Flows from Foreign Direct Investment- FDI and Foreign Portfolio Investments-FPI

Foreign Direct Investments (FDI) Meaning

Foreign Direct Investment (FDI) represents a significant financial commitment by a foreign entity to establish a long-term business presence in another country. FDI entails acquiring a substantial ownership stake, typically at least 10% of shares, in a foreign company. This level of ownership grants the investor considerable influence over the company's management and strategic decisions.

 

There are several forms through which FDI can be executed:

• Mergers and Acquisitions (M&A): Involves purchasing an existing company in the foreign country or merging with it, thereby gaining control over its operations and assets.

• Greenfield Investments: This involves establishing a completely new business operation or subsidiary in the foreign country, often from the ground up. It may include constructing new facilities, hiring local staff, and developing infrastructure.

• Joint Ventures: FDI can also take the form of joint ventures, where a foreign investor collaborates with a local company to establish a new entity. This allows for sharing resources, risks, and expertise in penetrating the foreign market.

Each form of FDI has its advantages and challenges, depending on factors such as market conditions, regulatory environment, and strategic objectives of the investor.

 

What is Foreign Portfolio Investments (FPI)?

Foreign Portfolio Investment (FPI) involves foreign investors purchasing securities like stocks, bonds, and other financial assets in foreign markets. Unlike Foreign Direct Investment (FDI), FPI does not grant control over the company and is typically a short-term strategy driven by market trends. It includes equity and debt investments, as well as instruments like mutual funds and exchange-traded funds. Now, let's delve into the differences between FDI and FPI.

Latest Trends in Foreign Direct Investment(FDI)

In recent years, India has experienced a surge in Foreign Direct Investment (FDI) due to favorable government policies. Initiatives like 'Make in India' and relaxed FDI norms in sectors like defense and oil refineries have attracted significant investment. India ranked 7th among top FDI host economies in 2021, receiving a record $84.84 billion, up from $60.22 billion in 2020. Factors driving this growth include India's growing GDP, skilled workforce, strategic location, and favorable investment climate.

Latest Trends in Foreign Portfolio Investment (FPI)

Foreign portfolio investment (FPI) in India has seen significant fluctuations in recent years. In 2021, FPI inflows reached a record high of $36.5 billion. However, by March 8, 2023, FPI outflows are projected to exceed double the inflows, reaching $64.3 billion.

To mitigate this volatility, the Indian government has implemented several measures. These include relaxing FDI rules, introducing tax reforms, and actively promoting India as an attractive investment destination.

 

International Trade, Exchange Rate, And Trade Deficit

International trade reflects a nation's total commercial activities with other countries globally. The balance of payments, divided into the current account and the capital account, records a country's transactions with the rest of the world.

• The current account includes details of revenue transactions, such as imports and exports of goods and services.

• The capital account encompasses capital flows like FDI, FII, loans, and grants.

A current account shortfall occurs when imports exceed exports, while an excess results from higher exports than imports. Similarly, a capital account surplus occurs when inflows exceed outflows, and a deficit arises when outflows surpass inflows. Surpluses and deficits in both accounts collectively determine a country's payment balance.

 

Persistent current account deficits may necessitate additional capital or reduction in foreign currency reserves, posing risks such as currency depreciation and loss of market confidence.

 

Currencies, traded in global markets like commodities, have exchange rates representing their value relative to other currencies. For example, an exchange rate of $/Rs. 65 implies one dollar equals 65 Indian Rupees. Currency values fluctuate based on the relative economic strength of countries, impacting exchange rates and trade dynamics.

Unemployment rate

The unemployment rate reflects the percentage of the country's willing-to-work population that is currently unemployed. During economic downturns, the unemployment rate tends to rise, while during periods of expansion, it decreases as more jobs become available.

 

Higher employment levels lead to increased income, empowering people to spend more, thereby stimulating potential economic growth. Conversely, in times of economic hardship and high unemployment rates, consumer spending and overall economic growth are constrained.

Frequently Asked Questions

1. What is the key difference between foreign investment and foreign direct investment?

Foreign Direct Investment (FDI) and Foreign Portfolio Investments (FPI) differ in control, investment duration, risk, and economic impact. FDI involves direct investment with control and a long-term outlook, while FPI entails investing in financial assets without control, typically for the short to medium term.

2. Is FPI less risky than FDI?

Foreign Portfolio Investment FPI generally exhibits higher liquidity and lower risk compared to Foreign Direct Investment (FDI) due to the lack of direct control over the securities or businesses involved.

3. What is the relationship between FPI and FDI?

Foreign Direct Investment (FDI) involves foreign investors directly investing in another nation’s productive assets, while Foreign Portfolio Investment FPI entails investing in financial assets like stocks and bonds of entities in a different country.

4. What are the 3 types of International direct investment?

International direct investments come in three main types: horizontal, vertical, and conglomerate. Horizontal FDI involves replicating domestic business operations in a foreign location.

5. Who regulates FDI and FPI in India?

SEBI regulates the Foreign Portfolio Investor (FPI) regime in India, consolidating previous modes like Foreign Institutional Investor (FII) and Qualified Foreign Investor (QFI) to streamline foreign investment into the country.