In the open economy, hardly there are political barriers barring some socialistic states, to restrict the flow of investment. Popularly, there are two types of foreign investments –portfolio and direct investment.
Foreign portfolio investment and foreign direct investment
Nowadays, investors transfer surplus funds out of country expecting better income in return. If the fund is invested to purchase financial assets, it is termed as foreign portfolio investment.
While, if such fund is invested to begin productive activities to reap profit in long run, is called foreign direct investment. These are the types of foreign investments I’m going to explain.
A. Foreign Direct investment explained
When a company aims to take controlling ownership in a company or business firms belong to another country, the investment made by such company is called foreign direct investment.
In the today’s open economies, the importance of foreign direct investment is much more than ever before.
Really, foreign direct investment is an effective means for investors outside country to purchase a direct business interests in other country to increase the value of theirs investment.
Undoubtedly, nowadays, FDI is heading to be the best way to bring economic integration by fuelling money, skills, expertise, and technologies from surplus to resources rich yet economically parched areas of the world.
Difference between foreign portfolio and direct investment
Foreign portfolio investment is a type of investment by which non-resident investors invest money to purchase financial assets like stocks, bonds, etc. in other countries.
Obviously, intention is to increase or grow the value of theirs capital. FPI is a debt creating investment and investors receive investment income in return after maturity.
On the other hand, foreign direct investment is non-debt investment aimed to acquire or control other business entities in other countries. It may include establishing a subsidiary in another country or acquiring or merging with an existing one
Factors responsible for foreign direct investment or FDI
There are two types of foreign direct investment. One is greenfield investment and other type is acquisition and merger of company.
1.Greenfield investment
Greenfield investment involves the creation of a new company or establishment of facilities abroad. It is a means to achieve the highest degree of control over foreign business entities.
2.Merger and acquisition
Second, acquisitions results in to taking the ownership of existing assets to an owner abroad. And, in a merger, two companies are merged to form one, while in an acquisition one company is taken over by non-resident investors in other countries.
Especially south Asian emerging nation India has faired well in the greenfield investment. But in overall investment, in 2022, it captured 7 th position in the World Investment Report (WIR).
Unlike foreign portfolio investment, foreign direct investment doesn’t bring mere foreign currency but technologies, skills, expertise, etc. in the foreign countries where cheap skilled labour force, abundant resources, and economic growth prospect is available.
Comparatively, in developing or emerging nation’s where doing business ease is excellent, flow of FDI is more.
Necessary things for FDI
Open economic atmosphere, less government regulations, easy availability of factors of production and future growth prospect are some necessitating and facilitating factors to attract foreign direct investment.
In India, except sensitive sectors like atomic energy, FDI cap is increased 100 percent by automatic and government approval routes.
Advantages and disadvantages of foreign direct investment
1.Unequivocally, FDI is instrumental in upgradation of the technology and human capital with better research and development and expertise in the country which doesn’t afford to burn money on R&D.
2.FDI is non-debt investment that always fuels productive activities to generate employment and export surplus. With greater production, country can export its products in the international market.
3.More investment leads to more productive activities and more production results in the greater economic growth and revenue for government exchaquer.
Portfolio investment = debit on financial account
If a country invests funds outside country in the portfolio investment to purchase financial assets, it is recorded debit in the financial account.
Direct investment = capital account
But, if the fund is invested outside of the nation in the form of direct investment, such outflow is called as debit in the capital account.
Meaning and examples of foreign portfolio investment FPI.
Equities, bonds (government and corporate), mutual funds, exchange traded funds, bank certificate of deposits, real estate investment funds, and other physical investment such as land, commodities etc. are well known components of FPI.
When investors from the foreign countries invest theirs fund in the above mentioned financial assets or instruments, is called foreign portfolio investment.
Such investment is termed as riskier because of its tendency to flee out in case of financial difficulties. This is the reason why such investment is labeled as “Hot money”.
Current account surplus and portfolio investment
Notably, countries having current account surplus, always pump surplus fund to buy financial assets of the foreign countries.
For example, China is the country that has huge current account surplus due to export driven economy. Hence, it purchases US bonds with its current account surplus.
Such outflow is called debitor to the financial account, but, when investment income arrives, it is credited to the current account.
Most of the time, current account deficit emerged due to outflow of fund to invest in the promising sectors brings more returns in the future time. So, current account deficit can’t act as the yardstick to judge the health of the economy of nation.
Impacts of portfolio investment
Actually, portfolio investment is a two-edged sward. On the one hand, it makes available easy foreign currency and fund in difficulties, provide better opportunity to invest and helps to develop broader equities market.
On the other hand, in case of financial difficulties, it flees outside, making country more vulnerable. Hence, it always preferred that the foreign direct investment is better option than that of the foreign portfolio investment.
Last words on types of foreign investments,
Unequivocally, foreign investment is like developmental glue that sticks nations together organically. It is a connecting rode between nations having surplus funds and promising resource rich regions.
Being practically, foreign investments is not absolutely free from negative fallouts if it is not used wisely and prudently.
Regional disparity, hire and fire policies to maximize profits, crowding out of the domestic firms, nepotism and chrony capitalism are some of unwanted results countries face in the world.
Despite some negative fallouts, the role of foreign direct investment in bringing greater economic integration, bring out people out of vicious cycle of poverty, and in using efficient resources is matchless.
Regarding portfolio investment
For portfolio investment, it is a better means that acts as a balancing act in terms of investment even if it is for short term purpose.
Because, ultimate goal of portfolio investment is to earn better return in value as investment income for country where it is sourced. At the present, it is playing greater role in the international economy due to more openness.
Q.1. What are the major types of foreign investments?
Ans: Foreign portfolio investment or FPI and foreign direct investment FDI. When investors from the foreign countries invest theirs fund in the financial assets or instruments like stocks, bonds and debentures, is called foreign portfolio investment.
On the other hand, FDI is non-debt investment that always fuels productive activities to generate employment and export surplus. With greater production, country can export its products in the international market.
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