Foreign Direct Investment


C. Kamaraj
II Year MBA (Batch 2007-09)
R.L. Institute of Management Studies
Madurai-625 022


Consistent economic growth, de-regulation, liberal investment rules, and operational flexibility are all the factors that help increase   the inflow ofForeign direct investment or FDI.FDI or Foreign Direct Investment is any form of investment that earns interest in enterprises which function outside of the domestic territory of the investor. FDIs require a business relationship between a parent company and its foreign subsidiary. Foreign direct business relationships give rise to multinational corporations. For an investment to be regarded as an FDI, the parent firm needs to have at least 10% of the ordinary shares of its foreign affiliates. The investing firm may also qualify for an FDI if it owns voting power in a business enterprise operating in a foreign country.

Types of Foreign Direct Investment: An Overview

FDIs can be broadly classified into two types: outward FDIs and inward FDIs. This classification is based on the types of restrictions imposed, and the various prerequisites required for these investments. An outward-bound FDI is backed by the government against all types of associated risks. This form of FDI is subject to tax incentives as well as disincentives of various forms. Risk coverage provided to the domestic industries and subsidies granted to the local firms stand in the way of outward FDIs, which are also known as "direct investments abroad." Different economic factors encourage inward FDIs. These include interest loans, tax breaks, grants, subsidies, and the removal of restrictions and limitations. Factors detrimental to the growth of FDIs include necessities of differential performance and limitations related with ownership patterns. Other categorizations of FDI exist as well.

Vertical Foreign Direct Investment

Vertical Foreign Direct Investment takes place when a multinational corporation owns some shares of a foreign enterprise, which supplies input for it or uses the output produced by the MNC. 

Horizontal foreign direct investments

Horizontal foreign direct investments happen when a multinational company carries out a similar business operation in different nations. Foreign Direct Investment is guided by different motives. FDIs that are undertaken to strengthen the existing market structure or explore the opportunities of new markets can be called "market-seeking FDIs." "Resource-seeking FDIs" are aimed at factors of production which have more operational efficiency than those available in the home country of the investor. Some foreign direct investments involve the transfer of strategic assets. FDI activities may also be carried out to ensure optimization of available opportunities and economies of scale. In this case, the foreign direct investment is termed as "efficiency-seeking." 

Benefits of Foreign Direct Investment

* Growth of capital stock
* Incorporated technologies
* Possibilities to gain managerial and labor skills
* Higher incomes and economic development. (Taxation for public sector)
   - Finance education
   - Finance health
   - Finance infrastructure development, etc.
   - Resource -transfer
   - Employment
   - Balance-of-payment (BOP)
     * Import substitution
     * Source of export increase

Costs of Foreign Direct Investment

* Adverse effects on the BOP
   - Capital inflow followed by capital outflow + profits
   - Production input importation
* Threat to national sovereignty and autonomy
   - Loss of economic independence


Economic development

Foreign direct investment is that it helps in the economic development of the particular country where the investment is being made. This is especially applicable for the economically developing countries. 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. An example of this could be seen in some countries of the East Asian region. It was observed during the financial problems of 1997-98 that the amount of foreign direct investment made in these countries was pretty steady. 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. 

Transfer of technologies

Foreign direct investment also permits the transfer of technologies. This is done basically in the way of provision of capital inputs. 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. It also assists in the promotion of the competition within the local input market of a country. 

Human capital resources

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. 

Job opportunity

Foreign direct investment helps in the creation of new jobs in a particular country. It also helps in increasing the salaries of the workers. This enables them to get access to a better lifestyle and more facilities in life. It has normally been observed that foreign direct investment allows for the development of the manufacturing sector of the recipient country. Foreign direct investment can also bring in advanced technology and skill set in a country. There is also some scope for new research activities being undertaken. 

Income generation

Foreign direct investment assists in increasing the income that is generated through revenues realized through taxation. It also plays a crucial role in the context of rise in the productivity of the host countries. In case of countries that make foreign direct investment in other countries this process has positive impact as well. In case of these countries, their companies get an opportunity to explore newer markets and thereby generate more income and profits. 


It also opens up the export window that allows these countries the opportunity to cash in on their superior technological resources. It has also been observed that as a result of receiving foreign direct investment from other countries, it has been possible for the recipient countries to keep their rates of interest at a lower level.

It becomes easier for the business entities to borrow finance at lesser rates of interest. The biggest beneficiaries of these facilities are the small and medium-sized business enterprises. 

Foreign direct investment leads to increase in profits within different industries as well as tax cuts and expanded marketability for singularly differing industries. Often times procurement of properties, buildings, and labor can be obtained at a fraction of the cost in host countries than would be the case within the company's home country. While this may seem unfair, it is a good idea to keep in mind the host countries economy and market. Companies are often forced to abide by local regulations rather than the regulations of their home country. On the other side of the coin, the host country benefits due to the increase in jobs it produces in the regional labor market to which the investment companies reach out to. Often times dying economies can be revived in the process of becoming a host for certain industries or markets in which that industry or market had not previously been. This is especially the case with third world countries that are trying to catch up to industrial nations or who need a boost due to changes in regional climates or in the advent of recovery from the aftermath of civil or world war. 

Foreign direct investment (FDI) in its classic definition, is defined as a company from one country making a physical investment into building a factory in another country. Its definition can be extended to include investments made to acquire lasting interest in enterprises operating outside of the economy of the investor. [1] The FDI relationship consists of a parent enterprise and a foreign affiliate which together form a Multinational corporation (MNC). In order to qualify as FDI the investment must afford the parent enterprise control over its foreign affiliate. The IMF defines control in this case as owning 10% or more of the ordinary shares or voting power of an incorporated firm or its equivalent for an unincorporated firm; lower ownership shares are known as portfolio investment[2].


In the years after the Second World War global FDI was dominated by the United States, as much of the world recovered from the destruction brought by the conflict. The US accounted for around three-quarters of new FDI (including reinvested profits) between 1945 and 1960. Since that time FDI has spread to become a truly global phenomenon, no longer the exclusive preserve of OECD countries.

FDI has grown in importance in the global economy with FDI stocks now constituting 28 percent of global GDP.

US International Direct Investment Flows


FDI Outflow

FDI Inflows



$ 42.18 bn

$ 5.13 bn

+ $ 37.04 bn


$ 122.72 bn

$ 40.79 bn

+ $ 81.93 bn


$ 206.27 bn

$ 329.23 bn

- $ 122.96 bn


$ 950.47 bn

$ 907.34 bn

+ $ 43.13 bn


$ 1,629.05 bn

$ 1,421.31 bn

+ $ 207.74 bn


$ 2,950.69 bn

$ 2,703.81 bn

+ $ 246.88 bn

Foreign direct investment (FDI) is an integral part of an open and effective International economic system and a major catalyst to development. Yet, the benefits of FDI do not accrue automatically and evenly across countries, sectors and local communities. National policies and the international investment architecture matter for attracting FDI to a larger number of developing countries and for reaping the full benefits of FDI for development. The challenges primarily address host countries, which need to establish a transparent, broad and effective enabling policy environment for investment and to build the human and institutional capacities to implement them.

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India Will Achieve its FDI Target This Year

Even as liquidity in the Indian economy is drying up, the government has assured the people that enough money is flowing in. Kamal nath, India's commerce and industry minister, announced that while export grew to 30 percent in October, FDI will rise above US$35 billion by the end of this year, meeting the governments target. Earlier he had mentioned that during April-August this year, India had already received US$14.6 billion in FDI.

"The huge growth in FDI in India despite global economic slowdown shows how sound and resilient our economy is," Kamal Nath said, adding there was nothing to worry at all. "In August, FDI growth was 124 % and 219% in July this fiscal, which is an indicator to the fact that India with its strong fundamentals can tide over global financial crisis, "he told the Times of India, hinting that India is still an attractive investments destination. Mr Nath told the Economic Times that FDI increase must be seen as a positive sign in the context of global slowdown. The manufacturing sector received US$5 bn during April-August, an year-on-year rise of 41 percent.

Major investments this year involved the Royal bank of Scotland buying shares in Reliance Ports and Terminals for US$382 million and DE Shaw Composite Investment pouring in US$384 million in DLF Assets.

C. Kamaraj
II Year MBA (Batch 2007-09)
R.L. Institute of Management Studies
Madurai-625 022

Source: E-mail October 21, 2008




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