Foreign Direct Investment

Session Speaker
Jayashree K
Asst. Professor

 M.S Ramaiah School of Advanced

Studies - Bangalore
 Why is FDI increasing in the world
economy?
 Why do firms often prefer FDI to other
market entry strategies?
 Why are certain locations favored for FDI?
 How does political ideology affect
government FDI policy?
 What are key FDI related costs and
benefits for receiving and source
countries?
 An investment made by a company or entity based in one
country, into a company or entity based in another country.
 The investing company may make its overseas investment in a
number of ways - either by setting up a subsidiary or associate
company in the foreign country, by acquiring shares of an
overseas company, or through a merger or joint venture.
 An example of foreign direct investment would be an American
company taking a majority stake in a company in China. Another
example would be a Canadian company setting up a joint venture
to develop a mineral deposit in Chile.
 Involves ownership of entity abroad for
 production
 Marketing/service
 R&D
 Access of raw materials or other resource

 Parent has direct managerial control

 Depending on its extent of ownership and
 On other contractual terms of the FDI

 No managerial involvement = portfolio

investment
 FDI occurs when a firm invests directly in
facilities to produce and/or market a
product in a foreign country
 Flow: Amount of FDI over a period of time (one
year)
 Stock: Total accumulated value of foreign
owned assets at a given point of time

 FDI is not the investment by individuals,

firms or public bodies in foreign financial
instruments
 Through financial collaborations..
 Through joint ventures and technical collaborations.
 Through capital markets
 Through private placements or preferential allotments.
 Firms want a presence in foreign markets
 Firms want control over growth of these
foreign markets
 To gain first mover advantages
 To ward off competitors
 To determine locations, advertising and other
related strategic decisions in the firm’s interest
 Flow and stock increased in the last 30 years
 In spite of decline of trade barriers, FDI has grown
more rapidly than world trade because:
 Businesses fear protectionist pressures
 FDI is seen as a way of circumventing trade
barriers
 Dramatic political and economic changes in many
parts of the world
 Globalization of the world economy has raised
the vision of firms who now see the entire world
as their market
 FDI Outflow: $35 billion in ‘75 to $1.3 trillion in ‘00 to $620
billion in ‘04
 FDI Flow (from all countries): from ‘92 to ‘04 up 260%,
compared to trade up 100% and world output up 32%
 FDI Stock: $3.5 trillion by ‘97 to more than $ 8.1 trillion in ‘03
 In ‘03:
 61,000 MNEs had:
 9,00,000 foreign affiliates
 54 million employees
 $17.6 trillion in global sales
 $9.2 trillions global exports
 Conclusion:
FDI flow growing faster than world trade and world output
 Engineering & Manufacturing sectors
 Roads & Highways, Ports and Harbors
 Industrial model towns/industrial parks
 Hotels & Tourism
 Pollution Control and Management
 Advertising & Film industry
 Power generation (hydro-electric, coal/lignite, oil or gas
based)
 Information Technology including E-Commerce
 Insurance- 26%
 Telecommunication- FDI is permitted up to
74% with FDI, beyond 49% requiring
Government approval
 Domestic airlines- 49%
 Mining (Mining of Diamonds and
precious stones)- 74%
 Airports- 74%
 Arms and Ammunition.
 Atomic Energy.
 Railway Transport.
 A. Agriculture
Floriculture, Horticulture, Development of
Seeds, Animal Husbandry, Pisciculture, Aquaculture,
Cultivation of vegetables & mushrooms and services
related to agro and allied sectors.
 B. Industry
 Mining covering exploration and mining of
diamonds & precious stones; gold, silver and minerals.
 C. Manufacturing
Alcohol- Distillation & Brewing
 Increase investment level and thereby income &
employment
 Increase tax revenue of government
 Facilitates transfer of technology
 Increase exports and reduce import requirements
 Increase competition and break domestic monopolies
 Improves quality and reduces cost of inputs
 Flow to high profit areas rather than main concern areas
 Through their power and flexibility, MNC can undermine
economic autonomy and control
 Sometimes interferes in the national politics
 Sometimes engage in unfair and unethical trade practices
 Sometimes result in minimizing / eliminating competition and
create monopolies or oligopolistic structures
Year Amount(in billion $)
2005-06 6.05

2006-07 8.96

2007-08 17.59

2008-09 27.3

2009-10 24.2

2010-11 19.4

2011-12 35
 Profitability
 Costs of production
 Economic Conditions
 Government policies
 Political factors
 Horizontal FDI:
 Investment in the same industry abroad as a firm
operates in at home
 Vertical FDI:
 Backward Vertical FDI: investment in an industry
abroad that provides inputs for the firm’s domestic
production processes eg: oil refining, Royal
Dutch/shell, British petroleum etc.)
 Forward Vertical FDI: investment in which an
industry abroad sells the outputs of the firm’s
domestic production processes eg: Volkswagon in
U.S.
 Resources seeking - looking for resources at a
lower real cost.
 Market seeking - secure market share and
sales growth in target foreign market.
 Efficiency seeking - seeks to establish
efficient structure through useful factors,
cultures, policies, or markets.
 Strategic asset seeking - seeks to acquire
assets in foreign firms that promote corporate
long term objectives.
• A Greenfield Investment
is the investment in a manufacturing,
office, or other physical company-
related structure or group of
structures in an area where no
previous facilities exist.
• The name comes from the idea of
building a facility literally on a
"green" field, such as farmland or a
forest.
• Green field operation:
– Mostly in developing nations
• Mergers and
acquisitions:
– Quicker to execute.
– Foreign firms have
valuable strategic
assets
– Believe they can
increase the
efficiency of the
acquired firm
• More prevalent in
developed nations
 Transportation costs are high
 Market Imperfections (Internalization Theory)
 Impediments to the free flow of products
between nations
 Impediments to the sale of know-how
 Follow the lead of a competitor - strategic rivalry
 Product Life Cycle - however, does not explain
when it is profitable to invest abroad
 Location specific advantages (natural
resources)
 FDI over exporting
 High transportation costs, trade barriers
 FDI over licensing or franchising
 Need to retain strategic control
 Need to protect technological know-how
 Capabilities not suitable for
licensing/franchising
 Follow few main competitors
 Immediate strategic responses
 Low Export

High
No FDI
Yes
Yes FDI
No
No FDI
Yes
Then license
 Costs
 Barriers
 Control
 Incentives like tax concessions, subsidies etc
 Location advantages
 Essential Criteria
 Access to skilled and educated workforce
 Proximity to world class research institutions
 Quality of life
 Access to venture capital
 Important Criteria
 Reasonable costs of doing business
 Established technology presence
 Available bandwidth and adequate infrastructure
 Favorable business climate and regulatory
environment

 Desirable Criteria
 Presence of suppliers and partners
 Availability of community incentives
Political Ideology and FDI

Radical Pragmatic Free

View Nationalism Market
 Marxist view: MNE’s exploit less-developed
host countries
 Extract profits
 Give nothing of value in exchange
 Instrument of domination, not development
 Keep less-developed countries relatively
backward and dependent on capitalist nations
for investment, jobs, and technology
 By the end of the 1980s radical view was
in retreat
 Collapse of communism
 Bad economic performance of countries that
embraced the radical view
 Strong economic performance of some
countries that embraced capitalism rather
than the radical view
• Adam Smith, Ricardo: international production should
be distributed per national comparative advantage
 Nations specialize in goods and services that
they can produce most efficiently
 Resource transfers benefit and strengthen the
host country
 Pro-investment changes in laws and growth
of bilateral agreements attest to strength of
free market view
 But all countries impose some restrictions on FDI
 FDI has benefits and costs
 Allow FDI if benefits outweigh costs
 Block FDI that harms indigenous industry
 Encourage FDI that is in national interest
 Tax breaks
 Subsidies

 But who can predict which FDI is in

national interest?
 Regulations open opportunity for favoritism
 Many of the most successful developing
countries – past and present – followed a
pragmatic nationalistic stance
 Japan
 South Korea
 China
 Economists note that Hong Kong, which
followed the
free market approach, was even more
successful
 Resource transfer
effects
 Capital
 Technology
 Management
 Employment effects
 Effect on competition
& economic growth
 Balance of payment effects
 Initial capital inflows
 Import substitution
 Export of goods & services to other countries
 In a free market view
 Many economists argue that the benefits of FDI
so outweigh the costs associated with pragmatic
nationalism that it is misguided
 The best policy would be for countries to forgo
all intervention in an MNE’s investment decisions
 Adverse effects on competition
 Adverse effects on balance of payment
 Outflow of earnings from foreign subsidiary
to its parent company
 Imports of raw material results into adverse
effect on current account
 Adverse effect on national sovereignty
and Autonomy
 Positive effect on Balance of payment due
to inward flow of foreign earnings &
demand of home-country exports of
capital-equipments
 Employment effects due to demand of
home country products
 MNE’s learn valuable skills from foreign
markets that can be transferred back to
the home country
 Adverse effect on BOP account:
 Adverse effect on capital account due to outflow of
capital
 Adverse effect on current account due to imports
from low production locations in foreign countries
 Adverse effect on current account due to export
substitution
 Reduced home country employment
 Home country
 Outward FDI encouragement
 Risk reduction policies (financing, insurance, tax
incentives)
 Outward FDI restrictions
 National security, BOP
 Host country
 Inward FDI encouragement
 Investment incentives
 Job creation incentives
 Inward FDI restrictions
 Ownership extent restrictions (national security); local
nationals can safeguard host country’s interests
 A portfolio is a combination of individual
assets or securities.
 According to portfolio theory an investor
decides to invest his wealth in assets or
securities with risk.
 Theory assumes that:
 the investors are risk-averse – try to minimise.
 the returns of assets are normally distributed

 M.S Ramaiah School of Advanced

Studies - Bangalore
 There are many advantages to trading ADRs as
opposed to direct investment in the company’s
shares:
 ADRs are denominated in U.S. dollars, trade on U.S.
exchanges and can be bought through any broker.
 Dividends are paid in U.S. dollars.
 Most underlying stocks are bearer securities, the
ADRs are registered.

 M.S Ramaiah School of Advanced

Studies - Bangalore
 A negotiable certificate held in the bank of one
country representing a specific number of
 shares of a stock traded on an exchange of
another country
 To raise money in more than one market, some
corporations use global depositary receipts

 M.S Ramaiah School of Advanced

Studies - Bangalore
 (GDRs) to sell their stock on markets in
countries other than the one where they have
their
 headquarters.
 The GDRs are issued in the currency of the
country where the stock is trading.

 M.S Ramaiah School of Advanced

Studies - Bangalore
 Foreign Currency Convertible Bond is a type
of convertible bond issued in a currency
different than the issuer's domestic currency.
 It is a quasi-debt instrument which are
attractive to both investors and issuers. The
investors receive the safety of guaranteed
payments on the bond and are also able to
take advantage of any large price appreciation
in the company's stock.

 M.S Ramaiah School of Advanced

Studies - Bangalore
Due to the equity side of the bond,
which adds value, the
coupon payments on the bond are
lower for the
company, thereby reducing its
debt-financing costs

 M.S Ramaiah School of Advanced

Studies - Bangalore
 FDI is boon or bane in India –write 1000 word
eassay
 Collect 2013-14 related FDI investment details

 Submit the assignment by 5th september 2014

 25 marks