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Foreign investments mean investment made in any entity of a foreign country. It involves a transaction of capital from one country to another country. Foreign investments play a vital role in the development of the economy for a country. Additionally, it is also considered a crucial factor in the development of international trade and commerce. The two major tools for placement of foreign investment are FDI and FPI. FDI stands for Foreign Direct Investment, and FPI stands for Foreign Portfolio Investment. It is interesting to analyze the FDI vs. FPI debate talking place form a long time in the investment industry.
Foreign investments via FDI and FPI are also crucial to boost the economic growth and employment opportunities to the host country. It also helps to reduce the economic disparity between different countries. Institutions, corporations, and individuals can undertake these investments. The terms FPI and FDI sound similar but they represent two different concepts of foreign investment.
FDI or Foreign Direct Investment involves anchoring a direct business interest in a foreign-based country, such as investing in the establishment of a manufacturing plant, the building of storage facilities or buying of long term business assets. FDI is similar to establishing a business in the Investor’s home country for them.
FDI aims to establish a long term business relationship with the host economy. The more extended period of the investment cycle is supplemented with a higher amount of investment capital. Given that the nature of investment needs a huge inflow of money, it is generally undertaken by Multinational companies, large corporate organizations, state owner organizations, venture capital organizations.
Channels of Foreign Direct Investment- FDI can be placed in many ways. They are entering into a joint venture with an entity of the host country, through merger or acquisition with a pre-existing entity in the host country or establishing a subsidiary company in a host country.
The major benefit of FDI is that it is undertaken with a long term investment view. This perception of investors helps to grow the host economy in the long term. The prolonged period of investment helps in employment creation and infrastructure of the economy. Additionally, it also helps in making a concrete channel of investment for the investors.
Another major advantage of FDI is that it allows the investors to establish direct control in the business invested. The investors have a say in the management of the business as well as in the establishment of policies and strategies after acquiring certain prescribed equity.
FDI is non- fluctuating in nature, and investment is made to create a stable investment contribution.
The nature of Investment via FDI is such that of creating a business just like in one’s own country. It requires a huge capital investment. Additionally, the investment is typical of a longer period. All these factors make it very difficult to liquidate the investment made under the FDI route.
The only approach to overcome this disadvantage is that the investors follow the ‘going concern’ strategy for their business interests. The assumption is to make the business profitable in operational activities and continue to run the business for an uninterrupted period.
The FDI investment involves more risk and more commitment towards the business. The investors need to have more responsibilities in FDI mode of direct investment.
Another vital tool of foreign investment is FPI. FPI stands for Foreign Portfolio Investment. This type of investment involves investment in the financial assets (Equity or Debt securities) of a business entity located in a foreign land. The financial assets, such as shares and bonds, act as tools of investment and are purchased via a stock exchange. This type of investment possesses opposite characteristics than that in FDI. This mode of investment is seen as less favorable for the host country as it involves short term investment.
Such term investments are seen as tools to make money in a short span of time. These investments do not contribute to the development of business entities and infrastructure in the long term. The foreign investors aim to sell their stake once it starts to yield a favorable return for them. FPI investors often go for investment instruments that are highly liquid in nature.
FPI is short term investments and does not provide control or management rights to the investors.
Also, Read: FDI Norms in Loan Company and Compliance under FEMA.
The FPI can be made with a lower amount of capital in comparison to the FDI. Hence, individual investors or organizations with limited capital can also invest this channel. Additionally, it is easier to sell off investments made via the FPI route due to the high liquidity nature of investments.
FPI also has certain disadvantages in comparison with FDI. The investments made via FPI do not provide control or management rights to the investors. The major disadvantage for the host country is that it is volatile in nature and does not offer a stable contribution to the economy.
The investment via FPI is unstable and unpredictable in nature. The course of such investments changes with change in economic factors of the economy of the host country.
A large corporate Organization ABC limited, a shoe manufacturing company situated in the USA wants to Invest in India. The organization has two options.
Read the following cases to understand the nature of FDI vs. FPI
Case 1: ABC limited buys substantial stake in XYZ limited situated in India and entered into a joint venture with it.
Case 2: The ABC limited enters into a merger with XYZ limited.
Case 3: The ABC limited acquires XYZ in India.
Case 4: The ABC limited establishes a wholly-owned subsidiary in India.
The above 3 cases are an example of FDI
Case 5: The ABC limited buys a 5% share of XYZ limited in the National Stock Exchange of India.
The above case 5 is an example of FPI
The role of the Investor is active in FDI. He takes active participation in the course of business. However, the role of Investors is limited to the capital contributed by investors in FPI.
The investment made via FDI does not enjoy high liquidity, whereas the investment made via FPI are highly liquid and can be quickly sold off.
The fund routed via FDI is engaged for a longer investment cycle. Whereas the fund routed via FPI, have a relatively shorter investment cycle.
It is easy to invest in a foreign country by way of Foreign Portfolio Investment. However, it takes a more sophisticated approach to invest by way of Foreign Direct Investment.
The share of investment in FDI is more than 10 % of equity. However, for FPI, the share of equity should be less than 10 % of equity.
The investors do not have the provision to establish a decision making position the invested entity if they invest via FPI. However, they enjoy the same if they make FDI.
It is easy to enter and exit when making investments in an FPI manner. However, it is difficult to enter and exit when making an investment in an FDI manner.
The investors invest in Physical Assets in FDI and invest in Financial Assets when they invest FPI.
Both the tools of investment have a unique advantage that does not create a debt for the host country. Unlike tools like Extra Commercial borrowing, FPI and FDI are non-debt creating for the invested country.
The type of investment to make among FDI and FPI is depended on multiple factors. The two main factors include
Other factors include economic stability, political stability, currency exchange rates, etc. An intelligent investor deiced the kind of foreign investment she wants to make after evaluating the above factors.
Our recommendation: Types of Foreign Investment in India.