FDI and FII: Difference

They make the headlines in financial dailies on a regular basis. ‘Market plunges on heavy FII selling’, ‘FII purchases jack up market’ -- these are two themes, variants of which often sum up activity in the stock market on a given trading day. ‘FDI in insurance set to go up’, ‘Left opposes the FDI hike in Aviation’ – these are samples of news headlines that we see about FDI and government’s policy relating to it. What are these two? Are they same or are they different? Many a time I have been asked this question through mail and also on the discussion groups.

FDI (Foreign Direct Investment) is an investment made to acquire a lasting management interest (usually 10 percent of voting stock) in an enterprise operating in a country other than that of the investor, the investor’s purpose being an effective voice in the management of the enterprise. It is the sum of equity capital, reinvestment of earnings, other long-term capital, and short-term capital as shown in the balance of payments. Usually countries regulate such investments through their periodic policies. In India such regulation is usually done by the Finance Ministry at the Centre through the Foreign Investment Promotion Board (FIPB).

Who are FIIs? Mutual funds, insurance companies, pension funds, university funds, investment trusts, endowment funds and charitable trusts incorporated outside India but investing in equity and debt securities in the country are known as FIIs. They collect money from individuals and corporates (primarily from countries belonging to the European and American continents), and invest it in financial instruments worldwide, with India being one of the targeted markets.

FIIs wanting to invest in equity and debt securities in India have to register with SEBI (Securities and Exchange Board of India) under the Securities and Exchange Board of India (Foreign Institutional Investors) Regulations, 1995. They also have to get approval from the RBI (Reserve Bank of India) to operate foreign currency accounts (to bring in and take out funds) and rupee bank accounts (to pay for transactions).

FIIs were first allowed to transact in Indian markets in 1993. SEBI lays down parameters relating to eligibility, investments and taxation. Chief among these relates to investment limits. The collective FII holding in a listed company cannot exceed 40 per cent of its equity capital.

Typically FIIs invest either directly or as sub accounts (through participatory notes) or as domestic entities. Participatory Notes (P Notes) are used by FIIs for foreign funds, not yet registered.

The key benefits of FII investments include reduced cost of capital, imparting stability to India's balance of payments, institutionalizing the market, improving market efficiency and strengthening corporate governance. FIIs have been termed as speculators, arbitrageurs and fair weather friends. FII inflows, globally, are considered hot money.