Foreign Direct Investment (FDI)

Submitted by
Ahmad Husnain
BBA-20-111 Morning B
Course Instructor
Ms. Rafia Kazmi
Course
International Business
Department of Business Administration
University of Sahiwal, Sahiwal
What Is a Foreign Direct Investment (FDI)?

Foreign direct investment (FDI) is an ownership stake in a foreign company or project made
by an investor, company, or government from another country.

Generally, the term is used to describe a business decision to acquire a substantial stake in a
foreign business or to buy it outright to expand operations to a new region. The term is
usually not used to describe a stock investment in a foreign company alone. FDI is a key
element in international economic integration because it creates stable and long-lasting links
between economies

How Does Foreign Direct Investment (FDI) Work?

Companies or governments considering a foreign direct investment (FDI) generally consider

target firms or projects in open economies that offer a skilled workforce and above-average
growth prospects for the investor. Light government regulation also tends to be prized. FDI
frequently goes beyond mere capital investment. It may include the provision of
management, technology, and equipment as well. A key feature of foreign direct investment
is that it establishes effective control of the foreign business or at least substantial influence
over its decision making.

The net amounts of money involved with FDI are substantial, with more than $1.8 trillion of
foreign direct investments made in 2021. In that year, the United States was the top FDI
destination worldwide, followed by China, Canada, Brazil, and India. In terms of FDI
outflows, the U.S. was also the leader, followed by Germany, Japan, China, and the United
Kingdom.

FDI inflows as a percentage of gross domestic product (GDP) is a good indicator of a

nation’s appeal as a long-term investment destination. The Chinese economy is currently
smaller than the U.S. economy in nominal terms, but FDI as a percentage of GDP was 1.7%
for China as of 2020, compared with 1.0% for the U.S. For smaller, dynamic economies,
FDI as a percentage of GDP is often significantly higher: e.g., 110% for the Cayman Islands,
109% for Hungary, and 34% for Hong Kong (also for 2020).

Special Considerations

Foreign direct investments can be made in a variety of ways, including opening

a subsidiary or associate company in a foreign country, acquiring a controlling interest in an
existing foreign company, or by means of a merger or joint venture with a foreign company.

The threshold for an FDI that establishes a controlling interest, per guidelines established by
the Organisation for Economic Co-operation and Development (OECD), is a minimum 10%
ownership stake in a foreign-based company. That definition is flexible. There are instances
in which effective controlling interest in a firm can be established by acquiring less than
10% of the company’s voting shares.
Types of Foreign Direct Investment

Foreign direct investments are commonly categorized as horizontal, vertical, or

conglomerate.

1- Horizontal FDI:

A company establishes the same type of business operation in a foreign country as it

operates in its home country. A U.S.-based cellphone provider buying a chain of phone
stores in China is an example.

2- Vertical FDI:

A business acquires a complementary business in another country. For example, a U.S.

manufacturer might acquire an interest in a foreign company that supplies it with the raw
materials it needs.

3- Conglomerate FDI:

A company invests in a foreign business that is unrelated to its core business. Because the
investing company has no prior experience in the foreign company’s area of expertise, this
often takes the form of a joint venture.

Classification of FDI

1-By Mode Of Entry:

 Mergers And Acquisitions (M&As): This occurs when a foreign company acquires
or merges with an existing domestic company.
 Joint Ventures: This occurs when a foreign company partners with a domestic
company to establish a new business.
 Greenfield Investments: This occurs when a foreign company establishes a new
business from scratch in a foreign country.

2-By Sector:

 Manufacturing: FDI in manufacturing is the most common type of FDI.

 Services: FDI in services is growing in importance, as the global economy becomes
increasingly service-oriented.
 Agriculture: FDI in agriculture is relatively small, but it is growing in importance in
developing countries.

3-By Home Country:

 Developed Countries: Developed countries are the largest source of FDI.

  Developing Countries: Developing countries are becoming increasingly important
sources and destinations of FDI.

4-By Host Country:

 Developed Countries: Developed countries are the largest hosts of FDI.

 Developing Countries: Developing countries are becoming increasingly important
hosts of FDI.

It is important to note that these classifications are not mutually exclusive. For example, a
horizontal FDI can be made through a greenfield investment or an M&A.

The classification of FDI can be useful for a number of purposes, such as:

 Policy Analysis: Governments can use the classification of FDI to analyze its impact
on the economy and to develop policies to attract and promote FDI in desirable
sectors.
 Investment Research: Investors can use the classification of FDI to identify
investment opportunities in different sectors and countries.
 Academic Research: Academics can use the classification of FDI to study its impact
on economic growth, trade, and other economic variables.
Dimensions Of FDI

The dimensions of FDI can be broadly classified into two categories:

A- Economic Dimensions:

These dimensions focus on the impact of FDI on the host economy. They include:

o Economic Growth: FDI can contribute to economic growth by increasing

investment, creating jobs, and boosting productivity.
o Trade: FDI can lead to increased trade between the host country and the home
country of the foreign investor.
o Technology Transfer: FDI can help to transfer new technologies to the host
country, which can improve the competitiveness of domestic firms and lead to
economic growth.
o Tax Revenue: FDI can generate tax revenue for the host government.

B- Non-Economic Dimensions:

These dimensions focus on the broader social and environmental impacts of FDI. They
include:
 o Employment: FDI can create jobs in the host country, which can reduce
poverty and improve living standards.
o Skills Development: FDI can lead to skills development and training for
workers in the host country.
o Human Rights: FDI can have a positive impact on human rights by
promoting labor standards and environmental protection.
o Sustainable Development: FDI can contribute to sustainable development by
investing in renewable energy, energy efficiency, and other green
technologies.

In addition to these two broad categories, FDI can also be analyzed along a number of other
dimensions, such as:

 Sector: FDI can be classified by the sector in which it occurs, such as manufacturing,
services, or agriculture.
 Mode Of Entry: FDI can occur through a variety of modes, such as mergers and
acquisitions, joint ventures, and greenfield investments.
 Home Country: FDI can be classified by the home country of the foreign investor.
 Host Country: FDI can be classified by the host country in which the investment takes
place.

The specific dimensions of FDI that are most relevant will vary depending on the context. For
example, a developing country may be more interested in the economic dimensions of FDI,
such as its impact on economic growth and employment. A developed country may be more
interested in the non-economic dimensions of FDI, such as its impact on human rights and
sustainable development.

What is the difference between foreign direct investment (FDI) and foreign
portfolio investment (FPI)?

Foreign portfolio investment (FPI) is the addition of international assets to the portfolio of a
company, an institutional investor such as a pension fund, or an individual investor. It is a
form of portfolio diversification, achieved by purchasing the stocks or bonds of a foreign
company. Foreign direct investment (FDI) instead requires a substantial and direct
investment in, or the outright acquisition of, a company based in another country, and not
just their securities.FDI is generally a larger commitment, made to enhance the growth of a
company. But both FPI and FDI are generally welcome, particularly in emerging nations.
Notably, FDI involves a greater responsibility to meet the regulations of the country that
hosts the company receiving the investment.