Sunday, August 30, 2009

FDI and FII: how impact to Indian economy

Both FDI and FII are part of foreign capital formation.

FDI: the official definition of foreign direct investment are – FDI occurs when an entity or investor from one country (home country e.g. India) obtain or acquires the controlling interest in an entity in another country (host country e.g. USA) and then operates and manages the entity and its assets as part of the multinational business of the investing entity.

FII: foreign institutional investor – its category of investment instrument that are more easily traded , may be less permanent , and do not represent a controlling stake in an enterprise , these include investment via equity instrument ( stocks) or debt ( bonds) of a foreign enterprise which does not necessarily represents a long term interest.

Their main intention is to make capital gain.
For e.g. if any FII bought GDR ( global depository receipt ) or any instrument which used by non citizen of India of reliance company at 90 US dollar and after some time share price touch 150 US dollar say after 2 day than he will immediately will sell that share to make capital gain.

FII: how to impact Indian economy
1. FII leads to appreciation of the currency: FII need to maintain an account with RBI fro all transaction. to understand the implication of FII on the exchange rate we have to understand how the value of one currency appreciate or depreciate against the other currency
What is currency appreciation: for example if the current foreign exchange rate is 1 USD = 50 INR (Indian rupees) but after some time the exchange rate fluctuate to 1 USD = 40 INR. This means Indian rupees appreciate over the US dollar. The logic is very simple.
e.g. if Indian customer want buy one quantity of ice cream from USA market ( suppose price of 1 ice cream is 1 USD ) he will have to pay 50 INR which is equal to 1 USD. But when exchange rate changes he will have to pay 40 INR instead of INR which is equal to 1 USD.
In short purchasing power of Indian customer have rise now they will have to pay less amount to buy ice cream or they can buy more quantity of ice cream at same price .

Depreciation: suppose forex rate is USD = 40 INR, after some time Its 1 USD = 50 INR that means INR have depreciate over the USD.
Reason is same.
We take one example.
Suppose India import ice cream from USA. First quote is 1 USD = 40 INR. And price of one quantity of ice cream is 1 USD.
This means Indian customer will have to pay equivalent to 1 USD that is 40 INR> but if forex rate is 1 USD = 50 INR. In this way Indian customer will have to pay 50 INR which is equal o 1 USD.
Now I come to point how domestic current appreciate or depreciate if there if FII inflow or FII outflow.
When FII come in India they creates rupees demand and by demand and supply rule the price of INR appreciates.
Similarly if FII withdraw the capital from the domestic market or we can say when they sell their share it creates the demand for US dollar and that time demand for dollar will be more and resulted INR will depreciate.
I would like to take one more example. In 2008 our forex rate over the US dollar was USD = 39 INR. This is just because of FII was net buyer (FII inflow was more in Indian market ) but now you will see 1 USD = 48 INR . This is because of FII out flow from Indian market is more and they are net seller.
This FII inflow makes the currency of the country invested in appreciate. (E.g. FII investing in India may lead to rupees appreciating over other currencies) and their selling and disinvestment may lead to depreciation.

2.FII and exports: if our Indian currency appreciates just because of FII (net inflow in India) there is adverse effect on our export. Our export industry will become uncompetitive due to appreciation of rupees.

E.g. if USD = INR 40 and a soap costs 1 USD. Now when the rupees appreciated 1 USD = 20 inr , I will have to sell the same soap to the US for 2 USD in order to sustain the same income that I have been making i.e. 40 INR.

Logic is very simple. First I sold my soap at INR which was equal to one USD. But after appreciation I would like to sell 2 USD to get my same income that means I will charge more US dollar from USA customer. So if we charge high price of course customer will be less.

The excess FII fund inflow in the country can also make a negative impact on the economy of the country.

In this situation our Indian IT industries, jewelry and textiles industry affect. However you have seen at the appreciation time government give them some package specially for this category.

3.FII and stock market: when cap on FII is high then they can bring in lot of funds in country’ stock market and thus have great influence on the way the stock market behaves, going up or down. The FII buying pushes the stock up and heir selling shows the stock market down.
4.FII and inflation: the huge amount of FII fund flow creates the huge demand for Indian rupees. In that situation RBI print more money in the market. this situation could lead to excess liquidity therby leading to inflation , where too much money chase too few goods and service ( perfect example of demand pull inflation)
Thus there should be a limit to the FII inflow in the country.
5.FII and local companies: when huge FII comes in any country there is much availability of fund for local company in this time local co. Can expand their coverage. `

6.Capital formation in domestic market: if there is much FII inflow in the country will not borrow from other country or from international bank. If home country’s saving rate are not sufficient to meet its investment programmed but if FII inflow is well there is no problem. India is developing country and its domestic saving is low compared to developed countries. So here is need for FII inflow.

FII is vey dangers in case of HOT MONEY concept:
We take one example. If RBI gives the interest rate 9% on foreign investor deposit which is high in Asia ten of course foreign investor will attract in Indian market to make capital gain. But if in this case bank of china raised their interest rate up to 10 % which will be higher in Asia of course all FII will be shift from Indian market to Chinese market an d this will be happen if any nation again increase the interest rate. These FII inflows are very volatile. Its disturb the economy at the time of coming and going. And Hench this concept called hot money concept.

Factors affecting the FII

1.INTEREST RATE OF THE COUNTRY: if the interest rate of the country high of course FII will want to invest in that country to make good capital gain.

2.MONEY SUPPLY AND INFLATION RATE: if money supply is adequate and inflation rate is stable FII will invest in that country.

3.EXCHANGE RATE OF THE COUNTRY: if the exchange rate of country is highly volatile or fluctuate of course FII will be discourage to invest in that country. So exchange rate should be stable.

4.BOP: deficit in balance of payment is the indicator. So FII will avoid investing in that country.

5.ECONOMIC GROWTH: of course FII will invest in those countries which are growing at fast rate like India, china and Korea.


In India FDI is regulated by RBI, ministry of finance and FIPB.

Impact on Indian economy.
1.Creates employment opportunity for domestic country.
2.Good relation between two countries.
3.Modern technology.
4.Inflow of foreign funds in Indian economy.
5.To provides the goods and services at best suitable price.
6.It creates the competition among the domestic company and MNC in this way domestic co can increase their efficiency.
7.Indian company get chance to work professional body.
8.Indian company get chance to work with world market Leader Company.
9.Backward area can be developed.
10.Creating good capital market in India.
11.Government earns in the form of licenses fees, registration fees, taxes which is spend for public expenditure.

Problem facing the MNC at the time of investing in other country
1.Communication problem
2.They will have to find new supplier and distributors.
3.Political problem : for e .g. if any Pakistan company want to invest in Indian market of course they will face problem or difficulty compare to other country
4.Taxation policy of country
5.Exchange rate of home country
difference between FII and FDI

meaining :

FDI : : if any foreign entity or investor obtain or acquire the controlling interest
FII :If any foreign investor want make capital gain and that is for short duration

duration :
FDI : long period
FII short period.

source :
FDI : FDI come from MNC’s and corporate so as to derive benefit of new market , cheaper resource , efficiency and skill etc

FII: FII come from investor, mutual fund company, portfolio management and corporate with pure motive of investment gains.

form :
FDI : FDI generally comes as subsidiary company or joint venture
FII:It comes through stock market

Regulator body :
FDI : RBI , ministry of finance and FIPB( foreign investment promotion board )
FII: SEBI ( security exchange board of India )

FDI : : diversification and expand at global coverage
FII: FII sole criteria and motive is gains on investment


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  2. Wow brijesh mind blowing excellent article u make me understood whole concept of FDI and FII

    but i didnt get hot money concept... what is hot money i dont know is because we can easily purchase and sale some instrument for capital gains.. it is called hot money?

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  5. I read a good article on FII to understand it basically and understood the positives and negatives of FII and FDI clearly. Thanks for the writer of this article.

  6. hey this is really a good one. i made my project on fii so it is helpful to me..

  7. good work..very simply defined and easy to understand.!thanks.

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