Every economy needs constant capital intake to ensure effective growth. However, they might fall short of generating a sufficient amount of capital on a regular basis. Thus, Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) become key instruments to fund a part of the economic growth.
FDI indicates the investment of foreign investors to own a controlling stake in companies of other countries, whereas, the FPI implies an investment of foreign investors in the financial instruments such as stocks, bonds and mutual funds, etc. Both these instruments share some similarities as well as differences.
Differences between FDI and FPI
An investor must note the differences between the FDI and FPI:
Investment Horizon – The investors of FDI tend to take a long period of time, approximately ranging from 6 months to a couple of years, to proceed from the planning stage to the project implementation stage.
On the other hand, the investment in foreign portfolios comparatively takes a shorter investment horizon.
Liquidity – The extent of liquidation is higher in FPIs than in FDIs. Usually, FDI takes a longer duration and thus it is not possible to liquidate assets under this investment. Followingly, the low liquidity leads to a decline in buying power of an investor and might increase the risk.
But the FPIs are highly liquid in nature and are widely traded. The investors must analyse properly for FDI while FPIs do not require such deep observation or study.
Degree of control – Both the FDI and FPI significantly vary in terms of the degree of control that any foreign investor can exercise. Generally, FDIs hold a higher degree of control and such controlling positions are taken up through joint ventures with domestic firms.
On the other hand, FPIs do not take up dominant control positions in the investments and thus have a lesser degree of control.
Volatility – The nature of liquidity not only determines the amount of trade but also the volatility involved. The volatility associated with FPI is greater than that of FDI. This is because FDI needs a longer investment horizon and narrows down the scope of liquidity and further reduces risks in the investment.
On the other hand, the FPI can be traded from time to time and leads to heavy liquidity. As a result, this causes heavy volatility as traders enter and exit the market swiftly.
Despite these differences, both the sources of overseas investments play an instrumental role in capital creation to ensure a steady economic growth in the country.