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Published by: Minhaz Iqbal Hazarika on Jan 21, 2011
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Foreign Direct Investment
‡ FDI refers to the purchase of a significant stake in the ownership of a foreign company in order to gain a certain degree of management control. Essentially, FDI involves international flow of capital. ‡ FDI is needed to fill the resource gaps that prevail in developing countries. The other reasons are to generate healthy competition, act as nucleus of growth.

‡ To fill the gaps in domestic saving and other resources. ‡ MNCs act as an agent of growth in developing countries. ‡ MNCs pose healthy competition to firms in recipient countries. ‡ Locational advantages attract FDI ‡ Poor countries need much more FDI than others

The parent enterprise through its foreign direct investment effort seeks to exercise substantial control over the foreign affiliate company. A parent business enterprise and its foreign affiliate are the two sides of the FDI relationship. Ownership share amounting to less than that stated above is termed as portfolio investment and is not categorized as FDI . which is in a different nation distinct from the investor's country of origin. 'Control' as defined by the UN. For an unincorporated firm one needs to consider an equivalent criterion. is ownership of greater than or equal to 10% of ordinary shares or access to voting rights in an incorporated firm.Definition of Foreign Direct Investment ‡ Foreign direct investment is that investment. which is made to serve the business interests of the investor in a company. Together they comprise an MNC.

FDI inflow in India is said to include the following: 1. Reserve Bank of India¶s automatic approval route for equity holding up to 51 percent. Foreign Investment Board¶s discretionary approval route for larger projects with equity holding greater than 51 percent. 2. Specifically. FDI is understood to cover a few more routes than the equity route stated above.NATURE of FDI In India. .

and 5. reinvested earnings. IMF¶s definition includes external commercial borrowings.NATURE of FDI 3. The Indian definition of FDI differs from that of the IMF. while the World Investment Report excludes external commercial borrowings. . External commercial borrowings (ADR/GDR route). 4. as well as of the World Investment Report. RBI¶s non-resident Indian (NRI) schemes. Acquisition of shares (since 1996).

Foreign direct investment. Flow of Inward FDI may face restrictions from factors like restraint on ownership and disparity in the performance standard. is a typical form of what is termed as 'inward investment'. loans on low rates of interest and specific grants. relaxation of existent regulations. Here. . which is being invested in some foreign resource. Outward FDI may also find use in the import and export dealings with a foreign country. which is outward. The idea behind this is that. The factors propelling the growth of Inward FDI comprises tax breaks. Outward FDI flourishes under government backed insurance at risk coverage. In this case it is the local capital. the long run gains from such a funding far outweighs the disadvantage of the income loss incurred in the short run.Classification of Foreign Direct Investment ‡ Foreign direct investment may be classified as Inward or Outward. investment of foreign capital occurs in local resources. Foreign direct investment. which is inward. is also referred to as ³direct investment abroad´.

and the government continues to encourage more investments of this sort ± but with $5. the Indian national government announced a number of reforms designed to encourage FDI and present a favorable scenario for investors. . FDI in India has ± in a lot of ways ± enabled India to achieve a certain degree of financial stability. India has continually sought to attract FDI from the world¶s major investors. growth and development. In 1998 and 1999. Foreign direct investment (FDI) in India has played an important role in the development of the Indian economy. This money has allowed India to focus on the areas that may have needed economic attention.3 billion in FDI in 2004 India gets less than 10% of the FDI of China.Foreign Direct Investment (FDI) in India FDI has helped the Indian economy grow. and address the various problems that continue to challenge the country.

approximately $352. but with a limit on foreign equity of INR 1. coal & lignite or mining industries.500 crores. nuclear. A number of projects have been announced in areas such as electricity generation. as well as the development of roads and highways. FDI is not permitted in the arms. railway.Foreign Direct Investment (FDI) in India ‡ FDI investments are permitted through financial collaborations. .5m. through private equity or preferential allotments. distribution and transmission. and in joint ventures. by way of capital markets through Euro issues. The Indian national government also provided permission to FDIs to provide up to 100% of the financing required for the construction of bridges and tunnels. with opportunities for foreign investors.

but less than 10% of the $60. big growth compared to previous years.Foreign Direct Investment (FDI) in India ‡ Currently. These services include the nonbanking financial services sector.3 billion in FDI. lag so far behind China in FDI amounts? . with a stable democracy and a smoother approval process. including the growing credit card business. FDI is allowed in financial services. Why does India. Foreign investors can buy up to 40% of the equity in private banks. although there is condition that stipulates that these banks must be multilateral financial organizations. By 2004. India received $5.6 billion that flowed into China. Up to 45% of the shares of companies in the global mobile personal communication by satellite services (GMPCSS) sector can also be purchased.

Federal democracy is perversely an impediment for India.Foreign Direct Investment (FDI) in India ‡ Although the Chinese approval process is complex. India actually receives less than half the FDI that the federal government approves. Local authorities are not part of the approvals process and have their own rights. it includes both national and regional approval in the same process. and this often leads to projects getting bogged down in red tape and bureaucracy. .

still it has failed to some extent in attracting more funds in the forms of investments.‡Sectors Attracting FDI ‡ Though the services sector in India constitutes the largest share in the Gross Domestic Product. Important sectors of the Indian Economy attracting more investments into the country are as follows: ‡ Electrical Equipments (Including Computer Software & Electronic) ‡ Telecommunications (radio paging. cellular mobile. basic telephone service) ‡ Transportation Industry .

Sectors Attracting FDI ‡ Services Sector (financial & non-financial) ‡ Fuels (Power + Oil Refinery) ‡ Chemical (other than fertilizers) ‡ Food Processing Industries ‡ Drugs & Pharmaceuticals ‡ Cement and Gypsum Products ‡ Metallurgical Industries .

Any form of foreign direct investment pumps in a lot of capital knowledge and technological resources into the economy of a country. Over the years. foreign direct investment has helped the economies of the host countries to obtain a launching pad from where they can make further improvements. .Foreign Direct Investment and Economic Development ‡ Foreign direct investment has a major role to play in the economic development of the host country. This trend has manifested itself in the last twenty years.

It has often been observed that the economically developing as well as underdeveloped countries are dependent on the economically developed countries for financial assistance that would help them to achieve some amount of economical stability .Foreign Direct Investment and Economic Development ‡ This helps in taking the particular host economy ahead. The fact that the foreign direct investors have been able to play an important role vis-a-vis the economic development of the recipient countries has been due to the fact that these countries have changed their economic stances and have allowed the foreign direct investors to come in and improve their economies.

The health sector of many a recipient country has been benefited by the foreign direct investment. on their part. .Foreign Direct Investment and Economic Development ‡ The economically developed countries. This financial assistance can be channelized into various sectors of the economy. There is ample scope of technological development of a country as well. The channelization is normally done on the basis of the requirements of particular sectors. Thus it may be said that foreign direct investment plays an important role in the overall economic and social development of a country. can help these countries financially by investing in these countries. It has been observed that the foreign direct investment has been able to improve the infrastructural condition of a country. The standard of living of the general public of the host country could be improved as a result of the foreign direct investment made in a country.

Foreign Direct Investment and Economic Development ‡ It has been observed that the private sector companies are not always interested in undertaking activities that help in improving the infrastructure of the country. there are no short term benefits as such. that are able to enhance their productivity and ultimately advance from an economic point of view. This is because the gains form these infrastructural activities are made only in the long term. . This is a very crucial contribution as most of these countries are not able to perform these functions on their own. ‡ This is where the foreign direct investment can come in handy. It can also assist in helping economically underdeveloped countries build their own research and development bases that can contribute to the technological development of the country. These assistances come in handy. especially in the context of the manufacturing and services sector of the particular country.

the money that comes in a country through the foreign direct investment can be utilized to buy or import technology from other countries. The developing countries can also tackle a number of healthcare issues with the help of the foreign direct investment. Foreign direct investment can also be helpful in assisting the host countries to set up mass educational programs that help them to educate the disadvantaged sections of the society. Such assistance is often provided by the non-governmental organizations in the form of subsidies. Else.Foreign Direct Investment and Economic Development ‡ At times foreign direct investment could be provided in form of technology. . This is an indirect way in which foreign direct investment plays an important part in the context of economic development.

.Benefits of Foreign Direct Investment ‡ One of the advantages of foreign direct investment is that it helps in the economic development of the particular country where the investment is being made. During the decade of the 90s foreign direct investment was one of the major external sources of financing for most of the countries that were growing from an economic perspective. It has also been observed that foreign direct investment has helped several countries when they have faced economic hardships. This is especially applicable for the economically developing countries.

It also assists in the promotion of the competition within the local input market of a country. It was observed during the financial problems of 1997-98 that the amount of foreign direct investment made in these countries was pretty steady.Benefits of Foreign Direct Investment ‡ An example of this could be seen in some countries of the East Asian region. . This is done basically in the way of provision of capital inputs. The other forms of cash inflows in a country like debt flows and portfolio equity had suffered major setbacks. Similar observations have been made in Latin America in the 1980s and in Mexico in 1994-95. The importance of this factor lies in the fact that this transfer of technologies cannot be accomplished by way of trading of goods and services as well as investment of financial resources. ‡ Foreign direct investment also permits the transfer of technologies.

Foreign direct investment helps in the creation of new jobs in a particular country. This enables them to get access to a better lifestyle and more facilities in life. It also helps in increasing the salaries of the workers. It has normally been observed that foreign direct investment allows for the development of the manufacturing sector of the recipient country .Benefits of Foreign Direct Investment ‡ The countries that get foreign direct investment from another country can also develop the human capital resources by getting their employees to receive training on the operations of a particular business. The profits that are generated by the foreign direct investments that are made in that country can be used for the purpose of making contributions to the revenues of corporate taxes of the recipient country.

. their companies get an opportunity to explore newer markets and thereby generate more income and profits. In case of these countries.Benefits of Foreign Direct Investment ‡ Foreign direct investment can also bring in advanced technology and skill set in a country. In case of countries that make foreign direct investment in other countries this process has positive impact as well. It also plays a crucial role in the context of rise in the productivity of the host countries. Foreign direct investment assists in increasing the income that is generated through revenues realized through taxation. There is also some scope for new research activities being undertaken.

It is normally the responsibility of the host country to limit the extent of impact that may be made by the foreign direct investment. They should be making sure that the entities that are making the foreign direct investment in their country adhere to the environmental. The situations in countries like Ireland. Singapore.Disadvantages of Foreign Direct Investment ‡ The disadvantages of foreign direct investment occur mostly in case of matters related to operation. governance and social regulations that have been laid down in the country. . Chile and China corroborate such an opinion. distribution of the profits made on the investment and the personnel. One of the most indirect disadvantages of foreign direct investment is that the economically backward section of the host country is always inconvenienced when the stream of foreign direct investment is negatively affected.

Disadvantages of Foreign Direct Investment ‡ The various disadvantages of foreign direct investment are understood where the host country has some sort of national secret ± something that is not meant to be disclosed to the rest of the world. is also disadvantageous for the ones who are making the investment themselves. at times. At times it has been observed that certain foreign policies are adopted that are not appreciated by the workers of the recipient country. It has been observed that the defense of a country has faced risks as a result of the foreign direct investment in the country. . Foreign direct investment.

.Disadvantages of Foreign Direct Investment ‡ Foreign direct investment may entail high travel and communications expenses. The differences of language and culture that exist between the country of the investor and the host country could also pose problems in case of foreign direct investment. Yet another major disadvantage of foreign direct investment is that there is a chance that a company may lose out on its ownership to an overseas company. This has often caused many companies to approach foreign direct investment with a certain amount of caution. This causes a lot of inconvenience to the investor. At times it has been observed that there is considerable instability in a particular geographical region.

It has less control over the functioning of the company that is functioning as the wholly owned subsidiary of an overseas company . it poses a lot of challenge for the investors. the condition of the host country could be important factors in the case of the foreign direct investment. as well as. At times it has been observed that the governments of the host country are facing problems with foreign direct investment. In case the host country is not well connected with their more advanced neighbors.Disadvantages of Foreign Direct Investment ‡ The size of the market.

Even in view of the various disadvantages of foreign direct investment it may be said that foreign direct investment has played an important role in shaping the economic fortunes of a number of countries around the world. At times there have been adverse effects of foreign direct investment on the balance of payments of a country.Disadvantages of Foreign Direct Investment ‡ This leads to serious issues. The investor does not have to be completely obedient to the economic policies of the country where they have invested the money. .

While some countries lowering standards to attract FDI in a "race to the bottom. ." others praise FDI for raising standards and welfare in recipient countries.Steps to attract FDI ‡ Promotional efforts to attract foreign direct investment (FDI) have become the important point of competition among developed and developing countries. This competition is also maintained when countries are adopting economic integration at another level.

which are reinforcing traditional impulses for foreign direct investment that is access to natural resources. Improvement in logistics necessarily allow production to be close to markets while taking advantage of the specific characteristic of individual production locations. and low-cost labor. . With the rise of globalization technological progress allows for the separation of production into more discrete phases across national barriers. Expansion in Information and communication technologies.Steps to attract FDI ‡ There are several trends. markets.

Many governments have created state agencies to help investors through this administrative paperwork. Others try to improve the general business climate of a country by changing the administrative barriers and red tapism. . Finally most of the countries have entered into international governing arrangements to increase their attractiveness for more investment.Steps to attract FDI ‡ Countries have adopted their respective policies for attracting more investment. Some countries focus on improving the infrastructure and skill parameter and creating a base meet the demands and expectations of foreign investors. cash grants and specific subsidies. Some countries rely on targeted financial concessions like tax concessions.

. Reform management matters as investment climate reforms are done politically. Political decisions play a significant role in this context. while costs are felt up front. strengthening property rights.Steps to attract FDI ‡ Sound investment climate is crucial for economic growth. and increasing firms' access to finance are necessary for raising living standards and reducing poverty in a country. Each and every countries over the globe are stepping forward to change the climate for attracting more investment. Microeconomic reforms aimed at simplifying business regulations. Reform is necessary for creating an investment-oriented climate. Opening up of doors by most of the nations have compelled them for adopting reforms. They often favor unorganized over organized groups and the benefits tend to accrue only in the long term. improving labor market flexibility.

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