Difference Between FDI and FPI | Espresso

Explain the Difference Between FPI and FDI

Capital is a key factor in economic growth, but most countries look to foreign investors because domestic resources alone cannot meet their general capital needs. Foreign Portfolio Investment (FDI) and Foreign Direct Investment (FDI) are the two most common ways to invest in a foreign economy.

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FPI means laying out money in financial assets like bonds and stocks of companies located in foreign countries. FDI refers to direct investment by foreign investors in the production assets of another country.

FPI and FDI are similar in some ways but very different in other ways. Therefore, countries with high levels of FDI should clarify the difference between FDI and FPI since overseas investors with high levels of FPI may face currency turmoil and market volatility during uncertain times.

What is FDI?

FDI or Foreign Direct Investment is when a company invests a significant amount in a foreign company by acquiring a controlling interest and participating in the company's day-to-day operations. Together with capital in foreign direct investment, the company provides knowledge, skills, and technical know-how. So, they have good control in terms of decision-making.

FDI typically comes from countries with high growth potential and a skilled workforce.

FDI may also arise if a company acquires assets or starts a business in another country. It is also very common to expand a business to a new country. In addition, companies may merge with foreign companies or form joint ventures.

Foreign Direct Investment can lead to horizontal expansion, vertical expansion, or conglomerates. The horizontal investment allows a company to invest in or start a similar business or establish a similar business. In vertical investing, companies invest in companies that complement their business. In the case of large companies, they invest in businesses that are completely unrelated to their main business.

The Indian economy opened to the world in 1991 and has attracted foreign investment since then.

Also Read: Foreign Exchange Market

What is FPI?

FPI or Foreign Portfolio Investment refers to passive investment in financial assets belonging to an overseas economy. Financial assets like bonds, stocks, and other financial belongings. Furthermore, none of these involves the active management of investors.

The main motive for FPI is to lay out money in foreign markets with the expectation of rapid returns. Therefore, it involves buying securities that can be easily sold and bought.

FPI is designed to generate short-term financial returns but not control administrative operations.

FPI is considered less profitable than direct investment because portfolio investments are easily liquidated. Sometimes the foreign direct investment is made to generate short-term profits rather than long-term investments in foreign countries (economy).

India recorded the highest FPI outflows in October 2018 and July 2020. This could mean that foreign investors turn to other developing countries for higher returns.

Difference Between FDI and FPI

FDI and FPI are more or less similar since they both deal with foreign investment. However, there exist certain differences:

FDI

  • FDI investors generally have a dominant position in joint ventures or domestic companies and are ardently involved in their management.
  • FDI investors take a very long approach to their investments and take years from planning to project execution.
  • FDI investors cannot liquidate their assets and leave the country since they are very illiquid and large.

FPI

  • FPI investors tend to be passive who do not actively participate in domestic companies' daily operation and strategic planning despite having a controlling stake.
  • FPI investors can insist on a long-term view, but the investment period is often much shorter, especially when the local economy faces instability.
  • FPI investors have to leave the country as their financial assets are widely traded and highly liquid.

Conclusion

FDI and FPI can be essential sources of capital for the economy, but FPI tends to be highly volatile, and such volatility can exacerbate economic problems in uncertain times. As such volatility may have a notable negative effect on investment portfolios, individual investors should be aware of the differences between these two major offshore investment sources.

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Frequently Asked Questions

The money invested in India is counted towards the FDI/FPI in the equity account of our Balance of Payment (BoP), but the income received from the investment is recorded as Profit/Interest/Dividend in the current account of the BoP.

The more the investor income, the more money is taken from India which is considered negative in current account transactions in Balance of Payment. On the other hand, more investments happening in India means more money inflow to India which is positive from equity account balance deemed payment transaction.

In FPIs, investors do not have direct control over businesses or securities. This means that FPI is more liquid and has fewer risks than FDI.

Foreign Portfolio Investment (FPI) provides investors with the opportunity to participate in an internal diversification of portfolio assets, helping to achieve higher risk-adjusted returns.