Foreign direct investment and foreign portfolio investment

FDI (foreign direct investment) and FPI (foreign portfolio investment) have become the major economic drivers of globalization in recent decades, as a heated debate, they are increasingly drawing many individuals’ attentions to know about it in contemporary society. According to the IMF (2003),’FDI refers to an investment made to acquire lasting interest in enterprises operating outside of the economy of the investor’,meanwhile OECD (2002) provides this assessment,’FPI refers to short term investments made by one country into the passive holdings of securities of another country’.

Therefore, this essay aims to differentiate between FDI and FPI by investigating their characteristics, effect factors, and major purpose. Also, by distinguish FDI and FPI to make the determiners more clear, thereby guiding individuals or firms to invest in foreign markets more reasonably. In my opinion,FDI is one of the main modern form of capital international, which refers to the form of investment implemented at international level that aims to a long-term realization of goals (such as owning cheap labors and expanding markets) —–by running an enterprise in a foreign country.

Furthermore, according to Neuhaus (2006), FDI particularly involves setting up some physical entities such as a factory or an enterprise in a foreign country. In contrast, what I state about FPI is that it is usually calculated to achieve short-term realization of goals, and rendering the investor benefits from foreign countries through two indirect ways – investing in financial markets (e. g. stocks, bonds, or other financial assets) and corporate participation but without the power to make decisions.

It is also worth mentioning that FPI often occurs in typical target countries like developing countries, where investors could easily retreat from the portfolio markets when target countries have been realized or when there is an unexpected occurrence influencing the economic stable of that country which may unfavorably impact foreign investments. (Brennan and Cao, 1997) In my point of view, the differences between FDI and FPI mainly manifest in three aspects: main characteristics; the inevitable factors of affecting them; and major purpose of the two concepts.

And the first point about main characteristics: frequency, risk, and employing. (a) Frequency: compared with FDI, there are a large number of flexibilities to regulate to the short-term price of portfolio changes, which makes it possible for FPI occurs even in one minute (Brennan and Cao, 1997). (b) Risk: even though FPI could bring excessive profit to investor, the risk of FPI is bigger than FDI. For the reason that the staggering benefits are accompanied by big risk because the financial markets are inundated with speculating and indiscriminate investment (Brennan and Cao, 1997).

(c) Employing: this is the most distinct distinguishing feature between FDI and FPI. Specifically, with reference to the United Nations Conference on Trade and Development (2002), being driven by over 64,000 transnational corporations with more than 800,000 foreign affiliates, the global development of FDI was already emerged 53 million jobs in 2001. The second point about the effect factors, FPI is more easily influenced by interest rate, exchange rate, and international investment environment, FDI is more easily influenced by cultural and political background of the target countries.

Especially exchange rate, Guerin, S. S (2006) argues that an unstable exchange rate could decline FPI sharply, because the changeability of exchange rate directly generates uncertainty on the returning business plan from the investing countries. Meanwhile, this also has been shown by Caruso (2001), he points out that the drawback of exchange rate, especially inflation, is that it will lead to lower real returns not only on money, but also on all other assets.

These low returns keep the running of financial markets and FPI back, as in order to make financial decisions, Investors are the most likely to expect returns. So if one oversea currency is not trustable, then the investors are less likely to engage in business relationships with the oversea country, therefore the lower investment, production and less socially positive interactions are really addressed about this issue. Also cause of other effects (e. g.

political effectors and investment environment), people may start to invest other countries, in order to avoid the unpredictable price levels due to inflation. Finally, in the respect of purpose, the returns that an investor acquires on FPI usually take the form of interest payments or dividends. However, FDI concentrates on controlling real economies (e. g. products, factories, technology, and cheaper labors). What is more, as Seo and Suh demonstrate (2006), FDI aims to help companies to avoid governmental pressure on local production and cope with protectionist measures by circumventing trade barriers.

The move into local markets also ensures that companies are closer to their consumer market, especially if companies set up locally-based sales offices. (Carson, C. S. 2005) Nevertheless, the gains that an investor obtains on FPI usually take the type of payment of interest or dividends. In conclusion, even though there are several differences between FDI and FPI, they are not mutually exclusive. Distinguished the two concepts of foreign investment, this essay is stressed on beneficial for investors and governments to increase foreign investment.

Additionally, with the development of economic globalization and growth of the Internet, many traditional cases of foreign investment which required huge amount of capital and physical investments are slowly becoming obsolete, and it can be predicted that FDI and FPI will play more significant roles in contemporary business, which could be more than only a challenge, but also an opportunity for multinational firms and developing countries. Therefore, it is imperative that the developing countries should be well-advised to reform their investment environment and to enact new business roles to attract more foreign investment.

Reference

Brennan, M. J. and Cao, H. H (1997) ‘International Portfolio Investment Flows’. The Journal of Finance, 52(5), pp. 1851-1880. Carson, C. S. (2005) ‘Foreign Direct Investment Trends and Statistics’. International Statistical Review, 73(2), pp. 157-160. Caruso, M.(2001)

‘Investment and the persistence of price uncertainty’. Research in Economics. 55(2), pp. 189-217 Guerin, S. S. (2006) ‘The Role of Geography in Financial and Economic Integration: A Comparative Analysis of Foreign Direct Investment, Trade and Portfolio Investment Flows’. The World Economy, 29(2), pp. 189-209. International Monetary Fund (2003). Foreign Direct Investment Trends and Statistics. Washington, D. C. : International Monetary Fund.