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Difference Between FDI and FII Explained in 10 Points

August 18, 2023

Finance serves as the lifeblood of businesses, enabling entrepreneurs not only to sustain their operations but also to drive technological advancements. FDI (Foreign Direct Investment) and FII (Foreign Institutional Investment) stand as two prominent methods of raising funds. These strategies, while primarily associated with business, hold far-reaching implications for the broader economy. Despite the difference between FDI and FII in terms of form and practice, both play pivotal roles in the process of nation-building. In this article, we delve into the nuances of FDI vs FII, elucidating key points that shed light on these concepts.

Exploring FDI: Foreign Direct Investment

Foreign Direct Investment, or FDI, refers to the scenario where a foreign company or organization invests in an Indian company with a long-term perspective. The primary aim of FDI is to cultivate a lasting interest in the recipient company. The investing entity extends its management control and exerts influence over the decisions of the recipient company. Given these attributes, this form of investment is often referred to as direct investment.

FDI extends beyond mere financial contribution, often serving as a conduit for the transfer of cutting-edge technology. Developed nations endowed with robust financial capabilities extend financial support to developing nations, particularly those constrained by limited financial resources. Foreign investors adopt various approaches to gain ownership within the organizations they invest in, including mergers and acquisitions (M&A), stock purchases, participation in joint ventures, and the establishment of wholly-owned subsidiaries.

The Pros and Cons of FDI

Foreign Direct Investment offers several advantages:

Enhancing Business Competitiveness: FDI fosters a competitive business landscape, compelling other enterprises to elevate the quality of their products and services while maintaining cost efficiency. This, in turn, raises the overall standard across industries.

Job Creation: FDI contributes to job creation, expanding employment opportunities for the workforce.
Technological Advancement: FDI serves as a conduit for introducing new technology, capabilities, knowledge, and financial resources, fueling economic growth and development.

However, FDI has disadvantages as well.

Impact on Domestic Businesses: A surge in FDI within an industry may adversely affect domestic businesses, particularly smaller enterprises that may struggle to compete with multinational corporations. This influx may raise the risk of local firms facing closure and impact a nation’s currency exchange rates.

Read Also: State-wise IPO in India

Deciphering FII: Foreign Institutional Investment

Foreign Institutional Investment, or FII, refers to investors or groups of investors pooling their funds to invest in national assets situated overseas. This strategy enables investors to swiftly generate profits by trading securities in the secondary market. Registration with the relevant securities market regulator of the host country is a prerequisite for FII participation. FIIs play a pivotal role in the economy of every nation; their investments often correlate with market fluctuations. When FIIs inject funds into the market, stock prices tend to ascend, while their withdrawal may trigger a market downturn. Institutional investors encompass hedge funds, mutual funds, pension funds, and investment banks.

In a bid to bolster foreign investments, the Securities and Exchange Board of India (SEBI) altered its regulations in 1996-97, permitting FIIs, NRIs, and OCBs to acquire up to 10% of an organization’s stock, subject to a cumulative investment ceiling of 24%.

As one can see, FIIs can easily invest in a company’s stock and can equally easily pull out its investment. Among FII and FDI differences, this is a major point.

The Pros and Cons of FII

Foreign Institutional Investment offers distinct advantages:

Enhanced Liquidity: FIIs contribute to the depth of securities markets, enhancing liquidity.
Equity Capital Inflow: FIIs bolster the inflow of equity capital, thereby fortifying the capital structure of the economy and bridging investment gaps.

Risk Management: FIIs play a crucial role in managing uncertainty and risk control.

FIIs serve as a means of managing uncertainty and risk control. However, there are also drawbacks associated with the influence of FIIs on the economy.

The surplus funds entering the economy heighten the demand for the rupee. To meet this demand, the RBI injects money into the market, leading to inflationary pressures.

Fluctuations in FII investments significantly affect the securities markets, especially the stock market. This poses a potential threat to small retail investors, whose financial stability is influenced by the actions of these large FIIs.
The rise in currency demand results in the domestic currency appreciating, thereby rendering the export industry less competitive.

It becomes evident why FDI is favored over FII. FDI entails establishing offices, hiring staff, and implementing long-term strategies. A key distinction between FII and FDI is the stability factor; FDI investments are generally more stable than FII investments. Unlike FII investors who occasionally withdraw significant amounts overnight, FDI investors cannot quickly repatriate large sums of money from the country, contributing to a more stable environment in the stock market.

Difference Between FDI And FII

PARAMETER	FDI	FII
Meaning	Here when the Investment in any Indian company by a foreign company is either located or incorporated in a foreign nation.	Here, when the Investment is done in the Indian stock market by any foreign investor.
Tenure of investment	Long-term (years)	Short-term (months)
Ease of investment	It is not easy for firms and corporations to enter and exit the market.	It is easy for the firms involved in the FII to enter and exit the market.
Benefits for the investee company	The benefits received by these companies are much more than capital. They receive technical and strategic knowledge.	The benefits received by these companies are only capital.
Targeted investment	They target specific companies and industries.	There is no such target. The investment undertaken here flows into the financial market.
Impact of investment	The investments from this form of investment are mostly beneficial for the entire cost leading to an increase in the GDP.	The impact of this form of investment leads to an increase in the capital of the company.
Transfer of control or of influence	Provides transfer of control over the company	Does not provide control over the company
Economic Growth	Yes	No
Strategic Control over a company	Yes	No
Entry and Exit	Government approval is authorized for entry and exit	No approval is required

Weighing the Scale: FDI vs FII – Making an Informed Choice

Both FDI and FII hold significance as investment avenues for recipient companies, each carrying its own set of advantages and drawbacks. In the debate between FDI and FII, FDI emerges as the favored choice among investee companies due to its multifaceted benefits. These encompass optimal management practices, governance enhancement, job creation, technology transfer, and capital inflow. Notably, governments also exhibit a preference for FDI over FII, given the enduring nature of the former.

In conclusion, while both FDI and FII contribute to economic growth, FDI’s comprehensive impact and long-term orientation make it the preferred route for both companies and nations striving for sustained development.