After the introduction of Industrial policy 1991, also known as LPG Policy, the trend of foreign investments has gained much importance, globalization a tool that acts as a gateway to foreign investment wherein one country invest into the assets and capital in another country by foreign investors, a state where the capital flow takes place from one end to another to strengthen the economic growth of countries. It acts as an accelerator towards future economic growth and also helps in seeking new and brighter opportunities, foreign investment can be done through two paths: Foreign Portfolio Investment and Foreign Direct Investment.
Foreign Portfolio Investment (FPI): The term foreign portfolio investment refers to purchasing financial assets such as stocks, bonds, mutual funds, exchange-traded funds, American Depository Receipts (ADR’s), and Global Depository Receipts (GDR’s), and other securities by investors from another country, which is a part of country’s capital account and counts in its balance of payment (BoP) calculation.
Foreign Direct Investment (FDI): in layman terms, FDI or Foreign Direct Investment can be understood as an investment that is made by one country’s firm into the business interest located in another country, or an investment made by a domestic company into a company located in another country( foreign country). It assists in establishing foreign business operations in a foreign company thereby plays a major role in enhancing the exports of the country.
Importance of FDI
FDI is most commonly made by open economies or in open markets wherein they get a skilled workforce with a fair chance to expand their international presence which is being curtailed in case of tightly bind or closely regulated economies.
Let have a look at the importance of FDI:
- First and foremost importance is the creation of employment opportunities, investment in FDI helps in boosting sectors and increased employment means an increased income which in turn helps in increment of buying power which in return benefits the economy of the country.
- FDI assist in gaining access to the latest tools and technologies within different sectors whether it be financing, operations, IT, etc. Newer and advanced technologies, processes in the economy result in increasing the efficiency, effectiveness, and productivity of the industry and become a part of the economic development of the country.
- It encourages maintaining a stable exchange rate within the country by the continuous flow of foreign currency or foreign exchanges, which assists in maintaining the reserves of the foreign exchange within the country by the Central Bank.
- It Is beneficial for the countries with limited or scarce domestic reserves, it’s an opportunity for these nations to raise funding from global markets and thereby contributes to the economic growth of the nation.
- Helps in maintaining a healthy competitive environment which in turn reduces the monopolies of domestic firms hence assists in enhancing the creativity and innovative thinking towards processes, which in turn helps in providing quality products and in gaining access to a varied range of products to consumers.
- Various tax privileges are also been given to companies undertaking FDI, some allow deductions on foreign income, and most of the countries allow some benefits related to taxes to the firm undertaking it.
- It acts as an opportunity for a multinational corporation to expand its business operations and also gets an open door to access new and advanced production markets, with a permit to gain access to countries resources whether it be resources related to fossil fuels or skilled labour, expertise, and technologies.
- It helps in achieving and diversifying the individual investor portfolios as their holdings now diversify to the outside of a specific region, country, industry, and that covers a broader area for investment.
Types of FDI
Foreign Direct Investment can be classified under various heads which are as follows:
Based on the Direction of Investment-
- Inward FDI – Direct Investment of foreign firms into domestic firms or domestic assets is termed as Inward FDI. Examples are Honda, LG in the Indian Market.
- Outward FDI – Domestic Firms investing in foreign firms or assets or domestic firms taking control of foreign assets. Illustrations of outward FDI are ONGC, Ranbaxy, Tata Motors, etc in foreign firms. Outward FDI is also termed as Direct Investment Abroad(DIA).
Classification Based on Types of Activity –
- Horizontal FDI – When a firm in a foreign country invests in the same production activity just like the one performed in the domestic country then it is known as horizontal FDI. Several Multinationals that expanded internationally with the help of horizontal FDI’s are Pepsi, Samsung, etc.
- Vertical FDI – When a firm wants to sell its domestic operations or domestic outputs overseas or to a firm abroad then it is termed vertical FDI.
- Conglomerate FDI – When overseas firms are aimed at manufacturing processes or products that are not manufactured in domestic or home country then it is known as conglomerate FDI.
Classification Based on Investment Objectives-
- Resource Seeking FDI – Multinationals Enterprise invests in countries with availability of natural resources which in turn helps in gaining more privilege over competitors. This type of investment is generally seen in agro-processing metals like bauxite, copper, etc.
- Market Seeking FDI – This type of investment is generally done in another country to helps the investment firm in the reduction of transaction cost, and thereby helps in improving buyer understanding and bring it closer to the target market.
- Efficiency Seeking FDI – In this type of FDI, investing firms not only give access to markets but also economies of scope, international sourcing of inputs, geographical diversification.
Classification Based on Modes of Entry –
- Greenfield Investments – This type of investment helps in investing in the new creation facilities or the expansion of existing facilities. Firms generally enter the international market through the Greenfield modes of investment where production technology and technology skills are the key factors.
- Merger and Acquisitions – Mergers and Acquisitions are becoming important and crucial tools for firms looking for internationalization with the help of mergers and acquisitions (M&A’s) firms have in establishing overseas production facilities, and also for enhancing the competitiveness to protect and enhance the position by acquiring internationally.
Classification Based on Sectors
- Industrial FDI – When foreign firms invest in the manufacturing sector then this investment is known as industrial FDI
- Non – Industrial FDI –When foreign firms invest in the services sector then it is termed as a non-industrial sector.
Agencies that Tracks the Foreign Direct Investment Statistics –
Following are four agencies that generally keeps the track of FDI
- UN Conference on Trade and Development – It summarizes the recent FDI trends around the world, this agency publishes the Global Investment Trends Monitor.
- Organization for Economic Cooperation and Development – Quarterly FDI statistics are being published for its member countries by Organization for Economic Cooperation and Development, it also reports about both inflows and outflows.
- IMF publishes its first worldwide survey on Foreign Direct Investment in 2010, it covers investment positions for 72 countries. IMF receives help from the following organization the European Central Bank, Eurostat, the Organization for Economic Cooperation and Development, and the United Nations Conference on Trade and Development.
- The Bureau of Economic Analysis – It reports about the FDI activities related to the US affiliates by helping in providing financial and operating data of these affiliates. It tells about the US companies being acquired and the companies been created by foreign ones. It also helps in identifying the investment made by US companies in the overseas market.
Foreign Direct Investment (FDI) in India
FDI acts as a major monetary source for the economic development of India. Foreign companies directly invest in fast-growing Indian businesses to take benefit of cheaper wages and changing business environment.
Routes through which India gets FDI
- Automatic Route – Entering through this route does not require any prior approval from the Government of India or the Reserve Bank of India.
- Government Route – Entering this route means the prior nod or prior approval from the government.
The application for approval needs to be made through a portal named Foreign Investment Facilitation Portal, which facilitates a single-window clearance. The application will be forwarded to the respective ministry for approvals, then the approval/rejection decision will be made by them in consultation with the Department for Promotion of Industry and Internal Trade, Ministry of Commerce.
Sectors that are prohibited for FDI
Sectors that are strictly prohibited under any routes are as follows;
- Gambling and betting businesses lotteries
- Atomic Energy Generation
- Investment in Chit funds
- Housing and Real Estate ( except for township, commercial projects, etc)
- Agricultural and Plantation activities ( except for fisheries, animal husbandry, tea plantations, etc.)
- Cigar, Cigarettes and tobacco industry
FDI being a critical driver of the economic growth of the country which in turn helps in contributing a major share in improving the GDP of the country and thereby assist in maintaining a quality standard of living of the country’s people.
