Foreign direct investment (FDI) Ilows into the primary market whereas Ioreign

institutional investment (FII) Ilows into the secondary market, that is, into the
stock market.
All other diIIerences Ilow Irom this primary diIIerence. FDI is perceived to be
more beneIicial because it increases production, brings in more and better products
and services besides increasing the employment opportunities and revenue Ior the
Government by way oI taxes. FII, on the other hand, is perceived to be inIerior to
FDI because it only widens and deepens the stock exchanges and provides a better
price discovery process Ior the scrips.
Besides, FII is a Iair-weather Iriend and can desert the nation which is what is
happening in India right now, thereby pulling down not only our share prices but
also wreaking 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 Iall is primarily due to demand and supply oI this currency in
the market. Liberalization has essentially allowed investments by Ioreign
companies (in the Iorm oI FDI) and Ioreign investor (in the Iorm oI FII).
Initially, we wanted inIlow oI dollars as our Balance oI Payment (BOP) was not in
good shape. However, over a period oI time, we have managed to attract Ioreign
Iund inIlow in match to that oI China. In recent times, Indian economy is Iacing
the problem oI surplus Ior the Iirst time. Then, we should be happy about it, as we
have successIully solved the problem oI BOP. But unIortunately, its not so simple,
as rise in Ioreign Iund inIlow (in the Iorm oI FII or FDI) will impact our currency
valuation, which Iurther aIIects Indian economy as a whole, and the job oI RBI is
to take care oI the turmoil and keep balance in the system.
So we have gone through a couple oI issues here which would help us in analyzing
this issue in a better manner. It is seen that the Iollowing would be the issues
primarily that would be getting aIIected: -
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 Iorm oI long term investment which will
not only bring Iunds but create job opportunity too. Whereas when FII brings Iund
in the country, it is essentially Ior short term and primarily invested in capital
markets but will not lead to any other economic activity like job creation, etc. It is
clear Irom this as to which mode oI Iund Ilow is intended and why. However, some
believe capital markets are indications oI 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 Ior every dollar invested, the equivalent amount oI rupee (either Rs.
45 or Rs. 40) is pumped in the system. As a result oI this, increase in Iund Ilow 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 Irom 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 oI crude oil bill, especially when experts predict crude oil
price might reach $100 a barrel. InIact, that is one oI 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 oI Dollar
viz-a-viz Rupee decreasing. However, this can be reduced by a concept oI
Currency Hedging.
Impact on InIlation due to Fluctuation in Rupee
InIlation in simple terms means excess oI liquidity. OIten it is seen that when
inIlation is high, the costs oI 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 increases inIlation. However, this can be curtailed by RBI as
mentioned above.
Impact on Interest Rate due to Fluctuation in InIlation
It is seen that when inIlation increases, interest rate increases, and vice-versa is
also true. This is because iI interest rate is high, people would like to save Irom
their surplus income due to high return, and would not borrow as well because oI
high cost oI Iund.
Impact oI all this on Indian Economy
Indian economy is currently undergoing a transition phase that is Irom 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 oI change is always painIul". The
RBI is doing a good job oI maintaining balance in the system but there is a
growing concern over the quality oI Iunds coming into the country. As discussed
earlier, whether it is FII or Hedge Fund investing through P -Note s, it is more
important to see that an inclusive growth happens in the economy.
It is India`s constant endeavor to attract Ioreign capital, either by allowing Ioreign
entities to invest here, or by permitting Indian companies to raise capital Irom
overseas markets. Since liberalization in 1991, the government has been opening
the Indian marketplace Ior 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 oI
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 oI
unlisted companies. Such investments, also known as portIolio investments, are
subject to various ceilings. FII investments are described as hot money` because
oI the speed at which they can travel. FE takes a Closer Look at Ioreign investment
and the issues involved:
What is FDI?
FDI basically means investment by a Ioreign company Ior purchase oI land,
equipment, buildings etc in another country. It also reIers to the purchase oI
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 labor pools in developing countries. As Ior developing nations, such
investments help them access technology and ensure jobs Ior its unemployed
population.
What is portIolio investment?
It reIers to the purchase oI stocks, bonds, debentures or other securities by an
FII.FIIs include pension Iunds, mutual Iunds, investment trusts, asset management
companies, nominee companies and incorporated/institutional portIolio managers.
In contrast to FDI, FIIs do not invest with the intention oI gaining controlling
interest in a company. They typically make short-term investments. These
investments are made-to- book proIits. Compared to FDI, a portIolio investor can
enter and exit countries with relative ease. This is a major contributing Iactor to the
increasing volatility and instability oI the global Iinancial system. Because oI the
very nature oI such investment, FII money is also called hot money`. The rapid
outIlow oI 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 Irom a
country.
What are investment caps?
Cap reIers to a ceiling up to which a Ioreign entity can invest in a company. There
are FDI caps in various sectors. It means a Ioreign investor is allowed to invest
only a portion oI equity. The remaining portion will have to be subscribed by
domestic companies or investors, which may include banks, Iinancial institutions
or the general public. For instance, there is a cap oI 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 diIIerent Ior diIIerent sectors.
Sometimes, FDI and FII caps are the same. In certain sectors, like oil exploration
and entertainment television, 100 Ioreign investment is allowed, while in others
like railways, no Ioreign investment is permitted.
Why is there a cap on Ioreign investment?
Every country is a sovereign entity to the extent that its government can choose
what is best Ior its industry, economy and the people. Even developed countries
impose caps on Ioreign investment. Sometimes, security concerns prompt a
country to impose such restrictions. These caps are decided on the basis oI public
policy and are relaxed or tightened with the aim oI serving a country`s broader
interests.