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Foreign Investment- FDI & FPI

Foreign Investment

By foreign investment, we mean the investment by foreign investors in shares, debentures and bonds of Indian companies. Foreign investment can be classified as under:

  • Foreign Direct Investment (FDI)
  • Foreign Portfolio Investment(FPI)

(A) Foreign Direct Investment (FDI):

It is investment of capital by national of one country in another country by way of setting up production facilities or to purchase share of companies in another country for the purpose of managing such companies.

The main characteristics of FDI are – (i) Control over management and (ii) Long term consideration.

Types of FDI

FDI can be of following three types:

  • Establishing wholly owned companies.
  • Acquisition of shares of existing concerns.
  • Foreign collaboration.

Three Components of FDI

  1. Equity Capital
  2. Re-invested earnings, the investor’s share of earning not distributed as dividends by affiliates; in proportion to its share in the equity (say for instance 50% in a certain joint venture).
  3. Intra-company loans, when the investor borrows funds from the affiliate companies usually without the intention of being asked to pay back.

FDIs are High When

  • Firms have sound financial positions but they consider that other countries have more favourable investment conditions.
  • The exchange rate is “high” in an historical perspective (e.g. after a revaluation), so foreign firms are “cheap” and exports are braked in this case FDI substitutes exports.
  • The trade balance is positive, with exports higher that imports, since capital flows usually compensate the commercial flows.

Need of FDI or Foreign Capital

The need for foreign capital FDI for a developing country like India can arise on account of the following reasons-

  1. Sustaining a high level of investment.
  2. Technical assistance for filling up the technological gap through the following three ways:
  • Provisions of expert services;
  • Training of Indian personnel and
  • Establishment of Educational, research and training institutions in the country.
  1. Exploitations of natural resources.
  2. Development f basic economic infrastructure.
  3. Improvement is the balance of payments position.
  4. Filling the capital gap of private entrepreneurs.

(B) Foreign Portfolio Investment (FPI)

If the investor only subscribes to the shares, bonds, debenture or other securities abroad, it is called portfolio investment.

This type of investment, management and control remain vested with the native companies themselves. Thus, FPI is essentially a financial transaction. Main differences between Foreign Direct Investment (FDI) and Portfolio Investments (FPI) are as follows.

  1. In case of FDI the foreign investor also manages the enterprise whereas in case of FPIs they do not take over management.
  2. FDI is governed by long term consideration whereas FPIs are governed by short term consideration and be easily liquidated in the stock markets.
  3. The impact of FDI is on the goods market while FPI, on the other hand it influences the assets market.

Government Policy towards Foreign Capital

With the advent of freedom, the pressure for economic development in India necessitated a realistic toward foreign capital. The late Prime Minister Pt. Jawaharlal Nehru made a statement in April 1949 giving three important assurances to foreign investors: (i) There would be no discriminate on between Foreign capital and Indian capital; (ii) Provision would be made for remittance of profits or repatriation of capital and (iii) Provision for fair compensation would be made in case of nationalization of industries.

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