Study Notes on Foreign Direct Investment || Commerce || Management || Economics

By BYJU'S Exam Prep

Updated on: September 13th, 2023

Table of content

Foreign Direct Investment

Meaning

Foreign Direct Investment means the investment of funds by a firm or individual of any country in the rest of the world.
It is an active investment strategy because the investment is directly made in a foreign country.
Foreign Direct Investment is considered a growth engine in developing countries.
It is significant for developing countries as they require more funds for growth and development.
Foreign Direct Investment is considered as a difficult investment as it carries more risk and red-tapism.
It is different from the concept of FPI (Foreign Portfolio Investment), which is an indirect investment.
FPI involves the investment in the securities listed in the stock exchange.

Rationale behind Foreign Direct Investment

Advantages of Foreign Direct Investment

The receiving country will get more funds or resources.
Foreign Direct Investment will open new investment avenues in the market.
Foreign Direct Investment will act as a potential for growth.
Foreign Direct Investment will bring foreign exchange to the invested country. So, it can adjust its BOP deficits and earn more foreign exchange with them.
As the competition comes to the market, it will increase the invested market’s efficiency.
Along with improving efficiency, local business can make a competitive advantage.
As the Foreign Direct Investment brings sophisticated technology, there will be a development of technical know-how.
Better international relations
Increase ease of doing business
It will boost the morale of industries

Disadvantages to the Foreign Direct Investment

Adverse impact on indigenous industries, as their market is being taken away by the foreign company.
As a foreign company is taking the profits back to their home country, then the guest country won’t get benefitted.
If the Foreign Direct Investment is increased up to an uncontrollable level, it can affect national sovereignty like in the case of East India Company.
Resources will be taken back to the homeland by the foreign company
Environmental damage
Vested interests of the foreign country

Types of Foreign Direct Investment

Greenfield Foreign Direct Investment means investment in order to start a business from scratch.
It is a risky venture to start from the grass-root level.
The setting up costs is higher in the case of Greenfield Foreign Direct Investment
But there can be resistance from the part of the local community
There will be adequate freedom in operations as there is no past for the business
But arranging the resources, such man, material, money, is a challenge
Adjusting to the culture of the country is also a hard nut to crack
For example, if Coca-Cola (A US company) is a starting a company in India

It is the investment in existing production arrangements by a foreign firm.
An important form of Brownfield investment is merger and acquisition by foreign MNCs in India.
Arranging the resources, such man, material, money, is will be comparatively easy
Adapting to the country’s culture is easy, but when foreign officials are appointed it may have an adverse impact
For example, if Air Asia (A Malaysian company) is investing in Air India

Horizontal Foreign Direct Investment means investment in the same business but in a different country
A firm conducts the same model and activities abroad relating to the main business.
Normally it is done when the current business achieved the saturation point in the existing market
If Starbucks (A US coffee company) is investing in the coffee business in India

It involves the investment on different levels of the supply chain, For example, McDonald’s could purchase a large scale farm in the US to produce meat for their restaurant.
It can be either forward or backward
Vertical Foreign Direct Investment means forward integration or backward integration
Forward integration means a company is going forward in its supply chain and making an investment.
For example, if Apple (basically a production company based in the US) going to install Apple stores (Retail selling) in India.
Backward integration means a company is going backwards in its supply chain and making an investment.
For example, Wal-Mart (a retail chain giant) is going back to manufacturing the products in India

Inward Foreign Direct Investment simply means the Foreign Direct Investment coming to the country
Foreign Direct Investment is coming to a country in which the investment environment is good
For example, Coca-Cola is coming to invest in India

Outward Foreign Direct Investment means the Foreign Direct Investment going out of the country.
It happens when the country’s investment environment is not good
When the entity is enough invested or they want to go overseas markets
If Infosys (An Indian company) is going to invest in Google(A US company)

Conglomerate Foreign Direct Investment involves investment in an unrelated industry and market. It is done as part of a diversification strategy
For example, ACC cement (An Indian cement company) is starting an insurance company in Australia
There is no relation with the insurance company and the cement company

Factors affecting the flow of Foreign Direct Investment

Tariff and rates will affect the flow because the flow will be more to the tax heavens and low tariff countries
In international investments, political and country risk is important, as the instability of government can create situations which will hardly hit the business.
Ease of doing business is the barometer used by the companies to decide whether to invest or not. The ease of doing business rankings is published by the World Bank.
The international relations also affect the flow of Foreign Direct Investment
In short, political, economic, social, technological, legal and ecological environment developments affect the flow of Foreign Direct Investment

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