What are the difference between foreign direct investment and foreign portfolio investment?

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.

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:

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

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