Difference between FDI & Portfolio Investment

Investments can be of two sorts. The first is when a firm or an individual buys
another firm with full, or very substantial, control of its operations. This investment
is called Foreign Direct Investment (FDI).

The other type of investment is called portfolio investment. In such an investment,

investors purchase stocks of a number of companies with the objective not to gain
management control, but to construct an investment portfolio

Purposes

The purposes of FDI and portfolio investments are different.

FDI allows investors to be actively involved in their investment. Investors not only can
take strategic decisions like what their foreign subsidiary will produce, in what quantities
and for whom, but also are involved in operational issues like cost control, HR, and
regulatory compliance. Investors may be motivated by different reasons including
improving operations of their existing businesses, and closely monitoring and
safeguarding their investments.

Investors, who decide to put their money in portfolios, are pursuing different objectives.
They want to spread the risk, without the need to learn about how to run different
businesses.

Investors

Individuals and companies making FDI and portfolio investments are usually very
different investors.

FDI investors are often big multinational companies, social organization (NGOs),
governmental or quasi governmental organizations (e.g., USAID) and venture capitalists.
They either get into partnerships with local enterprises, set up affiliates, or make
acquisitions of a foreign companies.

Portfolio investors are mutual funds, hedge funds, pension funds, and other investors who
wish to diversify their investments and not get involved in the day-to-day running of the
companies they buy into.

Risks

The risks associated with FDI and portfolio investment primarily are country risk and
currency exchange risk. The country risk includes political and economic instability
(revolutions, nationalization, tax hikes), and corruption. The currency exchange risk
occurs when the exchange rate of the country that has been invested in moves sharply
against the exchange rate of the home country.
It is necessary to note that even if investments (both FDI or portfolio investments) are
denominated in the home country currency (e.g., U.S. dollars), investors still bear the
exchange rate risk to some degree because the cash flows their investments generate will
need to be converted into the home currency and if the exchange rate has moved
substantially, the returns will suffer.

Portfolio investment, however, has additional risk, namely conflict of interests between
portfolio investors and control investors. Investors who have a big enough share of an
enterprise can appoint the management of the enterprise that will, accordingly, pursue
their interests vigorously, sometimes even acting to the detriment of minority, i.e.
portfolio investors.

Returns

Returns on FDI and portfolio investment are in line with average returns in the country
they are invested into. However, portfolio investments are more liquid, which normally
leads to higher valuations. But, on the other hand, FDI does not suffer from being a
minority investment, which should give it the so-called control premium. On balance,
though, FDI and portfolio investment have similar returns.

Macroeconomic Impact

Portfolio investment is much more volatile than FDI. In periods of crisis, foreign
portfolio investments are the first to leave the country, putting downward pressure on the
domestic exchange rate, often causing depreciation of the currency of the country from
which they are withdrawn.

The underlying reason is that the market for portfolio investment is much more liquid,
making it easier to take it out of a country (unless the country in question introduces
capital controls, which is not good for its reputation).

Because of this, FDI is a preferred source of capital, especially for developing countries.

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FDI-policy
India has one of the most transparent and liberal Foreign Direct Investment (FDI)
regimes among emerging and developing economies. Differential treatment is limited to a
few entry rules, predominantly in some Services sectors, spelling out the proportion of
equity that the foreign investor can hold in an India-registered company or business–
termed "sector caps". Foreign corporate and individual investment in India, termed
collectively as Foreign Direct Investment (FDI) when it relates to control or ownership of
a company in India, takes one of two routes:

Automatic route This requires no prior approval for FDI. Post-facto filing of data
relating to the investment made with the Reserve Bank of India (RBI) are for record and
data purposes. This route is available to all sectors or activities that do not have a “sector
cap” i.e. where 100% foreign ownership is permitted, or for investments that are within a
sector cap (e.g. less than or equal to 26% share of an Insurance company) and where the
Automatic route is allowed.

FIPB Approval – the Foreign Investment Promotion Board (FIPB) approves investment
proposals:

o where the proposed shareholding is above the prescribed sector caps, or

o where the activity belongs to that small list of sectors where FDI is either not
allowed or where it is mandatory that proposals be routed through the FIPB (e.g.
sectors that require industrial licensing)

The FIPB ensures a single-window approval for the investment and acts as a screening
agency (for sensitive/negative list sectors). FIPB approvals (or rejections) are normally
received in 30 days. Some foreign investors use the FIPB application route where there
may be absence of stated policy or lack of policy clarity.

An outline of the broad policies for groups of sectors is provided below:

Manufacturing:

o Most Manufacturing sectors are on the 100% automatic route. Foreign equity is
limited only in production of defence equipment (26%) and 5 specific industries where
an Industrial License (IL) is mandatory1.
o Most mining sectors are similarly on the 100% automatic route, with foreign
equity limits only on atomic minerals (74%), coal & lignite (74%).
o 100% equity is also allowed in non-crop agro-allied sectors (agro-processing) and
crop agriculture under controlled conditions (e.g. hot houses).

Infrastructure
100% FDI under the automatic route is allowed for most infrastructure sectors - highways
and roads, ports, inland waterways and transport, and urban infrastructure. Select
Infrastructure sectors have defined caps for e.g. Telecom Services has a sector cap of
74% and Airlines have a 49% 8 sector cap of foreign that are not airline.

Services

100% FDI under the automatic route is permitted for many service sectors such as real
estate construction, townships1, resorts, hotels and tourism (including tour operators and
travel agencies, serviced apartments, convention and exhibition centers), films, IT and IT
- enabled services, ISP/email/voice mail services, business services and consultancy,
renting and leasing, Venture Capital Funds/Companies (VCFs/VCCs), medical/health
services, education, advertising and wholesale trade and courier services. 100% FDI
permitted in non-banking financial services subject to minimum capitalization norms.

Certain service sectors are being opened up in a phased manner to allow domestic
companies to prepare for global competition. In both banking and insurance, foreign
investment is permitted subject to specific caps or entry conditions. FDI in media is
permitted with varying sector caps. Retail trade is currently restricted to 51% FDI
permitted in single brand retail stores and 100% FDI permitted in wholesale cash and
carry. Legal services are currently not open to foreign investment.

Restricted List of Sectors……………………………………………………………….

Sectors where FDI is prohibited are Retail Trading (except single brand product
retailing), Atomic Energy, Lottery Business, Gambling and Betting, Business of Chit
Fund, Nidhi Company, Trading in Transferable Development Rights (TDRs) and any
activity/sector that is not opened to private sector investment. Besides the above, FDI is
not allowed in plantations*.

Subject to these foreign equity conditions, a foreign company can set up a registered
company in India and operate under the same laws, rules and regulations as any India-
owned company.

India extends National Treatment to foreign investors with absolutely no discrimination

against foreign-invested companies registered in India or in favour of domestic ones.
What are the advantages and disadvantages of foreign direct investments?
Advantages
- causes a flow of money into the economy which stimulates economic activity
- employment will increase
- long run aggregate supply will shift outwards
- aggregate demand will also shift outwards as investment is a component of aggregate
demand
- it may give domestic producers an incentive to become more efficient
- the government of the country experiencing increasing levels of FDI will have a greater
voice at international summits as their country will have more stakeholders in it

Disadvantages
- inflation may increase slightly
- domestic firms may suffer if they are relatively uncompetitive
- if there is a lot of FDI into one industry e.g. the automotive industry then a country can
become too dependent on it and it may turn into a risk that is why countries like the
Czech Republic are "seeking to attract high value-added services such as research and
development (e.g.) biotechnology)"

Multinational Companies in India

Multinational companies are the organizations or enterprises that manage production or

offer services in more than one country. And India has been the home to a number of
multinational companies. In fact, since the financial liberalization in the country in 1991,
the number of multinational companies in India has increased noticeably. Though
majority of the multinational companies in India are from the U.S., however one can also
find companies from other countries as well.

Destination India

The multinational companies in India represent a diversified portfolio of companies from

different countries. Though the American companies - the majority of the MNC in India,
account for about 37% of the turnover of the top 20 firms operating in India, but the
scenario has changed a lot off late. More enterprises from European Union like Britain,
France, Netherlands, Italy, Germany, Belgium and Finland have come to India or have
outsourced their works to this country. Finnish mobile giant Nokia has their second
largest base in this country. There are also MNCs like British Petroleum and Vodafone
that represent Britain. India has a huge market for automobiles and hence a number of
automobile giants have stepped in to this country to reap the market. One can easily find
the showrooms of the multinational automobile companies like Fiat, Piaggio, and Ford
 Motors in India. French Heavy Engineering major Alstom and Pharma major Sanofi
Aventis have also started their operations in this country. The later one is in fact one of
the earliest entrants in the list of multinational companies in India, which is currently
growing at a very enviable rate. There are also a number of oil companies and
infrastructure builders from Middle East. Electronics giants like Samsung and LG
Electronics from South Korea have already made a substantial impact on the Indian
electronics market. Hyundai Motors has also done well in mid-segment car market in
India.

Why are Multinational Companies in India?

There are a number of reasons why the multinational companies are coming down to
India. India has got a huge market. It has also got one of the fastest growing economies in
the world. Besides, the policy of the government towards FDI has also played a major
role in attracting the multinational companies in India.

For quite a long time, India had a restrictive policy in terms of foreign direct investment.
As a result, there was lesser number of companies that showed interest in investing in
Indian market. However, the scenario changed during the financial liberalization of the
country, especially after 1991. Government, nowadays, makes continuous efforts to
attract foreign investments by relaxing many of its policies. As a result, a number of
multinational companies have shown interest in Indian market.

Following are the reasons why multinational companies consider India as a

preferred destination for business:

• Huge market potential of the country

• FDI attractiveness
• Labor competitiveness
• Macro-economic stability