A country needs funds to grow its economy. While approaching domestic sources is one way, approaching international sources is another way. There are two ways a country can get capital through international sources. Namely, Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI). Though they sound similar, they are poles apart. This article covers Foreign Direct Investment (FDI), Foreign Portfolio Investment (FPI), along with FDI vs FPI in detail.
What is Foreign Direct Investment (FDI)?
Foreign Direct Investment (FDI) is when a company invests a substantial amount in a foreign company by taking controlling ownership and participating in the company’s day-to-day business. In FDI, along with the capital, the company brings in knowledge, skill, and also technical know-how. Hence, they hold a good amount of control in terms of decision making.
- FDIs are commonly made in countries that have a high potential for growth and also in countries that have a skilled workforce.
- FDI can happen even when a company acquires assets or establishes a business in a foreign country. It is also a very common practice to expand business to new countries. Moreover, a company can either merge or enter into a joint venture with a foreign company.
- An FDI can lead to horizontal expansion, vertical expansion or also a conglomerate. In horizontal investment, the company invests in companies with similar businesses or establishes a similar business. While in vertical investment, the company invests in companies that are complementary to its business. And in a conglomerate investment, the company invests in a business that is totally unrelated to its core business.
- The Indian economy opened up in 1991 for the entire world and since then, it has been attracting foreign investment.
What is Foreign Portfolio Investment (FPI)?
Foreign Portfolio Investment (FPI) refers to passive investments in the financial assets of a foreign economy. Financial assets such as stocks, bonds, and other financial assets. Also, none of these involves any active management by the investor.
- The primary motive of FPI is to invest money in foreign markets with the hope to generate quick returns. Therefore, it involves the purchase of securities that can be easily bought and sold.
- FPIs are made to generate short term financial gains but not to gain control over the managerial operations of the business.
- Often, FPI’s are viewed as less favourable than direct investments since it is easy to liquidate the portfolio investments. At times, FPIs are made with an intention to earn short term gains rather than a long-term investment in the foreign country (economy).
- India witnessed the highest FPI out flow of 1.34 Lakhs Crore in 2022. This can be an indication that foreign investors are eyeing other developing nations for higher returns.
Difference between FDI vs FPI
Following are the key differences between FDI Vs FPI:
| Basis of Difference | FDI | FPI |
| Definition | Foreign Direct Investment (FDI) refers to either direct investments made in a foreign country to expand a firm, build new infrastructure, or make long-term investments in that country’s economy. | Foreign Portfolio Investment (FPI) is an investment in a foreign country’s financial assets, either stocks or bonds. It is mainly done to generate significant returns from the stock markets. |
| Type of Investors | Active | Passive |
| Type of Investment | Direct Investment | Indirect Investment |
| Degree of Control | High control | Very low control |
| Investment Term | Long Term | Short Term |
| Involvement | Long term interest in the company, therefore, involved in management and ownership control. | Looking for short term gains, therefore no active involvement in the managerial activities. |
| Project Management | Projects are managed efficiently. | Less efficiency in project management. |
| Type of Assets | Physical assets and stakes in the foreign companies. (Financial and also Non-Financial Assets). | Financial assets of the foreign country like stocks, bonds and also ETFs. |
| Entry and Exit | Difficult | Relatively easy |
| Motive | Business expansion. | Generating returns to the investor. |
| Leads to | Transfer of technology, funds and also resources to the foreign country. | Capital inflow to the foreign countries. |
| Volatility | Stable | Volatile |
Summary
Both FDI and FPI are the most common ways to hold an investment in a foreign country. The former allows investors to hold controlling interests, while the latter allows investors to own financial assets. FDI is available only to high-net-worth investors or institutional investors, while any retail investor can invest in shares or bonds or any other financial security in another country.
However, both FDI and FPI help increase the inflow of foreign funds into an economy and help improve the balance of payments situation for a country.
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