Shoeb Siddiqui - EP11B021
FDI has become an important
source of private external finance for developing countries. It is different
from other major types of external private capital flows in that it is
motivated largely by the investors' long-term prospects for making profits in
production activities that they directly control. Foreign bank lending and
portfolio investment, in contrast, are not invested in activities controlled by
banks or portfolio investors, which are often motivated by short-term profit considerations
that can be influenced by a variety of factors (interest rates, for example)
and are prone to herd behavior. These differences are highlighted, for
instance, by the pattern of bank lending and portfolio equity investment, on
the one hand, and FDI, on the other, to the Asian countries stricken by
financial turmoil in 1997: FDI flows in 1997 to the five most affected
countries remained positive in all cases and declined only slightly for the
group, whereas bank lending and portfolio equity investment flows declined
sharply and even turned negative in 1997.
FDI (Foreign Direct Investment), is defined as a controlling ownership in a
business enterprise in one country by an entity based in another country.
Foreign Direct Investments differ from passive investment in stocks and bonds
by the element of control.
According to the Financial Times, "Standard
definitions of control use the internationally agreed 10 per cent threshold of
voting shares, but this is a grey area as often a smaller block of shares will
give control in widely held companies. Moreover, control of technology,
management, even crucial inputs can confer de facto control."
The origin of the investment does not impact the
definition as an FDI, i.e. the investment may be made either by buying a
company in the target country or by expanding operations of an existing
business in that country.
Foreign
direct investment broadly includes mergers and acquisitions, building new
facilities, reinvesting profits earned from overseas operations and intra
company loans. In a narrow sense, foreign direct investment refers just to building
new facilities. The numerical FDI figures based on varied definitions are not
easily comparable. FDI is the sum of equity capital, other long-term
capital, and short-term capital as shown the balance of payments. FDI
usually involves participation in management, joint-venture, transfer
of technology and expertise. Stock of
FDI is the net cumulative
FDI for any given period. Direct investment excludes investment through
purchase of shares.
Types
of FDI
- Horizontal FDI arises when a firm duplicates its home country-based activities at the same value chain stage in a host country through FDI.
- Platform FDI Foreign direct investment from a source country into a destination country for the purpose of exporting to a third country.
- Vertical FDI takes place when a firm through FDI moves upstream or downstream in different value chains i.e., when firms perform value-adding activities stage by stage in a vertical fashion in a host country.
Methods
The
foreign direct investor may acquire voting power of an enterprise in an economy
through any of the following methods:
• By
incorporating a wholly owned subsidiary or company anywhere
• By
acquiring shares in an associated enterprise
• Through
a merger or an acquisition of an unrelated enterprise
• participating
in an equity joint venture with another investor or enterprise
Role of FDI
Apart
from contributing to the up-gradation of
knowledge, foreign investment can serve two broad purposes, namely, raise investment and relieve foreign exchange shortages.
Insofar as these are among the key factors influencing growth in developing
countries, FDI has the potential to become an important vehicle of growth.
·
FDI
and Privatization Initiatives
·
FDI,
Cross-Border Mergers & Acquisitions
·
FDI,
Domestic Capital Formation, Gross Domestic Product and Exports
·
FDI
and Balance of Payments
·
Significance for
developing countries
FDI has become an important
source of private external finance for developing countries. It is different
from other major types of external private capital flows in that it is
motivated largely by the investors' long-term prospects for making profits in
production activities that they directly control. Foreign bank lending and
portfolio investment, in contrast, are not invested in activities controlled by
banks or portfolio investors, which are often motivated by short-term profit considerations
that can be influenced by a variety of factors (interest rates, for example)
and are prone to herd behavior. These differences are highlighted, for
instance, by the pattern of bank lending and portfolio equity investment, on
the one hand, and FDI, on the other, to the Asian countries stricken by
financial turmoil in 1997: FDI flows in 1997 to the five most affected
countries remained positive in all cases and declined only slightly for the
group, whereas bank lending and portfolio equity investment flows declined
sharply and even turned negative in 1997.
While
FDI represents investment in production facilities, its significance for
developing countries is much greater. Not only can FDI add to investible
resources and capital formation, but, perhaps more important, it is also a
means of transferring production technology, skills, innovative capacity, and
organizational and managerial practices between locations, as well as of
accessing international marketing networks. The first to benefit are enterprises
that are part of transnational systems (consisting of parent firms and
affiliates) or that are directly linked to such systems through non-equity
arrangements, but these assets can also be transferred to domestic firms and
the wider economies of host countries if the environment is conducive. The
greater the supply and distribution links between foreign affiliates and
domestic firms, and the stronger the capabilities of domestic firms to capture
spillovers (that is, indirect effects) from the presence of and competition
from foreign firms, the more likely it is that the attributes of FDI that
enhance productivity and competitiveness will spread. In these respects, as
well as in inducing transnational corporations to locate their activities in a
particular country in the first place, policies matter.
