Group 4(ii)

• FOREIGN DIRECT INVESTMENT (FDI)

DEFINITION :• “Foreign direct investment occures when an

investor based in one country acquires assets in another country with the interest to manage the asset.”

• Foreign direct investment is investment of foreign assets into domestic structures, equipment, and organizations. It does not include foreign investment into the stock markets.

THEORIES OF FDI

1. THEORY OF IMPERFECT MARKET : The firms having comparative technological

or organizational advantage invest abroad to gain firm specific advantages

2. PRODUCT LIFE CYCLE THEORY : The product life cycle theory tries to explain

that when the product reaches the maturity stage the firm starts investing abroad

to low cost production areas

3. INTERNATIONALISATION : Firms invest abroad in order to retain inside

the group the firms competitive advantage4. ELECTIC THEORY OF FDI : According to this theory it is not possible for a

single theory to explain all forms of multinational strategies as there are a

wide range of factors that influence FDI decision

Factors influencing :

A. Ownership advantages : It arise due to the firm owning a special

knowledge or because of economies of scale or due to monopolistic advantage

B. Locational advantages : It is due to location bound endowments enjoyed

by a firmC. Internationalization advantage : It refers to the extent to which the firm can

market its advantages within the various units of the firm

WHY DO FIRMS INVEST ABROAD ?

• To reduce cost of production

• To have diversified sourcing facilities

• To increase volume of sale

• To promote knowledge sharing

• To retain domestic customers

FDI STRATEGIES :

• BRANCHES : Parent company open up branches in foreign

country• JOINT VENTURE : It is a partnership between the foreign and

domestic company where the partnership firms share equity and a new firm is formed

Eg : Vodafone’s purchase of 52% stake in Hutch Essar for about $10 billion

EXAMPLES :

• WHOLLY OWNED SUBSIDIARY : If the foreign investment is equal to the

entire equity capital it is called as a wholly owned subsidiary

Examples :

• MERGER : A merger is a combination of two or more

companies being merged into an existing company or a new company may be formed

Eg : Reliance Petrochemicals Ltd. Merged with Reliance Industries Ltd. In 2010

• ACQUISITION AND TAKEOVER : Acquisition is a simple act of acquiring control over

the management of other companies

Eg : HDFC Bank acquisition of Centurion Bank of Punjab for $2.4 billion

BENEFITS OF FDI

• FDI supplements domestic capital• Availability of scarce factors of production• Improvement in Balance of Payment• Influence on foreign trade• Development of social and economic

infrastructure• FDI promotes research

ARGUMENTS AGAINST FDI

• Capital flow may not be real : FDI may not bring fresh capital if the foreign

company purchases equity financed by domestic lenders.

• Obsolete and mismatched technology : The technology being brought by the MNCs is

one that run its course in the home country and has been rendered obsolete

• FDI may cause in loss of competition : When FDI is through mergers and

acquisition , it may reduce competition in the host country

• Exploitation of resources

FDI IN INDIA

• Foreign Direct Investment (FDI) is permitted as under the following forms of investments –

1. Through financial collaborations2. Through joint ventures and technical

collaborations3. Through capital markets via Euro issues4. Through private placements or preferential

allotments

• FDI is not permitted in the following industrial sectors :

1. Arms and ammunition2. Atomic Energy3. Railway Transport4. Coal and lignite5. Mining of iron, manganese, chrome, gypsum,

sulphur, gold, diamonds, copper, zinc

FDI-TOP INVESTERS IN INDIAMAURITIUS 38 %

SINGAPORE 10 %

U.K 9 %

JAPAN 7 %

U.S.A 6 %

NETHERLANDS 4 %

CYPRUS 4 %

GERMANY 3 %

FRANCE 2 %

U.A.E 1 %

FDI - LEADING SECTORS

SERVICES SECTOR 19 %

TELECOMMUNICATIONS 7 %

CONSTRUCTION ACTIVITIES 7 %

COMPUTER SOFTWARE & HARDWARE 7 %

HOUSING & REAL ESTATE 7 %

CHEMICALS 6 %

DRUGS & PHARMACEUTICALS 5 %

POWER 4 %

AUTOMOBILE INDUSTRY 4 %

METALLURGICAL INDUSTRIES 4 %