288 33 Powerpoint Slides Chapter 12 Foreign Direct Investment

Copyright @ Oxford University Press Copyright @ Oxford University Press International Business R. M. JoshiInternational Business R. M. Joshi

Chapter 12: Foreign Direct Chapter 12: Foreign Direct InvestmentInvestment

International BusinessInternational Business

Rakesh Mohan Joshi Rakesh Mohan Joshi

Professor & Chairperson, IIFT New DelhiProfessor & Chairperson, IIFT New Delhi

1



Foreign Direct Foreign Direct

InvestmentInvestment

Chapter 12



Learning ObjectivesLearning Objectives To explain the concept of foreign direct To explain the concept of foreign direct

investment (FDI)investment (FDI) To discuss various types of FDITo discuss various types of FDI To develop a conceptual understanding To develop a conceptual understanding

of the theories of international of the theories of international

investmentinvestment To understand policy framework to To understand policy framework to

promote FDIpromote FDI To discuss patterns of FDITo discuss patterns of FDI



Significance of FDISignificance of FDI

International trade and foreign direct International trade and foreign direct

investment (FDI) are the two most important investment (FDI) are the two most important

international economic activities integrating international economic activities integrating

the world economy. With the increase in the world economy. With the increase in

mobility of factors of production across mobility of factors of production across

countries, FDI has become an integral part countries, FDI has become an integral part

of firms’ strategy to expand international of firms’ strategy to expand international

business. business.



Concept of FDIConcept of FDI

In simple terms, FDI means acquiring In simple terms, FDI means acquiring

ownership in an overseas business entity. ownership in an overseas business entity.

Foreign direct investment occurs when an Foreign direct investment occurs when an

investor based in one country (the home investor based in one country (the home

country) acquires an asset in another country) acquires an asset in another

country (the host country) with the intent to country (the host country) with the intent to

manage it. manage it.



Foreign Portfolio Investment (FPI)Foreign Portfolio Investment (FPI)

An investment by individuals, firms, or a An investment by individuals, firms, or a

public body in foreign financial instruments, public body in foreign financial instruments,

such as foreign stocks, government bonds, such as foreign stocks, government bonds,

etc. etc.

In FPI, the equity stake in the foreign In FPI, the equity stake in the foreign

business entity is not significant enough to business entity is not significant enough to

exert any management control. exert any management control.



Raison d’etre for FDIRaison d’etre for FDI

Cost of transportationCost of transportation

Liability of foreignnessLiability of foreignness



Benefits of FDI to Host CountriesBenefits of FDI to Host Countries

Access to superior technologyAccess to superior technology

Increased competition Increased competition

Increase in domestic investment Increase in domestic investment

Bridging host countries’ foreign exchange Bridging host countries’ foreign exchange

gapsgaps



Negative Impacts of FDINegative Impacts of FDI

Market MonopolyMarket Monopoly

Crowding-out and unemployment effectsCrowding-out and unemployment effects

Technology dependenceTechnology dependence

Profit outflowProfit outflow

Corruption Corruption

National securityNational security



Factors Affecting Selection of FDI Factors Affecting Selection of FDI DestinationsDestinations

Cost of capital input Cost of capital input

Wage rate Wage rate

Taxation regimeTaxation regime

Cost of inputsCost of inputs

Cost of logisticsCost of logistics

Market demandMarket demand



Types of FDITypes of FDI

On the Basis of Direction of On the Basis of Direction of InvestmentInvestment

Inward FDIInward FDI: : Foreign firms taking control over Foreign firms taking control over

domestic assets.domestic assets.

Outward FDI:Outward FDI: Domestic firms investing overseas Domestic firms investing overseas

and taking control over foreign assets.and taking control over foreign assets.



On the Basis of Types of ActivityOn the Basis of Types of ActivityHorizontal FDIHorizontal FDI: Overseas investment in a similar activity as : Overseas investment in a similar activity as

carried out in the home country.carried out in the home country.

Vertical FDIVertical FDI: Overseas investment so as either to provide inputs : Overseas investment so as either to provide inputs

for the firm’s domestic operations or sell its domestic output for the firm’s domestic operations or sell its domestic output

abroad.abroad.

• Backward Vertical FDIBackward Vertical FDI: Direct investment aimed at providing : Direct investment aimed at providing

inputs for a firm’s production processes.inputs for a firm’s production processes.

• Forward Vertical FDIForward Vertical FDI: Direct investment overseas aimed to sell : Direct investment overseas aimed to sell

the output of a firm’s domestic production processes.the output of a firm’s domestic production processes.

Conglomerate FDIConglomerate FDI: Direct investment overseas aimed at : Direct investment overseas aimed at

manufacturing products not manufactured by the firm in the manufacturing products not manufactured by the firm in the

home country.home country.



On the Basis of Investment ObjectivesOn the Basis of Investment Objectives Resource-seeking FDIResource-seeking FDI: Direct investment : Direct investment overseas so as to gain privileged access to overseas so as to gain privileged access to resources vis-à-vis competitorresources vis-à-vis competitorMarket-seeking FDIMarket-seeking FDI: Direct investment overseas : Direct investment overseas with sizeable market and growth in order to with sizeable market and growth in order to protect existing markets, counteract competitors, protect existing markets, counteract competitors, and to preclude rivals from gaining new marketsand to preclude rivals from gaining new marketsEfficiency-seeking FDIEfficiency-seeking FDI: Direct investment : Direct investment overseas so as to improve efficiency and or seek overseas so as to improve efficiency and or seek advantages of process specialization or product advantages of process specialization or product rationalizationrationalization



On the Basis of Entry ModesOn the Basis of Entry Modes

Greenfield InvestmentsGreenfield Investments:: Overseas Overseas

investment to create new facilities or investment to create new facilities or

expansion of existing facilitiesexpansion of existing facilities

Merger & Acquisitions (M&As):Merger & Acquisitions (M&As): Transfer of Transfer of

existing assets of a domestic firm to a existing assets of a domestic firm to a

foreign firm that leads to mergers and foreign firm that leads to mergers and

acquisitions.acquisitions.



On the Basis of SectorOn the Basis of Sector

Industrial FDI:Industrial FDI: Investment by a foreign firm in the Investment by a foreign firm in the

manufacturing sector.manufacturing sector.

Non-industrial FDI:Non-industrial FDI: Investment by a foreign firm Investment by a foreign firm

in services sector.in services sector.



On the Basis of Strategic ModesOn the Basis of Strategic Modes

Export replacementExport replacement

FDI is made as a substitute for exports in FDI is made as a substitute for exports in

response to trade barriers of the host response to trade barriers of the host

country, such as import restrictions and country, such as import restrictions and

prohibitive tariff structure. prohibitive tariff structure.



Export PlatformsExport Platforms

In order to minimize a firm’s cost of In order to minimize a firm’s cost of

production and distribution, FDI is made so production and distribution, FDI is made so

as to utilize the target country to serve the as to utilize the target country to serve the

global markets. global markets.



Domestic SubstitutionDomestic Substitution

FDI aimed to obtain cheap inputs to support FDI aimed to obtain cheap inputs to support

home production.home production.



Theories of International Theories of International InvestmentInvestment



Capital Arbitrage TheoryCapital Arbitrage Theory

FDI takes place due to differences in the FDI takes place due to differences in the

rates of return on capital across countries. rates of return on capital across countries.



Market Imperfection TheoryMarket Imperfection Theory

To access countries with market imperfections, such To access countries with market imperfections, such

as government policies, including import as government policies, including import

restrictions and quotas, incentives on exports, tax restrictions and quotas, incentives on exports, tax

regimes, and government’s participation in trade regimes, and government’s participation in trade

etc, FDI is often employed as a strategic tool for etc, FDI is often employed as a strategic tool for

international business expansion.international business expansion.



Internalization TheoryInternalization Theory

When the know-how, technology, skills, or When the know-how, technology, skills, or

trade secrets available with a firm are trade secrets available with a firm are

crucial to the firm’s competitive advantage, crucial to the firm’s competitive advantage,

it needs to protect such knowledge base it needs to protect such knowledge base

within the organization. Therefore, it within the organization. Therefore, it

expands internationally by way of FDI. expands internationally by way of FDI.



Monopolistic Advantage TheoryMonopolistic Advantage Theory

An MNE is believed to possess monopolistic An MNE is believed to possess monopolistic

advantage, which enables it to operate advantage, which enables it to operate

overseas more profitably and compete with overseas more profitably and compete with

local firms. local firms.



International Product Life Cycle TheoryInternational Product Life Cycle Theory

The theory provides an explanation as to The theory provides an explanation as to

why the production locations are shifted why the production locations are shifted

across countries and suggests that an MNE across countries and suggests that an MNE

prefers those countries for investment as prefers those countries for investment as

manufacturing locations that have market manufacturing locations that have market

size large enough to support local size large enough to support local

production. production.



Eclectic Theory (OLI Paradigm)Eclectic Theory (OLI Paradigm)

It is a blend of macro-economic theory It is a blend of macro-economic theory

of international trade (L) and micro-of international trade (L) and micro-

economic theories of the firm (O&I). economic theories of the firm (O&I).



The Ownership (O) Factor The Ownership (O) Factor

Specific advantages possessed by a firm Specific advantages possessed by a firm

enabling it to reap profits from overseas enabling it to reap profits from overseas

investments. investments.



The Location (L) FactorThe Location (L) Factor

Country specific advantage contributing to Country specific advantage contributing to

relative attractiveness of an investment relative attractiveness of an investment

destination destination



The Internalization (I) FactorThe Internalization (I) Factor

Retaining firm’s know-how within the Retaining firm’s know-how within the

organization rather than transferring it to an organization rather than transferring it to an

unrelated firm overseas.unrelated firm overseas.



Policy Framework to Promote FDIPolicy Framework to Promote FDI

Attracting FDI has become a key part of Attracting FDI has become a key part of

national development strategies for most national development strategies for most

countries. Such investments are often countries. Such investments are often

viewed to augment domestic capital, viewed to augment domestic capital,

employment, and productivity, leading to employment, and productivity, leading to

economic growth. economic growth.



Major Regulatory Measures & Incentives Major Regulatory Measures & Incentives to Promote FDIto Promote FDI

Screening, admission, and establishmentScreening, admission, and establishment

Fiscal incentivesFiscal incentives

Financial incentivesFinancial incentives

Other incentives, such as subsidized Other incentives, such as subsidized

service fees, subsidized designated service fees, subsidized designated

infrastructure infrastructure

Performance requirements Performance requirements



Promotion of FDI in IndiaPromotion of FDI in IndiaInstitutional frameworkInstitutional framework

The Department of Industrial Policy and The Department of Industrial Policy and

Promotion plays an active role in investment Promotion plays an active role in investment

promotion through dissemination of promotion through dissemination of

information on investment climate and information on investment climate and

opportunities in India. It also advises opportunities in India. It also advises

potential investors about investment potential investors about investment

policies, procedures, and opportunities and policies, procedures, and opportunities and

helps resolve problems faced by foreign helps resolve problems faced by foreign

investors. investors.



Policy FrameworkPolicy Framework



•FDI ProhibitedFDI Prohibited

• Retail trading (Except single brand product Retail trading (Except single brand product retailing)retailing)

• Atomic energyAtomic energy• Lottery businessLottery business• Gambling and betting sectorGambling and betting sector• Business of chit fund and Business of chit fund and nidhinidhi company company• Plantation except tea Plantation except tea • Trading in Transferable Development Rights Trading in Transferable Development Rights

(TDR)(TDR)• Activity/ sector not opened to private sector Activity/ sector not opened to private sector

investmentinvestment



FDI up to 24 per cent allowedFDI up to 24 per cent allowed

• Manufacture of items reserved for small Manufacture of items reserved for small sector upto 24 per centsector upto 24 per cent


• FM broadcastingFM broadcasting• Up-linking a news and current affairs TV Up-linking a news and current affairs TV

channelschannels• Defence productionDefence production• InsuranceInsurance• Publishing of news papers and Publishing of news papers and

periodicalsperiodicals



FDI upto 49 per cent allowedFDI upto 49 per cent allowed

• BroadcastingBroadcasting Setting up hardware facilitiesSetting up hardware facilities Cable networkCable network:: Direct to Home (DTH)Direct to Home (DTH): :

• Scheduled Air transport services Scheduled Air transport services • Commodity exchangesCommodity exchanges• Credit information companies Credit information companies • Refining in case of PSUs Refining in case of PSUs • Asset reconstruction companies Asset reconstruction companies


• Single brand product retailingSingle brand product retailing



•FDI up to 74 per cent allowedFDI up to 74 per cent allowed

• ISP with gateways, radio-paging, and ISP with gateways, radio-paging, and end-to-end bandwidthend-to-end bandwidth

• Establishment and operation of satellitesEstablishment and operation of satellites• Private sector bankingPrivate sector banking• Telecommunications servicesTelecommunications services• Non-scheduled Air transport services, Non-scheduled Air transport services,

ground handling servicesground handling services



Foreign direct investment up to 100 per Foreign direct investment up to 100 per cent allowed cent allowed with prior government with prior government approvalapproval subject to conditions: subject to conditions:

• Trading:Trading: • Courier servicesCourier services• Tea sector, including tea plantation: Tea sector, including tea plantation: • ISP without gateway, infrastructure ISP without gateway, infrastructure

provider, electronic mail, and voice mail: provider, electronic mail, and voice mail: • Mining and mineral separation of titanium Mining and mineral separation of titanium

bearing minerals and ores, its value addition bearing minerals and ores, its value addition • Cigars and cigarettes manufactureCigars and cigarettes manufacture• Airports- existing projects with prior Airports- existing projects with prior

government approval beyond 74 per cent government approval beyond 74 per cent • Up-linking of a non-news and current affairs Up-linking of a non-news and current affairs

TV channels TV channels • Investing companies in infrastructure/ Investing companies in infrastructure/

services sector (except telecom sector)services sector (except telecom sector)• Publishing of scientific magazines, specialty Publishing of scientific magazines, specialty

journals and periodicalsjournals and periodicals



Foreign Direct Investment allowed up to Foreign Direct Investment allowed up to 100 per cent under automatic route100 per cent under automatic route• Agriculture sectorAgriculture sector• Industrial sectorsIndustrial sectors

MiningMining Manufacturing activitiesManufacturing activities Petroleum sectorPetroleum sector PowerPower Special Economic Zones and Free Trade Special Economic Zones and Free Trade

Warehousing ZonesWarehousing Zones Industrial Parks Industrial Parks Construction development projectsConstruction development projects

• ServicesServices• Civil aviationCivil aviation• Non banking finance companiesNon banking finance companies• Trading Trading

• In sectors/ activities not listed above, FDI is In sectors/ activities not listed above, FDI is permitted upto 100 per cent through permitted upto 100 per cent through automatic routeautomatic route



PatternsPatterns of of FDIFDI

Flow of FDI:Flow of FDI: The amount of FDI undertaken over a The amount of FDI undertaken over a given time period (for example, a year). If the given time period (for example, a year). If the investment is made by a foreign firm in a country, investment is made by a foreign firm in a country, known as inflow of FDI whereas investment made known as inflow of FDI whereas investment made overseas is termed as outflow of FDI. overseas is termed as outflow of FDI. The total accumulated value of foreign owned The total accumulated value of foreign owned assets at a given time is termed as stock of FDI. FDI assets at a given time is termed as stock of FDI. FDI comprises of equity capital and re-invested earnings comprises of equity capital and re-invested earnings as per IMF norms. Besides, capacity expansion as per IMF norms. Besides, capacity expansion financed by firms of foreign origin as well as short-financed by firms of foreign origin as well as short-term or long-term loans that form part of original term or long-term loans that form part of original packages are also treated as FDI.packages are also treated as FDI.



Components of FDI FlowsComponents of FDI Flows

FDI is mainly financed by TNCs throughFDI is mainly financed by TNCs through

Equity capitalEquity capital

Intra-company loans Intra-company loans

Reinvested earningsReinvested earnings



FDI Performance IndicesFDI Performance Indices

For carrying out cross-country comparison of For carrying out cross-country comparison of

FDI performance and FDI potential, the FDI performance and FDI potential, the

UNCTAD’s FDI performance and potential UNCTAD’s FDI performance and potential

indices serve as useful toolsindices serve as useful tools



Inward FDI Performance Index:Inward FDI Performance Index: Measure of Measure of

the extent to which a host economy receives the extent to which a host economy receives

inward FDI relative to its economy size.inward FDI relative to its economy size.

Outward FDI performance index: Outward FDI performance index: The ratio The ratio

of a country’s share in global FDI outflows to its of a country’s share in global FDI outflows to its

share inshare in

the world GDP.the world GDP.



FDI Trends in IndiaFDI Trends in India



Sector-wise Composition of FDI Sector-wise Composition of FDI InflowsInflows

Figure : Sectorwise Composition of FDI Inflows*

Metallurgical Industries3.7%

Automobile Industry4.0%

P ower4.1%

Housing & Real Estate5.8%

P etroleum & Natural Gas3.1%

Chemicals2.3%

others30.6%

Telecommunications6.3%

Construction Activities6.7%

Computer Software & Hardware

11.5%

Services Sector22.0%

**Figures for April 2000 to May 2008Figures for April 2000 to May 2008Source: Fact sheet on FDI, Department of Industrial Policy Source: Fact sheet on FDI, Department of Industrial Policy

and Promotion, and Promotion, Government of India, New Delhi, Government of India, New Delhi, 20082008



Country wise FDI InflowsCountry wise FDI Inflows

Figure: Country-wise Composition of FDI Inflows*

others24.6%

UAE1.1%

J apan3.1%

Netherlands4.0%

Germany2.3%

Cyprus1.7%

France1.4%

UK6.5%

Singapore7.1%

USA7.6%

Mauritius40.6%

**Figures for April 2000 to May 2008Figures for April 2000 to May 2008Source: Fact sheet on FDI, Department of Industrial Policy and Promotion, Source: Fact sheet on FDI, Department of Industrial Policy and Promotion,

Government of India, New Delhi, 2008Government of India, New Delhi, 2008



Foreign Direct Investment in Retail Foreign Direct Investment in Retail SectorSector

India is the second largest market in the India is the second largest market in the

world after China and it fascinates global world after China and it fascinates global

retailers to invest. It has opened up FDI upto retailers to invest. It has opened up FDI upto

51% in retail trade to “single brand 51% in retail trade to “single brand

products” from Feb, 2006. products” from Feb, 2006.

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