Finance is one of the key requirements for any organization. It is constantly needed to keep the wheels of the company rolling and ultimately meet the bottom line of generating profits for the shareholders. A company can need finance for various purposes like expansion, diversification, purchase of a new plant and machinery, meeting working capital needs, paying off short-term or long-term liabilities, etc.
One of the many sources of finances for Indian companies is the funds received from foreign sources. This can be from individual investors or companies or organizations located outside India. Such investments by foreign entities are known as FDI and FII. In the last few decades, Indian Companies have seen tremendous growth and the country is also one of the topmost emerging markets in the world. Also, post the initial slump in the Indian markets after the pandemic, the Indian economy has bounced back faster as compared to many other economies. This has further increased the investment opportunities for foreign investors who aim to benefit from this economic boom and earn higher returns as compared to investments in developed countries or other emerging markets.
Given below is the basic meaning of these two main sources of foreign investments, FDI and FII, as well as the key differences between the two.
What is the difference between FDI and FII
Foreign Direct Investment (FDI) and Foreign Institutional Investor (FII) are two forms of foreign investment in Indian companies.
- FDI is an investment by a foreign organization or company in an Indian company
- Investor gains long-term interest and control in the investee company
- Stable form of foreign investment with stringent regulations
- Investee company benefits from finance and technical knowledge of the foreign investor
- FII is an investment by foreign individual or institution in an Indian company
- Eligible FIIs can invest through registered stock exchanges
- Maximum investment limit set by central bank at 24% of paid-up capital
- Known as “hot money” due to easy entry and exit
- Usually short-term investment in the secondary market.
FDI Vs FII
After understanding the basic meaning of the two terms, let us now consider the key differences between FDI and FII.
|Investment in an Indian company by any company or organization located and incorporated in a foreign nation.
|Investment in an Indian stock market by a foreign investor
|Tenure of investment
|The investment by FDI is usually for long-term
|Investment by FII is for the short-term
|Ease of investment
|It is not easy for the investors to enter and exit the investment when it is made through FDI
|Investors can easily enter and exit the market when an investment is made through FII
|Benefits for the investee company
|The investee company receives many benefits other than capital inflow in the form of technical know-how, strategic knowledge and inputs, etc.
|Through an FII investment, the investee company receives only the funds and no additional benefits that are part of the investment through FDI.
|FDI investment targets a specific company.
|FII investment does not target a specific company.
|Impact of investment
|An investment through FDI is beneficial for the entire country as it results in an increase in the GDP of the country.
|Investment through FII results in an increase in the capital of the companies in the country.
|Transfer of control or influence
|FDI investment results in the transfer of control or influence over the investee company.
|FII investment does not provide any control or influence for the investors
Definition of FDI
FDI stands for Foreign Direct Investment and refers to investment made by a foreign company in another country’s company. The purpose of the investment is to gain long-lasting control or influence over the foreign company. FDI is a crucial form of acquiring external finance, especially for countries with limited financial resources. Foreign investors can gain controlling ownership through methods such as merger/acquisition, share purchase, joint venture, or by incorporating a wholly-owned subsidiary.
Definition of FII
FII stands for Foreign Institutional Investor. FIIs are a group of investors who pool their money to invest in foreign assets. FII is a quick way for investors to make money and includes institutions such as banks, mutual funds, insurance companies, and hedge funds. To invest, FII must be registered with the securities exchange board of the target country. FII plays a crucial role in a country’s economy, with market trends influenced by the presence or absence of their investment.
Key Differences Between FDI and FII
Key differences between FDI and FII are:
- FDI involves a direct investment in a company with the intention of acquiring management control or influence, while FII involves investment in securities or assets of a foreign company.
- FDI results in a long-term interest in the investee company, whereas FII investment is usually short-term and focused on the secondary market.
- FDI is subject to stricter regulations compared to FII, which allows for a relatively easy entry and exit from investment.
- FDI brings in not just finance, but also technical knowledge and direct involvement in the day-to-day operations of the foreign company, while FII investment primarily provides financial benefits.
- The maximum permissible investment by an FII in an Indian company is 24% of the paid-up capital, with a 2% lower cut-off, while there is no such limit for FDI.
- FDI is considered a more stable form of foreign investment as compared to FII, which is known as “hot money” due to its quick entry and exit from investments.
Importance of FDI and FII
Foreign Direct Investment (FDI) and Foreign Institutional Investment (FII) are two critical components of international capital flows that have a significant impact on the global economy. Here’s why they are important:
FDI and FII attract foreign capital:
Both FDI and FII provide opportunities for countries to attract foreign capital, which can be used for investment in various sectors, such as infrastructure, manufacturing, and services. This influx of capital fuels economic growth and development.
Technology transfer and knowledge sharing:
FDI involves long-term investments in a host country, which often leads to technology transfer, skill development, and knowledge sharing. This helps the host country improve its technological capabilities and enhance productivity.
Market integration and trade promotion:
FDI and FII contribute to market integration by creating links between economies. They encourage cross-border trade and investment, facilitate the transfer of goods and services, and promote economic cooperation among nations.
Employment generation and poverty reduction:
FDI and FII investments create job opportunities in the host country, leading to employment generation. This not only reduces unemployment but also helps alleviate poverty by increasing incomes and improving living standards.
Financial market stability and liquidity:
FII investments in financial assets contribute to increased liquidity in the stock market, making it more vibrant and efficient. This enhances the stability of financial markets and provides opportunities for diversification of investment portfolios.
FDIs and FIIs are both crucial forms of investment for any Indian company. It also creates an attractive investment opportunity for foreign investors and gives a boost to the growth and development of the company ultimately benefiting the shareholders. However, investment in the form of FDI is preferred by Indian companies as it brings a lot more to the company than simply capital inflow as in the case of FIIs.
FDI investment is not permissible in some of the sectors like gambling, trading in Transferable Development Rights (TDRs), activities or sectors that are prohibited for the private sector, manufacture of cigarettes, cigars, tobacco, and tobacco substitutes, chit funds and Nidhi Company.
When the FII investment hits the maximum limit set by RBI, any further FII investment in such a company is not permitted. Also, the central bank will notify the general public of such an event through a press release
Investment in FDI and FII is directed towards the primary market and secondary market respectively.
The different modes of investment through FDI which gives the investor a controlling interest in the investee company are through merger or acquisition, joint venture, or incorporation of a fully owned subsidiary.