There are many ways for a foreign investor to invest in a country. The most direct method, of course, is Foreign Direct Investment. However, there are other ways to enter an economy, like Foreign Institutional Investors. Let us learn more about FII.
Foreign Institutional Investors (FII)
Foreign Institutional Investors (FII) are an investment fund or a gathering of investors. Such a fund is registered in a foreign country, i.e. not in the country it is investing in. Such institutional investors mostly involve hedge funds, mutual funds, pension funds, insurance bonds, high-value debentures, investment banks etc.
We use this term FII for foreign players investing funds in the financial market of India. They play a big role in the development of our economy. The amount of funds they invest is very considerable.
So when such FII’s buy shares and securities the market is bullish and trends upwards. The opposite may also happen when they withdraw their funds from the markets. So they have considerable sway over the market.
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Advantages of FII’s
- FII’s will enhance the flow of capital into the country
- These investors generally prefer equity over debt. So this will also help maintain and even improve the capital structures of the companies they are investing in.
- They have a positive effect on the competition in the financial markets
- FII help with the financial innovation of capital markets
- These institutions are professionally managed by asset managers and analysts. They generally improve the capital markets of the country.
Disadvantages of FII’s
- The demand for the local currency (rupee) increases. This can cause severe inflation in the economy.
- These FII’s drive the fortune of big companies in which they invest. But their buying and selling of securities have a huge impact on the stock market. The smaller companies are taken along for the ride.
- Sometimes these FII’s seek only short-term returns. When they pull their investments banks can face a shortage of funds.
FDI vs FII
Let us clarify, both FDI and FII are forms of foreign investment in a country. However, they are starkly different in nature, target, and consequences. Let us study the differences between the two to understand them better.
Firstly FDI is a direct investment made in one particular business or company. The aim is to get a controlling interest in the business. FII, on the other hand, are funds which are invested in the foreign financial market.
There are many regulations and rules with respect to FDI. In fact, there are some industries like nuclear energy, agriculture etc. where there can be no foreign direct investment. But FII has fewer barriers for entry or exit from the market.
FDI is not only transfer of funds or capital. There is a transfer of technology, R&D, know-how, strategies, technical knowledge, and many other such aspects. In the case of FII, only the transfer of funds is there.
Solved Example on Foreign Institutional Investors
Question: What would a host economy(in terms of investment) prefer? FDI or FII? Explain.
Answer: As far as the economy in which the money is being invested, they would generally prefer FDI. Since FDI causes long-term economic growth by increasing the GDP of the country. FII will increase the capital in an economy, but may not have a significant effect on the economic growth of a country.