Understanding the dynamics of international investment is crucial for businesses and investors navigating the global economy. Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) are two key channels through which capital flows across borders. While FDI and FPI play significant roles in shaping economies and financial markets, they differ in their objectives, modes of operation, and impacts. In this blog, we delve into the differences of FDI vs FPI, and explore their characteristics, implications, and considerations for businesses and investors.
What is foreign direct investment?
Foreign Direct Investment (FDI) refers to the investment made by a business or entity based in one country into a business or entity based in another country.
FDI is when Indian companies invest capital directly into businesses or entities located in foreign countries.
This type of investment allows Indian entities to expand their operations internationally and gain access to new markets, resources, and opportunities.
FDI plays a significant role in global economic development, contributing to job creation, technology transfer, and fostering international trade relations.
What is foreign portfolio investment?
Foreign Portfolio Investment (FPI) refers to the investment made by individuals, institutions, or entities from foreign countries into financial assets such as stocks, bonds, and other securities of a country.
Unlike FDI, which involves a direct stake in a business and often entails management control, FPI is generally more passive in nature.
Foreign investors engaging in FPI typically seek financial returns through dividends, interest payments, and capital appreciation, without actively participating in the management or operations of the invested assets.
FDI vs FPI: differences
FDI and FPI differ in several key aspects:
Basis of difference | FDI | FPI |
Level of control | FDI involves a direct investment in a business or asset, giving the investor significant control and influence over the entity's operations. | FPI entails investing in financial assets such as stocks and bonds, and the investor typically does not have direct control over their management. |
Nature of Investment | In FDI vs FPI, FDI usually involves a long-term commitment, with the investor seeking to establish a lasting presence in the host country and actively participate in its economic activities. | FPI is often more short-term oriented, with investors primarily focused on earning financial returns through dividends, interest payments, and capital gains. |
Purpose | FDI is typically undertaken to gain access to new markets, resources, and technologies, expand business operations, and establish strategic partnerships. | FPI is primarily driven by investment objectives such as portfolio diversification, risk management, and capital appreciation. |
Risk and return | FDI generally carries higher risks and potential rewards compared to FPI. While FDI offers the potential for greater control and higher returns over the long term, it also entails greater exposure to risks such as political instability, regulatory changes, and currency fluctuations. | In FDI vs FPI, FPI offers greater liquidity and flexibility but may be more susceptible to market volatility and external shocks. |
Regulatory environment | The regulatory framework governing FDI and FPI may differ, with governments often imposing specific restrictions, regulations, and incentives to encourage or regulate foreign investments in their respective countries. FDI regulations may focus on factors such as foreign ownership limits, sectoral restrictions, and national security concerns. | In contrast, FPI regulations may involve measures to manage capital flows, safeguard financial stability, and promote investor confidence. |
Overall, while both FDI and FPI play important roles in facilitating cross-border investments and fostering economic development, they differ in their objectives, nature, and implications for investors and host countries.
FDI and FPI: examples
Let’s look at the examples of FDI and FPI to clearly understand them:
Example of FDI
Source | Example of FDI
Let’s understand FDI vs FPI better with examples. Say an Indian automotive manufacturer decides to build a manufacturing plant in the United States in collaboration with a US-based entity. They invest directly in constructing the plant, purchasing equipment, and hiring local workers. This move allows them to expand globally, access new markets, and leverage resources in the United States. It contributes to economic growth and job creation in both countries.
Example of FPI
Source | Example of FPI
For the latter in FDI vs FPI, an example would be when an Indian investor purchases shares of a multinational technology company listed on the New York Stock Exchange. In this case, the Indian investor is buying financial assets (shares) of a foreign entity without acquiring ownership or control over the company. The investment is purely financial, aimed at generating returns through dividends or capital appreciation.
Unlike FDI, FPI does not involve direct involvement in the management or operations of the company. Instead, the investor relies on market performance and economic conditions to determine the value of their investment.
How to pick between FDI and FPI ?
Choosing one out of FDI vs FPI depends on various factors, including your investment goals, risk tolerance, and level of control:
Investment goals
If you seek long-term ownership and control in a business, FDI may be suitable. FDI allows you to establish or acquire a stake in a company, contributing to its growth and profitability over time.
FPI might be preferable if you aim for short-term gains from market fluctuations. FPI involves buying and selling financial assets like stocks and bonds, providing opportunities for quick profits.
Risk tolerance
FDI typically entails higher risks due to the long-term commitment and direct involvement in business operations. Market volatility, regulatory changes, and economic downturns can affect FDI ventures significantly.
FPI generally involves lower risks as investments are made in financial markets rather than directly in businesses. However, FPI returns may still be subject to market risks and fluctuations.
Control and management
FDI offers greater control and influence over the invested business, allowing you to make strategic decisions and actively manage operations.
FPI provides limited control over the underlying assets, as investment decisions are typically based on market trends and portfolio diversification rather than direct management involvement.
Regulatory environment
FDI often requires compliance with stringent regulations and approval processes set by the host country, which can vary depending on the industry and jurisdiction.
FPI involves adherence to market regulations and may require compliance with foreign exchange rules and investment restrictions imposed by the host country's authorities.
Ultimately, the decision between FDI and FPI should align with your investment objectives, risk appetite, and strategic considerations.
FDI vs FPI: trends in India
Before we head out, let’s see some recent trends India has witnessed when it comes to the FDI vs FPI debate:
FDI inflow into India experienced a remarkable surge, doubling to $596 billion during the period of 2014-23 compared to the previous period of 2005-13, as highlighted by Finance Minister Nirmala Sitharaman in her Budget speech for 2024-25.
This surge is indicative of a golden era in FDI inflows, with figures showing a significant rise from $36 billion in 2013-14 to a record high of $85 billion in 2021-22.
The focus of bilateral investment treaties (BITs) being negotiated with foreign partners now revolves around the concept of 'first develop India,' a play on the FDI acronym. The government aims to ensure that foreign investment flows continue to support India's development interests through these BITs.
However, negotiations with countries like the UK and the EU are posing challenges, particularly concerning investor-state dispute settlement provisions and treaty definitions.
As India strives to become the third-largest economy, aligning its treaties with global investment practices and addressing concerns raised by previous treaty cancellations will be critical for fostering sustained foreign investment.
Foreign Portfolio Investors (FPIs) showed a strong interest in Indian equities and debt, injecting around ₹8,772 crore (just over $1 billion) in the first week of 2024. Data from depositories revealed that ₹4,773 crore went into equities, while ₹3,999 crore was allocated to debt securities.
This follows a record-breaking $8 billion FPI inflow into equities and $2 billion into debt in December 2023. The robust inflows at the start of 2024 have sparked speculation that this year may outperform 2023 in terms of FPI investments.
India emerged as the top destination for FPIs in 2023, with net inflows recorded for eight consecutive months.
Falling interest rates and a cooling US dollar could bolster emerging markets, including India, in 2024. This positive momentum in FPI inflows could support Indian markets, despite concerns about valuation.
With the impending inclusion of sovereign debt in global bond indices like the J P Morgan EM Bond Index, debt markets in India are expected to become more attractive than equities. This anticipated trend has already seen FPIs positioning themselves to capitalise on India's bond inclusion from June 2024.
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FAQs
1. What are the main risks associated with FDI and FPI?
Risks associated with FDI include political instability, regulatory changes, and currency fluctuations, while FPI risks may include market volatility, liquidity issues, and changes in investor sentiment.
2. Can individuals participate in FDI and FPI?
Corporations typically undertake FDI, while individuals can participate in FPI through investment vehicles such as mutual funds or ETFs.
