Differentiate Between FPI (Foreign Portfolio Investment) and FDI (Foreign Direct Investment)
As businesses expand their horizons beyond domestic boundaries, they encounter various investment options, two of which are Foreign Portfolio Investment (FPI) and Foreign Direct Investment (FDI). However, some of you must have heard about FPIs in many finance tabloids, while FDI maybe new to many.
While these terms may sound similar at first, there are peculiar differences between foreign trade and foreign investment. Thus, with distinct approaches to international investment, FPI vs FDI has their own implications and significance.
Therefore, in this blog, we will explore the fundamental differences between FDI and FPI, shedding light on their definitions, characteristics, and motives. Let’s begin.
What is Foreign Direct Investments (FDI)?
Foreign Direct Investment (FDI) occurs when a foreign entity invests in a foreign country to establish a lasting business presence. FDI refers to and typically involves acquiring a controlling interest in a foreign company by buying at least 10% of its shares, providing the investor with influence over the company’s management.
FDI takes various forms, such as mergers and acquisitions, where an existing company is purchased or merged with a local one, greenfield investments, involving the creation of a new company in a foreign location, and joint ventures, which entail collaborating with a local company to establish a new entity. Now, let us find out what is FPI.
What is Foreign Portfolio Investments (FPI)?
Foreign Portfolio Investment, which is the FPI full form, refers to foreign portfolio investors investing in securities like stocks, bonds, and other financial assets abroad. Unlike Foreign Direct Investment (FDI), FPI doesn’t entail gaining control of the company. It’s a short-term strategy driven by market trends, involving the buying and selling of securities.
FPI encompasses various forms, such as equity investments (buying shares in foreign companies), debt investments (acquiring bonds from foreign governments or companies), and other avenues like mutual funds, exchange-traded funds, and real estate investment trusts. Let us now explore the FDI and FPI differences.
What is the Difference Between FDI and FPI?
Understanding these disparities is crucial in comprehending the intricate web of global finance and its implications for both investors and host countries. Therefore, while FPI vs FDI, both involve investing money in a foreign country, they differ completely.
Following are the differences between FPI vs FDI:
| Aspect | Foreign Portfolio Investment (FPI) | Foreign Direct Investment (FDI) |
| Definition | Investment in foreign financial assets such as stocks, bonds, or other securities. | Investment in a foreign business with lasting interest and control over management and operations. |
| Type of Investment | Indirect Investment | Direct Investment |
| Purpose | Capitalize on market opportunities or diversify your investment portfolio. | Establish or expand business operations in a foreign country. |
| Nature of Investment | Short-term investment with no intention of controlling or managing the business | Long-term investment commitment |
| Level of Control | Very low or no control | High control |
| Entry & Exit | Relatively easy | Difficult |
| Return on Investment | Returns come from dividends, interest, or capital gains on financial assets. | Profits are generated through business operations and direct ownership. |
| Risk | Volatility | Stable |
| Impact on Economy | Can impact financial markets and liquidity, but with limited direct impact on the economy. | Potential to contribute to employment, technology transfer, and economic growth. |
| Regulatory Considerations | Focuses on regulating capital flows and investor behaviour. | Subjected to specific regulations and government approvals. |
Foreign Direct Investment (FDI) – A Brief Overview
Foreign Direct Investment or FDI means the investment made by individuals, companies, or entities from one country into another, with the intention of establishing lasting interest in the foreign economy. Also, it involves facilitating the flow of capital, technology, and knowledge across borders.
It enables businesses to expand their operations, tap into new markets, access resources, and leverage the comparative advantages of different countries.
The three ways of making FDI:
- Creating a joint venture.
- Through merger and acquisition.
- By establishing a subsidiary company
However, FDI is also subject to various regulations, policies, and risks that need to be carefully managed to ensure its positive impact on the economies involved.
What are the Latest Trends in Foreign Direct Investment(FDI)?
In recent years, Modi’s government has ensured the flow of foreign capital into the country through its favourable investment policy regime.
The Government of India (GOI) has taken a number of initiatives like relaxing FDI norms in the defence and oil refineries sector, introducing the ‘Make in India’ campaign to attract FDI in manufacturing and much more.
Additionally, India was ranked 7th among the top 20 host economies for FDI in 2021, according to the World Investment Report 2022 by the United Nations Conference on Trade and Development (UNCTAD). India received a record $84.84 billion in FDI in 2021, up from $60.22 billion in 2020. The report attributed India’s strong FDI performance to a number of factors, like – growing GDP, skilled workforce, strategic location, and favourable investment climate.
Foreign Portfolio Investment (FPI) – A Brief Overview
Unlike FDI, FPI means and (Foreign Portfolio Investment) involves the purchase of stocks, bonds, or other financial instruments issued by foreign companies or governments.
FPI provides investors with the opportunity to diversify their portfolios and access potential higher returns offered by foreign markets. It also allows countries to attract capital inflows, deepen their financial markets, and enhance liquidity.
Foreign Portfolio Investment flows can be influenced by factors such as economic conditions, interest rates, political stability, and investor sentiment. Governments and regulatory bodies monitor and regulate FPI to maintain stability and protect their financial systems.
In India, FPIs include investment groups of Foreign Institutional Investors (FIIs), Qualified Foreign Investors (QFIs), subaccounts, etc. NRIs don’t come under FPI.
What are the Latest Trends in Foreign Portfolio Investment (FPI)?
Foreign portfolio investment (FPI) in India has been on a roller coaster ride in recent years. In 2021, FPI inflows into India reached a record high of $36.5 billion. However, in 2022, FPI outflows will be more than double the inflows, reaching $64.3 billion as of March 8, 2023.
The government of India has taken a number of steps to address the recent volatility in FPI flows. These include relaxing FDI rules, introducing tax reforms, and promoting India as an investment destination.
Now, let us understand the differences between foreign direct investment vs foreign portfolio investment in detail here.
What are the Examples of FPI vs FDI?
Although FPI vs FDI may sound similar, the difference between foreign trade and foreign investment is what you should look out for.
Imagine that you are a multinational US company that is looking to expand its options. There are two options-(a) buying a share in the company that makes industrial machinery or (b) buying the company that has a production facility for making industrial machinery.
Thus, option A is an example of FPI (Foreign Portfolio Investment) where one purchases shares of a foreign company on a foreign stock exchange. However, option B is an example of FDI (Foreign Direct Investment) when a company from one country acquires a significant ownership stake or owns another company in a foreign company.
So if you want to open a factory in China, then this would be considered an FPI. However, if the machinery maker was located in a foreign jurisdiction country, such as Mexico, and you invested in it, your investment would be considered an FDI.
How to Choose Between FPI vs FDI?
Here are some prime factors to consider when choosing between FPI vs FDI:
- Control and Ownership: Assess your desired level of control and ownership. FDI provides significant control and ownership in the invested company, while FPI offers no substantial control or ownership.
- Investment Horizon: Evaluate your investment time frame. FDI involves a long-term commitment, while FPI is typically short to medium-term.
- Risk and Volatility: Consider your risk tolerance. FPI is more susceptible to market fluctuations and short-term capital flows, whereas FDI is relatively more stable due to its long-term nature.
- Sector and Focus: Determine the sector and focus of your investment. FDI focuses on business operations, physical assets, and infrastructure, while FPI targets financial markets, such as stocks, bonds, and mutual funds.
What are the Pros and Cons of FDI vs FPI?
We can distinguish between foreign trade and foreign investment as they have distinct pros and cons.
FDI brings long-term benefits such as job creation, technology transfer, and economic growth. It allows companies to expand their operations, access new markets, and benefit from local resources and infrastructure. FDI also provides a higher level of control and ownership in the invested company. However, FDI requires significant capital and managerial commitments, and it is subject to complex regulations and risks associated with operating in a foreign market.
On the other hand, FPI offers portfolio diversification, liquidity, and potentially higher returns. It provides flexibility and allows investors to access foreign markets without the same level of commitment as FDI. FPI also offers ease of entry and exit from investments. However, FPI is more volatile and susceptible to short-term capital flows, making it prone to market fluctuations and external economic factors. Additionally, investors have limited control and influence over the companies they invest in.
Therefore, the choice between FPI vs FDI depends on the specific objectives, risk tolerance, and resources of the investors or businesses involved.
Recent Trends on FDI vs FPI Worldwide
In 2020, China outpaced the United States as the top global recipient of Foreign Direct Investment (FDI), attracting $163 billion, while the U.S. secured $134 billion. This marks a substantial shift from 2019 when the U.S. led with $251 billion, and China received $140 billion.
Analyzing FDI as a percentage of Gross Domestic Product (GDP) provides insights into a nation’s attractiveness for long-term investments. Despite its smaller economy, China’s FDI as a percentage of GDP stood at 1.31% in 2019, slightly below the U.S. at 1.64%.
Notably, smaller and dynamic economies such as Singapore and Cyprus boast significantly higher FDI percentages relative to their GDP: 32.17% for Singapore and a remarkable 103.93% for Cyprus in 2019, the highest globally.
To Wrap It Up…
Overall, it is important to differentiate between foreign trade and foreign investment. FDI offers tangible benefits such as job creation and technology transfer, but requires greater commitment and involves more risks. FPI provides flexibility and diversification, but carries higher volatility and lacks control over the underlying companies. The choice between FPI vs FDI depends on specific investment objectives, risk tolerance, and market conditions. It’s advisable to consult with financial advisors or experts to make an informed decision.
FAQs
Foreign Direct Investment and Foreign Portfolio Investments differ in terms of control, investment duration, risk, and economic impact. FDI entails direct investment, offering control and a long-term outlook. On the other hand, FPI involves investing in financial assets without control, typically being short to medium-term.
Foreign Portfolio Investment (FPI) differs from Foreign Direct Investment (FDI) in that investors lack direct control over the securities or businesses involved. Consequently, FPI generally exhibits higher liquidity and lower risk compared to FDI.
Foreign Direct Investment (FDI) involves foreign investors directly investing in another nation’s productive assets. Conversely, Foreign Portfolio Investment (FPI) entails investing in financial assets, like stocks and bonds, of entities situated in a different country.
Foreign direct investments come in three main types of international investments: horizontal, vertical, and conglomerate. In a horizontal FDI, a company replicates its domestic business operations in a foreign location.
SEBI regulates the Foreign Portfolio Investor (FPI) regime, serving as a channel for foreign investment in India. It harmonizes the previous modes, namely Foreign Institutional Investor (FII) and Qualified Foreign Investor (QFI), streamlining foreign investment into the country.
More Difference Related Articles from Investment domain on smallcase –
Read more difference related articles to help you in your investment journey. One click away only on smallcase –
