INTERNATIONAL BUSINESS

ASSIGNMENT

FOREIGN DIRECT INVESTMENT

BY:
JYOTI PANDEY
ROLL NO-29
FOREIGN DIRECT INVESTMENT
Foreign Direct Investment (FDI) is normally defined as a form of investment made in order
togain unwavering and long-lasting interest in enterprises that are operated outside of the
economy of the shareholder/ depositor. In FDI, there is a parent enterprise and a foreign
associate, which unites to form a Multinational Corporation (MNC). In order to be deemed as a
FDI, the investment must give the parent enterprise power and control over its foreign affiliate.

The investment made by a company in new manufacturing and/or marketing facilities in a

foreign country is referred to as “FOREIGN DIRECT INVESTMENT”. Generally it is stipulated
that ownership of a minimum of 10 to 25 percent of the voting shares in a foreign company
allows the investment to be considered to direct.

The investment made by a company in a foreign country over a given period of time is called
“flow of foreign direct investment”.

The total amount of investment made by a company in a foreign country up to a given period of
time is called ”The stock of foreign direct investment”.

FORMS OF FDI

The forms of FDI include:

 Purchase of existing asset in a foreign country.

 New investment in property, plant, equipment.
 Participation in a joint venture with a local partner.
 Transfer of asset in exchange for equity in foreign companies.
 Export of goods for equity.
 Through trading in equity: Companies also invest in the equity of foreign companies by
purchasing the equity shares of foreign company.

INTERNATIONAL INVESTMENT THEORIES

 OWNERSHIP ADVANTAGE THEORY

This theory states that the firms having competitive advantage domestically derived from
its valuable asset like technology, brand name and large scale economies extend their
operations to foreign markets through FDI.
 INTERNALISATION THEORY
It states that the domestic company enter a foreign market through FDI when the cost of
transaction with a foreign firm is high. Companies with domestic competitive advantage
enters foreign market to utilize their assets.
 DUNNING’s ELECTIC THEORY
 According to John Dunning FDI occur when the three conditions are satisfied
Ownership advantage: the firm should have competitive advantage in ownership to
compete in the foreign market.
Location advantage : location manufacturing facilities in a foreign country should be
advantageous than operating from the domestic country.
Internalization advantage: it is advantageous to a domestic company to go for FDI
when the cost of monitoring, enforcing a contract is costly and practically difficult.
 FACTOR MOBILITY THEORY
According to this theory capital normally flows from those countries where the return on
capital is low to those countries where the return on capital is high. This is because
some countries are rich in capital in comparison to other countries and there would be
the pressure of capital flow from those countries where it is available abundantly to the
other countries.
 PRODUCT LIFE CYCLE THEORY
According to Vernon, the firms originally developed the product to establish
manufacturing facilities to produce the product in foreign countries. The firms establish
the manufacturing facilities in foreign countries, when the product reaches its maturity
stage in the home country.

FACTORS INFLUENCING FDI

 Supply factors
a) Production costs – Companies invest in foreign countries in order to avail the
benefits of lower production cost like low labour costs, land prices, commercial real
estates rents, tax rates etc.
b) Logistics – If the cost of transportation from the domestic country to a foreign
market is high and or the time of transportation of the product to a foreign market is
long, then the firms undertake the FDI.
c) Resource availability – Companies locate their manufacturing facililties close to the
places where the natural resources or critical inputs are easily accessible.
d) Access to technology – Firms go for FDI in order to have access to existing key
technology rather than developing technologies.
 Demand factors
a) Customer access – Certain business firms particularly fast food, service oriented
and retail outlets should locates their operations close to customers.
b) Marketing advantages – Companies can enjoy a number of marketing advantages
by locating their operations in a host country.
c) Exploitation of competitive advantages – Companies which enjoy competitive
advantages through trade mark, brand name, technology etc., go for FDI in order to
exploit its competitive advantages in various foreign markets.
d) Customer mobility – The companies which have one or a few customers select the
FDI strategy along with their customers.
 Political factors
a) Avoidance of trade barriers – Companies establish production facilities in foreign
markets in order to avoid trade barriers like high export tariffs, quotas etc.
 b) Economic development incentives – Government at different level offer incentives
to attract domestic as well as foreign investment.

REASONS FOR FDI

FDI is the ownership and control over assets held in foreign countries. There are a
number of reasons for FDI.

a) To increase Sales and Profits: Companies invest directly in various foreign countries in
order to increase sales and profits. This is because foreign markets offer more attractive
opportunities for business than domestic markets.
b) To enter fast growing markets: Some international market grow at a fast rate than
other markets. The fast growing market provides better opportunity for MNC for their
business growth.
c) To reduce costs: MNC’s invest in foreign countries with a view to reduce cost of
production and various other operation. This is due to the availability of various inputs
like raw materials, human resource etc.
d) To consolidate trade blocs: MNCs prefer to do business with other member countries
of the trade bloc because MNCs get preferential treatment in doing business.
e) To protect domestic markets: Some MNCs invest and operate in foreign markets with
a view to avoid the competition with the weak domestic firms.
f) To protect foreign markets: Some MNCs invest in foreign countries in order to protect
foreign markets.
g) To acquire technological and managerial know-how: Sometimes the technological
and managerial know-how in various foreign countries might be superior to those of
domestic country. In such cases MNCs invest in foreign countries in order to acquire the
superior foreign technological and managerial know-how.

COSTS AND BENEFITS OF FDI

Benefits to home country

 Inflow of foreign currencies in the form of dividend, interest etc.

 FDI increases export of machinery, equipment, technology, etc. from the home country
to the host country.
 The increased industrial activity in the home country enhances employment
opportunities.
 The firm and other home country firms can learn skills from its exposure to the host
country and transfer those skills to the industry in the home country.

Costs to home country

 Home country’s industry and employment position are at stake when the firms enter
foreign markets due to low cost labour.
 Current account position of the home country suffers as FDI is a substitute for direct
exports.
Benefits to host country

 Resource transfer effects: The resources which are scarce in the host country are
transferred from the foreign country. These resources include foreign capital,
technology, machinery and equipment, management and organization. Transfer of these
resources develop the host country economically and socially.
 Employment effects: The FDI contributes for the establishment of new industries and
business directly and for the employment of existing economic activity.
 Balance of payment effects: balance of payment position and foreign exchange
resources are very crucial from the view point of external situation of a country. FDI
provides for the production of a number of goods and services domestically. This in turn
reduces the import and thereby improves the current position of the host country’s
balance of payments.

Costs to the host country

 Intensifying competition: Foreign MNCs have more competitive abilities in view of

their large size, resource base and wide spread operations than that of the domestic
companies.
 Negative effects on balance of payments
I. Foreign companies repatriate the dividends to their home countries that affects
the current account.
II. The MNC in the host country imports the goods from its subsidiaries from other
countries. These import results in a debit on the current account of balance of
payments of the host country.
III. Some of the host governments fear FDI as it affects the sovereignty and
autonomy of the country.

FOREIG DIRECT INVESTMENT IN INDIA

In India, Foreign Direct Investment Policy allows for investment only in case of the following
form of investments:

 Through financial alliance

 Through joint schemes and technical alliance
 Through capital markets, via Euro issues
 Through private placements or preferential allotments

Foreign Direct Investment in India is not allowed under the following industrial sectors:

 Arms and ammunition

 Atomic Energy
 Coal and lignite
 Rail Transport
 Mining of metals like iron, manganese, chrome, gypsum, sulfur, gold, diamonds, copper,
zinc.
The government of India with regard to FDI announces significant measures since 1991
include:

 Granting of automatic permission for foreign equity participation up to 51 per cent in

high technology and high investment priority industries.
 Constitution of a specialized Empowered Board in order to attract FDI by negotiating
with multinational corporations.
 Allowing the MNCs to use their trade mark in India with effect from 14th may 1992
 Allowing 100 percent foreign equity for setting up power plants with free repatriation of
profits
 According to Finance Minister, FII portfolio investments are not subject to the sectoral
limits for foreign direct investment except in specialized sectors.
 Foreign investors are allowed to establish 100% operating subsidiary and should bring
at least US $ 50 million for this purpose.

India has been ranked at the third place in global foreign direct investments this year, following
the economic meltdown, and will continue to remain among the top five attractive destinations
for international investors during the next two years, according to United Nations Conference on
Trade and Development (UNCTAD)

India attracted FDI inflows of US$ 1.74 billion during November 2009, a 60 per cent increase
over the US$ 1.08 billion achieved in same month last year. The cumulative amount of FDI
inflows from August 1991 to December 2009 stood at US$ 127.46 billion, according to the latest
data released by the Department of Industrial Policy and Promotion (DIPP). India attracted FDI
equity inflows of US$ 1.54 billion during December 2009. On a cumulative basis, FDI equity
inflows of US$ 20.92 billion were recorded during April-December 2009.

The services sector comprising financial and non-financial services attracted FDI worth US$
3.54 billion during April-December 2009-10, while computer software and hardware sector
garnered about US$ 595 million during the said period. The telecommunications sector attracted
US$ 2.36 billion FDI during April-December 2009-10.

During the April- December period in 2009-10, Mauritius has led the investors into India with
US$ 8.91 billion worth of FDI, followed by Singapore with US$ 1.7 billion and the US with US$
1.58 billion, according to latest data released by DIPP.

The Indian retail market, which is the fifth largest retail destination globally, has been ranked the
most attractive emerging market for investment in the retail sector by A T Kearney's annual
Global Retail Development Index (GRDI), in 2009.

Investment Scenario

The total value of domestic mergers and acquisition (M&A) deals in January 2010 stood at US$
2,167 million (32 deals), as compared to US$ 1,324 million (eight deals) and US$ 223 million
(28 deals) during the corresponding months of 2009 and 2008, respectively.
In 2009, emerging markets grabbed a higher share of FDI—51.6 per cent—than developed
countries did, according to a study on globalization by Ernst & Young. This was mainly due to a
steep fall in FDI into developed markets, almost 50 per cent lower than in 2008.

Investments in the country's infrastructure sector have doubled from 4 per cent in 2004-05 to 8
per cent of the gross domestic product (GDP) over the past five years, according to the
Planning Commission.

With the economy coming back on the growth path, investment proposals by India Inc saw an
increase of about 16 per cent to US$ 345.3 billion in 2009, according to a study by a prominent
industry body.

Nine proposals for bringing in a total foreign investment of US$ 112.25 million were cleared in
December 2009 by the government. Among those approved is a proposal by Japan's Mitsui and
Company to bring in US$ 69.83 million to establish a fully-owned subsidiary in the warehousing
sector and the setting up of a joint venture entity in the container freight stations segment.

The government has given its nod to 14 FDI proposals in January 2010 to bring in foreign
investment totalling US$ 157.89 million. These include

 Proposal by the Asset Reconstruction Company to bring in FDI worth US$ 58.82 million.
 Standard Chartered Bank proposal to bring in FDI worth US$ 44.39 million that would
increase its FDI from 74.9 per cent to 100 per cent in its equity broking investment
banking and portfolio management arm.
 The US$ 54.28 million NDTV Lifestyle proposal and proposals by SaharaOne, NDTV
Imagine and KS Oils proposals.
 The proposal of the Mauritius-based India Infrastructure Development Fund to bring in
US$ 517.29 million FDI has been referred to the Cabinet Committee of Economic Affairs
(CCEA).

The government has also approved the FDI proposal of French power equipment manufacturer,
Alstom, to invest US$ 105.6 million and partner India's Bharat Forge for the manufacture of
power equipment. The government has approved the FDI proposals of the Federal Agency for
State Property Management of the Russian Federation to buy a 20 per cent stake in telecom
service provider Sistema-Shyam. Other cleared proposals include those of Delhi-based
Scorpios Beverages' which would involve US$ 115.4 million FDI and AG Mercantile to bring in
US$ 71.3 million. Besides, the proposal of Telecom Investments India for US$ 82.21 million FDI
was also approved.