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fdi vs fii

fdi vs fii

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Published by: karan_mib on Nov 30, 2009
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12/03/2012

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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 beinferior to FDI because it only widens and deepens the stock exchanges and provides a better pricediscovery 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 whenFIIs 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) andforeign investor (in the form of FII).Initially, we wanted inflow of dollars as our 
Balance of Payment (BOP)
was not ingood shape. However, over a period of time, we have managed to attract foreign fundinflow in match to that of China. In recent times, Indian economy is facing the problem of surplusfor the first time. Then, we should be happy about it, as we have successfully solved the problemof 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 abetter manner. It is seen that the following would be the issues primarily that would be gettingaffected: -
 
FDI Vs FII
It is most important to understand distinction between these two. When FDI comes in the countrythen 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 termand primarily invested in capital markets but will not lead to any other economic activity like jobcreation, 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 inthe 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) ispumped in the system. As a result of this, increase in fund flow in India results in rupeeappreciation. 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 increasein imports, and vice-versa is also true. Some say this is good as we will get less burden of crudeoil 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 haverisen 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 Rupeedecreasing. 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, thecost 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 canbe 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 isbecause if interest rate is high, people would like to save from their surplus income due to highreturn, 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 latenineties and early millennium to 8-10% GDP since last three years. In management, we alwayssay "process of change is always painful". The RBI is doing a good job of maintaining balance inthe system but there is a growing concern over the quality of funds coming into the country. Asdiscussed earlier, whether it is FII or Hedge Fund investing through
P-Notes
, it is more importantto see that an inclusive growth happens in the economy.
 It is India’s constant endeavour to attract foreign capital, either by allowing foreignentities to invest here, or by permitting Indian companies to raise capital from overseasmarkets. Since liberalisation in 1991, the government has been opening the Indianmarketplace 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 variousceilings. FII investments are described as ‘hot money’ because of the speed at which theycan 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 inexisting operations and businesses. It could be through mergers and acquisitions. It helpsMNCs keep production costs down by accessing low-wage labour pools in developingcountries. As for developing nations, such investments help them access technology andensure jobs for its unemployed population.
What is portfolio investment?
 It refers to the purchase of stocks, bonds, debentures or other securities by an FII.FIIsinclude 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 acompany. They typically make short-term inve-stments. These investments are made-to- book profits. Compared to FDI, a portfolio investor can enter and exit countries withrelative ease. This is a major contributing factor to the increasing volatility and instabilityof the global financial system. Because of the very nature of such investment, FII moneyis also called ‘hot money’. The rapid outflow of ‘hot money’ ,in the recent past, hascreated exchange-rate problems in Argentina and in southeast Asia. Since FIIs are verysensitive, a mere change in perception about an economy can prompt them to pull outinvestments from a country.
What are investment caps?
 Cap refers to a ceiling up to which a foreign entity can invest in a company. There areFDI caps in various sectors. It means a foreign investor is allowed to invest only a portionof 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 jointventure insurance company, say Tata-AIG, the US insurance giant AIG cannot have morethan a 26% stake. The remaining portion will be subscribed by the Tatas. FDI and FIIcaps are different for different sectors. Sometimes, FDI and FII caps are the same. Incertain sectors, like oil exploration and entertainment television, 100% foreigninvestment 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 onforeign investment. Sometimes, security concerns prompt a country to impose suchrestrictions. 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.

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