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FDI (Foreign Direct Investment) : Meaning, Types, and Advantages

What is FDI ? FDI means Foreign direct investment. In the previous articles, we have given 7 Principles of Insurance and 6 Consumer Rights that Every Indian should be aware of. Today we are discussing FDI. Foreign direct investment (FDI) is an investment made by a company or individual in one country in business interests in another country, in the form of either establishing business operations or acquiring business assets in the other country, such as ownership or controlling interest in a foreign company. Foreign direct investments are distinguished from portfolio investments in which an investor merely purchases equities of foreign-based companies. The key feature of foreign direct investment is that it is an investment made that establishes either effective control of or at least substantial influence over, the decision making of a foreign business.

FDI (Foreign Direct Investment)

Classifications of Foreign Direct Investment

FDIs can be classified as;

  • Inward FDI and
  • Outward FDI, depending on the direction of flow of money.

Inward FDI occurs when foreign capital is invested in local resources. The factors propelling the growth of inward FDI include tax breaks, low-interest rates, and grants. Outward FDI, also referred to as “direct investment abroad”, is backed by the government against all associated risk.

Advantages of FDI

In the context of foreign direct investment, advantages and disadvantages are often a matter of perspective. An FDI may provide some great advantages for the MNE but not for the foreign country where the investment is made. On the other hand, sometimes the deal can work out better for the foreign country depending upon how the investment pans out. Ideally, there should be numerous advantages for both the MNE and the foreign country, which is often a developing country. We’ll examine the advantages and disadvantages from both perspectives, starting with the advantages for multinational enterprises (MNES).

  • Access to markets: FDI can be an effective way for you to enter into a foreign market. Some countries may extremely limit foreign company access to their domestic markets. Acquiring or starting a business in the market is a means for you to gain access.
  • Access to resources: FDI is also an effective way for you to acquire important natural resources, such as precious metals and fossil fuels. Oil companies, for example, often make tremendous FDIs develop oil fields.
  • Reduces cost of production: FDI is a means for you to reduce your cost of production if the labor market is cheaper and the regulations are less restrictive in the target foreign market. For example, it’s a well-known fact that the shoe and clothing industries have been able to drastically reduce their costs of production by moving operations to develop countries.

FDI also offers some advantages for foreign countries. For starters, FDI offers a source of external capital and increased revenue. It can be a tremendous source of external capital for a developing country, which can lead to economic development.

Three main determinants of FDI:

In fact, foreign direct investment can be financed through loans obtained in the host country, payments in exchange for equity (patents, technology, machinery etc.), and other methods. The previous criticisms, along with assuming market imperfections, led Hymer to propose the three main determinants of foreign direct investment:

  • Firm-specific advantages: Once domestic investment was exhausted, a firm could exploit its advantages linked to market imperfections, which could provide the firm with market power and competitive advantage. Further studies attempted to explain how firms could monetize these advantages in the form of licenses.
  • Removal of conflicts: conflict arises if a firm is already operating in the foreign market or looking to expand its operations within the same market. He proposes that the solution for this hurdle arose in the form of collusion, sharing the market with rivals or attempting to acquire a direct control of production. However, it must be taken into account that a reduction in conflict through the acquisition of control of operations will increase the market imperfections.
  • The propensity to formulate an internationalization strategy to mitigate risk: According to his position, firms are characterized by 3 levels of decision making: the day to day supervision, management decision coordination and long-term strategy planning and decision making. The extent to which a company can mitigate risk depends on how well a firm can formulate an internationalization strategy taking these levels of decision into account.

Investments/ developments

Some of the recent significant FDI announcements are as follows

  • BSH Home Appliances Group, one of the leading home appliances manufacturers worldwide, opened its first technology center in India at Adugodi, Bengaluru, which will enable the company to further develop localized technologies for the Indian market.
  • Ford Motor Co. plans to invest Rs 1,300 crore (US$ 189.2 million) to build a global technology and business center in Chennai, which will be designed as a hub for product development, mobility solutions, and business services for India and other markets.
  • JW Marriott plans to have 175-200 hotels in India over the next four years.
  • China-based LCD and touchscreen panel manufacturer, Holitech Technology, plans to invest up to US$ 1 billion in India next year, as per the company’s CEO Mr. Bingshuang Chen.
  • Mr. Abdul Lahir Hassan, Chairman of UAE-based Gamma Group, outlined plans of investing around Rs 3,000 crore (US$ 436.5 million) in the infrastructure, health and education sectors of Kerala, which is expected to generate around 2,000 indirect and direct jobs in the state.
  • Mr. Stephane Descarpentries, Director of Operations FM Logistic Asia, outlined plans of investing around EUR 50 million (US$ 52.9 million) in India in the next four years, to contribute to a better efficiency of logistics market in the country.
  • The first Incredible India Tourism Investment Summit 2016, which was organized from September 21-23, 2016, witnessed signing of 86 Memoranda of Understanding (MoUs) worth around Rs 15,000 crore (US$ 2.18 billion), for the development of tourism and hospitality projects.
  • Apple Inc has started its first development center outside the US in Hyderabad, which will employ over 4,000 people and focus on Apple Maps, the company’s digital maps, and navigation service.
  • Panasonic Corporation plans to set up a new manufacturing plant for refrigerators in India with an investment of Rs 250 crore (US$ 36.4 million), and also invest around Rs 20 crore (US$ 3 million) on an assembly unit for lithium ion batteries at its existing facility in Jhajjar in the next 8-10 months.
  • Vista Group Ltd, a Hong Kong-based professional services provider, has acquired IL&FS Trust Company Ltd, India’s largest independent corporate trust services provider, which will enable Vista to expand the platform to provide a broader suite of corporate and fiduciary services and thereby gain a foothold in the Indian corporate services market.
  • Silver Spring Capital Management, a Hong Kong-based equity hedge fund, plans to invest over 2,000 crores (US$ 291.0 million) in Hyderabad-based infrastructure developer Transstroy India Ltd, for the construction of highways in the country.

The foreign direct investor may acquire the voting power of an enterprise in an economy through any of the following methods:

  • by incorporating a wholly owned subsidiary or company anywhere
  • by acquiring shares in an associated enterprise
  • through a merger or an acquisition of an unrelated enterprise
  • participating in an equity Joint venture with another investor or enterprise

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