Foreign Direct Investment (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.
Definition of Foreign Direct Investment
Foreign direct investment is that investment, which is made to serve the business
interests of the investor in a company, which is in a different nation distinct from the
investor's country of origin.
A parent business enterprise and its foreign affiliate are the two sides of the FDI
relationship. Together they comprise an MNC. The parent enterprise through its foreign
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
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
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 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-
Different Forms of Foreign Direct Investment (FDI)
Foreign direct investment is also define as when the firm invest directly to
produce or make a market in foreign country it takes following forms.
1. Green Field Investment
2. Acquiring or Merging
4. Horizontal FDI
5. Vertical FDI
1. Green Field Investment
In this form it involves the establishment of the new operation in a foreign country
2. Acquiring or Merging
Merger is combining operation with an existing firm in a foreign country. Acquiring can
be in minority where a firm takes 10% to 49% of share or in majority where a firm can
take 50% to 99% shares and full outright stake means 100% shares.
When a firm or a licenser give licenses to a foreign firm or the right to produce its
products, to use its production process or use its brand name or trade mark like Pizza Hut
4. Horizontal FDI
The FDI in the same industry in which the firm operates in the home country like telenor.
5. Vertical FDI
An industry that provides input for a firm’s domestic operations or it may be FDI in an
industry abroad that sells the output of a firm’s domestic operations.
Classification of Foreign Direct Investment
Foreign direct investment may be classified as Inward or Outward. Foreign direct
investment, which is inward, is a typical form of what is termed as 'inward investment'.
Here, investment of foreign capital occurs in local resources.
The factors propelling the growth of Inward FDI comprises tax breaks, relaxation
of existent regulations, loans on low rates of interest and specific grants. The idea behind
this is that, the long run gains from such a funding far outweighs the disadvantage of the
income loss incurred in the short run. Flow of Inward FDI may face restrictions from
factors like restraint on ownership and disparity in the performance standard.
Foreign direct investment, which is outward, is also referred to as “direct
investment abroad”. In this case it is the local capital, which is being invested in some
foreign resource. Outward FDI may also find use in the import and export dealings with a
foreign country. Outward FDI flourishes under government backed insurance at risk
Determinants of Foreign Direct Investment
One of the most important determinants of foreign direct investment is the size as
well as the growth prospects of the economy of the country where the foreign direct
investment is being made.
It is normally assumed that if the country has a big market, it can grow quickly
from an economic point of view and it is concluded that the investors would be able to
make the most of their investments in that country.
In case of foreign direct investments that are based on export, the dimensions of
the host country are important as there are opportunities for bigger economies of scale, as
well as spill-over effects.
The population of a country plays an important role in attracting foreign direct
investors to a country. In such cases the investors are lured by the prospects of a huge
Now if the country has a high per capita income or if the citizens have reasonably
good spending capabilities then it would offer the foreign direct investors with the scope
of excellent performances.
The status of the human resources in a country is also instrumental in attracting
direct investment from overseas. There are certain countries like China that have taken an
active interest in increasing the quality of their workers.
They have made it compulsory for every Chinese citizen to receive at least nine
years of education. This has helped in enhancing the standards of the laborers in China.
If a particular country has plenty of natural resources it always finds investors
willing to put their money in them. A good example would be Saudi Arabia and other oil
rich countries that have had overseas companies investing in them in order to tap the
unlimited oil resources at their disposal.
Inexpensive labor force is also an important determinant of attracting foreign
direct investment. The BPO revolution, as well as the boom of the Information
Technology companies in countries like India has been a proof of the fact that
inexpensive labor force has played an important part in attracting overseas direct
Infrastructural factors like the status of telecommunications and railways play an
important part in having the foreign direct investors come into a particular country.
It has been observed that if the infrastructural facilities are properly in place in a
country then that country receives a substantial amount of foreign direct investment. If a
country has extended its arms to overseas investors and is also able to get access to the
international markets then it stands a better chance of getting higher amounts of foreign
It has been observed in the recent years that a couple of countries has altered their
stance vis-à-vis overseas investment. They have reset their economic policies in order to
suit the interests of the overseas investors.
These companies have increased the transparency of the legal frameworks in
place. This has been done so that the overseas companies can understand the implications
of their investment in a particular country and take the appropriate decisions.
Foreign Direct Investment and Economic Development
Foreign direct investment has a major role to play in the economic development
of the host country. Over the years, foreign direct investment has helped the economies of
the host countries to obtain a launching pad from where they can make further
This trend has manifested itself in the last twenty years. Any form of foreign
direct investment pumps in a lot of capital knowledge and technological resources into
the economy of a country.
This helps in taking the particular host economy ahead. The fact that the foreign
direct investors have been able to play an important role vis-à-vis the economic
development of the recipient countries has been due to the fact that these countries have
changed their economic stances and have allowed the foreign direct investors to come in
and improve their economies.
It has often been observed that the economically developing as well as
underdeveloped countries is dependent on the economically developed countries for
financial assistance that would help them to achieve some amount of economical
The economically developed countries, on their part, can help these countries financially
by investing in these countries. This financial assistance can be canalized into various
sectors of the economy. The canalization is normally done on the basis of the
requirements of particular sectors.
It has been observed that the foreign direct investment has been able to improve
the infrastructural condition of a country. There is ample scope of technological
development of a country as well. The standard of living of the general public of the host
country could be improved as a result of the foreign direct investment made in a country.
The health sector of many a recipient country has been benefited by the foreign direct
investment. Thus it may be said that foreign direct investment plays an important role in
the overall economic and social development of a country.
It has been observed that the private sector companies are not always interested in
undertaking activities that help in improving the infrastructure of the country. This is
because the gains form these infrastructural activities are made only in the long term;
there are no short term benefits as such.
This is where the foreign direct investment can come in handy. It can also assist in
helping economically underdeveloped countries build their own research and
development bases that can contribute to the technological development of the country.
This is a very crucial contribution as most of these countries are not able to perform these
functions on their own. These assistances come in handy, especially in the context of the
manufacturing and services sector of the particular country, that are able to enhance their
productivity and ultimately advance from an economic point of view.
At times foreign direct investment could be provided in form of technology. Else,
the money that comes in a country through the foreign direct investment can be utilized
to buy or import technology from other countries. This is an indirect way in which
foreign direct investment plays an important part in the context of economic
development. Foreign direct investment can also be helpful in assisting the host countries
to set up mass educational programs that help them to educate the disadvantaged sections
of the society. Such assistance is often provided by the non-governmental organizations
in the form of subsidies. The developing countries can also tackle a number of healthcare
issues with the help of the foreign direct investment.
Foreign Direct Investment Policies
The foreign direct investment policies are the various rules and regulations that
have been laid down by the various countries in order to regulate the overseas investment
that is being made in a country.
The foreign direct investment policies take an important part in determining the
amount of foreign direct investment that comes in a country. These policies play an
important part in the decision making process of the foreign direct investors.
They are normally affected by the foreign direct investment policies that are in
place in a country and make their decision based on these policies. If the policies are
suitable enough for the companies they go ahead with their investment.
The foreign direct investment policies provide the various conditions under which
foreign direct investment may be made in a country. They also state the various situations
where exception would be made to the allowances that are provided to the foreign direct
The foreign direct investment policies are reviewed on a regular basis. The
changes that are made to the policies are also notified through a variety of means like the
press notes for example. There is also some mention in the policies about the various
ways in which foreign direct investment may be made in various sectors.
There are certain conditions where the investors need to seek permission from the
various authoritative figures like the national government or any other entity that is
responsible for looking after the various affairs that are related to foreign direct
The foreign direct investment policies are made mainly by entities that are
responsible for looking after the matters related to foreign direct investment in a country.
The policies may also be formulated by organizations that are meant to promote the
country as foreign direct investment destination. There are certain objectives behind the
foreign direct investment policies. The makers of these policies have two broad
objectives – to promote the investment opportunities that are present in the country to the
overseas investors and strike a balance between the overseas and local investors.
These policies also have various proposals that are made in order to improve the policies
that are in place for administering the foreign direct investment policies. These proposals
are important as they help in improving the foreign direct investment policy situations
and amend them so that they can appeal to the overseas investors. This would lead to an
increase in the foreign direct investment that is coming into the country. The foreign
direct investment policies also state the various areas where a country's government
would not allow foreign direct investment to be made. Some of those areas are real estate
and housing, gambling, lottery business, betting and chit funds for example.
Certain countries have formulated a number of foreign direct investment acts.
These acts lay down the various conditions where certain companies have to seek
permission from important authorities in order to receive foreign direct investment of any
form and shape. There are certain companies that are granted such permissions but only
after they complete certain formalities.
These formalities also need to be observed even after the permission has been
provided to these companies as far as foreign direct investment is concerned. The various
options in which an overseas investor can gain entry into the market of a country for the
purposes of making foreign direct investment are also mentioned in these foreign direct
Foreign Direct Investment and Infrastructure
One of the many areas in which foreign direct investment can benefit a country or
any entity, for that matter, is that of development of infrastructure. It has been observed
over the years, that a lot of countries as well as other recipients of direct investment from
overseas entities have used that money in order to develop the infrastructural facilities at
All the various types of infrastructure that are at the disposal of a country like
health or education, for example, may be benefited by foreign direct investment.
Technological infrastructure is one of the many areas in which foreign direct
investment is meant to benefit a country. With the help of foreign direct investment being
made in a country the government can construct, as well as, improve the existing
technological tools at their disposal.
This in turn also plays a very crucial role in the economic development of a
country as this technological advancement assists a country in upgrading its industries
and thus helps them to face the challenges of the contemporary global economy.
Foreign direct investment is also capable of upgrading the health infrastructure of
a particular country. This could be done by way of providing high-end equipments or
Such investment is normally made by the world level organizations in countries
that are economically backward and have no or little medical infrastructure to speak of.
For years, the World Health Organization, as well as the World Bank and the
International Monetary Fund have been providing a number of the economically
backward countries, all over the world and especially in Africa, with money and
medicines in order to eradicate critical diseases or improve the medical infrastructure in
They have also been sponsoring public health awareness programs that make
people aware about critical diseases that need to be eradicated. In India, for example,
pulse polio and HIV prevention measures have been at the center of such activities.
Communication infrastructure is an important area where the foreign direct
investment can come in handy. The money that is invested in a country by overseas
entities can be used for the construction of roads, railways and bridges.
These facilities are used for establishing connections with the remote areas of a
country and for transporting important services to these parts like medicines and aids at
times of floods or other natural disasters. A lot of construction groups are taking active
interest in developing the communicational infrastructure of other countries.
Foreign direct investment is also used for the purpose of educating the unskilled
labor force that is present in a country. In India during the later stages of 80s and 90s
there was a situation whereby there was a huge labor force but it was mostly unskilled
and was employed in the unorganized sector.
It was possible with the help of the financial assistance from the overseas direct
investors to train these people so that they may be capable of being recruited into the
industry. Foreign direct investment is also useful for executing mass educational
programs that can educate those people who remain out of the bounds of conventional
and institutional education as they are not able to afford it or it may not be available in
Advantages of Foreign Direct Investment
One of the advantages of 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.
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.
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.
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
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.
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
Investment effort seeks to exercise substantial control over the foreign affiliate
company. 'Control' as defined by the UN, is ownership of greater than or equal to 10% of
ordinary shares or access to voting rights in an incorporated firm. For an unincorporated
firm one needs to consider an equivalent criterion.
Ownership share amounting to less than that stated above is termed as portfolio
investment and is not categorized as FDI.
Disadvantages of Foreign Direct Investment
The disadvantages of foreign direct investment occur mostly in case of matters
related to operation, distribution of the profits made on the investment and the personnel.
One of the most indirect disadvantages of foreign direct investment is that the
economically backward section of the host country is always inconvenienced when the
stream of foreign direct investment is negatively affected.
The situations in countries like Ireland, Singapore, Chile and China corroborate
such an opinion. It is normally the responsibility of the host country to limit the extent of
impact that may be made by the foreign direct investment. They should be making sure
that the entities that are making the foreign direct investment in their country adhere to
the environmental, governance and social regulations that have been laid down in the
The various disadvantages of foreign direct investment are understood where the
host country has some sort of national secret – something that is not meant to be
disclosed to the rest of the world. It has been observed that the defense of a country has
faced risks as a result of the foreign direct investment in the country.
At times it has been observed that certain foreign policies are adopted that are not
appreciated by the workers of the recipient country. Foreign direct investment, at times, is
also disadvantageous for the ones who are making the investment themselves.
Foreign direct investment may entail high travel and communications expenses.
The differences of language and culture that exist between the country of the investor and
the host country could also pose problems in case of foreign direct investment.
Yet another major disadvantage of foreign direct investment is that there is a
chance that a company may lose out on its ownership to an overseas company. This has
often caused many companies to approach foreign direct investment with a certain
amount of caution.
At times it has been observed that there is considerable instability in a particular
geographical region. This causes a lot of inconvenience to the investor.
The size of the market, as well as, the condition of the host country could be
important factors in the case of the foreign direct investment. In case the host country is
not well connected with their more advanced neighbors, it poses a lot of challenge for the
At times it has been observed that the governments of the host country are facing
problems with foreign direct investment. It has less control over the functioning of the
company that is functioning as the wholly owned subsidiary of an overseas company.
This leads to serious issues. The investor does not have to be completely obedient
to the economic policies of the country where they have invested the money. At times
there have been adverse effects of foreign direct investment on the balance of payments
of a country. Even in view of the various disadvantages of foreign direct investment it
may be said that foreign direct investment has played an important role in shaping the
economic fortunes of a number of countries around the world.