Tuesday, June 3, 2014

Basics on Foreign direct investment (FDI)


Foreign direct investment (FDI) is a direct investment into production or business in a country by an individual or company of another country, either by buying a company in the target country or by expanding operations of an existing business in that country. Foreign direct investment is in contrast to portfolio investment which is a passive investment in the securities of another country such as stocks and bonds.


Broadly, foreign direct investment includes "mergers and acquisitions, building new facilities, reinvesting profits earned from overseas operations and intra company loans". In a narrow sense, foreign direct investment refers just to building new facilities. The numerical FDI figures based on varied definitions are not easily comparable.

As a part of the national accounts of a country, and in regard to the GDP equation Y=C+I+G+(X-M)[Consumption + gross Investment + Government spending +(eXports - iMports], where I is domestic investment plus foreign investment, FDI is defined as the net inflows of investment (inflow minus outflow) to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor. FDI is the sum of equity capital, other long-term capital, and short-term capital as shown the balance of payments. FDI usually involves participation in management, joint-venture, transfer of technology and expertise. There are two types of FDI: inward and outward, resulting in a net FDI inflow (positive or negative) and "stock of foreign direct investment", which is the cumulative number for a given period. Direct investment excludes investment through purchase of shares. FDI is one example of international factor movements


1. Horizontal FDI arises when a firm duplicates its home country-based activities at the same value chain stage in a host country through FDI.

2. Platform FDI Foreign direct investment from a source country into a destination country for the purpose of exporting to a third country.

3. Vertical FDI takes place when a firm through FDI moves upstream or downstream in different value chains i.e., when firms perform value-adding activities stage by stage in a vertical fashion in a host country.


The foreign direct investor may acquire voting power of an enterprise in an economy through any of the following methods:

· by incorporating a wholly owned subsidiary or company anywhere

· by acquiring shares in an associated enterprise

· through a merger or an acquisition of an unrelated enterprise

· participating in an equity joint venture with another investor or enterprise.

Forms of FDI incentives:

Foreign direct investment incentives may take the following forms:

· low corporate tax and individual income tax rates

· tax holidays

· other types of tax concessions

 · preferential tariffs

 · special economic zones

 · EPZ – Export Processing Zones

 · Bonded warehouses

 · Maquiladoras

· investment financial subsidies

 · soft loan or loan guarantees

 · free land or land subsidies

· relocation & expatriation

 · infrastructure subsidies

 · R&D support

 · derogation from regulations (usually for very large projects)

Governmental Investment Promotion Agencies (IPAs) use various marketing strategies inspired by the private sector to try and attract inward FDI, including Diaspora marketing.

 · by excluding the internal investment to get a profited downstream.

 Importance and Barriers of FDI:

The rapid growth of world population since 1950 has occurred mostly in developing countries. This growth has been matched by more rapid increases in gross domestic product, and thus income per capita has increased in most countries around the world since 1950. While the quality of the data from 1950 may be of question, taking the average across a range of estimates confirms this. Only war-torn and countries with other serious external problems, such as Haiti, Somalia, and Niger have not registered substantial increases in GDP per capita. The data available to confirm this are freely available.

An increase in FDI may be associated with improved economic growth due to the influx of capital and increased tax revenues for the host country. Host countries often try to channel FDI investment into new infrastructure and other projects to boost development. Greater competition from new companies can lead to productivity gains and greater efficiency in the host country and it has been suggested that the application of a foreign entity’s policies to a domestic subsidiary may improve corporate governance standards. Furthermore, foreign investment can result in the transfer of soft skills through training and job creation, the availability of more advanced technology for the domestic market and access to research and development resources. The local population may be able to benefit from the employment opportunities created by new businesses.

 Developing world :

A 2010 meta-analysis of the effects of foreign direct investment on local firms in developing and transition countries suggests that foreign investment robustly increases local productivity growth.  The Commitment to Development Index ranks the "development-friendliness" of rich country investment policies.

China :

 FDI in China, also known as RFDI (renminbi foreign direct investment), has increased considerably in the last decade, reaching $59.1 billion in the first six months of 2012, making China the largest recipient of foreign direct investment and topping the United States which had $57.4 billion of FDI. During the global financial crisis FDI fell by over one-third in 2009 but rebounded in 2010.

 India :

 Foreign investment was introduced in 1991 under Foreign Exchange Management Act (FEMA), driven by then finance minister Manmohan Singh. As Singh subsequently became the prime minister, this has been one of his top political problems, even in the current times. India disallowed overseas corporate bodies (OCB) to invest in India. India imposes cap on equity holding by foreign investors in various sectors, current FDI limit in aviation sector is maximum 49%.

Starting from a baseline of less than $1 billion in 1990, a 2012 UNCTAD survey projected India as the second most important FDI destination (after China) for transnational corporations during 2010–2012. As per the data, the sectors that attracted higher inflows were services, telecommunication, construction activities and computer software and hardware. Mauritius, Singapore, US and UK were among the leading sources of FDI. Based on UNCTAD data FDI flows were $10.4 billion, a drop of 43% from the first half of the last year.

United States :

 Broadly speaking, the U.S. has a fundamentally 'open economy' and low barriers to foreign direct investment.

U.S. FDI totaled $194 billion in 2010. 84% of FDI in the U.S. in 2010 came from or through eight countries: Switzerland, the United Kingdom, Japan, France, Germany, Luxembourg, the Netherlands, and Canada. A 2008 study by the Federal Reserve Bank of San Francisco indicated that foreigners hold greater shares of their investment portfolios in the United States if their own countries have less developed financial markets, an effect whose magnitude decreases with income per capita. Countries with fewer capital controls and greater trade with the United States also invest more in U.S. equity and bond markets.

White House data reported in July 1991 found that a total of 5.7 million workers were employed at facilities highly dependent on foreign direct investors. Thus, about 13% of the American manufacturing workforce depended on such investments. The average pay of said jobs was found as around $70,000 per worker, over 30% higher than the average pay across the entire U.S. workforce.

President Barack Obama said in 2012, "In a global economy, the United States faces increasing competition for the jobs and industries of the future. Taking steps to ensure that we remain the destination of choice for investors around the world will help us win that competition and bring prosperity to our people."

 In September 2013, the United States House of Representatives voted to pass the Global Investment in American Jobs Act of 2013 (H.R. 2052; 113th Congress), a bill which would direct the United States Department of Commerce to "conduct a review of the global competitiveness of the United States in attracting foreign direct investment."Supporters of the bill argued that increased foreign direct investment would help job creation in the United States.

Canada :

Foreign direct investment by country and by industry are tracked by Statistics Canada. Foreign direct investment accounted for CAD$634bn in 2012. Canada eclipses the US in this important economic measure. Global FDI inflows and outflows are tabulated by Statistics Canada.

United Kingdom :

 The United Kingdom has a very free market economy and open to foreign investment. The current Prime Minister David Cameron has sought investment from emerging markets and from the Far East in particular and some of Britain's largest infrastructure including energy and skyscrapers such as The Shard have been built with foreign investment. The United Kingdom has been a nation of free trade and open to global markets and investment for decades often taking advantage of countries looking to make investments.


Forms in which Business can be conducted by a Foreign Company in India:

A foreign company planning to set up business operations in India may:

· Incorporate a company under the Companies Act, 1956, as a Joint Venture or a Wholly Owned Subsidiary.

· Set up a Liaison Office / Representative Office or a Project Office or a Branch Office of the foreign company which can undertake activities permitted under the Foreign Exchange Management (Establishment in India of Branch Office or Other Place of Business) Regulations, 2000.

 Procedure for receiving Foreign Direct Investment in an Indian Company:

An Indian company may receive Foreign Direct Investment under the two routes as given under:

i.                     Automatic Route:  FDI is allowed under the automatic route without prior approval either of the Government or the Reserve Bank of India in all activities/sectors as specified in the consolidated FDI Policy, issued by the Government of India from time to time.

ii.                   Government Route:  FDI in activities not covered under the automatic route requires prior approval of the Government which are considered by the Foreign Investment Promotion Board (FIPB), Department of Economic Affairs, Ministry of Finance. Application can be made in Form FC-IL, which can be downloaded from http://www.dipp.gov.in. Plain paper applications carrying all relevant details are also accepted. No fee is payable.


 Sectors where FDI is not allowed in India, both under the Automatic Route as well as under the Government Route:

FDI is prohibited under the Government Route as well as the Automatic Route in the following sectors:

 i) Atomic Energy ii) Lottery Business iii) Gambling and Betting iv) Business of Chit Fund v) Nidhi Company vi) Agricultural (excluding Floriculture, Horticulture, Development of seeds, Animal Husbandry, Pisciculture and cultivation of vegetables, mushrooms, etc. under controlled conditions and services related to agro and allied sectors) and Plantations activities (other than Tea Plantations) (c.f. Notification No. FEMA 94/2003-RB dated June 18, 2003). vii) Housing and Real Estate business (except development of townships, construction of residen­tial/commercial premises, roads or bridges to the extent specified in Notification No. FEMA 136/2005-RB dated July 19, 2005). viii) Trading in Transferable Development Rights (TDRs). ix) Manufacture of cigars , cheroots, cigarillos and cigarettes , of tobacco or of tobacco substitutes.

Read more at: http://www.mbaclubindia.com/articles/foreign-direct-investment-2603.asp#.U415p3YkTZk

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