Just like private companies, every country needs money for its growth. While the private firms and individuals turn to banks for it or take some other routes, nations look forward to foreign investors. So, the two most common routes through which the capital comes into any country are FDI or Foreign Direct Investment and FPI or Foreign Portfolio Investment.
Foreign investors take the FDI route when they have a long-term interest in mind. In FDI, an investor usually acquires foreign business assets, establishing ownership or controlling interest in a company. With FDI, foreign companies are directly involved with day-to-day operations in the other country. This means they are not just bringing money with them, but also knowledge, skills and technology.
Under such circumstances, the investor company has at least 10 per cent stake in the company, thus commanding a substantial amount of influence and control over the investee company. For example, Walmart acquiring 77 per cent stake in India’s biggest online retailer, Flipkart, is an FDI investment.
Now, let us explore the ways through which the FDI comes into India. According to the rules prescribed by the Indian government, FDI can either come via automatic route or via government route.
In the automatic route, non-resident or Indian companies do not need prior nod of RBI or the government for FDI. It is for the sectors where the FDI is not restricted and doesn’t need government scrutiny. And the second is the government route. For this, the company will have to file an application through Foreign Investment Facilitation Portal, which facilitates single-window clearance. So, if FDIs get ownership in a company, what do FPIs get? Let us find out.
Unlike the FDI, Foreign Portfolio Investment or FPI is meant for short-term profit booking. Through this route, foreign investors put capital in financial assets, such as stocks and bonds. In other words, FPI involves the purchase of securities that can be easily bought or sold. Such an investment is made with the aim of making short term financial gain and not for obtaining significant control over managerial operations of the enterprise.
In a nutshell, FDIs own controlling stake in a company by investing in its physical assets while FPIs invest only in financial assets. While FDI is a more stable long-term investment, FPI money is usually considered ‘hot money’.
Now, let us understand which one is a better investment route? FDI and FPI are both important sources of funding for most economies. However, FDI is preferred by most countries for attracting foreign investment, since it is much more stable than FPI and signals long-lasting commitment.
FPIs, on the other hand, have a higher degree of volatility because of its tendency to flee at the first signs of trouble in an economy. These massive portfolio flows can exacerbate economic problems during periods of uncertainty.