First let’s understand each one of them separately and then compare to list the differences.

FDI (Foreign Direct Investment): If a foreign firm opens a manufacturing hub, research centre or any other unit in the form of a subsidiary in India, then the investment is classified as FDI. If a foreign company starts a new company in a joint venture with an Indian firm, it is classified as FDI. If a foreign company invests in a domestic Indian company to inject some fresh capital, again it is considered to be FDI. FDI is stable and long term money getting invested in the country. It helps in building new businesses which results in more jobs, higher GDP leading to increased prosperity. It also brings in product expertise and new technology of foreign company and helps in increasing efficiency.

FII (Foreign Institutional Investment): It consists of foreign money getting invested in the stock/bond markets of a country. A foreign company buying shares of Reliance on NSE, is an example of FII. The money coming in through this route is generally not a long term investment, as the investee company can sell shares anytime and take the money back to its own country. No new businesses are created from this money, as through FII route foreign institutions are buying shares already trading on exchanges and no new investment is flowing directly to the company. Thus FII funds just makes buying and selling shares on exchanges easy by increasing liquidity, however it does not help in creating new jobs by building new business or increasing the GDP. 

Both FDI and FPI are part of the capital account. FDI is a long term investment. For example Maruti Suzuki is a joint venture between Maruti and Suzuki. If tomorrow Suzuki wants to take the money back, it cannot do so by just pressing one button. At the same time, the joint venture has helped in creating so many new jobs and added to the goods produced inside the geographical boundary of India, increasing India’s GDP. On the contrary, let’s consider the example of Morgan Stanley buying shares of TATA Motors on NSE. This transaction does not help in getting access to any new technology, creation of new jobs or access to new funds for business expansion. Overall there is no contribution to the GDP. Thus FDI is always preferred over FPI.