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

By Mohit Choudhary|Updated : June 13th, 2022

                                                                                                                                                                                                                             

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

  • It became popular after globalization.
  • Globalization led the path to international investments.
  • In a globalized world, no country can stay isolated.
  • It requires mutual assistance. 

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

  1. Greenfield 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
  1. Brownfield Foreign Direct Investment
  • 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
  1. Horizontal Foreign Direct Investment
  • 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
  1. Vertical Foreign Direct Investment
  • 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
  1. Inward Foreign Direct Investment
  • 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
  1. Outward Foreign Direct Investment
  • 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)
  1. Conglomerate Foreign Direct Investment
  • 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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