TYBBA (SEM-V)

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Chapter- 2
Foreign Direct Investment
Content: Meaning, Types of FDI, Factors affecting FDI, Merits
and Demerits of FDI, FDI Trends in India
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1. Introduction:
Meaning: A foreign direct investment (FDI) is an investment made by a firm or
individual in one country into business interests located in another country.
Generally, FDI takes place when an investor establishes foreign business operations
or acquires foreign business assets in a foreign company.

It is the process whereby residents of one country (home) acquire ownership of assets
for the purpose of controlling the production, distribution and other activities of a firm
in another country (host).

2. Types Of FDI:
1. Greenfield Investment: It is the direct investment in new facilities or the
expansion of existing facilities. It is the principal mode of investing in developing
countries.

 Merits:

1. Create new production capacity and jobs.

2. Transfer technology.

3. Additional capital investments.

 Demerits:

1. Loss of market share of domestic firms.

2. Profits flow back entirely to the multinational’s home country.

2. Mergers and Acquisitions: Cross-border acquisitions occur when the control of assets
operations is transferred from a local foreign company, with that local company
becoming an affiliate of the foreign company.

3. Horizontal FDI: It occurs when a company investment is made for conducting the
similar business operations in another country.

4. Vertical FDI: Vertical integration is the expansion of a firm into a stage of the
production process other than of the original business.
3. Factors Affecting FDI:

A) Supply Factors:
1. Production Cost: Companies invest in foreign countries in order to avail the
benefits of lower production costs like; low labor cost, land prices,
commercial real estate rent rates etc. For eg; Samsung plastics-a South Korean
firm- established its manufacturing facilities in Mericali, Mexico and saved
two third of the labor cost.

2. Logistics: If the cost of transportation from the domestic country to a foreign

market is high and or the time of transportation of the products to a foreign
market is long, then firm take FDI. For eg; Coca-Cola selected the FDI
strategy as the cost of transportation is heavy because most part of its product
is water.

3. Availability of Natural Resources: Companies locate their production

facilities near to the sources of critical inputs. For eg; The US based oil
refining companies established their oil refinery facilities in Saudi Arabia and
other Gulf countries.

4. Availability of quality Human resource at Low Cost: High quality HR

contributes to high value addition to the products/ services. Further, if such
HR available at low cost, the level of productivity in monetary terms is higher
 and the cost of value addition is still lower. As such high quality HR at low
cost attract FDI. For eg; India, South Korea, Malaysia, China and Thailand
attract FDI, as the cost of operational business in these countries are relatively
less.

5. Access to Key Technology: Firm go for FDI in order to have access to

existing technology rather than developing technologies.

B) Demand Factors:
1. Customer Access: Certain business firm particularly fast food, service
oriented and retail outlets should locate their operations close to customers.
For eg; KFC, Aetna (American Insurance Company) locate their operations
close to customers in order to increase the demand for their products or
services.

2. Marketing Advantages: Companies can enjoy a number of marketing

advantages by locating their operations in a host country. These advantages
include lower marketing costs, accessibility to hands-on experience regarding
customer and market handling, improving customer services etc. For eg; delta
products of Taiwan-produces battery packs for laptop computers shifted its
operation to US-Mexican border in order to meet the US customer needs
quickly and flexibly.

3. Exploitation of Competitive Advantages: Companies which enjoy

competitive advantages through trade mark, brand name, technology etc., go
for FDI in order to exploit its competitive advantages in various foreign
markets. This decision is based on the cost of contract negotiation,
implementation and control.

4. Customer Mobility: The companies which have one or a few customers

select the FDI strategy along with their customers. In other words, the
ancillary industrial units locate their production facilities in those foreign
countries where their parents companies locate their production facilities. For
eg; The business firms supplying parts of Japanese automobile companies
located their production facilities in the USA along with the Japanese
automobile companies.

C) Political Factors:
1. Avoidance of Trade Barriers: Companies establish production facilities in
foreign markets in order to avoid trade barriers like high export tariffs, quotas
etc. For eg; Japanese automobile companies established factories in the USA
when the US Government increased import tariff rates in order to protect
domestic automobile companies.
 2. Economic Development Incentives: Governments at different levels i.e;
Local, State and National levels offer incentives to attract domestic as well as
foreign investment. For eg; Indian Govt. as well as govt. of Andhra Pradesh
offered a number of incentives to FDI. These incentives include low tax rate,
development of infrastructural facilities, employee training programmers etc.

4. Merits and Demerits of FDI:

A) Merits of FDI:
1. Economic Development Stimulation: Foreign direct investment can stimulate the
target country’s economic development, creating a more conducive environment for
you as the investor and benefits for the local industry.

2. Easy International Trade: Commonly, a country has its own import tariff, and
this is one of the reasons why trading with it is quite difficult. Also, there are
industries that usually require their presence in the international markets to ensure
their sales and goals will be completely met. With FDI, all these will be made easier.

3. Employment and Economic Boost: Foreign direct investment creates new jobs, as
investors build new companies in the target country, create new opportunities. This
leads to an increase in income and more buying power to the people, which in turn
leads to an economic boost.

4. Development of Human Capital Resources: One big advantage brought about by

FDI is the development of human capital resources, which is also often understated as
it is not immediately apparent. Human capital is the competence and knowledge of
those able to perform labour, more known to us as the workforce. The attributes
gained by training and sharing experience would increase the education and overall
human capital of a country. Its resource is not a tangible asset that is owned by
companies, but instead something that is on loan. With this in mind, a country with
FDI can benefit greatly by developing its human resources while maintaining
ownership.

5. Tax Incentives: Parent enterprises would also provide foreign direct investment to
get additional expertise, technology and products. As the foreign investor, you can
receive tax incentives that will be highly useful in your selected field of business.

6. Resource Transfer: Foreign direct investment will allow resource transfer and
other exchanges of knowledge, where various countries are given access to new
technologies and skills.
B) Demerits of FDI:
1. Hindrance to Domestic Investment:

As it focuses its resources elsewhere other than the investor’s home country,
foreign direct investment can sometimes hinder domestic investment.

2. Risk from Political Changes:

Because political issues in other countries can instantly change, foreign direct
investment is very risky. Plus, most of the risk factors that you are going to
experience are extremely high.

3. Negative Influence on Exchange Rates:

Foreign direct investments can occasionally affect exchange rates to the

advantage of one country and the detriment of another.

4. Higher Costs:

If you invest in some foreign countries, you might notice that it is more expensive
than when you export goods. So, it is very imperative to prepare sufficient money
to set up your operations.

5. Economic Non-Viability:

Considering that foreign direct investments may be capital-intensive from the

point of view of the investor, it can sometimes be very risky or economically non-
viable.

6. Expropriation:

Remember that political changes can also lead to expropriation, which is a

scenario where the government will have control over your property and assets.

5. FDI TRENDS IN INDIA:

Foreign direct investment (FDI) in India is a major monetary source for
economic development in India. Foreign companies invest directly in fast
growing private Indian businesses to take benefits of cheaper wages and
changing business environment of India.

The Government of India has amended FDI policy to increase FDI inflow. In
2014, the government increased foreign investment upper limit from 26% to
 49% in insurance sector. It also launched Make in India initiative in
September 2014 under which FDI policy for 25 sectors was liberalised further.

FDI inflows in India increased to $55.56 billion in 2015-16, $60.22 billion in

2016-17, $60.97 billion in 2017-18 and the country registered its highest
ever FDI inflow of $62.00 billion (provisional figure) during the last Financial
Year 2018-19.

The policy of the Government of India towards the foreign direct investment
has been positive due to the shortage of domestic capital. This is evident from
various industrial policy resolutions and the declarations issued by the
Government from time to time. The economic liberalizations of 1991 have
given greater opportunity to FDI.

The Government of India with regard to FDI announces significant measures

since1991 include:

 Granting of automatic permission for foreign equity participation

up to 51% in high technology and high-investment priority
industries.

 Allowing foreign equity participation up 51% in international

trading companies, hotel industry and tourist industry.

 100% FDI permitted in B2B e-commerce, power sector and oil

refining.

 Foreign companies can use their trade marks in India w.e.f. May
14, 1992.

 Foreign investors are allowed to establish 100% operating

subsidiaries and should bring at least US $50 million for this
purpose.

 Allowing 100% foreign equity for setting up of power plants with

free repatriation of profits.

 Dispersing with the bureaucratic rules and regulations which

caused delays and created hurdles for the FDI.

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