COURSE TITLE: DEVELOPMENT FINANCING

COURSE CODE: DVS 525

TOPIC:

FOREIGN DIRECT INVESTMENT AS A SOURCE OF FINANCING DEVELOPMENT

BY:

NWOSU CHIDERA CHRISTABEL

REG NO: PG/MSc/20/94363

LECTURER: DR. UGWUANYI

DATE: JANUARY, 2023.

FOREIGN DIRECT INVESTMENT AS A SOURCE OF FINANCING DEVELOPMENT

IN NIGERIA.

INTRODUCTION

Have you ever wondered how the rich got their wealth and then kept it growing? How the rich

nations keep getting richer? Investing is essential to good money management because it ensures

both present and future financial security. Not only do you end up with more money in the bank,

but you also end up with another income stream. Investing is the only way to achieve both

growing wealth and passive income. Foreign direct investment (FDI) is seen as a way of filling

the gap between domestic available supplies of saving, government revenue, human capital skills

and the desired level of resources needed to achieve growth and development targets. FDI is

believed to have filled the gaps in management, entrepreneurship and technology through

spillovers and other externalities. FDI occurs or takes place when a firm invests directly in

facilities to produce or market a product in a foreign country (Hill, 2005), and is usually embarked

upon by Multinational enterprises (MNEs) or Multinational corporations (MNCs). MNEs or

MNCs are firms that have business facilities or interest spread over several countries, but

controlled by a central headquarter (Stonner, Freeman, & Gilbert, 2007). MNES or MNCS are

believed to improve the foreign exchange position of a host country; its long-run impact may

reduce foreign exchange earnings in both the current and capital accounts of the balance of

payment (BOP). The growth of foreign investment has become more prominent in the world

economy due to its contribution to the growth and development of an economy. Nigeria is in the

forefront of African nations who depend fully on foreign goods and services.
CONCEPT OF INVESTMENT

An investment is an asset or item acquired with the goal of generating income or appreciation.

Appreciation refers to an increase in the value of an asset over time. When an individual

purchases a good as an investment, the intent is not to consume the good but rather to use it in the

future to create wealth.

Investment can also be defined as the commitment of current financial resources in order to

achieve higher gains in the future. It deals with what is called uncertainty domains. From this

definition, the importance of time and future arises as they are two important elements in

investment. Hence, the information that may help shape up a vision about the levels of certainty

in the status of investment in the future is significant. From an economic perspective, investment

and saving are different; saving is known as the total earnings that are not spent on consumption,

whether invested to achieve higher returns or not. Consumption is defined as one’s total

expenditure on goods and services that are used to satisfy his needs during a particular period.

The values of investment or saving, as well as consumption, can be determined at the

macroeconomic level, or at the individual level, through different statistical methods.

Investment is using money to purchase assets in the hope that the asset will generate income over

time or appreciate over time. Consumption, on the other hand, is when you purchase something

with the immediate intent of personal use and with no expectation that it will generate money or

increase in value. Investment also helps grow the economy because it creates economic activity,

such as the buying and selling of goods and services and employing people. Employed people get

paid and either save, invest, or spend their money. If they spend their money, businesses make

more profits. Businesses can then reinvest the profits in further business activities that
expand the economy. Of course, too much of a good thing can be bad. If everyone is investing,

then no one is consuming. If no one is consuming, consumer-orientated businesses, such as

restaurants and retail establishments, will suffer. This may lead to layoffs. The key is to find the

proper balance between investment and consumption.

CONCEPT OF FOREIGN DIRECT INVESTMENT

Foreign direct investment (FDI) is an ownership stake in a foreign company or project made by

an investor, company, or government from another country. Generally, the term is used to

describe a business decision to acquire a substantial stake in a foreign business or to buy it

outright to expand operations to a new region. The term is usually not used to describe a stock

investment in a foreign company alone.

FDI is described as investment made to acquire a lasting management interest (usually at least

10% of voting stock) and acquiring at least 10% of equity share in an enterprise operating in a

country other than the home country of the investor (Mwilima, 2003).

A foreign direct investment refers to a purchase of a particular organization’s interest by another

foreign organization. Such an organization or investor is located in a different country than the

organization whose interest is purchased. It involves a business decision whereby a significant

stake is acquired in a foreign business. Generally, organizations undertake FDI to expand

operations to a foreign location.

The International Monetary Fund’s Balance of Payments defines foreign direct investment as an

investment that is made to acquire a lasting interest in an enterprise operating in an economy

other than that of the investor, the investor’s purpose being to have an effective voice in the

management of the enterprise.

The United Nations 1999 World Investment involving a long term relationship and reflecting a

lasting interest and control of a resident entity in one economy(foreign direct investor or parent

enterprise) in an enterprise resident in an economy other than that of the foreign direct investor

(FDI enterprise, affiliate enterprise or foreign affiliate). Foreign direct investment is considered a

key driver of economic growth and development, as it can bring capital, technology, and jobs to

the host country. It can also help companies expand their global reach and access new markets.

Foreign direct investment as a category of international investment where resident entity in one

country obtains a lasting interest in an enterprise resident in another country. FDI can be in form

of equity capital, reinvested earnings and other capital (NBER, 2002). Beneficial as FDI can be,

especially for developing economies through technology transfer, increasing market liquidity,

increase resource absorption, its contribution can bring with it negativities in the form of loss in

domestic production control, distortion of the economy, damage of our lands and resources with

the emission coming from their industries, crowding of domestic enterprise through unfair

competition and mortality of infant industries.

An investment is called direct when the concept of control is introduced to it. In addition, direct

investment possesses some other features such as; high commitment of capital, personnel and

technology between countries, high access to foreign materials for either resources or products.

The ownership of a controlling interest in a foreign operation is the highest type of commitment

to foreign operations. For an investment to be considered direct therefore there has to be either a

minimum of 10 or 25 percent ownership of the voting rights or shares in a foreign enterprise. The
concept of control is very important in the operation of foreign direct investment because in most

cases, it is the single most important fact that motivates investors to be willing to transfer

technology and other competitive assets

TYPES OF FOREIGN DIRECT INVESTMENT

By now you know what FDI is. Let us now study its main types:

Horizontal Investment: Here, the organization establishes and runs the same business type in the

foreign nation as it does in its home nation. For example, A UK computer products provider

purchasing a chain of computer products stores in France.

Vertical Investment: Here, an organization, in another nation, purchases a complementary

business organization. For example, a UK furniture manufacturer acquiring an interest in a

foreign organization that provides it with wooden material.

Conglomerate Investment: Here, an organization invests in a foreign organization which has no

resemblance to its core operations. In conglomerate foreign direct investment, a certain amount of

money is invested in a foreign business by an organization. In many cases, that business is the

one that is related to the type of business of the organization. Sometimes, the investing

organization may invest in a new type of business with which it has no prior experience. A joint

venture is formed in this way. Usually, this happens as a joint venture since the home

organization lacks experience.

Platform Investment: It is a unique form of investment; businesses invest in a foreign company to

manufacture goods. They then sell the finished product in a third country.
COMPONENTS OF FDI

1. Equity capital: Equity capital is the foreign direct investor’s purchase of shares of an

enterprise in a country other than its own.

2. Reinvested earnings: This comprise the direct investor’s share (in proportion to direct

equity participation) of earnings not distributed as dividends by affiliates, or earnings not

remitted to the direct investor. Such retained profits by affiliates are reinvested

3. Intra-company loans: Intra-company loans or intra-company debt transactions refer to

short or long term borrowing and lending of funds between direct investors (parent

enterprise) and affiliate enterprises.

FOREIGN DIRECT INVESTMENT EXAMPLES CAN BE:

One of the best examples here is NAFTA,

The North Atlantic Free Trade Agreement (NAFTA).

Mergers

Acquisitions

Partnerships

The partnerships in FDI can be in various sectors such as follows:

Retail

Services

Logistics

Manufacturing
One of the most sweeping examples of FDI in the world today is the Chinese initiative known as

One Belt One Road (OBOR). This program sometimes referred to as the Belt and Road Initiative,

involves a commitment by China to substantial FDI in a range of infrastructure programs

throughout Africa, Asia, and even parts of Europe. The program is typically funded by Chinese

state-owned enterprises and organizations with deep ties to the Chinese government. Similar

programs are undertaken by other nations and international bodies, including Japan, the United

States, and the European Union.

WHY DO FIRMS GO ABROAD TO INVEST?

Firms invest in foreign countries either through partnership or establishing branches. These firms

which have branches globally are called Multinational Companies (MNCs). They invest in other

nation to access wider markets, formation of distribution networks and existence of available

cheap labor especially in developing countries. Here are some reasons why they go abroad to

invest;

1. LOWER YOUR COMPETITION IN GROWING MARKETS

Gaining a competitive advantage over current business competitors is one of the biggest reasons

to expand internationally. Businesses and organizations that initiate global expansion often do so

to gain a first-mover advantage. The move allows them to leave a saturated domestic market and

find new customers in developing markets. Moreover, entering new markets gives businesses

greater visibility. This allows their company to build strong brand awareness and a connection

with local consumers. Even when their domestic competitors do enter the market, they have the

advantage of having a more recognizable brand name. Lowering your competition does not only

apply to customers or consumers but also to suppliers. An international expansion can also help
your company find better suppliers and access new technologies that may boost business

operations. This can be one of the most popular reasons why companies go global.

2. OFFSET FLUCTUATIONS IN YOUR LOCAL MARKET

Global expansions and a diversified market presence offer your company a way to mitigate

longterm risks from the effects of a fluctuating local and global market. Triumphantly entering

new markets overseas allows companies to decrease their dependency on their local market.

Instead of feeling the brunt of one market’s highs and lows, companies can use the profitable

operations of one market to offset the negative performance of another. Another reason why

companies go global is so that they can take advantage of foreign markets to introduce unique

products and services based on local palates. A poorly performing product in domestic markets

may also be offset by introducing it in another country where customer preferences indicate a

better reception.
3. IMPROVE YOUR MARGINS

Going global gives businesses access to new talent pools and new technology. These may help

bring down production or operational costs, allowing companies to improve their profit margins.

Moving divisions to foreign countries is not a new concept. China, India, and other Asian

countries have gained a reputation for being economical production places. More affordable

talent, material, and labor costs allow businesses to keep manufacturing costs down while still

ensuring quality products and business performance. Entering a new market also allows you to

prolong the sales life of an existing product or service. In particular, products that are on a decline

locally due to market saturation may be positively received abroad. Instead of spending time and

money on new product development, companies can create a new revenue source by finding new

consumers for a previously successful product.

4. JUMP ON A UNIQUE OPPORTUNITY

Sudden changes within the management, the industry, or the local market are ideal openings for

expanding internationally. Mergers, acquisitions, and new office locations, in particular, are

opportunities you can capitalize on to move forward internationally. Unexpected events also

create unique opportunities for global expansion. A prime example is how businesses and

consumers across the world increasingly went digital when the pandemic hit. Experts at

UNCTAD noted a three-percentage point increase in e-commerce retail sales to 19% in 2020.

There has been a surge in e-commerce transactions and contactless payments as consumers move

to shopping online instead of in person. Consumers no longer limit themselves to what is locally

available. Rather, they are exploring overseas retailers and rewarding businesses that responded to

the increased demand for global payments support.

5. RESPOND TO DEMAND

One of the most common and most telling reasons why companies go global is the existence of

measurable demand. Companies that do not expand their operations to international markets after

seeing significant demand for their products and services miss out on highly lucrative

opportunities. It is increasingly easier to see how foreign markets respond to products, even ones

that are not yet available to them, thanks to the internet. When you see international consumers

showing interest in your goods, it is highly advised to try testing the market through a small

expansion. This way, companies can tentatively enter international markets while keeping risks

low, but at the same time have the leeway to scale up operations if the reception is favorable.

FACTORS FIRMS CONSIDER BEFORE INVESTING ABROAD

1. REGULATION AND COMPLIANCE

Businesses and organizations need to have a thorough understanding of the regulations and laws

in the country they are trying to enter. Unnecessary and avoidable compliance issues can greatly

slow down a company’s expansion. It may also negatively affect public perception.

Some regulatory proceedings and legal requirements you need to plan for are:

• Opening local bank accounts

• Registering tax requirements

• Getting necessary health and safety certifications

• Maintaining financial and corporate records

 Renting or buying commercial property

2. OPERATIONS

Smooth business operations rely on your chosen business model. You will need to adapt your

current business model to incorporate your expansion strategy and work in a new foreign market.

Having a functional infrastructure is also necessary for effective and efficient business operations.

Your company will also need to arrange local employee divisions to handle different departments,

such as human resources, payroll, accounting, and legal counsel.

3. FOREIGN MARKET RESEARCH

Understanding why companies go global is one thing. But actually going global is another. It’s a

major decision. As such, you need to make sure the foreign market you plan to enter is truly the

optimal choice for your business and your products or services. Researching Google Trends,

interviewing industry experts, and looking at stable economics are important when doing foreign

market research. Additionally, conducting a market analysis is essential before diving into a

foreign market. You need to know who your consumers are, their preferences, potential local

competitors, necessary taxes or regulations, and more.

4. PRODUCT DISTRIBUTION

Any company’s foreign expansion strategy should outline the product or service distribution. You

need to remain in control of your sales process to ensure a smooth delivery of goods to your new

customers. You need to figure out which type of distribution strategy would work best in an

international market. A well-constructed distribution strategy will allow your business to reach
the maximum potential customers while maintaining distribution costs at a minimum. If your

product distribution strategy is not properly thought through, it may lead to losses and market

expansion failure.
5. PAYMENT METHODS

When expanding internationally, it is imperative to allow global payments. Among two

companies that expanded internationally at the same time, the one with a seamless payment

system holds the competitive advantage. Your business can attract more consumers by providing

an easy and accessible way to pay. More so if your payment system allows customers to pay

using their local currencies. This lessens the hassle of opening a foreign currency account and

converting currencies themselves. Moreover, providing an option for mobile payment

transactions or integrating with a widespread local mobile payment system can help increase

consumers’ willingness to buy your product.

WHAT ARE THE ADVANTAGES AND DISADVANTAGES OF FDI?

FDI can foster and maintain economic growth, in both the recipient country and the country

making the investment. On one hand, developing countries have encouraged FDI as a means of

financing the construction of new infrastructure and the creation of jobs for their local workers.

On the other hand, multinational companies benefit from FDI as a means of expanding their
footprints into international markets. A disadvantage of FDI, however, is that it involves the

regulation and oversight of multiple governments, leading to a higher level of political risk.

The advantages of foreign direct investment can be enumerated as follows:

Best practices: It brings technology to developing nations. Besides, it brings the most efficient

management ideas to the business that is the recipient. Also, the recipient organization's

employees learn innovative ways of accomplishing goals prevalent internationally.

Consequently, the lifestyle of the workers in recipient organizations enhances.

High Standard of Living: Due to FDI, the living standard of the entire developing nation

increases. This is possible as the recipient organization receives a significant amount of money

due to foreign financing. Consequently, it pays a higher amount of taxes. This in turn benefits the

people of the developing nation.

Establishing stable long-term lending: A major benefit of FDI is that it removes the volatile effect

of hot money. Hot money refers to a capital whose transferring takes place frequently with the

aim of maximizing capital gain. Due to this, the entire nation can be ruined. With foreign direct

investment, this problem is effectively tackled.

DISADVANTAGES OF FDI

Danger to comparative advantage: Foreign direct investment is not appropriate for major

industries that are strategic to a nation. In case a nation allows foreign ownership in such

industries, it could lose its comparative advantage.

 There may be no real value: The aim of many organizations with FDI is to seek the maximum

value out of the foreign business while adding no real value in return. For example, these

foreigners could sell off less profitable organizational aspects to inferior non-worthy investors.

Most investors lack high ethical standards: In order to seek access to a foreign market, investors

go for immoral ways. For example, they can find lower-cost local loans by making use of the

organization’s collateral. Now, they may lend these funds to the parent organization rather than

reinvest.

What kind of reserves does FDI help maintain?

Foreign direct investment facilitates the maintenance of stable and secure foreign exchange

reserve levels. This way, the promotion of long-term lending takes place in the following

markets:

• Bond market

• Currency market

• Equity markets

What is meant by Greenfield FDI?

A Greenfield FDI investment is a type where a subsidiary is created by a parent organization

other than the home country. This way, an organization builds its operations from the basic

foundation in the new country.

What is brownfield investment?

A brownfield investment is one where a certain sum is invested by an organization in an existing

facility for initiating business processes in a foreign nation. We can look at this type of

investment as a lease or purchase of a facility that already exists in a foreign nation.

WHAT IS THE DIFFERENCE BETWEEN FOREIGN DIRECT INVESTMENT (FDI) AND

FOREIGN PORTFOLIO INVESTMENT (FPI)?

Foreign portfolio investment (FPI) is the addition of international assets to the portfolio of a

company, an institutional investor such as a pension fund, or an individual investor. It is a form of

portfolio diversification, achieved by purchasing the stocks or bonds of a foreign company.

Foreign direct investment (FDI) instead requires a substantial and direct investment in, or the

outright acquisition of, a company based in another country, and not just their securities.

FDI is generally a larger commitment, made to enhance the growth of a company. But both FPI

and FDI are generally welcome, particularly in emerging nations. Notably, FDI involves a greater

responsibility to meet the regulations of the country that hosts the company receiving the

investment.

WHAT IS THE DIFFERENCE BETWEEN FOREIGN DIRECT INVESTMENT (FDI) NET

INFLOWS AND NET OUTFLOWS?

FDI net inflows are the value of inward direct investment made by non-resident investors in the

reporting economy. FDI net outflows are the value of outward direct investment made by the

residents of the reporting economy to external economies.

Inward Direct Investment, also called direct investment in the reporting economy, includes all

liabilities and assets transferred between resident direct investment enterprises and their direct

investors. It also covers transfers of assets and liabilities between resident and nonresident fellow

enterprises, if the ultimate controlling parent is nonresident.

Outward direct investment, also called direct investment abroad, includes assets and liabilities

transferred between resident direct investors and their direct investment enterprises. It also covers

transfers of assets and liabilities between resident and nonresident fellow enterprises, if the

ultimate controlling parent is resident. Outward direct investment is also called direct investment

abroad.

Foreign direct investment is a category of cross-border investment associated with a resident in

one economy having control or a significant degree of influence on the management of an

enterprise that is resident in another economy. As well as the equity that gives rise to control or

influence, direct investment also includes investment associated with that relationship, including

investment in indirectly influenced or controlled enterprises, investment in fellow enterprises

(enterprises controlled by the same direct investor), debt (except selected debt), and reverse

investment. Implementation of the Balance of Payments Manual 6th Edition (BPM6)

methodology has brought changes to the definition of direct investment by making it consistent

with the OECD Benchmark Definition of Foreign Direct Investment, notably the recasting in

terms of control and influence, treatment of chains of investment and fellow enterprises, and

presentation on a gross asset and liability basis as well as according to the directional principle.

Data on FDI flows are presented on net bases (capital transactions' credits less debits between

direct investors and their foreign affiliates). Net decreases in assets or net increases in liabilities
are recorded as credits, while net increases in assets or net decreases in liabilities are recorded as

debits. Hence, FDI flows with a negative sign indicate that at least one of the components of FDI

is negative and not offset by positive amounts of the remaining components. These are instances

of reverse investment or disinvestment.

Data on FDI net inflows and outflows are based on the sixth edition of the Balance of Payments

Manual (2009) reported by the International Monetary Fund (IMF). Foreign direct investment

data are supplemented by the World Bank staff estimates using data from the United Nations

Conference on Trade and Development (UNCTAD) and official national source.

GOVERNMENT POLICIES ON FOREIGN DIRECT INVESTMENT

In recognition of its importance and role in the nation's economic growth process, the

government has put in place various policies and incentives to attract FDI to Nigeria. For

example, to augment the domestic shortfall of capital resources for the realization of sustainable

level of growth and development, the government expressed her readiness in the 1997 budget, to

enter into investment protection, agreements with foreign governments or private organizations

wishing to invest in Nigeria, as well as discuss additional incentives with prospective investors.

In this ' connection, the government inaugurated, the Nigerian Investment Promotion

Commission (NIPC), which replaced the Industrial Development Coordination Committee

(IDCC), as a one-stop agency that would facilitate the inflow of FDI. The IDCC was established

in 1988 for the purpose of fostering a conducive regulatory environment and serve as the first

port of call to a potential investor. The Nigerian Investment Promotion Decree No. 16 of 1995

reflected the new enhanced liberal foreign investment policy of the government. There were also
tax related incentive measures such as pioneer status, tax relief for Research and Development

which provides for a graduated amount of tax allowance to be deducted from profit; company

income tax which has been amended to encourage potential and existing investors; tax free

dividends as well as tax relief for investments in economically disadvantaged local government

area. The Debt Conversion Program (DCP) was also introduced as a major vehicle for the inflow

of foreign investment. The privatization and commercialization program in which government

disengage from activities that could be effectively undertaken by private economic agents was

among others meant to encourage the inflow of foreign investments. Similarly, the establishment

of the Export Processing Zone at Calabar was aimed at attracting more foreign investments

through provision of infrastructural facilities and elimination of bureaucratic bottlenecks. While,

the repeal of the Nigerian Enterprises Promotion Decree (NEPD) of 1972, and the Exchange

Control Act of 1962, were aimed at making the investment climate more conducive for foreign
investors.
CONCLUSION

Foreign capital and its role in global economy as well as in the economic development of nations

have remained significantly dominant and controversial. It has not only been requires as a

supplement to the available internal resources of the nation for growth and development, but its

utility has also continued to be the catalyst for rapid industrialization. In a developing and

changing economy with low capital base such as ours therefore, foreign direct investment of

sufficient magnitude and relevance becomes a valid complementary option. In Nigeria,

unnecessary delays and administrative bottlenecks, the persistent poor macroeconomic policy and

performance, the political instability among others have all combined to frustrate many recent

foreign investment policies put in place to woo foreign investors. Though we cannot ignore the

lack of patience on the part of the international community to understand the peculiarity of the

country at managing her own affairs, excessive reliance on Nigerian’s peculiar way of getting

things done makes Nigeria appear like a nuisance among community of nations. Since we do not

have differences in the way we hear, see, taste, smell and touch we must be ready to allow some

implantation of tested good ideas embraced by other countries.

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Investing101: A Tutorial for beginner investors http: //www .marketoracle.couk/

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