment | Short term investment |
| Management of Projects | Efficient | Comparatively less efficient |
| Investment has done on | Physical assets of the foreign country | Financial assets of the foreign country |
| Entry and exit | Difficult | Relatively easy |
| Leads to | Transfer of funds, technology, and other resources to the foreign country | Capital inflows to the foreign country |
| Risks Involved | Stable | Volatile |
The Bottom Line
An investor from a foreign country can easily make a foreign portfolio investment.
FDI and FPI are simply two methods through which foreign capital can be brought into the domestic economy.
Such an investment has both positive and negative aspects, as the inflow of funds improves the position of balance of payment while the outflow of funds in the form of dividends, royalty, import, etc. will result in the reduction of the balance of payment.
Disclaimer: The views expressed in this post are that of the author and not those of Groww