A country can obtain capital from international sources in two ways. They are- Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI). If you want to know "what is the difference between FDI and FPI", then read this article till the end!
But first, let's know what FDI and FPI are to understand the difference between them.
What Is Foreign Direct Investment (FDI)?
Foreign Direct Investment (FDI) occurs when a company invests significant money in a foreign company by obtaining control and participating in its day-to-day operations. In addition to capital, the company invests skills, knowledge, and technical know-how. This gives them substantial control and the ability to impact the company’s decisions.
Latest FDI trends in India: Total FDI inflows into India over the last 22 years (April 2000-March 2022) is USD 847 billion. The total FDI inflow in the last 8 years (April 2014-March 2022) was USD 523 billion, accounting for almost 40% of total FDI inflows over the last 22 years.
What is Foreign Portfolio Investment (FPI)?
Like FDI, FPI refers to purchase of financial assets such as stocks and bonds by companies based in foreign countries. But unlike FDI, it doesn’t provide the investor direct ownership of the company or control over assets and businesses.
Current FPI trends in India: FPIs made a net withdrawal of ₹1.21 lakh crore from the Indian equity markets in 2022.
Differences between FPI and FDI
Both FPI and FDI are important foreign investments and are a source of funds for the economy. However, there are four basic differences between them:
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Volatility
The liquidity of an asset is determined by how widely it is traded and its volatility. For countries seeking foreign investment, FDI can be more stable than FPI because foreign direct investment requires a longer investment period.
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Control
FDI gives an investor more control over the company than FPI. FPI investors, on the other hand, are less involved in the company's day-to-day operations. Hence, they are classified as passive investors.
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Liquidity
FDI investments are made over a longer term. Investors typically do not liquidate their assets and leave the country. FDI assets are larger than FPI assets and are significantly less liquid. Lack of liquidity reduces investors’ purchasing power and increases the risk slightly. FPI investments, meanwhile, are widely traded and highly liquid. FPI investors can exit their investments with just a few mouse clicks.
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Investment horizon
Another difference is that FDI investors need to have a long-term strategy for their investment, as projects can take years to implement. In contrast, FPI investors often have very short investment horizons, especially when local economies are experiencing turmoil.
Pros and cons of FDI and FPI
Most economies rely heavily on FDI and FPI for funds. Foreign capital in the form of either FDI or FPI can be used for the following:
- Building infrastructure
- Construction of production facilities and service centers
- Investments in other constructive assets, such as machinery and equipment
It means, funds obtained through FDI or FPI are directly and indirectly used to bolster economic growth and job creation.
However, FDI is much more stable than FPI and represents a long-term commitment. Hence, it is the preferred way to attract foreign investment for most countries. Companies looking to make foreign investments often select companies with skilled and efficient workforce. Usually, they prefer to work in open economies because of above average growth prospects. Another factor that can influence FDIs is the severity of tax regulation in the country. Foreign companies like to opt for countries with lighter tax rules.
FPIs are an attractive source of investment capital but exhibit much higher volatility than FDIs. FPIs are often called 'hot money' as they tend to flee upon the initial signs of economic trouble. In uncertain times, these large portfolio movements can exacerbate economic problems.
Conclusion
For an average retail investor, foreign portfolio investments are more suitable. FDI, on the other hand, is the territory of institutional investors, companies, and billionaires. However, these heavyweight investors can also use FPIs.
Disclaimer
The investment options and stocks mentioned here are not recommendations. Please go through your own due diligence and conduct thorough research before investing. Investment in the securities market is subject to market risks. Please read the Risk Disclosure documents carefully before investing. Past performance of instruments/securities does not indicate their future performance. Due to the price fluctuation risk and the market risk, there is no guarantee that your personal investment objectives will be achieved.