Investment is one thing that can make or break a company’s economic progression. Foreign direct investment, or FDI, is one such investment that helps companies to thrive.
Companies that receive a substantial investment can work on building a better team, and they also look for a highly profitable return on investment (ROI). Foreign direct investment helps companies with both of these factors.
What is Foreign Direct Investment or FDI?
It is a category of cross-border investment where an investor residing in one country/economy has an ongoing interest and significant influence in another company in another country/economy is called foreign direct investment.
For example, a company in America can help a newly established company in India to reach its goals through its investments.
FDI is also an insightful indicator of a specific country’s political and socio-economic stability. It implies that a country that receives large amounts of investments from foreign entities regularly is more likely to have a dynamic and vibrant economy.
How Does Foreign Direct Investment Work?
Foreign investments can be of two types, either organic or inorganic. In organic investments, a foreign investor will invest funds to expand and accelerate growth in established businesses.
Inorganic investments occur when an investing company purchases a business in the target nation. In developing and emerging economic nations like India and other parts of South-East Asia, FDI offers much-needed support to businesses in their target country.
Foreign investors can invest in India via one of two routes : the automatic route and the government route. Automatic routes do not require prior government approval.
Foreign investors do not have to go through the government or various ministries to invest in a country’s companies. Whereas in the Government route, the investors need to follow strict rules and regulations set by the government before investing in any Indian business or company.
Types of Foreign Direct Investment
Depending on the type of company, there are four different kind of foreign direct investment :-
1. Horizontal FDI:- Horizontal FDI involves investing capital in a foreign company in the same sector or industry where the investor owns his business. Here a company invests in another company located in another country and produces similar goods.
2. Vertical FDI:- This FDI type refers to the investment within the typical supply chain of companies that may or may not be in the same industry. When vertical direct investment occurs, companies invest in foreign companies that can supply or sell their products.
3. Conglomerate FDI:- When companies invest in two completely different companies in completely different industries, the transaction is known as conglomerate FDI. Therefore, FDI is not directly related to the investor’s businesses.
4. Platform FDI:- The last type refers to business expansion to a foreign country, but everything will be exported to a third country. Platform FDI is seen in free-trade zones of FDI-hungry countries.For Example, the french perfume brand set up a manufacturing plant in the USA and export products to other countries like India , South East Asia , Africa etc.
Examples of FDI
The importance of FDI cannot be undermined. It has resulted in infrastructure improvements which led to job creation, increased exports and helped the formal sector immensely.
Here are some notable examples of foreign investments in India:-
- Byju’s, an online Ed-Tech company, raised USD 500 million in a Silver Lake-led funding round in September 2020. Silver Lake is a noted US equity firm.
- Also, in September 2020, Unacademy, a competitor of Byju’s in the same niche, raised a total of USD 150 million. Japan SoftBank Group led the round.
- General Atlantic, One of New York’s most respected equity firms, invested over USD 900 million for a stake in Reliance’s Jio Platforms in June 2020.
Benefits of Foreign Direct Investment
The following are the key advantages of foreign direct investment in developing countries :-
- Provide exclusive market access in other countries.
- FDIs increase manufacturing activity and improve the service sector, thus creating more employment opportunities.
- Exports Increase when foreign investment boost production.
- The per capita income of the population will increase as the income opportunities increase.
- It also helps improve technology and operational practices through knowledge sharing.
- Build Industries and factories to improve the country’s infrastructure and help underdeveloped areas to develop.
Foreign Direct Investment positively impacts developing countries as it improves their economic and social growth. However, there may be some potential risks that can limit its actual benefits. The high share of foreign direct investment in a country’s total capital inflows may reflect the weakness rather than the strength of that country’s institutions. Therefore, Policy recommendations are needed to improve the investment climate of both the foreign and domestic businesses necessary for developing countries.