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Lesson V: International Investment

International Investment is one of the International Investment provides an

investment strategies in which an investor opportunity for investors to capitalize on the
diversifies his portfolio by purchasing various good performance of the foreign economy if
financial Instruments like shares, mutual their domestic economy’s performance is
funds, etc. or investing to acquire ownership relatively bad. These investments are mostly
or collaboration in different companies across driven by the macroeconomy of the country
the globe in order to maximize the return and and most investor focus on the emerging
to reduce their exposure to various economy.
investment risks.

Types of International Investment Example #1 – FDI: Brownfield Investment:

(Tata & Corus deal)
On the basis of the use of investment foreign
investments are classified into two categories: Tata Steel one of the Indian steel market giants
 Foreign Direct Investment (FDI) acquired Corus Group plc, known as
 Foreign Portfolio Investment (FPI) one of the largest steel producers of the UK. The
deal was officially announced on April 2nd, 2007,
Foreign Direct Investment the total value of this acquisition was ₤6.2 billion
(US$12 billion). This states that Tata Steel an
FDI is an investment when the investor invests in a Indian company made a direct investment of ₤6.2
business situated on foreign land billion (US$12 billion) in the Corus Group plc a UK-
in order to acquire ownership or collaboration. based enterprise in order to acquire management
Through FDI investors establish a lasting control in the enterprise.
interest with the business entity that implies the
existence of the long-term relationship of the Example #2 – FDI: Greenfield Investment
investor with the enterprises with a significant
degree of influence on the management of the Investment by MNCs like Coca-Cola, Starbucks,
business. Accenture, etc. in various overseas countries is a
good example of greenfield investment. These
According to the Organization of Economic companies don’t enter the foreign market through
Cooperation and Development (OECD), mergers or acquisitions, they directly invest in the
the direct or indirect ownership of 10% or more of foreign economy to construct a new production
the voting power in the business by facility, offices, etc.
foreign investors are considered under the
category of FDI. Foreign Portfolio Investment (FPI)

FDI Transactions are done in mainly three ways: FPI is an investment made in a foreign economy by
 Greenfield Project an investor with no motive to gain any role in the
 Joint Ventures management of any organization. Foreign Portfolio
 Merger & Acquisition (M&A) also Investors purchase securities traded in another
called Brownfield investment country, which is highly liquid and can easily get
buyers when required. Such securities include
The three ways are explained below: instruments like stocks and bonds. FPI can be
short-term in nature in cases when the investor
1. Greenfield Projects: When FDI is used to wants a quick return due to a change in the
start an enterprise in a foreign country from exchange rate, interest rate, etc. Otherwise, the
scratch and don’t acquire an existing company to foreign portfolio investment is done with plans of
enter the market. Greenfield project also includes holding onto the asset for the long-term, and such
the construction of new plants, offices, etc. investments are driven by the growth rate of the
economy, Macroeconomic stability, Interest rates,
2. Joint Ventures: When FDI is used to enter etc.
in venture with the foreign corporations in
order to expand their business in a foreign country. Factors Affecting International Investment:

3. Brownfield Investment: It is another type In Case of FDI

of FDI transaction in which investment is used to  Ease of Doing Business of the country, like
merge or acquire an enterprise on foreign land. rules and regulations related to entry in
Joint Ventures and Brownfield investments are the market and to support operations of
mostly used to enter the foreign market. the new greenfield business.

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 Political and Social conditions of the the purchasing power of people and
economy. increase their standard of living.
 Policies on the functioning & structure of  Parent enterprises would also provide
markets (esp. competition & merger and investment to get additional expertise,
acquisition [M&A] Policies. technology, and products.
 Policies related to ease the business, such  As an Investor International Investment is
as investment promotion, incentives, an opportunity to expand his business,
improvements in amenities and other  diversify his portfolio, to get entry into the
measures to reduce the cost of business. new market.
 Privatization Policy.  Reduction in cost of production.
 Trade policy (barriers-tariff & non-tariff)  Tax Incentives
and coherence of FDI and trade policies.
Disadvantages
In Case of FPI  International Investment makes things
o National economic growth rates. tough for local companies by creating huge
o Exchange Rate stability. competition.
o General macroeconomic stability.  The risk of Political change will always be a
o Levels of foreign exchange concern for investors as it can lead to
reserves. expropriation.
o Interest rates.  Unstable Economic conditions can make
o Taxes on Capital gains your investment economically non-viable.
o Regulation of the stock and bond
markets International Investment can impact exchange
o Quality of domestic accounting and rates that can make things worse for the investor
or the target economy.
disclosure systems
o Dispute settlement systems of the
Investors through international investors can invest
economy and degree of protection
in foreign financial instruments and also expand
of investor’s rights.
their business in foreign territory. All the
International investments are done through FDI or
International Investment Calculation
FPI route. These investments are highly rewarding
but also carries risk with it, so it becomes very
The calculation of international investment is
important to do proper analysis and due diligence
explained below:
before making such investments.
Net Foreign Investment (NFI): NFI is also referred
Understanding the Types of International
to as net capital outflow from the economy. It is
Investments
the difference between net investment is done by
people in the overseas economy and net
There are two main categories of international
investment done by overseas people in the
investment—portfolio investment and foreign
domestic economy.
direct investment. Portfolio investment refers to
the investment in a company’s stocks, bonds, or
NFI= Net Outflow of Investment – Net Inflow
assets, but not for the purpose of controlling or
of Investment
directing the firm’s operations or management.
Typically, investors in this category are looking for
NFI includes Outflow and Inflow of both Foreign
a financial rate of return as well as diversifying
Direct Investment and Foreign Portfolio
investment risk through multiple markets.
Investment. It is also one of the important
parameters to analyze the Financial Condition of
Foreign direct investment (FDI) refers to an
the economy. A negative NFI states that the nation
investment in or the acquisition of foreign assets
is a debtor nation and vice versa.
with the intent to control and manage them.
Companies can make an FDI in several ways,
Advantages and Disadvantages of
including purchasing the assets of a foreign
International Investment
company; investing in the company or in new
property, plants, or equipment; or participating in a
Below are the different advantages and
joint venture with a foreign company, which
disadvantages of International Investment:
typically involves an investment of capital or know-
how. FDI is primarily a long-term strategy.
Advantages
Companies usually expect to benefit through
 Foreign Investment can stimulate the
access to local markets and resources, often in
country’s economy and also boost the local
exchange for expertise, technical know-how, and
industries.
capital. A country’s FDI can be both inward and
 International Investment creates new job
outward. As the terms would suggest, inward FDI
opportunities; this leads to an increase in
refers to investments coming into the country and

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outward FDI are investments made by companies These are just a few of the many factors that might
from that country into foreign companies in other influence a company’s decision. Keep in mind that
countries. The difference between inward and a company doesn’t need to sell in the local market
outward is called the net FDI inflow, which can be in order to deem it a good option for direct
either positive or negative. investment. For example, companies set up
manufacturing facilities in lowcost countries but
Governments want to be able to control and export the products to other markets.
regulate th flow of FDI so that local political and
economic concerns are addressed. Global There are two forms of FDI—horizontal and vertical.
businesses are most interested in using FDI to
benefit their companies. As a result, these two  Horizontal FDI occurs when a company is
players—governments and companies—can at trying to open up a new market—a retailer,
times be at odds. It’s important to understand why for example, that builds a store in a new
companies use FDI as a business strategy and how country to sell to the local market.
governments regulate and manage FDI.  Vertical FDI is when a company invests
internationally to provide input into its core
Factors That Influence a Company’s Decision operations—usually in its home country. A
to Invest firm may invest in production facilities in
another country. When a firm brings the
Let’s look at why and how companies choose to goods or components back to its home
invest in foreign markets. Simply purchasing goods country (i.e., acting as a supplier), this is
and services or deciding to invest in a local market referred to as backward vertical FDI. When
depends on a business’s needs and overall a firm sells the goods into the local or
strategy. Direct investment in a country occurs regional market (i.e., acting as a
when a company chooses to set up facilities to distributor), this is termed forward vertical
produce or market their products; or seeks to FDI. The largest global companies often
partner with, invest in, or purchase a local engage in both backward and forward
company for control and access to the local vertical FDI depending on their industry.
market, production, or resources. Many
considerations influence its decisions: Many firms engage in backward vertical FDI. The
auto, oil, and infrastructure (which includes
Cost: Is it cheaper to produce in the local market industries related to enhancing the infrastructure
than elsewhere? of a country—that is, energy, communications, and
Logistics: Is it cheaper to produce locally if the transportation) industries are good examples of
transportation costs are significant? this. Firms from these industries invest in
Market: Has the company identified a significant production or plant facilities in a country in order to
local market? supply raw materials, parts, or finished products to
Natural resources: Is the company interested in their home country. In recent years, these same
obtaining access to local resources or industries have also started to provide forward FDI
commodities? by supplying raw materials, parts, or finished
Know-how: Does the company want access to local products to newly emerging local or regional
technology or business process markets.
knowledge?
Customers and competitors: Does the company’s There are different kinds of FDI, two of which—
clients or competitors operate in the country? greenfield and brownfield—are increasingly
Policy: Are there local incentives (cash and applicable to global firms. Greenfield FDIs occur
noncash) for investing in one country versus when multinational corporations enter into
another? developing countries to build new factories or
Ease: Is it relatively straightforward to invest stores. These new facilities are built from scratch—
and/or set up operations in the country, or is there usually in an area where no previous facilities
another country in which setup might be easier? existed. The name originates from the idea of
Culture: Is the workforce or labor pool already building a facility on a green field, such as
skilled for the company’s needs or will extensive farmland or a forested area. In addition to building
training be required? new facilities that best meet their needs, the firms
Impact: How will this investment impact the also
company’s revenue and profitability? create new long-term jobs in the foreign country by
Expatriation of funds: Can the company easily take hiring new employees. Countries often offer
profits out of the country, or are there local prospective companies tax breaks, subsidies, and
restrictions? other incentives to set up greenfield investments.
Exit: Can the company easily and orderly exit from
a local investment, or are local laws and A brownfield FDI is when a company or
regulations cumbersome and expensive? government entity purchases or leases existing
production facilities to launch a new production
activity. One application of this strategy is where a

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commercial site used for an “unclean” business the control of local markets or industries in their
purpose, such as a steel mill or oil refinery, is citizens’ hands. Some countries, such as Malaysia,
cleaned up and used for a less polluting purpose, go even further and encourage that ownership be
such as commercial office space or a residential maintained by a person of Malay origin, known
area. Brownfield investment is usually less locally as bumiputra. Although the country’s
expensive and can be implemented faster; Foreign Investment Committee guidelines are
however, a company may have to deal with many being relaxed, most foreign businesses understand
challenges, including existing employees, outdated that having a bumiputra partner will improve their
equipment, entrenched processes, and cultural chances of obtaining favorable contracts in
differences. Malaysia.

You should note that the terms greenfield and Tax rates and sanctions. A company’s home
brownfield are not exclusive to FDI; you may hear government usually imposes these restrictions in
them in various business contexts. In general, an effort to persuade companies to invest in the
greenfield refers to starting from the beginning, domestic market rather than a foreign one.
and brownfield refers to modifying or upgrading
existing plans or projects. How Governments Encourage FDI

Why and How Governments Encourage FDI Governments seek to promote FDI when they are
eager to expand their domestic economy and
Many governments encourage FDI in their attract new technologies, business know-how, and
countries as a way to create jobs, expand local capital to their country. In these instances, many
technical knowledge, and increase their overall governments still try to manage and control the
economic standards. Countries like Hong Kong and type, quantity, and even the nationality of the FDI
Singapore long ago realized that both global trade to achieve their domestic, economic, political, and
and FDI would help them grow exponentially and social goals.
improve the standard of living for their citizens. As
a result, Hong Kong (before its return to China) was 1. Financial incentives: Host countries offer
one of the easiest places to set up a new company. businesses a combination of tax incentives
Guidelines were clearly available, and businesses and loans to invest. Home-country
could set up a new office within days. Similarly, governments may also offer a combination
Singapore, while a bit more discriminatory on the of insurance, loans, and tax breaks in an
size and type of business, offered foreign effort to promote their companies’
companies a clear, streamlined process for setting overseas investments. The opening case
up a new company. on China in Africa illustrated these types of
incentives.
In contrast, for decades, many other countries in 2. Infrastructure: Host governments
Asia (e.g., India, China, Pakistan, the Philippines, improve or enhance local infrastructure—in
and Indonesia) restricted or controlled FDI in their energy, transportation, and
countries by requiring extensive paperwork and communications—to encourage specific
bureaucratic approvals as well as local partners for industries to invest. This also serves to
any new foreign business. These policies created improve the local conditions for domestic
disincentives for many global companies. By the firms.
1990s (and earlier for China), many of the 3. Administrative processes and
countries in Asia had caught the global trade bug regulatory environment: Host-country
and were actively trying to modify their policies to governments streamline the process of
encourage more FDI. Some were more successful establishing offices or production in their
than others, often as a result of internal political countries. By reducing bureaucracy and
issues and pressures rather than from any regulatory environments, these countries
repercussions of global trade. appear more attractive to foreign firms.
4. Invest in education: Countries seek to
How Governments Discourage or Restrict FDI improve their workforce through education
and job training. An educated and skilled
In most instances, governments seek to limit or workforce is an important investment
control foreign direct investment to protect local criterion for many global businesses.
industries and key resources (oil, minerals, etc.), 5. Political, economic, and legal stability:
preserve the national and local culture, protect Host-country governments seek to
segments of their domestic population, maintain reassure businesses that the local
political and economic independence, and manage operating conditions are stable,
or control economic growth. A government use transparent (i.e., policies are clearly stated
various policies and rules: and in the public domain), and unlikely to
change.
Ownership restrictions. Host governments can
specify ownership restrictions if they want to keep Encouraging Foreign Investment

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Transport. The bribes were paid to officials in oil-

Governments seek to encourage FDI for a variety rich countries—Nigeria,
of reasons. On occasion, though, the process can Brazil, Azerbaijan, Russia, Turkmenistan,
cross the lines of ethics and legality. In November Kazakhstan, and Angola. In the United States,
2010, seven global companies paid the US Justice global firms—including ones headquartered
Department “a combined $236 million in fines to elsewhere, but trading on any of the US stock
settle allegations that they or their contractors exchanges—are prohibited from paying or even
bribed foreign officials to smooth the way for offering to pay bribes to foreign government
importing equipment and materials into several officials or employees of state-owned businesses
countries.” The companies included Shell and with the intent of currying business favors. While
contractors Transocean, Noble, Pride International, the law and the business ethics are clear, in many
Global Santa Fe, Tidewater, and Panalpina World cases, the penalty fines remain much less onerous
than losing critical long-term business revenues.

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Prepared by:

CHERRIE MAE S. GUMIA-RIVERA

Faculty-in-Charge

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