Global capital flows are broadly classified into FDI (foreign direct investment) and FPI (foreign portfolio investment). FPI refers to investments made by foreign investors in stock markets in overseas markets. On the other hand, foreign direct investment means investment made directly into physical assets such as companies or factories in a foreign country.
The primary difference between FDI and FPI is in the level of control exerted over investments made. While FDI is a more substantial and lasting investment that confers control, FPI typically concerns short-term investments in financial products that do not seek significant control. It is important to distinguish between FDI and FPI as these investments influence the country’s economy and stock markets. Let’s dig in to learn more.
What is Foreign Direct Investment (FDI)?
Companies need capital to expand their business and increase profits. Tapping the stock market for funds is tough and borrowing involves paying back with high interest. Foreign direct investment (FDI)—made by a company or an individual located in one country into a business located in a different country—is a boon for firms looking for capital to expand. FDI usually takes one of these routes: Companies can set up a wholly-owned subsidiary elsewhere, buy a significant stake in the firm, or even form a joint venture. FDI, which tends to be a long-term investment, is an important driver of economic growth.
What is Foreign Portfolio Investment (FPI)?
In foreign portfolio investment, an investor or a group of investors purchase financial instruments in another country, generally stocks and bonds. Making portfolio investments in promising economies such as India is a time-tested strategy adopted by foreign investors. Strong FPI inflows can boost a country’s stock market and foreign investors can profit from the upside. However, the downside is that FPI inflows are generally for the short term, and a premature exit from the market can often spell doom. Generally speaking, foreign portfolio investors do not seek operational control of the firms they invest in.
What is the difference between FDI and FPI?
Foreign organizations can invest in a nation through two different channels: FPI and FDI which are two instruments of global investments, both having their objectives and characteristics. The main differences between FPI and FDI are as follows.
Nature of Investment
FDI is the direct investment of money in a foreign firm or company to purchase a sizable stake and exercise significant control over the company management. However, FPI refers to investments made in foreign stocks or bonds without seeking operational control of the firm.
Degree of Management
In the FDI, the investor gets a large part of shares or assets, which gives a great deal of ownership and control over the business. Due to this control, the investor can participate in the management and decision-making processes within the company. Since FPI investors typically own a portfolio of financial assets, they generally have no say or control over the company’s management.
Duration and Objective
Long-term investments are made through FDI to create a strong corporate presence and support economic expansion. FPI, on the other hand, comprises short-term investments, with the primary goal of buying assets to generate quick profits.
Risks and Profits
Because FDI requires operational engagement and a long-term commitment, it carries significant risks. But it also has the potential to yield large rewards, such as capital growth and business operating profits. Short-term investments (FPI) have lesser risks but returns could vary.
Effects on the Economy
Since FDI brings in capital, technological skills, and job opportunities, it is generally seen as good for the recipient nation’s economy. It boosts productivity and helps the home business expand. Additionally, technology transfer and knowledge spillovers get a boost. The stability of the country’s financial markets could be impacted by the fickle nature of FPI investments. Although FPI supports the local market by supplying liquidity, capital flight often triggers more capital flight.Â
Investment Horizon
Since FDI is meant for long-term commercial operations and requires a significant amount of capital, it usually includes long-term investments. Over a lengthy period, perhaps years or decades, the investor anticipates a return on their investment. Conversely, FPI often has a short- to medium-term duration. The goal of FPI investors is to profit from transient market opportunities.
Foreign Direct Investment (FDI): A brief overview
Investment that is made in a business or a project in a country by an entity operating in another country is called FDI or foreign direct investment. FDI can be broadly classified into three categories: Conglomerate, vertical, and horizontal integration strategies.
Horizontal FDI happens when a firm replicates its home-country operations in another country, or a business carries out its activities in a foreign market. The type of FDI where investors invest in related businesses overseas—normally in supply chain segments—is called vertical FDI. Conglomerate FDI is the kind of investment that occurs when a firm invests in a business firm in another country that is entirely unrelated to its own business.
What are the latest trends in foreign direct investment (FDI)?
India has followed a policy that encourages the flow of foreign direct investments into the country. Multinationals such as Apple and Samsung Electronics, for instance, have spruced up manufacturing in India. However, the country witnessed a fall in FDI inflows in 2023 as global uncertainties weighed. Upping its game, India hopes to attract close to $100 billion in FDI every year, hoping to cash in on the trend of multinationals shunning China.
Foreign Portfolio Investment (FPI): A brief overview
FPI refers to investment in stocks or bonds of a foreign country. Portfolio investments are generally viewed as less stable than foreign direct investments, primarily because they are deemed transient investments that can be easily sold. In other words, they have the perception of being a short-term investment that can vanish anytime, often impacting the host nation’s stock markets.
What are the latest trends in Foreign Portfolio Investment (FPI)?
Understanding the difference between FPI and FDI is essential to put things in perspective. India is a classic case in point which illustrates how FPI can boost the country’s stock market to newer heights. Essentially, FPIs shifted allegiance away from China, which was considered a growth market till a few years back and moved their investments to India.
However, FPI inflows into Indian equities has been unsteady. If 2023 witnessed robust inflows, it moderated in the first half of 2024 as elections-related concerns, hawkish central bank stances, and high valuations made FPIs cautious. Looking ahead, anticipated rate cut in the US bodes well for FPI inflows into India.
What are the examples of FPI vs. FDI?
Understanding the difference between FPI and FDI is important. Imagine a situation where a Europe-based tech company wants to deploy some of its capital in India. It can either (a) buy a minority stake in an Indian software company or (b) acquire the Indian firm. FPI is represented by Option A, in which investment is restricted to the purchase of shares only, with no ownership of the business. On the other hand, option B represents FDI in which the European corporation purchases the Indian company outright and gains complete control.
How to choose between FPI vs. FDI?
While choosing between FDI and FPI, one has to keep a few things in mind. The basic question to ask yourself is your level of commitment. If you are looking for a quick bargain, you can consider FPI, but if you want to transform a business, FDI route would work for you. Be sure about your investment horizon and the type of investor you are, short-term or long-term.
FDI is more stable due to its extended time horizon, while FPI is more exposed to market risks and other short-term capital movements. FPI invests in stocks, bonds, and mutual funds, while FDI focuses on transforming businesses.
What are the pros and cons of FDI vs. FPI?
The two main forms of foreign investment are foreign portfolio investments (FPI) and foreign direct investment (FDI), each with its unique advantages and disadvantages.
Purchasing a sizable portion of a foreign company allows for direct control and long-term interest. Stable investment, knowledge transfer, and job creation are benefits of FDI that support economic growth in the host nation. Long-term earnings and management control are additional benefits it offers. The drawbacks, however, are increased risk brought on by a large financial investment, geopolitical uncertainties, and regulatory hurdles.
On the other hand, FPIs invest primarily in bonds and stocks where the investor has no operating control of the business. The advantages are ease of investment and the flexibility to invest in instruments of choice. On the downside, the fickle nature of investments means a sudden pullout would rock the financial markets of the host nation. As far as global capital flows are concerned, FDI and FPI are both useful and the selection will depend on the nature of the investment and risk preferences of the investor.
Recent trends in FDI vs. FPI worldwide
Global capital is always on the move, chasing better yields. As a general rule, businesses hate uncertainty. FDI, which is the more stable form of global capital flows, always look for good bargains in stable businesses worldwide. For instance, FDI inflows into India that had soared in 2023, moderated in the first half of 2024 as political uncertainty and high valuations played spoilsport.
On the other hand, FPIs always look for opportunities to make quick profits in well-performing stock markets. Broadly speaking, FDI is long-term in nature, while FPIs generally exit once the short-term objective is achieved.
Conclusion
Foreign direct investment (FDI) and foreign portfolio investment (FPI) are two of the most important components of global capital flows. Both contribute to economic growth in their respective ways. While FPI focuses on trading securities in the financial markets for quick gains, FDI involves direct investment in a firm or a country to gain a controlling stake. The primary differences between FDI and FPI are their duration and impact on the host country. To promote economic growth and stability, leaders and investors may make more informed judgments by becoming aware of these distinctions.
