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.