FDI- Full Form, Types, Foreign Direct Investment UPSC Notes

By Shubhra Anand Jain|Updated : November 2nd, 2022

Foreign Direct Investment, also known as FDI, is an investment made upon buying an interest in a company by another company not located in the same country. To simplify, FDI is a business decision to hold a substantial stake in a foreign investment/business. This can also include buying it for reasons like expanding the company’s operations in the new borders. There are different types of FDI such as horizontal, vertical, and conglomerate.

Foreign Direct Investment or FDI is not just a stock investment in a foreign country; it is also an opportunity to grow and expand the business in other countries and regulate the company. In addition, doing business with foreign company help to understand their tactics and techniques, which can help to advance the business. Foreign Direct Investment [FDI] is an essential topic for the exam. The aspirants preparing for UPSC exam must prepare well for the topic.

Table of Content

What is FDI?

Foreign Direct Investment or FDI is when a foreign company invests its money in a company of another country. When a company or individual invests money in a company of another country, then the nation of the investment company is called the home country, and the country where the investment takes place is called the host country. The term Foreign Direct Investment [FDI] refers to an investment made through capital instruments by a person not a resident of India.

  • In an unlisted Indian firm or
  • Ten percent or more of a listed Indian company's post-issue paid-up equity capital is fully diluted.

Through this FDI, the company can take ownership and stakes in more than one company in different fields. As a result, it can help to increase and expand the business. In addition, through this act, investors become capable of being part of the daily discussion and decision process of the company in which they have invested.

Not Capital Intensive: FDI is how one business supports the other in various ways.

  • For example, foreign investors fund businesses and bring new technology to companies with the required resources to boost business growth.
  • Most of cases, foreign direct investments are made when they find the potential in the business and the market in which they are investing,

FDI is the best way to get investment from foreign companies without debt to improve and boost the business model.

Types of Foreign Direct Investment [FDI]

Foreign direct investment can be classified into horizontal, vertical, and conglomerate. The types of FDIs are segregated on the basis of the companies that the investors are investing in. Walk through the illustrated points to get complete details of the types of FDI.

Horizontal FDI

It is a type of investment in which the company makes investment only in the company running their type of business in foreign. Example - If any sportswear company wants to make investments, they will only invest in any other sportswear company in another country rather than in any other sector. It's called horizontal investment.

Vertical FDI

In this type of investment, the company makes the investment in another company dealing with a complementary type of business. For example, Suppose company X wants to invest in any company in the form of FDI. In that case, they will invest in a company selling raw materials required by company X, called a vertical investment.

Conglomerate FDI

In this type of investment, the company could invest in any firm, business, or startup, even if it is not from the same industry. FDI investment will make a huge opportunity for the business to explore the new area and gain experience in different fields.

Components of FDI

The Government has made numerous attempts to uplift the amendments and policies in India for boosting Foreign Direct Investment [FDI]. The three FDI components and their brief description is mentioned below-

  • Equity capital happens when the company owns a share to profit from the multiple-business. The purchase of shares in a company in a country other than one's own by a foreign direct investor is known as equity capital.
  • Reinvested earnings: The direct investor reinvests profit in the company for further profits. Profits not dispersed as dividends by affiliates or earnings not remitted to the direct investor are referred to as "reinvested earnings." Affiliates reinvest their reserved gains.
  • Intra-company loans include investing by any investor for a brief period for further gains. Intra-company loans are short- and long-term borrowing and lending transactions between direct investors (or firms) and affiliate enterprises.

Method of FDI in India

In this method, when investors are investing, they do not need the government's permission to invest in the country and can make investments easily without any approval. In the Government method of FDI approval is mandatory. You can get the complete details of the Foreign Direct Investment [FDI] in India which is mainly made through two channels:

Automatic Method of FDI

In India, automatic FDI investments are made only in no critical sectors like medical, thermal power insurance, petroleum, and aviation.

  • The Automatic Route eliminates the need for a non-resident investor or an Indian corporation to seek Government of India clearance for their investment.
  • The Reserve Bank of India manages the Automatic Route of FDI.

Government Method of FDI

The Government Approval Route necessitates approval from the Indian government before investment. In this method, the company needs to take the government's permission before making an investment in the country; such investments are made for critical sectors like defense, telecommunication, satellite, and private security agencies only after the government's permission.

  • The foreign investment facilitation department must approve investment permission before making it.
  • The administrative ministry/department in question reviews proposals for Foreign Direct Investment [FDI] through the government route are reviewed by the administrative ministry/department in question.

Foreign Direct Investment In India

India opened its door to FDI in 1991 when the government invited companies to invest in India by initiating strategies like liberation, globalization, and privatization. The government of India made the FDI easy by easing the investment policies in India.

  • Invest India's national investment promotion and facilitation agency was established in 2009. This is a non-profit venture run by the Ministry of Commerce and Industry's Department for Promotion of Industry and Internal Trade. Invest India focuses on sector-specific investor targeting and the formation of new partnerships to facilitate long-term investment in India.
  • All the sectors welcome investment from all foreign countries, which increases the chances to expand their business, and gives them vast opportunities.
  • India is also on the list of 100 countries in the index of ease of doing business.
  • India has shown an improvement in Foreign direct investment in the past years. According to a UN report, investment has increased by 16% from 2018 to 2019.
  • According to the new policy from the department of promotion of industry and Trade, a company in a country that shares a border with India or investors in India can invest only through the government method.
  • The Make in India initiative was launched with FDI in liberalized manufacturing norms.

FDI Boost in India

There have been several efforts by the government to increase FDI in India in the form of amendments and changes in government policies. The production-linked incentive scheme by the government for electronic manufacturing has been connected and attracted foreign direct investment from all over the world. Amendment in the policy of investment to allow automatic investment in various sectors has further influenced investors to invest more funds in Indian companies.

Government Change In Policy

The government also allows FDI in the digital industry, which opens the opportunity for the company because of excellent internet penetration and surge in connection and demands, which will give huge profits to investors.

The government makes the permission process easier for foreign investors by providing a portal to take approval through online modes. Foreign direct investment will increase because the investors seem influenced by the government’s new investment policy.

Role of FDI in the Indian Economy

The major advantages of the Foreign Direct Policy [FDI] include uplifting the business economy, it lends support to local companies. The advantages and disadvantages of FDI in India are listed below-

Advantages of FDI in India

  • It helps to enhance the business and the economy by supporting the local company which can do their own business and contributes considerably to the economy.
  • It will help in the development of big businesses and the expansion of local businesses. All of these will help to enhance the economy and reduce poverty.

Disadvantages of FDI in India

  • Foreign direct investment or exchange rate limits may be harmful to investors.
  • When a company invests in other countries, it can affect the investment in the companies in the domestic market.
  • Often, exchange rates are limited to benefit one company and derogate the benefit of another company.
  • Foreign direct investment is a capital-intensive deal, which makes it risky for the company to invest in a new start-up and business in the market due to the higher risk of failure.

Impact of Foreign Direct Investment on Indian Economy

Foreign direct investment can help increase the economy by transferring resources, skills, and technology to businesses that expand and grow. Every investment has a gestation period, and the return increases after a few years.

  • FDI also increases the company's assets by expanding the company's profit by improving cash flow by making an investment. This increases the productivity of the business & workers.
  • It makes the rupee strong compared to the dollar due to an increase in foreign countries' exports.
  • As consumption increases, which leads to an increase in the companies' income and a rise in tax revenue and government spending.

New FDI Policy in India

Foreign Direct Investment [FDI] in India is mainly made through two channels-The Automatic Route eliminates the need for a non-resident investor or an Indian corporation to seek Government of India clearance for their investment. The Reserve Bank of India manages Automatic Route. The Government Approval Route necessitates approval from the Indian government before investment. The administrative ministry/department in question reviews proposals for Foreign Direct Investment [FDI] through the government route are reviewed by the administrative ministry/department in question. The points below illustrate the main points of the FDI in India-

  1. To change the ownership in Foreign direct investment made by the company in an agreement, permission is required from the government in the agreement form.
  2. Investors not covered under the policy must notify the government after making a capital transaction rather than before the trade.
  3. According to the new law, China, along with Afghanistan and Bangladesh, have to invest through government methods, which means they have to take government permission, which was earlier limited to Afghanistan and Bangladesh.

Future of FDI in India

Foreign direct investment became the primary source of a growing economy which cannot be removed in the future, as it has become the prime economic regulation source. India's economic recovery after covid and market growth also increased the chances of more investment and attracted investors to the market soon.

Foreign direct investment contributes to the economy through money, skills, and technology, and these investments help the company gain higher profits and increase its experience in various businesses. This is also the best way to build good relations with foreign countries, which can help future trade and industry. Furthermore, FDI helps to know about other countries' businesses and their technology which can help do business in their own country.

Key Facts about the Foreign Direct Investment [FDI]

Foreign Direct Investment [FDI] is an essential part of India's economy. It boosts the financial economy and brings a mix of cultures into the country. Several factors like demographics, availability of the internet, etc., facilitate Foreign Direct Investment [FDI].

FDI Equity: FDI equity inflows increased by 112 per cent year over year in the April-July period of FY 2021-22 (USD 20.42 billion).

Top Sectors: The Automobile Industry has emerged as the leading sector, accounting for 23% of total FDI Equity inflow, followed by Computer Software & Hardware (18%) and the Services Sector (9%).

Leading the FDI Recipient States: Karnataka was the top recipient state during the period, accounting for 45 per cent of overall FDI Equity inflows, followed by Maharashtra (23%) and Delhi (2%). (12 per cent).

Government Initiatives to Attract Foreign Direct Investment [FDI]

Invest India's national investment promotion and facilitation agency was established in 2009. This is a non-profit venture run by the Ministry of Commerce and Industry's Department for Promotion of Industry and Internal Trade. Invest India focuses on sector-specific investor targeting and the formation of new partnerships to facilitate long-term investment in India.

  • The Make in India initiative was launched with FDI in liberalized manufacturing norms.
  • In certain sectors, the FDI ceiling has been raised.
  • To promote FDI influx, the Indian government changed its FDI policy.
  • The Financial Industry Regulatory Authority (FIRB) was disbanded.

Sectors in which Foreign Direct Investment [FDI] is Prohibited

The Government and private lotteries and internet lotteries are all part of the lottery business, and no FDI is allowed in all of these lotteries. Casinos, gambling, and betting are all examples of gambling and betting and hence are not open for Foreign Direct Investment [FDI].

  • Funds for chits
  • Nidhi is a corporation based in India and is not open to an FDI
  • Transferable Development Rights (TDRs)
  • Construction of Farm Houses or Real Estate Businesses
  • Manufacturing tobacco or tobacco substitutes for cigars, cheroots, cigarillos, and cigarettes
  • Activities/sectors that are not open to private sector investment, such as (I) atomic energy and (II) Railway operations, are two examples (other than permitted activities).

FDI UPSC Notes

Foreign direct investment UPSC is an important topic from the economics subject; the matter is crucial for UPSC Prelims, mains, and interview process; UPSC aspirants need to focus on the detail of this topic as per the UPSC syllabus and keep an account related to current affairs for excellent preparation.

Foreign Direct Investments UPSC PDF

To cover all related topics, candidates can also download UPSC Books or NCERT Books for UPSC. It is highly essential for the candidates to practice the previous year papers for the exam in order to get ideation of the types of questions asked in the exam.

FDI UPSC Prelims Sample Question

It is of high essentiality for the candidates to be completely conversant with the details of the Foreign Direct Investment [FDI] to be able to gain insights into the topic. The UPSC sample questions have been facilitated here for effective practice of the topic. Download the UPSC Previous Year Question Papers to practice and evaluate your comprehension of the topic.

Question- Consider the following: (2021)

  1. Foreign currency convertible bonds
  2. Foreign institutional investment with certain conditions
  3. Global depository receipts
  4. Non-resident external deposits

Which of the above can be included in Foreign Direct Investments?

  1. 1, 2 and 3
  2. 3 only
  3. 2 and 4
  4. 1 and 4

Answer- A

Other Important UPSC Notes
Comptroller and Auditor General of IndiaEmployees State Insurance
Sustainable Development Goals (SDGs)Collegium System
French RevolutionWorld Heritage Sites in India
BiodiversityBattle of Buxar
Freedom fighters of India2nd ARC Report
Payment BanksRowlatt Act
Preamble of Indian ConstitutionConstituent Assembly of India

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FAQs on FDI [Foreign Direct Investment]

  • Foreign direct investment is made by companies in other countries through foreign investors to make profits and long-term partnerships. In India, around a thousand of the company have made investments in the country, which include companies like JSW steel, Haldia petrochemicals, Mahindra, and Mahindra.

  • In most cases, FDI is prohibited in the sector which is open to the private sector, like gambling, getting into the railway, or in a sensitive area where the government does not want the control of a  foreign company, like in defence and telecommunication.

  • The Department for Promotion of Industry and Internal Trade administers all the Foreign Direct Investment [FDI]s that come through the Government route. One of the key factors of the Foreign Direct Investment [FDI] is that the equity inflows have increased by 112 percent.

  • Foreign direct investment helps to increase and expand the business in the market to a new sector through transferring resources like technology, money, skills, and skilled man. It leads to a boost in the economy and enhances the global market to attract more investors in the market.

  • The Department for Promotion of Industry and Internal Trade administers all the Foreign Direct Investment [FDI]s that come through the Government route. The two routes that one can follow for FDI are:

    • Automatic Route
    • Government Route
  • The term Foreign Direct investment means the investment that is made by a firm not located in India or a person who is a non-resident of India. The three components of Foreign Direct Investment [FDI] are:

    • Equity Capital
    • Reinvested Earnings
    • Intra-Company Loans
  • Foreign direct investment not only brings capital to the company but also increases the company's productivity. It also increases the technology, physical assets, and employment opportunity in the business and can enhance enterprises.

  • FDI was first introduced in India in 1991 by finance minister Dr. Manmohan Singh. Karnataka is the state that tops the list of recipients of Foreign Direct Investment [FDI] in India.

  • Certificate from the company secretary for the person or company whose residence is outside of the country in which they are making an investment. A certificate from the charted accountant indicates the manner of the price of the share issued to the person whose residence is outside.

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