What is FDI
FDI Definition
A foreign direct investment refers to a purchase of a particular organisation’s interest by another foreign organisation. Such an organisation or investor is located in a different country than the organisation whose interest is purchased. It involves a business decision whereby a significant stake is acquired in a foreign business. Generally, organisations undertake FDI to expand operations to a foreign location.
Working of FDI
Organisations looking forward to FDI will select only those businesses that have an efficient and skilled workforce. Usually, organisations look for such businesses in countries with an open economy. This is because, in such open markets, investor growth prospects are above average. Another important factor to select a foreign location for FDI is tax regulations. Naturally, those places where tax regulations are light are preferred.
The scope of foreign direct investment is wider and bigger than capital investment. It includes the following:
Significance of FDI
Foreign direct investment is very important for developing nations. In order to expand internationally, the organizations of such nations need foreign funding. Such funding allows these organizations to spread sales internationally. Moreover, with foreign direct investment, the developing nations get funding for the following:
Types of Foreign Direct Investment
By now you know what is FDI. Let us now study its main types:
Horizontal direct investment: Here, the organization establishes and runs the same business type in the foreign nation as it does in its home nation. For example, A UK computer products provider purchasing a chain of computer products stores in France.
Vertical investment: Here, an organization, in another nation, purchases a complementary business organization. For example, a UK furniture manufacturer acquiring an interest in a foreign organization that provides it with wooden material.
Conglomerate investment: Here, an organization invests in a foreign organization which has no resemblance to its core operations. Usually, this happens as a joint venture since the home organization lacks experience.
Examples of Foreign Direct Investments
Foreign direct investment examples can be:
The partnerships in FDI can be in various sectors such as follows:
All these forms allow an organization to pursue a multinational strategy for international growth.
Advantages of FDI
The advantages of foreign direct investment can be enumerated as follows:
Best practices: It brings technology to developing nations. Besides, it brings the most efficient management ideas to the business that is the recipient. Also, the recipient organization's employees learn innovative ways of accomplishing goals prevalent internationally. Consequently, the lifestyle of the workers in recipient organizations enhances.
High Standard of Living: Due to FDI, the living standard of the entire developing nation increases. This is possible as the recipient organization receives a significant amount of money due to foreign financing. Consequently, it pays a higher amount of taxes. This in turn benefits the people of the developing nation.
Establishing stable long-term lending: A major benefit of FDI is that it removes the volatile effect of hot money. Hot money refers to a capital whose transferring takes place frequently with the aim of maximizing capital gain. Due to this, the entire nation can be ruined. With foreign direct investment, this problem is effectively tackled.
Disadvantages of FDI
Danger to comparative advantage: Foreign direct investment is not appropriate for major industries that are strategic to a nation. In case a nation allows foreign ownership in such industries, it could lose its comparative advantage.
There may be no real value: The aim of many organizations with FDI is to seek the maximum value out of the foreign business while adding no real value in return. For example, these foreigners could sell off less profitable organisational aspects to inferior non-worthy investors.
Most investors lack high ethical standards: In order to seek access to a foreign market, investors go for immoral ways. For example, they can find lower-cost local loans by making use of the organization’s collateral. Now, they may lend these funds to the parent organization rather than reinvest.
What kind of reserves does FDI help maintain?
Foreign direct investment facilitates the maintenance of stable and secure foreign exchange reserve levels. This way, the promotion of long-term lending takes place in the following markets:
What is meant by conglomerate foreign direct investment?
In conglomerate foreign direct investment, a certain amount of money is invested in a foreign business by an organisation. In many cases, that business is the one that is related to the type of business of the organisation. Sometimes, the investing organisation may invest in a new type of business with which it has no prior experience. A joint venture is formed in this way.
What is meant by greenfield FDI?
A greenfield FDI investment is a type where a subsidiary is created by a parent organisation other than the home country. This way, an organisation builds its operations from the basic foundation in the new country.
What is brownfield investment?
A brownfield investment is one where a certain sum is invested by an organisation in an existing facility for initiating business processes in a foreign nation. We can look at this type of investment as a lease or purchase of a facility that already exists in a foreign nation.
What has been the effect of the Covid pandemic on foreign direct investment?
Due to the Covid pandemic, FDI all over the world was significantly reduced. This can be clearly understood by taking a look at the United Nations Conference on Trade and Development data. According to his data, foreign investment dropped from $1.5 trillion in 2019 to $859 billion in 2020 globally.
Disclaimer: This content is authored by an external agency. The views expressed here are that of the respective authors/ entities and do not represent the views of Economic Times (ET). ET does not guarantee, vouch for or endorse any of its contents nor is responsible for them in any manner whatsoever. Please take all steps necessary to ascertain that any information and content provided is correct, updated and verified. ET hereby disclaims any and all warranties, express or implied, relating to the report and any content therein.
A foreign direct investment refers to a purchase of a particular organisation’s interest by another foreign organisation. Such an organisation or investor is located in a different country than the organisation whose interest is purchased. It involves a business decision whereby a significant stake is acquired in a foreign business. Generally, organisations undertake FDI to expand operations to a foreign location.
Working of FDI
Organisations looking forward to FDI will select only those businesses that have an efficient and skilled workforce. Usually, organisations look for such businesses in countries with an open economy. This is because, in such open markets, investor growth prospects are above average. Another important factor to select a foreign location for FDI is tax regulations. Naturally, those places where tax regulations are light are preferred.
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The scope of foreign direct investment is wider and bigger than capital investment. It includes the following:
- Provision of management
- Provision of technology
- Provision of equipment
- Establishment of a substantial level of control over foreign business
- Ability to impact the decision-making of the foreign business
Significance of FDI
Foreign direct investment is very important for developing nations. In order to expand internationally, the organizations of such nations need foreign funding. Such funding allows these organizations to spread sales internationally. Moreover, with foreign direct investment, the developing nations get funding for the following:
- Infrastructure
- Energy
- Water
- Combating climate change effects
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That’s not all; FDI opens up the pathway for developing trade agreements. One of the best examples here is NAFTA, the North Atlantic Free Trade Agreement (NAFTA).Types of Foreign Direct Investment
By now you know what is FDI. Let us now study its main types:
Horizontal direct investment: Here, the organization establishes and runs the same business type in the foreign nation as it does in its home nation. For example, A UK computer products provider purchasing a chain of computer products stores in France.
Vertical investment: Here, an organization, in another nation, purchases a complementary business organization. For example, a UK furniture manufacturer acquiring an interest in a foreign organization that provides it with wooden material.
Conglomerate investment: Here, an organization invests in a foreign organization which has no resemblance to its core operations. Usually, this happens as a joint venture since the home organization lacks experience.
Examples of Foreign Direct Investments
Foreign direct investment examples can be:
- Mergers
- Acquisitions
- Partnerships
The partnerships in FDI can be in various sectors such as follows:
- Retail
- Services
- Logistics
- Manufacturing
All these forms allow an organization to pursue a multinational strategy for international growth.
Advantages of FDI
The advantages of foreign direct investment can be enumerated as follows:
Best practices: It brings technology to developing nations. Besides, it brings the most efficient management ideas to the business that is the recipient. Also, the recipient organization's employees learn innovative ways of accomplishing goals prevalent internationally. Consequently, the lifestyle of the workers in recipient organizations enhances.
High Standard of Living: Due to FDI, the living standard of the entire developing nation increases. This is possible as the recipient organization receives a significant amount of money due to foreign financing. Consequently, it pays a higher amount of taxes. This in turn benefits the people of the developing nation.
Establishing stable long-term lending: A major benefit of FDI is that it removes the volatile effect of hot money. Hot money refers to a capital whose transferring takes place frequently with the aim of maximizing capital gain. Due to this, the entire nation can be ruined. With foreign direct investment, this problem is effectively tackled.
Disadvantages of FDI
Danger to comparative advantage: Foreign direct investment is not appropriate for major industries that are strategic to a nation. In case a nation allows foreign ownership in such industries, it could lose its comparative advantage.
There may be no real value: The aim of many organizations with FDI is to seek the maximum value out of the foreign business while adding no real value in return. For example, these foreigners could sell off less profitable organisational aspects to inferior non-worthy investors.
Most investors lack high ethical standards: In order to seek access to a foreign market, investors go for immoral ways. For example, they can find lower-cost local loans by making use of the organization’s collateral. Now, they may lend these funds to the parent organization rather than reinvest.
What kind of reserves does FDI help maintain?
Foreign direct investment facilitates the maintenance of stable and secure foreign exchange reserve levels. This way, the promotion of long-term lending takes place in the following markets:
- Bond market
- Currency market
- Equity markets
What is meant by conglomerate foreign direct investment?
In conglomerate foreign direct investment, a certain amount of money is invested in a foreign business by an organisation. In many cases, that business is the one that is related to the type of business of the organisation. Sometimes, the investing organisation may invest in a new type of business with which it has no prior experience. A joint venture is formed in this way.
What is meant by greenfield FDI?
A greenfield FDI investment is a type where a subsidiary is created by a parent organisation other than the home country. This way, an organisation builds its operations from the basic foundation in the new country.
What is brownfield investment?
A brownfield investment is one where a certain sum is invested by an organisation in an existing facility for initiating business processes in a foreign nation. We can look at this type of investment as a lease or purchase of a facility that already exists in a foreign nation.
What has been the effect of the Covid pandemic on foreign direct investment?
Due to the Covid pandemic, FDI all over the world was significantly reduced. This can be clearly understood by taking a look at the United Nations Conference on Trade and Development data. According to his data, foreign investment dropped from $1.5 trillion in 2019 to $859 billion in 2020 globally.
Disclaimer: This content is authored by an external agency. The views expressed here are that of the respective authors/ entities and do not represent the views of Economic Times (ET). ET does not guarantee, vouch for or endorse any of its contents nor is responsible for them in any manner whatsoever. Please take all steps necessary to ascertain that any information and content provided is correct, updated and verified. ET hereby disclaims any and all warranties, express or implied, relating to the report and any content therein.