Most countries in the world require some additional forms of financing to keep their economy going. Some forms of investment external to the country are foreign investment methods. Foreign investment involves individuals or businesses of a country investing their money in the assets of a different country. Two forms of foreign investment are Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI).
Investment through the purchase of physical assets is FDI and investment through the purchase of financial assets is FPI. Both methods help improve the economic development of host countries.
This article explores the investment methods further and explains the difference between the two methods.
FDI vs FPI
FDI or Foreign direct investment involves investing in a foreign country through physical assets. A company may purchase a business, start a business or join one in a foreign country. FDI is a form of long-term investment. The investor has an active involvement in the workings and decision-making of the company in the host country. Since a foreign company is setting up their business in the host country and using its resources, the foreign company will have to follow many regulations of the host company. FDI provides many benefits for the host country like an increase in employment, profits, technological access, etc. It also raises certain concerns for the host country because it leaves them with no control, dependence on foreign investment, and environmental issues.
FPI or Foreign Portfolio Investment involves investing in the financial assets of a foreign country. The investor may purchase stocks, bonds, or other related assets. FPI is a form of short-term investment. The assets in FPI are easily liquefiable. The investor can buy and sell stocks readily. FPI investors are subject to fewer regulations from the host country. FPI provides certain benefits like diversity, liquidity, and currency hedging. It also brings certain disadvantages like volatility, dependence on foreign investment, capital flight, etc.
Difference Between FDI and FPI in Tabular Form
| Parameters of Comparison | FDI | FPI |
| Meaning | Purchasing a business in a foreign country | Purchasing assets like stocks in a foreign country |
| Full form | Foreign Direct Investment | Foreign Portfolio Investment |
| Period | Long term investment | Short term investment |
| Control | The buyer gains control over the business in the foreign country | No control over the foreign business |
| Risk | Risks in the host country will affect your business | Market risks |
| Owner’s involvement | The owner is actively involved in the operations and decision-making of the business | The asset owner has no involvement in the country’s operations |
| Exiting | Exiting from an FDI commitment is difficult and time-consuming | It is simple and easy to exit an FPI. Investors can simply sell their stocks and assets. |
| Regulations | Compared to FPI, FDI has more regulations to follow | Fewer regulations about investing |
| Investor role | Active | Passive |
| Assets invested in | Physical assets | Financial assets |
| Result | Transfer of funds, technology, and resources | Capital inflows |
What is FDI?
When a business invests by purchasing the businesses of another country, it is FDI (Foreign Direct Investment). Companies can purchase a significant part of a business in a different country, thus becoming the primary holder. Another method of FDI is to build a company or facilities in a new country. Foreign direct investment is beneficial to the host country because they help increase employment rates, and brings in new technology and capital.
Establishing an FDI
Foreign direct investment can happen in many ways. Some are as follows,
- Opening new offices or branches in a different country
- Purchasing a majority of the business share in a different country
- Acquiring a business or joining a business venture in a foreign country
- Building and starting a business in a foreign country
Pros of FDI
More Capital
Foreign investors bring in capital when they purchase products in the host country. The host country gains access to the capital. They can use it to fund their expansion and growth.
Increase in Employment Opportunities
FDI involves starting or buying a new company in a foreign country. In both cases, new job opportunities arise. A new company will need employees at all levels. It also opens employment opportunities for supporting industries. External suppliers and workers also receive job contracts. Hence, FDI helps increase employment rates in the host country.
Newer Technology
Through FDI, companies can bring new technologies and management practices to the host country. Countries vary in their level of technological advancements. Some countries may follow researched and effective managerial practices, while others may still be following an outdated and less efficient method. When companies from more developed countries invest in a foreign country, they bring with them all these technology and effective management practices.
In addition, companies may invest in countries with advanced technology to gain access to those technological benefits. If the required technology and resources are not available in one's country, one can begin a business in a country in which the resources are available.
Increase in Exports
When foreign companies start their business in a new country, they increase the host country’s export rates. Sometimes companies may choose to start a business in a different company because it is cost-effective. After they finish making their products, they will export them to different countries.
Economic Growth
Through FDI, citizens in host countries receive employment opportunities, wages, and demand for their goods and services. They help bring up the income rate of the citizens. All these benefits help improve the citizen’s standard of living.
Improvement in the balance of payments
FDI helps bring in more income to the host country. They increase the host country’s profits and export rates. Therefore, it reduces the host country’s need to borrow money from foreign countries. Hence, FDI improves the host country’s balance of payments.
Cons of FDI
No Control
Foreign companies usually only care about their profits and interest. They do not care about the situation of the host country. Foreign countries may take over key industries and resources of the host country. This situation can lead to the host country having less control over their resources.
Increase Dependence
FDI brings many benefits to the host country. It increases employment, profits, and exports. These benefits can lead the host country to become dependent on foreign companies. This situation can become damaging in the event of a global economic crisis.
Displacement Issues For Domestic Companies
When foreign companies take over the host country's production and services, it can harm the host country's domestic firms. The firms will lose customers and businesses. They may have to close their business, which will lead to job losses. When the number of domestic firms reduces, it will result in less competition. Since competition is what encourages firms to keep improving, a reduction in competition will be damaging.
Environmental Issues
Different countries have different environmental laws. Foreign companies may not comply with the host country's environmental laws. The non-compliance may be because of unawareness about the laws or simply disinterest in complying with the laws. Companies that focus on their profits above all will not care about environmental issues. When foreign countries act without regard for the environment, they are damaging the host country’s environmental situation.
Cultural Issues
Every country has a unique culture. They have their values, lifestyles, and business rules. Through FDI, foreign companies may bring their culture and values to the host country. The cultural values of both countries may be incompatible. In addition, over time the culture of the host country may get affected.
Speculative Capital
Economic situations can lead to a reduction in FDI. This situation can result in a rise in inflation, economic destabilisation of the host country, currency appreciation, etc.
What is FPI?
When foreign companies invest in the financial assets of a different country, it is FPI (Foreign Portfolio Investment). Companies may invest in stocks, real estate, and bonds of other countries. Those engaging in FPI are institutional investors or individuals. FPI gives quick returns to the investor. The assets in FPI are highly liquefiable, the investors can sell them at any time.
Reasons for FPI
- Capital appreciation
- Investment diversification
- Income generation
Pros of FPI
Diversification
A crucial step in keeping yourself safe during investing is diversification. Buying a variety of assets in different markets instead of focusing all your money in one place is necessary for protecting yourself against economic uncertainties. Through FPI, companies have access to a large variety of markets and investment opportunities.
Newer And Varied Markets
FPI gives companies opportunities to invest in newer and varied markets. If their country does not have an investment opportunity as per the company’s wishes, a different country may provide the opportunity.
Increase in Returns
Not all countries have the same rate of economic growth. When a company only invests in their domestic country, all its profits and losses will be dependent on the country's economic state. Investing in a country with great economic growth can help companies to increase their returns.
Currency Hedging
The global economic situation is ever-changing. The currency exchange rates also keep changing. All these factors can affect the company’s returns. FPI helps hedge against currency risks.
Liquidity
Portfolio investments have high liquidity. Companies can buy and sell stocks anytime they wish. FPI provides the opportunity to liquefiable assets to companies.
Improves The Economic State Of The Host Country
Investment by foreign companies helps increase the revenue and capital of the host company’s businesses. When local companies thrive, it positively affects the economy. Hence, it helps improve the economic state of the host country.
Cons of FPI
Possibility of Exploitation
FPI can exploit the natural resources and labour of the host country. This exploitation can in turn negatively affect the environmental conditions of the host country.
Short-Term Gains
FPI only provides short-term gains to the host country. In the long term, it does not provide any benefit to the host.
Volatility
If the market situation of the host country experiences any negative situations, foreign investors will sell their assets and withdraw from the market. This action can cause fluctuations in the market situation of the host country.
Dependence on Foreign Capital
If a country is keeping its economy afloat using foreign investments, it becomes dependent and vulnerable to foreign investments. If anything happens to the global economy, it can affect the FPI rates. This situation can put the host country at risk.
Effect of Foreign Currency
FPI affects the currency exchange rates. Fluctuations in currency can affect the export and import rates in the host country. The cost of exporting goods and services increases and the cost of importing decreases. When imported goods and services become cheaper than domestic products, it can affect the industries and employment in the host.
Capital Flight
Political factors, and natural, and economic situations affect the markets. In the event of market fluctuations occur foreign investors withdraw their investments. This withdrawal of assets can lead to a capital shortage in the host country.
Main Differences between FDI and FPI (in Points)
- The full form of FDI is foreign direct investment and FPI is foreign portfolio investment.
- FDI involves investment in a foreign country by purchasing physical assets like businesses, joining a business or starting a company. FPI involves purchasing financial assets like stocks and bonds in a foreign country.
- In FDI, a company begins business in a foreign country and hence has control over the business. In FPI, the company or individual invests in shares and bonds of a foreign company. The investor has no control over the workings of the host company.
- In the case of FDI, all and any risks in the host country will affect the business and hence the investment. Market fluctuations affect the investments in FPI.
- Since the company owns the business in a different country in FDI, exiting is hard. They will have to find someone to sell the business to which is a difficult procedure. Exiting from FPI is simple and easy as the assets are all readily liquefiable.
- In FDI, you will be starting a business in a new country and using its resources and workers. Hence, the method has to follow many regulations from the host country. In FPI, you are only investing in assets. Therefore, there are fewer regulations to follow.
Conclusion
In short, FDI and FPI are methods of foreign investment. FDI involves investing in a foreign country by purchasing or starting businesses. FPI involves investment through forms of stocks, bonds, etc. Both FDI and FPI are useful for a country's economic development. They help bring in additional revenue and improve the economic situation.
References
- https://testbook.com/key-differences/difference-between-fdi-and-fpi
- https://www.5paisa.com/blog/fdi-vs-fpi
