Project on FDI

What is FDI?
Foreign direct investment (FDI) is when a company takes controlling ownership in
a business entity in another country. With FDI, foreign companies are directly
involved with day-to-day operations in the other country. This means they aren’t
just bringing money with them, but also knowledge, skills and technology.
FDI serves as a means for companies to expand their operations beyond their
home country’s borders. It can bring in new capital, technology, management
expertise, and access to new markets.
Broadly, foreign direct investment includes mergers and acquisitions, building new
facilities, reinvesting profits earned from overseas operations, and intra company
loans. In a narrow sense, foreign direct investment refers just to building new
facility, and a lasting management interest (10 percent or more of voting stock) in
an enterprise operating in an economy other than that of the investor.[2] FDI is
the sum of equity capital, long-term capital, and short-term capital as shown in
the balance of payments.
Advantages of FDI
Foreign Direct Investment (FDI) can bring several advantages to both the host
country and the investing company such as :-
1. Economic growth:- Foreign Direct Investment (FDI) has been one of the
most fascinating and intriguing topics among researchers in international
business. It is one of the significant forms of rapid international expansion
to increase ownership of assets, derive location-specific advantages and
acquire additional knowledge.
Important effect of FDI is its contribution to the growth of the economy. FDI
has an impact on country’s trade balance, increasing labour standards and
skills, transfer of new technology and innovative ideas, improving
infrastructure, skills and the general business climate. FDI also provides
opportunity for technological transfer and up gradation, access to global
managerial skills and practices, optimal utilization of human capabilities and
natural resources, making industry internationally competitive, opening up
export markets, providing backward and forward linkages and access to
 international quality goods and services and augmenting employment
opportunities.
2. Job creation :- FDI creates new job in a nation. Especially in developing one,
its service and manufacturing sectors receive a boost, which in turn results
in the creation of jobs. Employment, in turn, results in the creation of
income sources for many. People then spend their income, thereby
enhancing a nation’s purchasing power.

3. Transfer of technology and skills:- The entire process of foreign direct

investment is robust. For instance, when foreign direct investment occurs,
businesses are provided with access to the latest tools in technology,
finance, and operational practices. As time passes, introducing enhanced
technologies gets integrated into the local economy. This makes the fin-tech
industry more effective and efficient.

4. Infrastructure Development: FDI can lead to improvements in

infrastructure, such as roads, ports, and telecommunications, as companies
require these facilities for their operations.

5. Development of human resource:- FDI aids with the development of

human resources, especially if there is transfer of training, technology and
best practices. The employees, also known as the human capital, are
provided adequate training and skills, which help boost their knowledge on
a broad scale. But if you consider the overall impact on the economy,
human resource development increases a country’s human capital quotient.
As more and more resources acquire skills, they can train others and create
a ripple effect on the economy.

6. Increased export:- The goods that are produced through FDI are marketed
domestically and exported abroad, creating an essential revenue stream.FDI
helps improve a country’s exchange rate and creates a competitive market
and capital inflow and it helps smooth international relations.
7. Stability and Long-Term Commitment: FDI can contribute to the stability of
a host country’s economy as foreign investors typically make long-term
commitments.

8. Government Revenue: FDI can generate tax revenue for the host
government through corporate taxes, import duties, and other fees. And As
a foreign investor, you can get tax incentives that will be highly useful in the
selected business area.

Types of FDI
Foreign Direct Investment (FDI) can take various forms, depending on the
nature of the investment and the level of control exerted by the investing
entity. Here are the primary types of FDI:-

1. Horizontal FDI:- Horizontal FDI is the most common type of FDI. In a

horizontal FDI, a company invests its funds in a foreign company belonging
to the same industry or business. Here, a company invests in another
company located in a different country but produces similar goods.
An example of horizontal FDI is Spain-based company Zara investing in the
Indian company Fab India, which produces similar products as Zara. Both
these companies belong to the merchandise and apparel industry.

2. Vertical FDI:- Vertical FDI is another common type of FDI which occurs when
a company invests in the supply chain of a foreign company, which may or
may not belong to the same industry. Through vertical FDIs, a company
looks to invest in a foreign company that might become its supplier or
buyer. Vertical FDIs are further classified into backward vertical integrations
and forward vertical integrations.
 3. Conglomerate FDI:- When investments are made in two completely
different companies of entirely different industries, the transaction is
known as conglomerate FDI. As such, the FDI is not linked directly to the
investors business. For instance, the US retailer Walmart may invest in TATA
Motors, the Indian automobile manufacturer.

4. Platform FDI:- The last type of FDI on this list is platform FDI. It occurs when
a company expands its base in a foreign country only to export the output
to a third country. In other words, the investing company uses the foreign
country as a platform to manufacture its products and then exports them to
other countries. For example, almost all luxury fashion brands manufacture
their products in countries like Bangladesh, Thailand, and Vietnam and then
export them to their target countries, such as France, Spain, etc.
Methods of Foreign Direct Investment (FDI)
Prominent FDI routes are as follows:
1. Greenfield Investments:-Many companies start everything from scratch
when operating in a foreign country. They build new factories and train the
workforce. McDonald’s and Starbucks India are examples of that. Both
started from scratch and became prominent in a foreign nation. These are
called greenfield investments.

2. Brownfield Investments:- It can be viewed as a shortcut. Some foreign

businesses decide not to start from scratch—they save time and effort.
Instead, they expand their business by going for cross-border mergers. As a
result, they can operate right away. Tata Motors’ acquisition of Jaguar is one
such example. Tata did not need to build a new factory in the UK. Instead,
they picked up where Jaguar left; from the existing factory.

Factors affecting foreign direct investment

1. Wage rate:-A major incentive for a multinational to invest abroad is
to outsource labour Intensive production to countries with lower
wages. If average wages in the US are $15 an hour, but $1 an hour in
the Indian sub-continent, costs can be reduced by outsourcing
production. This is why many Western firms have invested in clothing
factories in the Indian sub-continent. However, wage rates alone do
not determine FDI, countries with high wage rates can still attract
higher tech investment. A firm may be reluctant to invest in Sub-
Saharan Africa because low wages are outweighed by other
drawbacks, such as lack of infrastructure and transport links.

2. Labour skills:- Some industries require higher skilled labour, for

example pharmaceuticals and electronics. Therefore, multinationals
will invest in those countries with a combination of low wages, but
high labour productivity and skills. For example, India has attracted
significant investment in call centres, because a high percentage of
the population speak English, but wages are low. This makes it an
attractive plane for outsourcing and therefore attracts investment.

3. Tax rate:- Large multinationals, such as Apple, Google and Microsoft

have sought to invest in countries with lower corporation tax rates.
For example, Ireland has been successful in attracting investment
from Google and Microsoft. In fact it has been controversial with
because Google has tried to funnel all profits through Ireland, despite
having operations in all European countries

4. Transport and infrastructure:- A key factor in the desirability of

investment are the transport costs and levels of Commerce-
infrastructure. A country may have low labour costs, but if there is
then high transport coots to get the goods onto the world market,
this is a drawback. Countries with access to the sea are at an
advantage to landlocked countries, who will have higher costs to ship
goods.
5. Size of economy/potential for growth:- Foreign direct investment is
often targeted to selling goods directly to the country involved in
attracting the investment. Therefore the size of the population and
scope for economic growth will be important for attracting
investment. For example, Eastern European countries, with a largo
population, eg, Poland offers scope for new markets. This may attract
foreign car firms, eg Volkswagen, Fiat to invest and build factories in
Poland to sell to the growing consumer class. Small countries may be
at a disadvantage because it is not worth investing for a small
population. China will be target for foreign investment as the new
emerging Chinese middle class could have very strong demand for
the goods and services of multinationals.

6. Political stability/property rights:- Foreign direct investment has an

element of risk. Countries with an uncertain political situation, will be
a major disincentive. Also, economic crisis can discourage investment
For example, the recent Russian economic crisis, combined with
economic sanctions, will be a major factor to discourage foreign
investment. This is one reason why former Communist countries in
the East are keen to join the European Union. The EU is seen as a
signal of political and economic stability, which encourages foreign
investment Related to political stability is the level of corruption and
trust in institutions, especially judiciary and the extent of law and
order.

7. Commodities:- One reason for foreign investment is the existence of

commodities. This has been a Major reason for the growth in FD
within Africa – often by Chinese firms looking for a secure supply of
commodities

8. Clustering effects:- Foreign firms often are attracted to invest in

similar areas to existing FOI. The reason is that they can benefit from
external economies of scale-growth of service industries and
transport links. Also, there will be greater confidence to invest in
areas with a good track record. Therefore, some countries can create
 a virtuous cycle of attracting Investment and then these initial
investments attracting more. It is also sometimes known as an
agglomeration effect.

9. Access to free trade areas:- A significant factor for firms investing in

Europe is access to EU Single market, which is a free trade area but
also has very low non-tariff barriers because of harmonisation of
rules, regulations and free movement of people. For example, UK
post-brexit is likely to be less attractive to FDI, if it is outside the
Single Market

10. Exchange rate:- A weak exchange rate in the host country can attract
more FDI because it will be cheaper for the multinational to purchase
assets. However, exchange rate volatility could discourage
investment.

Evaluation
There are many different factors that determine foreign direct investment (FD)
and it is hard to isolate individual factors, given there are many different variables.
It also depends on the type of industry. For example, with manufacturing FDL low
want costs tend to be the most important, as they are a labour intensive industry.
For service sector FDL macro-economic stability and political openness tend to be
more import it.