FDI, FPI, and FII are 3 terms that are much talked about with respect to the foreign investment arena. They may seem to be similar on the face of it but are fundamentally different. While the internet is filled with articles explaining the difference between FDI and FPI, decoding the ‘what’ and ‘whereabouts’ of FPI is tricky. Because the information available lacks clarity.
So, we took up this endeavour of investigating into the matter and finding out what is what. Here’s our humble attempt in doing so. We have tried to put our words in as simple a manner as we could.
This article covers:
Overview of a foreign investment
Foreign money helps to bridge the gap in the funding requirements of an economy or a company. There are various forms of foreign investments of which FDI, FPI, and FII are popular. Though these terms are similar in many ways, they are fundamentally different. You cannot use the terms interchangeably, and certainly not swap FII for FPI and vice versa. Because FII has been subsumed with FPI. More on this later in the article.
Need for a foreign investment
You may have probably heard a thousand times that finance is the lifeblood of a business. Without money, businesses come to a standstill and the owners have to pack their bags and leave. And so small business owners bring in the capital either from their savings, loan, or revenue earned over time.
However, arranging capital for big corporations is not as simple. Many can’t meet their capital requirements via internal sources alone. Willingness and motivation don’t equal finance. And if the plan is to make it big, the economy and businesses operating within its borders need access to a big bundle of money. Enters foreign investment. Before looking at the types of foreign investments, let us see whatever happened to FII.
FII was subsumed by FPI
FII stands for foreign institutional investment. These are institutions such as mutual funds, pension funds, and investment banks that invest in the assets of Indian companies. Before 2002, foreign institutions enjoyed a relatively simpler process to invest in domestic companies. Foreign individual investors were restricted. They were mandated to have a sub-account (SA) with an FII to invest in India. This limited the flow of foreign investment in the economy.
To address this issue, QFI was introduced in 2002. Qualified Foreign Investors or QFI refers to a foreign individual, resident, group or association belonging to the approved countries that can make foreign investment in India. Unlike before, Qualified Foreign Investors would invest in India without having a SA with the FII. However, they were still required to have a demat and a trade account with a depositor. Besides, they were also required to take prior approval from a depository if their total investment breached 8% of the company’s equity paid-up capital. But the change did widen the scope of foreign investment in India.
However, it all changed in 2014. QFIs were merged with Foreign Portfolio Investors (FPI) in 2014. And so were FII. This was done to simplify and attract foreign portfolio investments in India. So, by virtue of the FPI Regulations 2014, sub-accounts, FII, and QFI are now merged with Foreign Portfolio Investors.
Categories of FPI
FPI is divided into 3 categories based on the investor’s risk profile:
- Category I: government and related foreign investors
- Category II: persons, pension funds, regulated broad-based funds (BBF), university funds, and unregulated BBFs with regulated investment managers registered as an FPI
- Category III: those who don’t fall under the above categories
By default, the QFIs that existed back in 2014 were included under Category III of FPI. But, they could also be included under the other 2 categories if they met the respective eligibility. Note that FPI can only invest in up to 10% of the total issued capital of an Indian company.
Now that the FII part is clear, let us look at FDI vs FPI.
Foreign direct investment (FDI)
FDI is an abbreviation for Foreign Direct Investment. It is a direct method of investing in a foreign country. Here, a foreign investor, whether an institution or an individual, invest directly in the economy and gain a controlling interest in the recipient business.
Foreign portfolio investment (FPI)
FPI or Foreign Portfolio Investment, on the other hand, means investment made by a foreign investor in the financial instruments or assets of a domestic company. These may be stocks and bonds.
Understanding FDI and FPI with an example
George, a US national, runs a multi-million dollar business in America and is interested in investing in India. He has two ways—FDI and FPI—to do it.
If he wants to take the FDI route, he must:
- Establish a wholly-owned subsidiary of his US business in India OR
- Acquire an ownership interest in an Indian company (where he buys a huge stake in a domestic company that interests him) OR
- Participate in a joint venture
- Enter into a merger or acquisition deal
In any way George chooses, he will gain a controlling interest in the business. Meaning, he has a say in the operations of the business in India. But, if George is not interested in having a controlling interest in an Indian company and he merely wants to make a profit, he can take the FPI route. Here, he simply purchases equity shares of an Indian company.
Note that FDI is usually done by individuals or businesses that can afford to invest directly in the host country. Whereas, retail investors like you and me, are most likely to take the FPI route. But FDI and FPI are different in a few other ways too, which are worth noting.
FDI vs FPI
|Points of differences||FDI||FPI|
|Degree of control in the management of the business||High||None|
|Investment horizon||Long-term||Usually short-term|
|Ease of entry||Difficult||Relatively easier|
|Ease of exit||Investment avenue is quite illiquid, so exiting is not easy||Investment avenue is liquid, so exiting is easy|
|Form of investment||Funds, R&D, technology, strategies, know-how, and technical knowledge||Only funds|
|Impact||Can increase GDP||Only increases the country’s capital|
|Target||Specific company||Financial markets|
FDI or FPI, which is better for the economy?
Both FDI and FPI have pros and cons. As mentioned, foreign capital can bridge the gap in funding requirements of an economy. In turn, this contributes to the growth of the target business and creates employment opportunities, which ultimately propels economic growth.
But most countries prefer FDI over foreign portfolio investment for the following reasons:
- Investors making an FDI intend to gain a controlling power in the business’ day-to-day management and strategic plans. They look for long-term gain and so have a long-term investment horizon. This makes FDI a stable and reliable source of foreign investment.
- FPI, on the other hand, is relatively volatile. This is because investors taking the FPI route only intend to make profits on investing in stocks of domestic companies or bonds floated by the government. They don’t intend to stay long. Also, these instruments are liquid, which makes it easier for them to exit. So, if the FPI investors sense some kind of danger or turmoil in the target business or the broader economy it operates in, they most likely liquidate their investments. Following this, a huge chunk of funds goes out of the economy leading it to sink.
Naturally, economies prefer FDIs over Foreign portfolio investments. However, if the economy and the business is stable, FPIs may stay for long and contribute to economic growth.
What do foreign investors consider before making an FDI or FPI?
Investing in a foreign company is not like taking a walk in the park. It is risky. Therefore, foreign investors consider many factors before parking their funds overseas. These include:
- Economic factors such as GDP growth, inflation, infrastructure and foreign exchange controls
- Governmental factors such as policymaker’s business philosophy and political stability
- Incentives for them relating to tax and property rights
- Business factors including opportunities and local competition
More on foreign direct investment
According to OECD, a foreign investment qualifies to be an FDI, when an overseas investor invests 10% or more in an India company. FDIs are governed by the FDI policy, which is regulated by the Foreign Exchange Management Act, 2000.
Types of FDI
FDI is of 2 types: automatic route and government route.
1. Automatic route of FDI: here, the investor need not seek RBI’s prior approval to invest in a domestic company. They can inform RBI after making an FDI. Further, this route of foreign investment allows 100% investment in many sectors expect some, which are discussed later
2. Government route: here, the investor is mandated to get prior approval from the concerned Departments or Ministries via a Foreign Investment Facilitation Portal (FIFB). This portal is administered by the Ministry of Commerce and Industry, Department of Industrial Policy & Promotion (DIPP), and Government of India
Sector-wise details of FDI investments
As per the FDI policy, FDIs are not allowed in all the sectors of the economy. And not all of the non-prohibited sectors permit 100% investment via the automatic route. Here are the details:
Sectors that allow 100% FDI via automatic route:
- Agriculture & animal husbandry
- Air-transport services
- Broadcast Content Services
- Cash and carry wholesale trading
- Coal and Lignite
Sectors that allow up to 100% automatic route
- Insurance: up to 49%
- Pension: 49%
- Power exchanges: 49%
- Petroleum Refining (by PSUs): 49%
- Medical Devices: up to 100%
- Infrastructure company in the securities market: 49%
Sectors that allow up to 100% Foreign Direct Investment under the government route
- Banking and public sector: 20%
- Broadcasting content services: 49%
- Core investment company: 100%
- Food products retail trading: 100%
- Print Media: 26%
- Satellite: 100%
Sectors that allow up to 100% FDI under the automatic and government routes
- Private sector banking: up to 49% via automatic route + above 49% via government route
- Biotechnology (Brownfield): up to 74% via automatic route + above 74% government route
- Defence: up to 49% via automatic route + above 49% via government
Read the entire list of each category on the Make In India website.
List of prohibited sectors for FDI
- Atomic energy generation and railway operations sectors except the permitted activities listed in the consolidated FDI policy
- Manufacturing of tobacco or tobacco substitutes including cigars, cigarettes, and cheroots
- Lotteries in any form such as online, government, and private
- Chit funds
- Agricultural and plantation activities except for fisheries, horticulture, tea plantations, animal husbandry, and so on
- Housing and real estate except for projects, townships, commercial projects, roads, and bridges
- Gambling or betting businesses including casinos
- Trading in Transferable Development Rights (TDR)
- Nidhi Company
Recent amendments in the FDI policy
In April 2020, the government made certain amendments to the FDI policy. Before the change was announced, only companies or individuals belonging to Pakistan and Bangladesh were only allowed to invest in India via the government route. Other foreign investors could invest in the country via the automatic route subject to some conditions.
But the government revised the FDI policy for all neighbouring countries this year. This was to protect domestic companies from opportunistic takeovers and acquisitions due to the coronavirus (COVID-19) pandemic. Unable to operate seamlessly, cash-strapped businesses would naturally look for financial resources including foreign investments. But how exactly does this revision in the FDP policy protect Indian businesses? To understand this, read the impact of the revised FDI policy on Indian economy here.
Impact of FDI on the environment
It is true that foreign direct investment fuels economic growth. That is why governments across the globe try to attract investors by revising their foreign investment policies. And this is especially true for developing economies.
But FDI has certain downsides too. Cutting to the core, its impact is mostly felt on the host country’s extracting industry and environment. In fact, both FDI and environment impact each other. Read the impact of FDI on the environment and vice versa to learn more.
We hope to have elaborated FDI vs FPI vs FII in a simple manner through this article. Also, we hope that you have a better understanding of how FDI and FPI impact the host country and its environment. Let us know your thoughts in the comments section below. Also, we are more than happy to cover a topic suggested by you.