Fdi vs fpi
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Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) Kanchan Kandel BBA
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Transcript of Fdi vs fpi
Foreign Direct Investment (FDI) and Foreign Portfolio
Investment (FPI)
Kanchan KandelBBA
Modes of International Business
The hierarchy of modes of Int’l Business from the least amount to risk to the greatest is as follows:
Int’l Trade (Import & Export)
License/Franchise Agreements
Joint Ventures
Foreign Direct Investment
Foreign Portfolio Investment
Franchising Licensing
Governed by: Securities law Contract law
Registration: Required Not required
Territorial rights: Offered to franchisee Not offered; licensee can sell similar licenses and products in same area
Support and training: Provided by franchiser Not provided
Royalty payments: Yes Yes
Use of trademark/logo:Logo and trademark retained by franchiser and used by franchisee
Can be licensed
Examples: McDonalds, Subway, 7-11, Dunkin Donuts
Microsoft Office
control: Franchiser exercise control overfranchisee.
licensor does not have control over licensee
Licensing
It is an arrangement in which a firm (the licensor) grants legal permission to another firm or individual (the licensee) to use specified components of its production or marketing process for a limited period of time.
The licensed components may include patents, copyrights, trademarks, technology, managerial skills and so forth. The licensee then produces and markets a product in the foreign country similar or different to one the licensor produces and markets at home.
FranchisingIt is an arrangement in which a firm (the franchisor) grants a package of support services to another firm or individual (the franchisee) to undertake production and/or marketing in a specified location. Franchise contracts usually cover more aspects of the foreign operation and have a longer duration than the licensing contracts.
The package may include product input supplies, production equipment, ongoing management assistance, advertising and promotional materials, strategic planning and so on. Franchising may also involve some financing, particularly in the early stages of developing the foreign business.
Cont..Under both licensing and franchising
agreements, the licensee/franchisee compensates the licensor/franchisor with royalties and fees.
Joint Venture
Partial commitment for capital investment supplemented by remaining commitment for capital investment by another form for a business project.
Merger & Acquisitions- Horizontal M & A: In this, two or more firms engaged
in similar activities join hands. For example, if two firms manufacturing automobiles merge, it will be called horizontal merger. It helps create economies of scale because the size of the firm becomes larger to reap such gains.
- Vertical M & A: This occurs among firms involved in different stages of the production of a single final product. Thus, if an oil exploration firm and a refinery unit merge, it will be called a vertical merger. It reduces cost of transportation and of communicating and coordinating production.
- Conglomerate M & A: It involves two or more firms in unrelated activities.
Foreign Direct Investment (FDI)
It involves the establishment of new production facilities in foreign countries . Through FDI, a company becomes multinational.
FDI could be a greenfield investment i.e., building brand new production facilities or brownfield investment i.e., purchasing existing building and other assets.
Reasons for Foreign Investment
Trade Barriers
Imperfect labor market
Intangible Assets
Vertical integration
Product life cycle
Shareholder diversification services [email protected]
Trade Barriers• Government may impose tariffs, quotas,
embargo and other restrictions on export and imports goods and services hindering the free flow of these products across national boundaries.
Classic example for trade barrier motivated FDI is Honda’s investment in Ohio. Since the cars produced in Ohio would not be subject to US tariffs and quotas, Honda could circumvent these barriers by establishing production facilities in the United States.
Imperfect Labor Market• Labor services in a country can be severely
underpriced relative to its productivity because workers are not allowed to freely move across boundaries to seek higher wages. Among all factor markets, the labor market is the most imperfect.
• When workers are not mobile because of immigration barriers, firms themselves should move to the workers in order to benefit from the underpriced labor services. This is one the main reasons MNCs are making FDIs in less developed countries such as Mexico, China, India and Southeast Asian countries. [email protected]
Intangible Assets• MNCs may undertake investment projects in a
foreign country, despite the fact that local firms may enjoy inherent advantages. This implies that MNCs should have significant advantages over local firms. Examples are: technological, managerial, and marketing know how, superior R&D capabilities, and brand names.
• Coca-Cola has invested in bottling plans all over the world rather than say, licensing local firms to produce Coke. The reason is it wanted to protect the formula for its famed soft drink. If Coca-Cola licenses a local firm to produce Coke, it has no guarantee that the secrets of the formula will be maintained.
Product Life Cycle
- FDI takes place when a product reaches maturity and cost becomes an important consideration. FDI can thus be interpreted as a defensive move to maintain the firm’s competitive position against its domestic and foreign rivals.
- Personal computers ( PCs) were first developed by US firms ( such as IBM and Apple Computer) and exported to overseas markets. As PC’s became a standardized commodity, however, the US became a net importer of PCs from foreign producers based in such countries as Japan, Korea and Taiwan as well as foreign subsidiaries of US firms.
Shareholder Diversification Services
• If investors cannot diversify their portfolio holdings internationally because of barriers to cross-border capital flows, firms may be able to provide their shareholders with indirect diversification services by making direct investments in foreign countries.
Global FDI Market• During the five year period during 1997-2001, total annual worldwide FDI flows amounted to about USD 830 billion on average. The United States is the largest recipient, as well as initiator, of FDI. Besides USA, France, Germany, the Netherlands and UK are the leading sources of FDI outflows, whereas the UK, China, France, Germany and the Netherlands are the major destinations for FDI in the five year period.
FDI in Nepal• History of foreign investment in Nepal began from
the establishment of Biratnagar Jute Mill in 1936.
• Post-1990, market liberalization has played a vital role in attracting foreign investment.
• But the trend, unfortunately could not continue, as the post-1990 governments did not realize that the free market economy could not survive only on political foundation. Without social foundation, it became meaningless.
All data are sourced from the latest UNTCAD’s World Investment Report 2011. Here is a WIR’s FDI profile of [email protected]
Total FDI inflows
FDI inflows (US$ million) 1990-1995 1996-2000 2001-2005 2006-2010 2009 2010
Afghanistan -0.01 571.81 566.38 1041.65 185.00 75.65
Bangladesh 125.85 4608.81 2338.69 4158.61 700.16 913.30
Bhutan 2.25 18.93 17.18 138.28 14.68 11.69
India 4220.69 43360.95 28827.96 148512.08 35648.78 24639.92
Maldives 41.57 249.65 182.86 565.43 112.34 163.82
Nepal 8.16 89.80 31.70 77.89 38.56 38.99
Pakistan 2591.56 7556.31 5059.00 19655.00 2338.00 2016.00
Sri Lanka 658.88 2191.96 1102.01 2717.20 404.00 477.60
Total FDI inflows
FDI inflows (US$ billion) 1990-1995 1996-2000 2001-2005 2006-2010 2009 2010
World 1349.12 7825.63 3750.82 7605.60 1185.03 1243.67
Developing economies 423.78 2214.48 1199.64 2744.64 510.58 573.57
South Asia 7.53 72.40 51.56 188.43 42.46 31.95
Least developed countries (LDCs) 8.40 79.49 56.34 132.93 26.54 26.39
Landlocked developing countries 7.81 65.02 42.29 102.30 26.19 23.02
Nepal’s Prospect in tapping FDI
The FDI potential in Nepal can be segregated into three types:
FDI potential in short term
FDI potential in medium term
FDI potential in long term
Cont…• FDI Potential in short term
- Tourism
- Export Manufacturing under Trade Preferences
• FDI Potential in medium term
- Hydropower for the Indian and domestic market
- Agro based industries
- Privatization of PSUs
• FDI Potential in long term
- Regional [email protected]
Tourism• Nepal have plenty of area to attract tourist like
mountain, one horn rhino, culture and tradition.
• Low expenditure also attract tourist.
To increase FDI in Tourism following step should need
Removal of the ban on overseas tour operators’ and travel agencies ownership of operations in Nepal
Formulation of a tourism development certificate & incentive
Structuring of tourism development [email protected]
Export Manufacturing under trade preferences
In backdrop of Nepal’s trade treaty with India, there is potential for international investors to invest in Nepal keeping in view the opportunities to export the products to India.
Hydropower• Nepal has a huge potential of hydro power that comes
to about 83,000 MW out of which 43,000 MW is economically viable.
• Until now, Nepal has not been able to exploit much of its potentiality and the people in Nepal still face severe power shortages.
• In order to harness and develop hydropower, private sectors were involved to carry out small and medium sized hydro power projects.
• Similarly the government is encouraging private foreign investment in this sector.
FDI Potential in Agro-based industries
Nepal has potential for producing vegetable and flower seeds. It also has an ideal climate for cut flowers, strawberries, mushrooms and other crops.
FDI Potential in Regional Services
• Nepal has the opportunity in the long run to be an offshore services centre for regional countries, especially India.
• These services could include offshore financial services for Indian residents and location of basic business and professional and back-office services focused on regional markets.
• Nepal's core attributes are a temperate climate, low wage costs, a smaller and more accessible bureaucracy, and an attractive expatriate lifestyle.
Strength Location between the two potentially largest
markets in the world: China and India
Trainable and low-cost workforce
Substantial natural and cultural assets
Small and accessible bureaucracy and a generally business-friendly Government
Macroeconomic stability and a relatively liberal economy
Weakness• Lack of direct access to airports• Poor ground transportation• Lack of skilled labor and technological expertise• Inadequate power• Inadequate water supply• Few local raw materials• Non-transparent and arbitrary tax administration• Inadequate and obscure commercial legislation • Rigid and intrusive labor legislation• Political instability and weak implementation
OpportunitiesTourism, including sports and adventure tourism,
health tourism and cultural tourism
A variety of niche agricultural and agro-business activities
Hydropower generation and infrastructure development generally
IT-based [email protected]
Foreign portfolio Investment (FPI)
• A grouping of investment assets that focuses on securities from foreign markets rather than domestic ones.
• An international portfolio is designed to give the investor exposure to growth in emerging and international markets and provide diversification.
Benefit of FPIIncreases the liquidity of domestic capital
markets, and can help develop market efficiency as well
Researching new or emerging investment opportunities
Development of equity markets and the shareholders’ voice in corporate governance.
Introducing more sophisticated instruments and technology for managing portfolios
FDI FPIInvolvement - direct or indirect:
Involved in management and ownership control; long-term interest
No active involvement in management. Investment instruments that are more easily traded less permanent and do not represent a controlling stake in an enterprise.
Sell off: It is more difficult to sell off or pull out.
It is fairly easy to sell securities and pull out because they are liquid.
Comes from:
Tends to be undertaken by Multinational organizations
Comes from more diverse sources e.g. a small company's pension fund or through mutual funds held by individuals; investment via equity instruments (stocks) or debt (bonds) of a foreign enterprise.
What is invested:
Involves the transfer of non-financial assets e.g. technology and intellectual capital, in addition to financial assets.
Only investment of financial assets.
Stands for:
Foreign Direct Investment Foreign Portfolio Investment
Volatility: Having smaller in net inflows Having larger net inflows
Management:
Projects are efficiently managed Projects are less efficiently [email protected]
Risks Foreign Investment vs. Domestic Investment
Investment in foreign companies carry some additional risks when compared to domestic investment. These risks stem from the uncertainties related to the conversion of the realization proceeds into the domestic currency which can be broadly classified under Country risk as follows:
• Country Risk
Political risk (Risk of host government interference)
Governance risk (The ability to exercise effective control over the foreign affiliate within the country’s legal environment)
Transfer risk (The ability to move capital freely and efficiently in and out of the host country)
Foreign Exchange Risk (The value of the local currency cash flows generated and remitted to the parent in parent currency terms.)
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