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Foreign Investment

What is the Difference Between FDI and FPI?

Ankita Tiwari
18 Apr, 2023 18 Apr, 2023
FDI and FPI

Investments are essential for the growth of an economy and every country encourages domestic industries to invest in various investment avenues for the economic growth of the country. Investments in a country comprise domestic investments as well as foreign investments. FDI and FPI are the most common routes through which capital inflow takes place in a country abroad. We all know that Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) are the most common forms of foreign investments in India. We know that both contribute to the economic growth[1] and development of the country. We also know that the Indian government along with the security market regulators are actively involved in reducing the regulatory requirements to promote FDI and FPI in India. But do we know the differences between FDI and FPI? Do we know what FDI and FPI exactly are? If not, then we will find out in this blog.

The various basic difference between FDI and FPI is that when a foreign investor invests with the intention to have a long-term interest, it is known as FDI. To make FDI, the investor mainly acquires business assets, obtains ownership or controlling interest in a company and gets involved in the day-to-day business operations. Inflow is not only limited to money but also knowledge, skills and technology. To make FDI in India, an investor has to acquire a minimum of 10% of the total stake in the company. Acquiring at least 10% of the stake allows the investor to get a substantial amount of influence and control over the investee company. Whereas talking of FPI, is a short-term profit-making investment vehicle where foreign investors invest capital in financial assets like stocks and bonds. It involves the purchase of financial securities which can be easily bought or sold. FPIs yield short-term financial gain and it does not result in control over managerial operations in the investee company. Unlike FDI, FPIs have to be less than 10% of the total stake in a company. Once it touches 10% of the total stake in a company, it will be considered FDI.  In simple words, it can be said that FDI acquires a controlling stake in a company by investing in physical assets to obtain a more long-term investment. Whereas FPI is invested in the financial assets of a company and is usually considered ‘hot money’.

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Major Differences between FDI and FPI

FeatureFDIFPI
DefinitionFDI means investment by a foreign entity or individual in a company or business located in another country.FPI means investment by a foreign entity into the securities such as stocks, bonds, and mutual funds of another country.
Type of InvestmentDirect investmentIndirect investment
TermFDI is a long-term investment in business operations.FPI is a short-term investment in foreign securities.
Asset InvolvedPhysical assets of businesses in the foreign country.Financial securities and assets in the foreign country.
ControlIn FDI, the acquisition of a controlling stake in a foreign company takes place which gives the investor significant influence over its operations and management.In FPI, the purchase of minority stakes in foreign companies takes place which gives little to no control over the operations and management of the company.
IntentionThe intention is to establish a long-term presence in the foreign market.The intention is to generate a financial return in the form of stock price appreciation or dividends.
RiskFDI is a higher-risk investment as the risk associated with operating in a foreign market together is shifted on the investor. In addition, the political and economic stability of the country also affects the risk involved.FPI is a lower-risk investment when compared to FDI as the director does directly get involved in the operations of a foreign company and is only subjected to market fluctuations.
ReturnFDI yields higher returns as the investor manages the investee company and benefits from the economies of scale and scope.FPI returns mainly depend upon the performance of the securities in which the foreign investor has invested and is generally lower than FDI returns.
Role of InvestorInvestors are actively involved.Investors are passively involved.
ExitExit is difficult and time-consuming as the investor needs to find a buyer and negotiate an exit with the government.Exit is faster and easier in FPIs. The investor is simply required to sell their securities on the open market.
Management of ProjectsEffective and Efficient management of the project.Management of the project is less efficient and comparatively low.
RegulationFDI is subject to more regulation as governments may want to limit foreign ownership to protect domestic industries.FPI has fewer regulations than FDI as governments are more open to foreign investments in the securities market.
LiquidityFDIs are difficult to liquidate and are held for a longer duration.FPIs are widely traded high-liquidity assets.
VolatilityStableHighly volatile
TaxationTax incentives are available to the investor for investing in FDIs.FPI is either subjected to higher taxes or withholding taxes.
TransparencyFDIs are more transparent as the investor has to disclose information relating to the investment in the host country.FPIs are less transparent as they may or may not require disclosure of information.
Impact on the host countryFDI has the potential to increase productivity, create jobs, lead to an inflow of technology and knowledge and lead to infrastructural development in the host country.FPI may or may not have a direct impact on the host country’s economy.
BenefitsImproves the balance of payments through exports and repatriated profits and reduced the need for foreign borrowing.Provides capital to businesses and entrepreneurs and contributes to the local economy.
De-meritsIt leads to a loss of control over key industries and resources.It exploits natural resources and labor in the host country.

The recent trend of FDI and FPI in India

The Indian Government has taken several steps to relax the FDI norms across various sectors such as defence, PSU, oil refineries, power exchanges, stock exchanges, etc. In the financial year 2021-22, India has attracted the highest-ever FDI inflows including FDI equity inflows in service sectors. In addition to this, the UNCTAD’s World Investment Report, 2022 states that India will be the 7th largest beneficiary of FDI in the list of top 20 countries.

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When it comes to FPI, it is a new form of investment vehicle which have been operating since 2019 subject to certain exceptions which came into force in 2021. So it is too early to analyze the performance of FPIs in India.

Conclusion

FDI, as well as FPI, are common ways to invest in a foreign country. Both are important sources of fundraising sources for most countries. FDI is usually preferred for attracting foreign investment as it is stable when compared to FPI and also ensures a long-term commitment. FPIs on the other hand are highly volatile and uncertain. In FDI, high-net-worth individuals or institutions can invest whereas in FPI only a retail investor can invest. However, both have a positive impact on the inflow of funds in the country and improve the position of the balance of payments.

Also Read:
CFDI vs. FPI – Read the Exhaustive Analysis of Foreign Investment
Analysis on Types of Foreign Investment in India: FPI, FDI and FI

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