FDI
Foreign Direct Investment or FDI
Foreign Direct Investment, or FDI, is one of the most crucial channels of direct
investments between countries.
Unlike Foreign Portfolio Investments or FPIs, an investor in one country can hold
a controlling stake of any business or organization in a foreign country that
receives the investment. FDI is also a significant and insightful indicator of a
certain country's political and socio-economic stability.
This essentially implies a country that receives large amounts of investments from
foreign entities on a regular basis is more likely to have a dynamic and vibrant
economy.
How Does FDI Work?
Foreign investments can be either 'organic' or 'inorganic'. With organic
investments, a foreign investor will pump in funds to expand and accelerate growth
in established businesses.
Inorganic investments are instances when an investing entity buys out a business in
its target country.
In developing and emerging economies like India and other parts of South-East
Asia, FDIs offer a much-needed fillip to businesses that may be in poor financial
shape.
The Government of India has undertaken several measures to ensure that larger
chunks of investments pour into the country across sectors including defence
production, the telecom sector, PSU oil refineries and IT.
Since Foreign Direct Investment is a non-debt financial resource, it has the
potential to become a major driver of economic development in India.
Globalization and internationalization are 2 factors which made FDI possible.
However, the celebrated Canadian economist Stephen Hymer, considered the
'Father of International Business', theorized in the 1960s that foreign investments
would continue growing rapidly because -
It provided control over companies in a foreign land.
It helped certain business sectors overthrow monopolistic practices, and
Most importantly, since market imperfections will always exist, such
investments provide companies with a cushioning effect if there was a sharp
and unpredictable decline in business activity.
FDI Examples
Over the last decade, India has witnessed a steady flow of Foreign Direct
Investment. From pharmaceuticals to automobiles, textiles to railways, nearly
every sector has received significant sums of foreign investment.
The Importance of FDI cannot be undermined. It has resulted in infrastructure
improvements, led to job creation, increased exports, and helped the formal sector
to a great extent.
Here are some notable examples of recent foreign investments in India -
Byju's, an online Ed-Tech firm, raised USD 500 million in a Silver Lake-led
funding round in September 2020. Silver Lake is a noted US equity and VC
firm.
Also, in September 2020, Unacademy- a competitor of Byju's in the same
niche - raised a total of USD 150 million. Japan's SoftBank Group led the
round.
Google picked up 7.73% of Reliance's 'Jio Platforms' for USD 4.5 billion,
making it one of the biggest deals in recent Indian corporate fundraising
sessions.
General Atlantic, one of New York's most respected equity firms, invested
more than USD 900 million for a stake in Reliance's 'Jio Platforms' in June
2020.
Data show that the majority of Foreign Direct Investment in India came from 5
countries- Singapore, the USA, Japan, the Netherlands, and Mauritius.
Advantages of Foreign Direct Investment.
1. Economic Development Stimulation.
Foreign direct investment can stimulate the target country’s economic development,
creating a more conducive environment for you as the investor and benefits for the local
industry.
2. Easy International Trade.
Commonly, a country has its own import tariff, and this is one of the reasons why trading
with it is quite difficult. Also, there are industries that usually require their presence in the
international markets to ensure their sales and goals will be completely met. With FDI, all
these will be made easier.
3. Employment and Economic Boost.
Foreign direct investment creates new jobs, as investors build new companies in the
target country, create new opportunities. This leads to an increase in income and more
buying power to the people, which in turn leads to an economic boost.
4. Development of Human Capital Resources.
One big advantage brought about by FDI is the development of human capital resources,
which is also often understated as it is not immediately apparent. Human capital is the
competence and knowledge of those able to perform labor, more known to us as the
workforce. The attributes gained by training and sharing experience would increase the
education and overall human capital of a country. Its resource is not a tangible asset that is
owned by companies, but instead something that is on loan. With this in mind, a country
with FDI can benefit greatly by developing its human resources while maintaining
ownership.
5. Tax Incentives.
Parent enterprises would also provide foreign direct investment to get additional
expertise, technology and products. As the foreign investor, you can receive tax
incentives that will be highly useful in your selected field of business.
6. Resource Transfer.
Foreign direct investment will allow resource transfer and other exchanges of knowledge,
where various countries are given access to new technologies and skills.
Disadvantages of Foreign Direct Investment
1. Hindrance to Domestic Investment.
As it focuses its resources elsewhere other than the investor’s home country, foreign
direct investment can sometimes hinder domestic investment.
2. Risk from Political Changes.
Because political issues in other countries can instantly change, foreign direct investment
is very risky. Plus, most of the risk factors that you are going to experience are extremely
high.
3. Negative Influence on Exchange Rates.
Foreign direct investments can occasionally affect exchange rates to the advantage of one
country and the detriment of another.
4. Higher Costs.
If you invest in some foreign countries, you might notice that it is more expensive than
when you export goods. So, it is very imperative to prepare sufficient money to set up
your operations.
5. Economic Non-Viability.
Considering that foreign direct investments may be capital-intensive from the point of
view of the investor, it can sometimes be very risky or economically non-viable.
6. Expropriation.
Remember that political changes can also lead to expropriation, which is a scenario
where the government will have control over your property and assets.
Type Definition
Horizontal The first type is observed whenever a business expands and enters a foreign country via
the FDI route without changing its core activities.
An example would be McDonald's investing in an Asian country to increase the number
of stores in the region.
Vertical Here, a business enters a foreign economy to strengthen a part of its supply chain without
changing its business in any way.
If McDonald's bought a large-scale meat processing plant in Canada or in a European
country to bolster its meat supply chain in the target nation, it would amount to vertical
FDI.
Conglomerate This 3rd type is noticed whenever a business invests in a foreign country and buys an
entity which manufactures totally different products.
The idea is to add more business niches and start new journeys in other countries.
In the late 1980s, Sir Richard Branson's Virgin Group launched clothing stores in France,
called 'Virgin Clothing'. The venture, however, failed miserably and very few outlets
remain, mostly in the Middle-East.
Platform The last type refers to the expansion of a business to a foreign country, but everything
manufactured there is exported to a third country. Platform FDI is seen in free-trade zones
of FDI-hungry countries.
Almost all luxury items marketed by famous fashion brands are manufactured in countries
like Bangladesh, Vietnam and Thailand. They are then sold in other countries, a clear case
of platform FDI at work.
Types of FDI
