What is meant by foreign direct investment FDI?

What is foreign direct investment FDI and why is it important?

Foreign Direct Investment (FDI) (2024)

What is Foreign Direct Investment?

A foreign direct investment (FDI) is made by an individual or an organization, into a business located in a foreign country. The host nation receives job creation prospects, advanced technology, a higher standard of living, infrastructural development, and overall economic growth.

According to the Organization for Economic Co-operation and Development (OECD), any foreign investor possessing 10% or more ownership in a foreign organization is labeled a ‘lasting interest.’ Lasting interest status helps foreign individuals or organizations exercise a meaningful influence on the company’s management.

What is Foreign Direct Investment?
- Foreign Direct Investment Explained
- Factors Affecting FDI
- Methods of Foreign Direct Investment (FDI)
  - #1 – Greenfield Investments
  - #2 – Brownfield Investments
- Foreign Direct Investment (FDI) Example
  - Example #1
  - Example #2
- Types of Foreign Direct Investment (FDI)
- Foreign Direct Investment Advantages and Disadvantages
- Frequently Asked Questions (FAQs)
- Foreign Direct Investment Video
- Recommended Articles

Key Takeaways

Foreign direct investment (FDI) is a strategy for contributing funds and resources—to establish business units in foreign countries.
In addition to the funds, the investment includes technology, equipment, raw materials, knowledge, and management skills.
The investing companies get favorable deals—resources, workforce, facilities, land concessions, tax concessions, and subsidies. It gives investors an opportunity to expand their business into a new market.

Foreign Direct Investment Explained

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Foreign direct investment (FDI) is a method of business expansion—it involves international mergers, acquisitionsAcquisitionsAcquisition refers to the strategic move of one company buying another company by acquiring major stakes of the firm. Usually, companies acquire an existing business to share its customer base, operations and market presence. It is one of the popular ways of business expansion.read more, and the development of new facilities outside geographical boundaries. It is important for both—the investor nation and the host nation. The former gets tax benefits and relaxed regulations. The latter receives capital which can lead to growth.

Investing nations look for host nations possessing natural resources, human resources, technology, and ease of establishment. Host nations with a struggling economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more openly welcome investment.

Factors Affecting FDI

Following are favorable factors that a foreign investor looks for:

Open Economy: Foreign direct investments are made when a host nation possesses an open economy—welcoming investments from developed countries. Investors avoid capital investment in a closed economy.
Above-Average Growth: Usually, foreign investors are less interested in established markets. If a country is still developing with room for above-average growth, investments are more likely.
Environmental Stability: Investors prefer sound political environments and geographically well-positioned nations.
Skilled and Cheap Labour: Investors intend to employ affordable human resources with basic skills like communication and technical know-how.
Exchange Rate Stability: The exchange rates between the investor and host nations should not fluctuate too much.
Government Support: Investing companies often look for concessions—tax policies lenient towards the FDI.
Return on Investment: Investors anticipate high returns—there should be sufficient scope for profitability.
Good Infrastructure: Investors prefer countries that provide better infrastructureInfrastructureInfrastructure refers to fundamental physical and technological frameworks that a region or industry establishes for its economy to function properly.read more —networks, transportation, and other facilities that can further ease business operations.

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.

Foreign Direct Investment (FDI) Example

Example #1

Many American companies and European companies invested in Ukraine—Nestlé, ArcelorMittal, BASF, Bayer, and 1000 other businesses. However, amidst the 2022 Russian attacks on the host country, an evacuation was recommended. But, the businesses relied on their contingency plans to deal with the adversities—postponing evacuation.

Example #2

In 2020. during the Covid pandemic, popular companies invested in India—Google, Facebook, and Walmart. Moreover, Facebook made an FDI of $5.7 billion into Reliance Jio.

Types of Foreign Direct Investment (FDI)

Depending on the type of company(recipient), there are four different kinds of foreign direct investments (FDI):

Horizontal FDI: Here, investors put their money on foreign companies that operate in the same industry—niche in which the investor operates domestically. This way, firms expand their existing business into different nations.
Vertical FDI: When a company acquires or merges with a foreign company to add more value to its supply chain, it is called a vertical FDI. For example, if an automobile company invests in a foreign company manufacturing semi-conductor chips, the vertical integration would improve supply chain.
Conglomerate FDI: Here, investors invest in completely different segments—unrelated to their existing operations.
Platform FDI: It is a unique form of FDI—businesses invest in a foreign company to manufacture goods. They then sell the finished product in a third country.

Foreign Direct Investment Advantages and Disadvantages

Foreign Direct Investment (FDI) is an opportunity for emerging economies. At the same time, it paves the way for investors who want to expand into new geographical regions. Investors avail themselves affordable workforce, rare natural resources, cheaper setups, available land, tax benefits, and subsidies. Investors can tap into uncaptured market potential by investing in developing countries.

For the host nation, more investment means better infrastructure, flooding job opportunities, new technology, new machinery, and trained labor. Also, FDI stabilizes the host nation’s exchange rate, increases imports, improves exports, and encourages innovation.

However, there are a couple of drawbacks. FDI discourages domestic businesses; they can’t always compete with global players. It is a capital-intensive decision; natural calamities or political unrest occurring in a host nation can cause significant losses. Cultural differences also offer a challenge—many FDIs fail due to inefficient management and local protests.

Frequently Asked Questions (FAQs)

How does a foreign direct investment (FDI) affect economic growth?

Foreign Direct Investment (FDI) bridges the gap between a developed nation and a developing nation. It results in the economic growth of the host nation—new technology, capital investment, and multiple job opportunities.

What is the advantage of foreign direct investment?

Benefits for the developing nations:
– Capital investment and financing
– Infrastructure development
– More job opportunities
– Improves standard of living
– Technological advancement
– Economic growth
– Trained personnel
Advantages for FDI investors:
– Business expansion
– Cheap and skilled human resource
– Easy availability of raw material
– Tremendous growth opportunity
– Tax benefits, tariffs, and subsidies
– Newmarket acquisition

What are the four types of foreign direct investments (FDI)?

The four different types of foreign direct investment include:
1.Horizontal FDI
2.Vertical FDI
3. Conglomerate FDI
4. Platform FDI