What is FDI and FPI, Differences and Importance in Global Investment

Stuti Mishra

5 months ago

Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) are two pivotal components of international finance that drive global economic integration. FDI focuses on long-term investments in business operations or infrastructure, granting investors managerial influence and contributing to sustained economic growth. In contrast, FPI involves investments in financial markets, such as stocks and bonds, aiming for short-term profits without ownership or control. Together, FDI and FPI play a vital role in shaping global trade, economic policies, and financial stability. We have come up with the article to properly understand FDI and FPI for gearing up your preparation on UGC NET Commerce exam 2024.

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FDI vs FPI

Foreign investment in India is broadly categorized into two types: Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI). Lets have a look on their broad comparison:

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Aspect	Foreign Direct Investment (FDI)	Foreign Portfolio Investment (FPI)
Definition	Long-term investment in physical assets or businesses in India.	Short-term investment in financial assets like stocks and bonds in Indian markets.
Ownership	Provides significant ownership and control over the invested business or assets.	No ownership or control over the businesses; focuses on market returns.
Nature of Investment	Stable and long-term; aimed at creating infrastructure and boosting productivity.	Volatile and short-term; driven by stock market fluctuations.
Entry Route	Automatic route (up to a limit) or Government approval depending on the sector.	Relatively easier entry through registered stock exchanges.
Impact on Economy	Enhances employment, technology transfer, and industrial growth.	Influences capital markets, liquidity, and exchange rates.
Key Sectors	Manufacturing, services, infrastructure, e-commerce, and retail.	Stocks, bonds, mutual funds, and other financial instruments.
Regulatory Body	Governed by the Department for Promotion of Industry and Internal Trade (DPIIT).	Regulated by the Securities and Exchange Board of India (SEBI).
Examples	Amazon’s investment in Indian e-commerce, Walmart’s acquisition of Flipkart.	Foreign investors buying shares of Indian companies like Infosys and TCS.

What is Foreign Direct Investment (FDI)?

Foreign Direct Investment (FDI) represents the net inflow of foreign funds into a business operating outside the financier’s home country.

Role in Development: It is a cornerstone of an open global economic system and a key driver of development.
Global Growth: FDI has emerged as a prominent form of international capital transfer in recent decades.
Stability and Longevity: Recognized for its stability and long-term objectives, FDI promotes sustainable growth.
Economic Impact: Over time, it fosters economic expansion, creates jobs, and stimulates various economic activities.
Historical Trends: Between 1980 and 1990, global FDI flows tripled, reflecting its growing significance.

Broad Classification of FDI

Foreign Direct Investment (FDI) is categorized into distinct types based on the nature, purpose, and strategy of investment. Here’s a concise classification:

Based on Entry Strategy:
- Greenfield Investment: Establishing new facilities in the host country, such as factories or offices, from scratch.
- Brownfield Investment: Acquiring or leasing existing businesses or infrastructure in the host country.

Based on Sector:
- Horizontal FDI: Investment in the same industry as the investor’s domestic operations.
- Vertical FDI: Investment in different stages of the supply chain, such as raw materials or distribution.
- Conglomerate FDI: Investment in entirely unrelated industries to diversify portfolios.
Based on Flow Direction:
- Inward FDI: Capital flowing into a country from foreign investors or companies.
- Outward FDI: Investments made by domestic firms into businesses in foreign economies.
Based on Ownership and Control:
- Majority-Owned: Investor holds over 50% equity, gaining full decision-making control.
- Minority-Owned: Investor holds less than 50% equity, with limited influence over operations.

FDI trends in India 2024

Decline in Overall FDI: India’s FDI inflows dropped by 31% to $25.5 billion in FY 2023-24 (first 10 months), despite a global rise in FDI by 3%
Leading FDI Sectors: The services sector, including financial services, technology, and business outsourcing, remains a top attraction for foreign investors. Additionally, infrastructure and construction sectors are showing significant growth in FDI
Shift in Sector Preferences: Telecom, pharmaceuticals, and automobile sectors have seen declines, with FDI down by 48%, 54%, and 20%, respectively
Key FDI Contributors: Singapore, Mauritius, USA, and Netherlands are the largest contributors to India’s FDI, accounting for nearly 70% of total inflows
FDI in Emerging Sectors: The renewable energy and technology services sectors are gaining momentum, signaling a shift towards newer industries for future growth.

What is Foreign Portfolio Investment (FPI)?

Foreign Portfolio Investment (FPI) refers to investments in financial assets like stocks, bonds, and other securities in a foreign market. Unlike FDI, FPI does not result in ownership control over companies. FPI in India reached $16.9 billion in 2023, with foreign institutional investors (FIIs) continuing to contribute significantly to India’s stock market growth. FPI plays a vital role in enhancing market liquidity and attracting global capital to emerging economies.

Nature of Investment: FPI involves investing in securities and financial assets in foreign markets, such as stocks, bonds, and commodities.
No Ownership Control: Unlike FDI, FPI does not give investors direct control over the company’s assets or management.
High Liquidity: FPI investments are highly liquid, meaning they can be quickly bought or sold based on market conditions.
Investment Type: Typically involves stocks, bonds, money market instruments, or commodities in other countries.
Global Capital Flow: Alongside FDI, FPI serves as a key avenue for foreign investment, aiding economic growth and market development.
Investor Involvement: FPI investors are not involved in the day-to-day management of the companies they invest in.

Factors affecting Foreign Portfolio Investment (FPI)

The factors affecting Foreign Portfolio Investment (FPI) are diverse, reflecting the complexities of global financial markets. Here are the main factors that affect FPI:

Market Liquidity: FPI thrives in markets with high liquidity, as investors prefer assets that can be quickly bought or sold with minimal price fluctuation
Interest Rates and Return on Investment: High returns on investments, often driven by higher interest rates or the potential for capital gains, attract FPI. Countries with stable or rising interest rates tend to draw more foreign investment
Economic Stability and Growth: Investors seek stable, growing economies. Economic indicators like GDP growth, inflation rates, and fiscal policies are crucial in influencing FPI. For example, India’s growth potential continues to attract foreign portfolio capital
Exchange Rate Volatility: FPI is sensitive to exchange rate movements. Strong, stable currencies attract foreign investors, while volatile currencies may deter investment due to the risk of currency losses
Political Stability: Political uncertainty or instability can significantly reduce FPI, as investors seek countries with predictable governance and regulatory frameworks
Regulatory Environment: A transparent and investor-friendly regulatory environment enhances FPI. Countries with clear tax policies, less bureaucratic red tape, and a free-market approach tend to receive higher levels of foreign portfolio inflows
Global Market Sentiment: FPI is also affected by broader global economic conditions, such as financial crises, trade wars, or shifts in investor risk appetite. For instance, during periods of global economic uncertainty, FPI often retracts as investors move towards safer assets

Classification of Foreign Portfolio Investment (FPI)

The classification of Foreign Portfolio Investment (FPI) is generally categorized as:

Equity Investment: Investment in stocks or shares of companies in foreign markets. These are typically considered high-risk but offer high returns.
Debt Investment: Involves investment in government or corporate bonds, providing steady returns with relatively lower risk compared to equity.
Hybrid Instruments: Combines elements of both equity and debt, such as convertible bonds or hybrid securities, offering a balance between risk and return.

FDI vs. FPI Conclusion

In conclusion, FDI and FPI are two vital channels of global capital investment, each playing a distinct role in economic development. While FDI drives long-term growth, job creation, and technological advancement, fostering deeper ties between investors and host countries, FPI offers liquidity and short-term gains, benefiting from market fluctuations. Both investments contribute to financial markets, with FDI typically associated with higher stability and impact, and FPI providing flexibility and rapid capital flow. Understanding these differences is essential for investors, policymakers, and economies looking to maximize the benefits of global capital investments.