Fdi Vs Fii

Foreign direct investment (FDI) flows into the primary market whereas foreign institutional investment (FII) flows into the secondary market, that is, into the stock market. All other differences flow from this primary difference. FDI is perceived to be more beneficial because it increases production, brings in more and better products and services besides increasing the employment opportunities and revenue for the Government by way of taxes. FII, on the other hand, is perceived to be inferior to FDI because it only widens and deepens the stock exchanges and provides a better price discovery process for the scrips. Besides, FII is a fair-weather friend and can desert the nation which is what is happening in India right now, thereby puling down not only our share prices but also wrecking havoc with the Indian rupee because when FIIs sell in a big way and leave India they take back the dollars they had brought in.

Indian Rupee rise or fall is primarily due to demand and supply of this currency in the market. Liberalization has essentially allowed investments by foreign companies (in the form of FDI) and foreign investor (in the form of FII). Initially, we wanted inflow of dollars as our Balance of Payment (BOP) was not in good shape. However, over a period of time, we have managed to attract foreign fund inflow in match to that of China. In recent times, Indian economy is facing the problem of surplus for the first time. Then, we should be happy about it, as we have successfully solved the problem of BOP. But unfortunately, its not so simple, as rise in foreign fund inflow (in the form of FII or FDI) will impact our currency valuation, which further affects Indian economy as a whole, and the job of RBI is to take care of the turmoil and keep balance in the system. So we have gone though a couple of issues here which would help us in analyzing this issue in a better manner. It is seen that the following would be the issues primarily that would be getting affected:  FDI

Vs FII

It is most important to understand distinction between these two. When FDI comes in the country then it is essentially in the form of long term investment which will not only bring funds but create job opportunity too. Whereas when FII brings fund in the country, it is essentially for short term and primarily invested in capital markets but will not lead to any other economic activity like job creation, etc. It is clear from this as to which mode of fund flow is intended and why. However, some believe capital markets are indications of how good or well the development is happening in the country. 

Fluctuation in Rupee due investment in Dollar (FII or FDI)

It is seen that for every dollar invested, the equivalent amount of rupee (either Rs. 45 or Rs. 40) is pumped in the system. As a result of this, increase in fund flow in India results in rupee appreciation. This appreciation in rupee can be curtailed by RBI by using a method called as MSS (Market Stabilization Scheme) which helps in sucking-up excess liquidity from the system. 

Impact on Import due to Fluctuation in Rupee

It is seen that as rupee appreciates, the imports become cheaper, which in turn leads to increase in imports, and vice-versa is also true. Some say this is good as we will get less burden of crude oil bill, especially when experts predict crude oil price might reach $100 a barrel.

Infact, that is one of the reasons that in recent times Energy Companies (Power Sector-Imports Coal and Oil Marketing Companies-Imports Crude Oil) stocks have risen in capital markets. 

Impact on Export due to Fluctuation in Rupee

It is seen that as rupee appreciates, the exports drop due to relative cost of Dollar viz-a-viz Rupee decreasing. However, this can be reduced by a concept of Currency Hedging. 

Impact on Inflation due to Fluctuation in Rupee

Inflation in simple terms means excess of liquidity. Often it is seen that when inflation is high, the cost of goods start increasing, and vice versa is also true. When there is excess dollar in market, it increases the rupee circulation in the system which in turn increase inflation. However, this can be curtailed by RBI as mentioned above. 

Impact on Interest Rate due to Fluctuation in Inflation

It is seen that when inflation increases, interest rate increases, and vice-versa is also true. This is because if interest rate is high, people would like to save from their surplus income due to high return, and would not borrow as well because of high cost of fund. Impact of all this on Indian Economy Indian economy is currently undergoing a transition phase that is from a 4-6% GDP growth in late nineties and early millennium to 8-10% GDP since last three years. In management, we always say "process of change is always painful". The RBI is doing a good job of maintaining balance in the system but there is a growing concern over the quality of funds coming into the country. As discussed earlier, whether it is FII or Hedge Fund investing through P-Notes, it is more important to see that an inclusive growth happens in the economy.

It is India’s constant endeavour to attract foreign capital, either by allowing foreign entities to invest here, or by permitting Indian companies to raise capital from overseas markets. Since liberalisation in 1991, the government has been opening the Indian marketplace for investment in a calibrated manner. Recently, the government allowed Foreign Direct Investment (FDI) in integrated township projects. It has expressed its intention to increase FDI cap in the insurance sector. It is also planning to allow FDI in private FM radio, within the composite limit of 20%. Presently, only FII up to 20% is permitted. In 1992, the government permitted Foreign Institutional Investors (FIIs) to invest in all securities traded in the secondary and primary market and also the equity of unlisted companies. Such investments, also known as portfolio investments, are subject to various ceilings. FII investments are described as ‘hot money’ because of the speed at which they can travel. FE takes a Closer Look at foreign investment and the issues involved:

What is FDI? FDI basically means investment by a foreign company for purchase of land, equipment, buildings etc in another country. It also refers to the purchase of controlling interest in existing operations and businesses. It could be through mergers and acquisitions. It helps MNCs keep production costs down by accessing low-wage labour pools in developing countries. As for developing nations, such investments help them access technology and ensure jobs for its unemployed population. What is portfolio investment? It refers to the purchase of stocks, bonds, debentures or other securities by an FII.FIIs include pension funds, mutual funds, investment trusts, asset management companies, nominee companies and incorporated/institutional portfolio managers. In contrast to FDI, FIIs do not invest with the intention of gaining controlling interest in a company. They typically make short-term inve-stments. These investments are made-tobook profits. Compared to FDI, a portfolio investor can enter and exit countries with relative ease. This is a major contributing factor to the increasing volatility and instability of the global financial system. Because of the very nature of such investment, FII money is also called ‘hot money’. The rapid outflow of ‘hot money’ ,in the recent past, has created exchange-rate problems in Argentina and in southeast Asia. Since FIIs are very sensitive, a mere change in perception about an economy can prompt them to pull out investments from a country. What are investment caps? Cap refers to a ceiling up to which a foreign entity can invest in a company. There are FDI caps in various sectors. It means a foreign investor is allowed to invest only a portion of equity. The remaining portion will have to be subscribed by domestic companies or investors, which may include banks, financial institutions or the general public. For instance, there is a cap of 26% in the insurance sector. What it means is that in a joint venture insurance company, say Tata-AIG, the US insurance giant AIG cannot have more than a 26% stake. The remaining portion will be subscribed by the Tatas. FDI and FII caps are different for different sectors. Sometimes, FDI and FII caps are the same. In certain sectors, like oil exploration and entertainment television, 100% foreign investment is allowed, while in others like railways, no foreign investment is permitted. Why is there a cap on foreign investment? Every country is a sovereign entity to the extent that its government can choose what is best for its industry, economy and the people. Even developed countries impose caps on foreign investment. Sometimes, security concerns prompt a country to impose such restrictions. These caps are decided on the basis of public policy and are relaxed or tightened with the aim of serving a country’s broader interests.

Eg, when insurance was opened to the private sector in India, the government decided to allow 26% foreign investment in joint venture companies. The aim was to allow the private sector to gain experience and establish a foothold in the sector. Over the past few years, the Insurance Regulatory and Development Authority (Irda) too has been able to gain experience in regulating the insurance sector. P Chidambaram, in his 2004 Budget, promised to raise the foreign investment cap in the sector to 49%. As governments function in a dynamic situation, it is imperative for them to remain alive to the changing realities of the marketplace and respond appropriately by readjusting the ceiling of foreign investment.