What is the difference between foreign direct investment and foreign portfolio investment? (2024)

FDI investment is a more hands-on and active investment with more control over the management and decision-making processes of the foreign business. Some examples are Toyota plants in the US and Unilever operations in India.In contrast, FPI represents a more indirect form of investment in a foreign market. Unlike FDI, FPI does not grant the investor substantial control or influence over the day-to-day operations of the companies in which they invest. For instance, purchase of share in foreign tech company, or investment in a global technology mutual fund.

Petroleum exploration, extraction,pipeline, and transportation, refinery business ventures of the big oil companies that are multinational and have holding companies at each node of the business continuum. Some go as far downstream as retail outlets. Extractive companies for minerals are an example of huge upstream investment outlays for the longterm

Examples may include pension scheme investments and reinsurance plans. They are term based with maturities known or expected at annual, biannual or multiyear rates

For investors, the benefits can also include the ability to obtain residency and citizenship rights in the host country, which provide them with greater mobility and access to global markets.

Displacement of local businesses: FDI can lead to the displacement of local businesses, particularly in industries where foreign companies have a competitive advantage. This can harm domestic employment and innovation. Governments can mitigate this risk by providing support to local businesses, such as tax incentives and training programs.Economic Shocks: An overreliance on FDI can make a country vulnerable to economic shocks. If foreign investors lose confidence in the country's economy, they may withdraw their investments, leading to job losses and economic instability. Governments should diversify their economies and invest in domestic industries to reduce their dependence on FDI.

FPI is much more accessible to investors than FDI. As FPI simply refers to securities issued in another country, it’s not difficult for retail investors to go on to their investment platform of choice and participate in FPI (even unknowingly in some cases.)It’s a more passive form of investment than FDI and doesn’t come with the same large minimum requirements often required for FDI.Think of how easy it is for the average retail investor to get exposure to foreign securities via ETFs, as an example.Invest in the S&P 500? Nikkei? MSCI World? You have foreign investment exposure.And that easiness extends to both buying and selling those securities, as they’re usually highly liquid, at least compared to FDI.

Increased market volatility: FPIs are known for their quick and often unpredictable movements, leading to increased volatility in the host country's markets. This volatility can make it difficult for domestic companies to raise capital and for investors to make informed investment decisions.Vulnerability to external shocks: FPI flows are sensitive to global economic and political developments, making host countries vulnerable to external shocks. Sudden changes in global investor sentiment or economic conditions can lead to rapid outflows of FPI, potentially destabilizing the host country's financial system.Further, FPI may sometimes engage in speculative investments, driven by short-term gains rather than long-term value creation.

Conclusion: FDI and FPI are both important sources of foreign capital for host countries, but they differ in their nature, objectives, and impacts. FDI can contribute to long-term economic development through job creation, technology transfer, and increased exports. FPI can provide access to foreign capital and diversification of investment opportunities. However, both types of investment also carry potential drawbacks, such as increased market volatility and vulnerability to external shocks. Governments and policymakers need to carefully consider the benefits and risks of each type of investment and implement policies to manage the potential negative impacts.