Foreign Direct Investment, or FDI, is one of the most crucial channels of direct investments between countries.
Unlike Foreign Portfolio Investments or FPIs, an investor in one country can hold a controlling stake of any business or organization in a foreign country that receives the investment. FDI is also a significant and insightful indicator of a certain country's political and socio-economic stability.
This essentially implies a country that receives large amounts of investments from foreign entities on a regular basis is more likely to have a dynamic and vibrant economy.
How Does FDI Work?
Foreign investments can be either 'organic' or 'inorganic'. With organic investments, a foreign investor will pump in funds to expand and accelerate growth in established businesses.
Inorganic investments are instances when an investing entity buys out a business in its target country.
In developing and emerging economies like India and other parts of South-East Asia, FDIs offer a much-needed fillip to businesses that may be in poor financial shape.
The Government of India has undertaken several measures to ensure that larger chunks of investments pour into the country across sectors including defence production, the telecom sector, PSU oil refineries and IT.
Since Foreign Direct Investment is a non-debt financial resource, it has the potential to become a major driver of economic development in India.
Globalization and internationalization are 2 factors which made FDI possible. However, the celebrated Canadian economist Stephen Hymer, considered the 'Father of International Business', theorized in the 1960s that foreign investments would continue growing rapidly because -
- It provided control over companies in a foreign land.
- It helped certain business sectors overthrow monopolistic practices, and
- Most importantly, since market imperfections will always exist, such investments provide companies with a cushioning effect if there was a sharp and unpredictable decline in business activity.
Types of FDI
The following are the main types of Foreign Direct Investment -
Type | Definition |
Horizontal | The first type is observed whenever a business expands and enters a foreign country via the FDI route without changing its core activities. An example would be McDonald's investing in an Asian country to increase the number of stores in the region. |
Vertical | Here, a business enters a foreign economy to strengthen a part of its supply chain without changing its business in any way. If McDonald's bought a large-scale meat processing plant in Canada or in a European country to bolster its meat supply chain in the target nation, it would amount to vertical FDI. |
Conglomerate | This 3rd type is noticed whenever a business invests in a foreign country and buys an entity which manufactures totally different products. The idea is to add more business niches and start new journeys in other countries. In the late 1980s, Sir Richard Branson's Virgin Group launched clothing stores in France, called 'Virgin Clothing'. The venture, however, failed miserably and very few outlets remain, mostly in the Middle-East. |
Platform | The last type refers to the expansion of a business to a foreign country, but everything manufactured there is exported to a third country. Platform FDI is seen in free-trade zones of FDI-hungry countries. Almost all luxury items marketed by famous fashion brands are manufactured in countries like Bangladesh, Vietnam and Thailand. They are then sold in other countries, a clear case of platform FDI at work. |
FDI Examples
Over the last decade, India has witnessed a steady flow of Foreign Direct Investment. From pharmaceuticals to automobiles, textiles to railways, nearly every sector has received significant sums of foreign investment.
The Importance of FDI cannot be undermined. It has resulted in infrastructure improvements, led to job creation, increased exports, and helped the formal sector to a great extent.
Here are some notable examples of recent foreign investments in India -
- Byju's, an online Ed-Tech firm, raised USD 500 million in a Silver Lake-led funding round in September 2020. Silver Lake is a noted US equity and VC firm.
- Also, in September 2020, Unacademy- a competitor of Byju's in the same niche - raised a total of USD 150 million. Japan's SoftBank Group led the round.
- Google picked up 7.73% of Reliance's 'Jio Platforms' for USD 4.5 billion, making it one of the biggest deals in recent Indian corporate fundraising sessions.
- General Atlantic, one of New York's most respected equity firms, invested more than USD 900 million for a stake in Reliance's 'Jio Platforms' in June 2020.
Data show that the majority of Foreign Direct Investment in India came from 5 countries- Singapore, the USA, Japan, the Netherlands, and Mauritius.
Pros and Cons of FDI
Despite its many benefits, FDIs have their share of cons. Following is an analysis of both these sides -
Advantages of Foreign Direct Investment –
- For businesses, more FDI means preferential tariffs, tax breaks or incentives, and an ability to diversify further.
- For a country that receives foreign funds, some benefits include greater employment opportunities, a stimulus to its domestic economy, and access to some of the latest technologies and modern management methods.
Disadvantages of Foreign Direct Investment-
- Local businesses lose out as big corporations take over markets. One example is Walmart, which was accused of ruining age-old smaller stores with its deep pockets.
However, Walmart's foray was not successful; its entire portfolio is now owned by Flipkart.
- There is always the risk of profit repatriation, which means that any profits generated in India will not enter the domestic economy.
There is no doubt that Foreign Direct Investment will continue to rise in India exponentially. The Central Government has made some sectors 100% open to FDIs. India's Airlines are one of these sectors.
As more global players enter the domestic market, it is the consumers who will benefit the most due to intense competition.
FAQs
Foreign direct investments are commonly categorized as horizontal, vertical, or conglomerate. With a horizontal FDI, a company establishes the same type of business operation in a foreign country as it operates in its home country. A U.S.-based cellphone provider buying a chain of phone stores in China is an example.
What is an example of a FDI? ›
Below are some examples:
- Acquiring voting stock in a foreign company.
- Mergers and acquisitions.
- Joint ventures with foreign corporations.
- Starting a subsidiary of a domestic firm in a foreign country.
Foreign direct investment (FDI) is the category of international investment that reflects the objective of obtaining a lasting interest by an investor in one economy in an enterprise resident in another economy.
What is foreign direct investment FDI and why is it important? ›
Foreign Direct Investment refers to the investment made by a company or an individual from one country to a business located in another country. This investment can be of various forms, including the creation of a new business, the acquisition of an existing company, or a joint shareholder of a foreign company.
What is FDI and how it works? ›
Any investment from an individual or firm that is located in a foreign country into a country is called Foreign Direct Investment. Generally, FDI is when a foreign entity acquires ownership or controlling stake in the shares of a company in one country, or establishes businesses there.
What is a non example of FDI? ›
The correct answer is The purchase of bonds or stocks issued by Pharma Company overseas.
What are examples of FDI benefits? ›
Here are some of the advantages of FDI:
- Boosts a nation's economic growth and development.
- Creates ease in international trade.
- Facilitates job creation.
- Drives human capital development.
- It helps provide tax incentives.
- Assists in the transfer of skilled resource.
Sector-wise FDI Equity Inflows during April-September 2022
During the first half of this fiscal, Singapore emerged as the top investor. It was followed by Mauritius, the U.A.E., the U.S.A., the Netherlands and Japan.
What does FDI mean in simple words? ›
Foreign direct investment (FDI) is a category of cross-border investment in which an investor resident in one economy establishes a lasting interest in and a significant degree of influence over an enterprise resident in another economy.
How does FDI affect economic growth? ›
However, the higher productivity of FDI holds only when the host country has a minimum threshold stock of human capital. In addition, FDI has the effect of increasing total investment in the economy more than one for one, which suggests the predominance of complementarity effects with domestic firms.
FDI has accelerated investment in new infrastructure. E.g. the Addis Ababa – Djibouti road; provides coastal access for land-locked Ethiopia. Other projects include dams and airports, mines and wind farms providing opportunities for African nations to grow capacity in renewable energy.
What are the two main types of FDI? ›
FDI can take two different forms: Greenfield or mergers and acquisitions (M&As).
- greenfield investment involves the creation of a new company or establishment of facilities abroad. ...
- mergers and acquisitions amounts to transferring the ownership of existing assets to an owner abroad.
FDI is primarily a long-term strategy. Companies usually expect to benefit through access to local markets and resources, often in exchange for expertise, technical know-how, and capital. A country's FDI can be both inward and outward.
What is FDI advantages and disadvantages? ›
FDI Advantages And Disadvantages In Tabular Form
| Advantages | Disadvantages |
|---|
| 1. Capital Infusion and Job Creation | 1. Risk of Political Instability |
| 2. Transfer of Technology and Skills | 2. Negative Effects on Domestic Firms |
| 3. Increased Competition and Productivity | 3. Dependence on Foreign Investment |
2 more rowsMar 31, 2023
There are many ways in which FDI benefits the recipient nation:
- Increased Employment and Economic Growth. ...
- Human Resource Development. ...
- 3. Development of Backward Areas. ...
- Provision of Finance & Technology. ...
- Increase in Exports. ...
- Exchange Rate Stability. ...
- Stimulation of Economic Development. ...
- Improved Capital Flow.
Top recipients of FDI inflows worldwide in Q3 2022 were the United States (USD 86 billion), Ireland (USD 37 billion) and the United Kingdom (USD 36 billion).
What is the most common form of FDI? ›
Horizontal direct investment is perhaps the most common form of direct investment. For horizontal investments, a business already existing in one country establishes the same business operations in a foreign country.
Who is the largest source of FDI? ›
The United States recorded the largest increase of inward foreign direct investment of all economies in 2021.
What are the 3 components of FDI? ›
FDI has three components: equity capital, reinvested earnings and intra-company loans.
What are the 3 major types of investment styles? ›
It will be the way you divide your contributions among the three basic investment categories: stocks, bonds and stable value money market funds.
inward foreign direct investment and outward foreign direct investment (resulting in a net FDI inflow (positive or negative) and "stock of foreign direct investment", which is the cumulative number for a given period.)
What are the components of the FDI? ›
Three components of FDI are usually identified: equity capital, reinvested earnings, and intracompany loans. Other than having an equity stake in an enterprise, foreign investors may acquire a substantial influence in many other ways.
What causes FDI? ›
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. Foreign firms often are attracted to invest in similar areas to existing FDI.
How does FDI help growth? ›
FDI creates new jobs and more opportunities as investors build new companies in foreign countries. This can lead to an increase in income and mor purchasing power to locals, which in turn leads to an overall boost in targetted economies.
How does FDI affect income distribution? ›
The findings show that FDI reduces the income inequality for countries with well- developed absorptive capacity more than for those countries whose absorptive capacity is less developed. That is, FDI could be harmful to the income distribution of those host countries that have low levels of absorptive capacity.
What are the 4 methods of FDI? ›
There are four major modes through which firms undertake foreign direct investment (FDI): merger and acquisition (M&A), joint venture, new plant, and others. The four modes of FDI are distinct from each other, and each has its own unique advantages and disadvantages.
Who are the 5 largest investors of FDI? ›
According to the latest results of our Coordinated Direct Investment Survey , and as shown in our Chart of the Week, the world's top ten recipients of foreign direct investment by end-2020 were the United States, the Netherlands, Luxembourg, China, the United Kingdom, Hong Kong SAR, Singapore, Switzerland, Ireland, and ...
