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Every economy requires capital to grow and progress and while most of this capital is sourced domestically, some of it also comes from the foreign markets. Two important terms of foreign investments you might have heard of are Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI).
These terms are often used by people interchangeably without understanding their deeper nuances. In this article, we will look at each of them in detail, study some of their trends, and look at the difference between FDI and FPI.
What is Foreign Direct Investment (FDI)?
Foreign direct investment is when an investor has a lasting interest in a foreign country and has a large capital to invest. Some sources of FDIs are establishing a direct business interest by establishing a business, buying buildings or establishing warehouses. It involves creating long-term capital in a foreign country.
Since the investment involved is large, the FDIs are often undertaken by venture capital firms, large organisations or MNCs. These investments are favourable because of their long-term nature and investment in the well-being of another country. Some ways of doing a foreign direct investment involve creating a joint venture, establishing a subsidiary company and through mergers and acquisitions.
The Indian government has taken initiatives to increase the FDIs in the country, especially in sectors such as defence, telecom, power exchange, stock exchange, etc by relaxing the norms. As a result, the FDIs in India are growing at a rapid pace.
What is Foreign Portfolio Investment (FPI)?
Foreign Portfolio Investment refers to another form of investment in foreign countries. It is executed by investing in the financial assets of a company such as bonds and stocks. These investments are usually made in assets that are easy to buy and sell and can help earn profits in short time frames.
The FPIs are considered less favourable than FDIs because they are relatively short-term investments targeted at earning short-term profits instead of long-run investments. Further, this form of investment does not give any control over the asset to the investors. Equity investments, debt investments, mutual funds, real estate investment trusts and ETFs are some forms of FPIs.
The FPIs in India include the investment groups of Qualified Foreign Investors (QFIs), Foreign Institutional Investors (FIIs) and subaccounts, etc.
Difference between FDI and FPI
With a basic understanding of what the two terms mean, let us now delve into the FDI vs FPI difference to get a more comprehensive understanding of the two. The key factors in FDI vs FPI are:
- Type of investment
FDI is a direct investment that happens with a long-term interest and control over the asset. As against this, FPI is an indirect short-term investment in foreign financial assets like stocks, bonds, ETFs, etc.
- Purpose
The purpose of FDI is to establish business operations or expand them in a foreign country. The purpose of FPI on the other hand is to either diversify the investment portfolio with securities of another country or capitalise on the market opportunities.
- Nature of investment
FDI is a long-term investment commitment while FPI is a short-term investment with no control on the management or operations of the business.
- Level of control
Another FPI vs FDI India difference is that FDI has a high level of control while FPI has very low or no control at all.
- Entry and exit
It is difficult to enter or exit from an FDI and relatively easier to enter or exit an FPI.
- Return on investment
The profit in an FDI is generated through the business operations in which the investor has ownership. As against this, the return on investment in an FPI is in the form of dividends, interests or capital gains on a financial asset.
- Risk
There is relatively low risk in FDI because it is a stable investment while it is higher in an FPI as it is more volatile.
- Impact on economy
An FDI significantly contributes to the economy of the foreign country with its contribution towards employment, technology and overall economic growth. However, an FPI investment has a limited direct impact on the economy of a country as it can only impact the liquidity and financial markets.
- Regulations
An FDI investment is subject to government regulatory measures and approvals. On the contrary, the FPI’s regulatory considerations focus on regulating capital flows and influencing customer behaviour.
Conclusion
The FDI comes with more tangible economic benefits such as job creation and technology transfer. On the other hand, FPIs have an indirect benefit and are relatively more volatile. The choice between the two depends on the risk tolerance of businesses, investment objectives as well as market conditions. However, the more direct investment in the form of FDI, the better it is for the economy of the country. To learn financial concepts, read blogs on StockGro.
FAQs
The major difference between FDI and FPI is that FDI is more of a long-term direct investment. On the contrary, the FPI is an indirect form of short-term investment done in stocks, mutual funds, ETFs, etc.
FDI is less risky because it is a long-term investment and is more durable. As against this, FPI is a more volatile investment dependent on the market conditions.
The return on investment is higher for FDI compared with FPI as it is a long-term investment and accrues from business ownership instead of interest and dividends.
The FDI has a higher degree of control compared with FPI. FDI is a form of direct ownership in a business venture while FPI is only investing in stocks or mutual funds.
FPI is relatively easier to enter and exit while FDI is a long-term fixed investment. FPI is similar to investing in stocks and funds where the investor can enter and exit whenever they want.