Foreign Direct Investment INTERNATIONAL

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Objective:

FINANCIAL MANAGEMENT

This section discusses various issues associated with foreign direct investments by MNCs, which play a key role in shaping the nature of the emerging global economy. EUN / RESNICK
Second Edition
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Outline
Global Trends in FDI Why Do Firms Invest Overseas? Cross-Border Acquisitions Political Risk and FDI

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Global Trends in FDI

Foreign Direct Investment often involves the establishment of production facilities abroad. Greenfield Investment
Involves building new facilities from the ground up.

Cross-Border Acquisition
Involves the purchase of existing business.
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Global Trends in FDI

Several developed nations are the sources of FDI outflows.
About 90% of total world-wide FDI comes from the developed world.

Both developing and developed nations are the recipient of inflows of FDI.

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100 120 20 40 60 80 0

us t

Average Annual FDI (USD Billions )

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ra l C ia an ad a C hi na Fr an c G er e m an y Ita ly Ja pa M n e N et xic he o rla nd s S pa in S w e S w den U ni itze te d rlan K d U ing ni te dom d S ta te s

Inflows

Outflows

Why Do Firms Invest Overseas?

Trade Barriers Labour Market Imperfections Intangible Assets Vertical Integration Product Life Cycle

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Trade Barriers
Government action leads to market imperfections. Tariffs, quotas, and other restrictions on the free flow of goods, services and people. Trade Barriers can also arise naturally due to high transportation costs, particularly for low value-to-weight goods.
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Labour Market Imperfections

Among all factor markets, the labor market is the least perfect.
Recall that the factors of production are land, labor, capital, and entrepreneurial ability. If there exist restrictions on the flow of workers across borders, then labor services can be underpriced relative to productivity. The restrictions may be immigration barriers or simply social preferences.
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Labour Market Imperfections

Persistent wage differentials across countries exist. This is one on the main reasons MNCs are making substantial FDIs in less developed nations.
Country Hourly Cost $27.37 Germany $21.38 Japan $17.10 France/U.S. $9.06 Israel $5.47 Taiwan $2.57 Mexico
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Intangible Assets
Coca-Cola has a very valuable asset in its closely guarded secret formula.
To protect that proprietary information, Coca-Cola has chosen FDI over licensing. Since intangible assets are difficult to package and sell to foreigners, MNCs often enjoy a comparative advantage with FDI.

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Vertical Integration
MNCs may undertake FDI in countries where inputs are available in order to secure the supply of inputs at a stable accounting price. Vertical integration may be backward or forward: Backward: e.g. a furniture maker buying a logging company.

Forward: e.g. a U.S. auto maker buying a Japanese auto dealership.

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Product Life Cycle

U.S. firms develop new products in the developed world for the domestic market, and then markets expand overseas.
FDI takes place when product maturity hits and cost becomes an increasingly important consideration for the MNC.

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Product Life Cycle

The U.S. Quantity production exports imports

Quantity

Less advanced countries

New product

Maturing product

Standardized product exports

imports production New product Maturing product Foreign Direct Investment__ S.

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Standardized product

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Shareholder Diversification
Firms may be able to provide indirect diversification to their shareholders if there exists significant barriers to the cross-border flow of capital.

Capital Market imperfections are of decreasing importance, however. Managers can therefore probably not add value by diversifying for their shareholders as the shareholders can do so themselves at lower cost.

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Cross-Border Acquisitions
Greenfield Investment Building new facilities from the ground up. Cross-Border Acquisition Purchase of existing business. Cross-Border Acquisition represents 40-50% of FDI flows. Cross-border acquisitions are a politically sensitive issue: Greenfield investment is usually welcome. Cross-border acquisition is often unwelcome.

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Political Risk and FDI

Unquestionably this is the biggest risk when investing abroad. Does the foreign government uphold the rule of law? is a more important question than normative judgements about the appropriateness of the foreign governments existing legislation. A big source of risk is the non-enforcement of contracts.
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Political Risk and FDI

Macro Risk
All foreign operations put at risk due to adverse political developments.

Micro Risk
Selected foreign operations put at risk due to adverse political developments.

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Political Risk
Transfer Risk
Uncertainty regarding cross-border flows of capital.

Operational Risk
Uncertainty regarding host countries policies on firms operations.

Control Risk
Uncertainty regarding expropriation.
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Hedging Political Risk

Geographic diversification Simply put, dont put all of your eggs in one basket. Minimize exposure Form joint ventures with local companies. Local government may be less inclined to expropriate assets from their own citizens. Join a consortium of international companies to undertake FDI. Local government may be less inclined to expropriate assets from a variety of countries all at once. Finance projects with local borrowing.
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Hedging Political Risk

Insurance--The Overseas Private Investment Corporation (OPIC) a U.S. government federally owned organization, offers insurance against: 1. The inconvertibility of foreign currencies. 2. Expropriation of U.S.-owned assets. 3. Destruction of U.S.-owned physical properties due to war, revolution, and other violent political events in foreign countries. 4. Loss of business income due to political violence 5. Whether anything like this is available in India??
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India
Foreign Direct Investment in India__ an empirical study showing the position of different sectors and states Whether infrastructure has any relation to the inflow of FDI.

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India- infrastructure index and FDI_ relation

Relationship between State level FDI and Infrastructure Index
30000 25000

FDI Approved

20000 15000 10000 5000 0 60 80 100 120 Infrastructure Index 140 160

FDI

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India: Urbanization and FDI_ any relation?

Relationship between State level FDI and Urbanaisation Growth

30000 25000

FDI Approved

20000 15000 10000 5000 0 -4 -2 0 2 4 Urbanaisation Grow th 6 8 10 12

FDI

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India

Relation between State level FDIand SDP Growth rate

30000 25000

FDI Approved

20000 15000 10000 5000 0 0.00

-30.00

-20.00

-10.00

10.00 SDP Grow th rate

20.00

30.00

40.00

50.00

FDI

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India Actual inflow of

1991199219931994199519961997 1998l9992000
(August.)Government's

Approval 1.9 89.915.038.757.6101.382.461.948.1RBI Automatic Approval 0.52.43.65.36.28.76.17.610.2NRI Schemes 1.61.55.611.119.720.610.43.63.51.9Total 3.56.817.929.763.784.4120.492.173.06 0.2
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India

FDI Inflow into India (Rs Million)

120000 100000 80000 60000 40000 20000 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 Aut Gov Total

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India: automatic vs. government route

Distribution of Automatic and Government Route in Total Inflow of FDI in Inda (% Shares)
100 90 80 70 60 50 40 30 20 10 0 1992 1993 1994 1995 1996 1997 1998 1999

Gov Aut

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India: source of FDI

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1992 1993 1994 1995 1996 1997 1998 1999 NRI S. Korea France Germany Japan U.K. Mauritius U.S.A.

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India: why actual inflow much lower compared to approval

Actual FDI as Percentage of Approved FDI (1991-1999) (Country-wise)
70

60

50

40

30

20

10

A ustralia

Denmark

Ho ngko ng

Ko rea(So uth)

Netherlands

Russia

Actual as%of Approval Thailand

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India: sectoral inflow

Exhibit 6: FDI Inflows (1991-1999) in Major Sectors
Commercial, office & household equipment Drugs and Transportation industry 0.8% pharmaceuticals 7.3% Chemicals (other than Textiles (includ dyed, 1.2% Electricals equipment Trading 6.6% fertilizers) printed) 1.0% Food processing 5.7% 1.2% industries Telecommunications 3.4% Fuels 5.8% Service sector 5.2% Glass 5.8% 0.8% Industrial machinery Paper and pulp including 0.5% paper product Hotel & tourism 1.2% 0.4% Miscellaneous Nri scheme Miscellaneous industries Mettallurgical industries mechanical & 11.2% 39.9% engineering 0.9% 1.2%

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India: Whether Infrastructure is important

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India

Thank you Reference::

S. Nandi, International Finance and Global Macroeconomics

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End

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