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. Difference between FDI vs FPI
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 investments
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.
Just like private companies, every country needs money for its growth. While the private firms and individuals turn to banks for it or take some other routes, nations look forward to foreign investors. So, the two most common routes through which the capital comes into any country are FDI or Foreign Direct Investment and FPI or Foreign Portfolio Investment.
Foreign investors take the FDI route when they have a long-term interest in mind. In FDI, an investor usually acquires foreign business assets, establishing ownership or controlling interest in a company. With FDI, foreign companies are directly involved with day-to-day operations in the other country. This means they are not just bringing money with them, but also knowledge, skills and technology.
Under such circumstances, the investor company has at least 10 per cent stake in the company, thus commanding a substantial amount of influence and control over the investee company. For example, Walmart acquiring 77 per cent stake in India’s biggest online retailer, Flipkart, is an FDI investment.
Now, let us explore the ways through which the FDI comes into India. According to the rules prescribed by the Indian government, FDI can either come via automatic route or via government route.
In the automatic route, non-resident or Indian companies do not need prior nod of RBI or the government for FDI. It is for the sectors where the FDI is not restricted and doesn’t need government scrutiny. And the second is the government route. For this, the company will have to file an application through Foreign Investment Facilitation Portal, which facilitates single-window clearance. So, if FDIs get ownership in a company, what do FPIs get? Let us find out.
Unlike the FDI, Foreign Portfolio Investment or FPI is meant for short-term profit booking. Through this route, foreign investors put capital in financial assets, such as stocks and bonds. In other words, FPI involves the purchase of securities that can be easily bought or sold. Such an investment is made with the aim of making short term financial gain and not for obtaining significant control over managerial operations of the enterprise.
In a nutshell, FDIs own controlling stake in a company by investing in its physical assets while FPIs invest only in financial assets. While FDI is a more stable long-term investment, FPI money is usually considered ‘hot money’.
Now, let us understand which one is a better investment route? FDI and FPI are both important sources of funding for most economies. However, FDI is preferred by most countries for attracting foreign investment, since it is much more stable than FPI and signals long-lasting commitment.
FPIs, on the other hand, have a higher degree of volatility because of its tendency to flee at the first signs of trouble in an economy. These massive portfolio flows can exacerbate economic problems during periods of uncertainty.