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Foreign Direct Investment

VSAT 2022

Foreign Direct Investment: An Introduction

Foreign Direct Investment can be stated as the investment made by potential investors outside the country. FDI can be acquired by taking up substantial stakes in firms abroad. It is an important part of the global economy, and it has a positive impact on both the host country and the foreign companies involved. It can stimulate a country’s economy by creating new job openings, increasing the production capacity of the nation, and improving the lives of residents.


In recent years, we have seen China making multiple Foreign Direct Investments in India to outsource labour and increase their sales and manufacturing. The factors favourable for making FDIs are growth potential, i.e., before making the investments, investors have to analyse the growth potential of the country in which the investments are to be made.


What is Foreign Direct Investment?

Foreign direct investment is an investment where an entity acquires stakes in a company based in another country. Foreign Direct Investment is vital in supporting developing countries by motivating them to participate in international trade by facilitating the flow of capital, skills, and knowledge. There are certain factors that may affect international investments. A few of the factors are discussed in the article.


Foreign Direct Investments


Foreign Direct Investments


Importance of Foreign Direct Investment

1. It Helps in Diversifying Investor's Portfolio

Investors investing in FDI will have a diversified portfolio comprising many investments that can be national investments or FDI.


2. It Infuses New Technology in Developing Nation

Advanced countries making FDI are a great opportunity for developing countries. They are likely to bring cutting-edge technology and skills with them to the host country which can be very helpful to a developing country like India.


3. Creates Further Jobs and Openings

Foreign Direct Investments (FDI) create more job opportunities in the host country, indirectly boosting the economy and attracting more investments.


What is the Lasting Interest and Element of Control in FDI

Any investments made abroad will only be termed as FDI if only the investor gets a lasting interest. The lasting interest is confirmed when the investor gets 10% voting rights in the invested firm abroad.

However, the element of control is the intent to control or manage the operations of the foreign firm. Many a time, investors give up their lasting interest and accept the element of control that allows them to influence the operations of the firms.


Factors Affecting International Investments

The core factors that influence international investments are listed below:

  1. Wage Rates in Different Countries

Usually, companies invest abroad to outsource labour from countries where wages for production workers are less. By doing so, they save up a huge amount of production costs.

  1. Labour Skills

Certain businesses require skilled workers for day-to-day operations. A few examples of such businesses are electronic manufacturing companies and pharmaceutical companies. Companies requiring skilled labour will invest in countries with lower wage rates with highly skilled labour.

  1. Tax Rates of the Countries

Investors keep a check on the corporate tax of each country and decide which countries they should invest in based on the corporate tax rate of individual countries.

  1. Political Stability

It is one of the major factors that affect foreign direct investments. A stable government is merely necessary for any investments related to FDI. Investors look out for countries whose governments support FDIs and will not take steps that will hamper the operations of the business.

  1. Transportation and Infrastructure

Government should take active steps to expand its ports, construct more power plants, extend its roadways, etc. These conditions are very favourable for businesses looking for FDI.


FDI whole Over the World


FDI whole Over the World


Factors Favourable for any Investment

  1. Interest Rates

Investments are made out of current savings and by borrowing from finance firms like banks. Thus, interest rates play an influential role in investments. Higher interest rates for borrowing make it more costly whereas keeping money in the bank will yield higher rates of interest.

  1. Economic Growth

Businesses make investments to fulfil future demands. If there is a recession in a country, firms already invested will draw back their investments. Investors study the economic growth of countries before investing to analyse recession and investment falls. If a country's economy is booming, investors are likely to invest as they expect a rise in demand.

  1. Inflation

Inflation rates are significant in investments. Higher inflation rates create hesitation and confusion within the firms with the added uncertainty over the future cost of acquisition.


FDI Scenario in China

China has been attracting numerous FDIs in the past decade. Shanghai is the economic capital of China. According to the reports released by the World Bank in 2019, China had $170 billion in FDIs. The United States is the largest recipient of FDIs in the world whereas China and Hong Kong are ranked below the United States on the list of the world's largest recipients of FDIs.


Effects of FDI from China at the Global level

FDI has played a major role in fostering Chinese economic growth, and the FDI technological spillovers are propelling China to new growth milestones. Because China wants to develop, there is rivalry for FDI. The poor protection of the environmental system cannot stop FDI from entering into China's polluting and resource-intensive manufacturing cycle, generating environmental difficulties.

  1. Effect on Technological Innovation: A nation may innovate via independent invention or technology imports. Foreign-invested firms may provide innovative manufacturing technology and management to the host nation via FDI inflows. Foreign investment increases the host country's market competitiveness.

  2. Effect on Environmental Pollution: China, a significant growing economy, has progressively opened up in recent years, and its FDI has overtaken the US. FDI may drive economic growth and offer superior technology and knowledge, but at a hefty environmental cost.


Conclusion

Countries are willing to be a part of the booming globalisation process. Foreign Direct Investment can be seen as an approach by many countries allowing globalisation. FDI has a positive impact on the host country as it brings innovation, creates jobs, and expands businesses. FDI can be made by acquiring 10 % lasting interest, i.e., the right to vote. There are a few factors that can influence international investments/ foreign direct investments like corporate tax, the infrastructure of the host country, and labour charges.

Additionally, FDI helps investors or businesses access new markets and an option to set up manufacturing units abroad. They can also acquire the foreign business as a whole or form a subsidiary or merge with the foreign business.

FAQs on Foreign Direct Investment

1. Is exporting goods an example of Foreign Direct Investment?

No exporting goods will not be classified as foreign direct investment. Exporting is a part of international trade from a country. It helps businesses earn profits and to get the global reach of the products. On the other hand, FDI is an investment made outside of the country to acquire controlling rights in a foreign business. FDI allows investors to set up manufacturing plants or subsidiaries in a foreign country. Investors can also merge with or acquire a foreign business.

2. What are the factors that play a vital role in Foreign Direct Investments?

There are various factors that can influence foreign direct investments. Investors willing to make FDI firstly select a host country in which they will invest. Then they study the markets of that country and analyse the growth capacity of  the country. Countries with lower corporate taxes are always on the radar of investors. Lower corporate taxes will allow investors to use the money for more production or to acquire more stakes in businesses. Infrastructure and skilled labour are the backbones of every existing business. Therefore, it will have a great impact on FDI.

3. What is the impact of FDI on GDP?

FDI has the potential to boost investments, and it will increase the consumption level of the country. It will have a corresponding direct effect on the investments. Nations accepting FDI tend to have technological advancements and skills across the globe. As per the FDI norms, inventors have to bring advanced technology and skills to the host countries that can be a resource to the host countries. Exposure to new technologies and skills will help the GDP of the country to a greater extent.

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