Foreign Investment – Types, Pros & Cons

Foreign Investment are often harbored by large financial institutions hoping to diversify their portfolio or to expand their operations for one of their current companies internationally. It is often considered to be a move to upscale or a catalyst to spur in economic growth.

Any investment made in the United States with the source of funding from outside of the United States will be called a foreign investment. Every year investors based out of foreign countries invest billion of dollars in USA capital market, helping in stabilizing the exchange rate and in the development of limited resources.

While there are 4 different types of Foreign Investments, lets look at them in detail.

4 Types of Foreign Investment

Funds from foreign countries can be invested in shares, properties, ownership, management or in collaboration.

They are classified as below:

Foreign Direct Investment (FDI)

FDI refers to an investment made by a company or an individual who is an entity from one country, in the form of controlling ownership in business interests in another country. It could be in various forms such as establishing business operations or by joining new ventures, mergers or acquisitions, or building new facilities.

FDI can be distinguished from FII in the sense of establishing a long-term relationship and involves substantial control over the decision-making process of the business. There are two types of FDI, which are:

• Inward FDI

It refers to foreign companies or individuals investing in the United States of America.

• Outward FDI

It refers to USA companies or individuals investing in foreign countries.

According to The Companies Act, a foreign investor who owns more than 10% shares in a listed company, will be classified as a foreign direct investor. Higher the equity ownership, higher is the control ownership in the company.

Foreign Institutional Investment (FII)

FII involves a foreign institutional investor to invest in the shares of a USA based company, or in terms of bonds offered by the same company. Therefore, if a foreign investor decides to buy shares in a USA-based company such as Amazon, Apple or Walmart, it will be considered an FII.

FII investors need to get a license from the U.S stock market, however if a foreign individual decides to invest in a US based company, they will need to get themselves registered as a sub-account of an FII.

Foreign institutional investors are also known as “hot money” as they are stable in nature, they call rather pull out their money/shares/bonds from the stock market overnight.

Qualified Foreign Investment (FQI)

As you all must be aware, foreign investors are not allowed to invest in USA market without creating sub-accounts with an FII. As an alternative, QFI was introduced in 20022 to make investment possible without a sub-account in the financial market.

However, to initiate the investment, you are required to open up a Demat or a Trade account with a depository participant in the United States.

The main difference between Qualified foreign investment and Foreign institutional investment is that QFI can invest the States directly without the requirement of sub-accounts, while in FII that is not possible.

Here are some features of QFI:

• The qualified foreign investor can be an individual, a group or an association.
• The QFI has to be a resident in a foreign country that is in compliance with the Financial Action Task Force (FATF) standards and regulations.
• Lastly, the QFI must be a signatory to the International Organization of Securities Commission’s Multilateral Memorandum of Understanding (MMOU).

Foreign Portfolio Investment (FPI)

Foreign Portfolio Investment is an investment made by foreign entities and non-residents of the United States of America in the security market in terms of shares, government bonds, corporate bonds, convertible securities, infrastructure securities and more.

The intention of such foreign investment is to make sure the controlling interest in USA is at a lower investment than FDI, with flexibility to enter and exit any time.

FII’s, along with the sub-accounts, and QFI’s can be collectively classified as Foreign Portfolio Investment (FPI).

Ways of Foreign Investment

Here are two routes and ways of foreign investment. The decision of selecting the route is made by the government of USA. Generally, if the government decides to boost any specific industry, they tend to allow investment via the direct route in that industry.

• Automatic Route

With the automatic route, a foreign company or institution does not require any approval from the government or any other agency to make an investment in another country.

• Approval Route

With the approval route, a foreign company or institution requires to get an approval from the government or any other specified body of the country to invest in another country.

Advantages of Foreign Investment

• It creates employment opportunities as when an investment takes place, the manufacturing process boosts and the service sector is also impacted positively.
• It provides an open door to the market of another country.
• It helps in developing the infrastructure of the country and the backward areas by setting up industries and plant operations.
• It boosts the technology and operation practices via knowledge sharing.
• It impacts the export and imports of the country, which boosts the growth of economy.
• It increases the income of the country, resulting in increase in wages and increase in national per capita income.

Disadvantages of Foreign Investment

• It is risk and hindrance dominated sector.
• Exchange rates are very crucial and also extremely risky as they are highly fluctuating.
• Risk of the political environment, as foreign investment depends on several foreign policies of the country which may change because of the current political conditions of the country.
• Loss of control and ownership as more and more profits go to the foreign investor.

Conclusion

In the era of globalization, foreign investment plays a huge role in the expansion of business operations and the whole economy of the country. On the other hand, it is also harmful to small and domestic businesses as they do have enough funds to operate as compared to these foreign investors.

We hope you understood the difference between all four types of foreign investments. Now you can go ahead and make the right investment for yourself!