Foreign direct investment, also typically referred to as FDI, is an investment made in a business by an entity, individual or company, from a foreign country. The defining characteristic of FDI is that it represents a degree of direct control that the investor possesses with regards to their stake, rather than just facilitating a transfer of funds. FDI is one of the most vital channels for international direct investments and acts as an indicator of a nation’s socio-economic and political stability. Unlike Foreign Portfolio Investment, FDI allows the investor to hold a stake in a company based in a foreign country while exercising some control over their investment. FDI can also provide insight into the economic conditions of a country; the greater the number of foreign investments, the likelier it is that the recipient country has a dynamic and flourishing economy.
FDI can be categorized as ‘organic investment’ or ‘inorganic investment’. Organic investments are when a foreign investor lends capital to a certain established business to facilitate its growth and expansion. On the other hand, when a foreign entity buys out said business, it is known as inorganic investment.
In emerging economies and developing markets such as India, FDIs are a stimulus that can provide a much-needed boost to a business that is in need of financial support. In order to direct investments through this channel, the Indian government has introduced a multitude of measures that serve to promote FDI in various sectors of the economy like IT, telecom sector, defence production and PSU oil refineries. In India, FDI is a promising candidate for becoming a spearhead for economic development, since it is a non-debt resource. Foreign direct investment has been made thanks to two main factors- globalisation and internationalisation. There are a few reasons for the viability and popularity of FDI; they have helped in overthrowing monopolistic business practices, they can provide control over businesses in foreign countries and they provide a helpful cushion that protects companies in the event of a sudden decline in business due to market fluctuations.
Foreign investors can partake in foreign direct investments in a number of different ways. They can expand their own operations in a foreign country, or they can obtain voting stocks of a business based in a different country. Here are a few different ways in which FDIs can be used to penetrate overseas markets:
The investment market is vast, with several avenues for investment opportunities. Even within FDI, there are four distinct types of investments, each with its own approach. Here are the different types of foreign direct investments:
1. Horizontal FDI
Horizontal FDI is the most common type of foreign investment. It involves investing capital in a foreign company that belongs to the same industry sector that the investor conducts or owns business operations in. Thus, the investment is made through the domestic company in a foreign company, both of which produce similar goods and belong to the same industry. The distribution of funds is seen horizontally across the sectors, despite being in different countries since the core business undertaking is the same. It can also be seen as an expansion of the investor’s domestic business overseas.
A vertical FDI is when an entity invests within the supply chain of a business, but the component may not necessarily belong to the same industry. Thus the investor chooses to invest in a foreign company that can supply that component. For instance, a coffee producer may invest capital in overseas coffee plantations. Here, since the investing company is purchasing a provider in the supply chain, this is known as backward vertical integration. On the other hand, when the investor invests in a foreign company that is placed higher in the supply chain it is known as forwarding vertical integration. For example, the same coffee company may want to invest in a foreign grocery chain. Thus, the business expansion occurs on a different level in the business supply chain, but the undertakings are still associated with the primary business. This helps the investor is effectively strengthening their supply chain without drastically modifying their business.
When an investor chooses to invest in two entirely different businesses based in completely different industries, it is known as conglomerate FDI. In this scenario, the FDI is not directly linked to the foreign investor’s business. For instance, an automobile manufacturer may decide to invest in Pharma. Here, the investor is undertaking foreign business investments that are completely unrelated to their domestic business. This type is relatively uncommon since the difficulty of establishing a business in a new country is compounded by the difficulty of a breakthrough in a new market or industry. The goal of a conglomerate FDI is to expand into new niches and explore different business opportunities.
Platform FDI is the final type of foreign direct investment. In this case, the investor’s business works towards expansion in a foreign country, with the ultimate aim of exporting the manufactured products to a completely different, third country. For example, a clothing brand based in North America may outsource their manufacturing process to a developing country in Asia, and sell the finished goods in Europe. Thus the expansion occurs in one foreign country, and the output is carried on to a different foreign country. This type of FDI is generally seen in free-trade regions in countries that are actively seeking FDI. Luxury clothing brands are a classic example of this type of FDI and manufacturing process.
After 1991’s economic liberalization, India was able to open its markets to foreign investors. The past few decades have seen several government reforms that have been introduced to encourage foreign direct investments in the country. In addition to facilitating business expansion and economic growth, FDI also plays a significant role in building trade relations, creating new employment opportunities, improving managerial expertise, technological advancement and bettering infrastructure. According to the UN’s World Investment Report 2020, India received a record-shattering USD 51 billion in FDI in the year 2019 across all economic sectors. However, in spite of their benefits, FDIs do carry certain disadvantages. Here is a brief overview of the pros and cons of FDIs.
The last decade or so has seen a steady influx of foreign direct investment in India in numerous sectors such as automobiles, pharmaceuticals, transport and textiles. This inflow is expected to not only continue but also increase considerably in the coming years. Some economic sectors such as Indian airlines have been made 100% open to foreign investment. FDI infusion is also expected to help programs such as ‘Make in India’. If you’re looking to invest via foreign direct investment, you need to acquaint yourself with how FDIs work and what different types of FDI come into play. The investments made through FDIs can be greatly beneficial for your own business or can bring considerable returns through another.
Foreign direct investment, also typically referred to as FDI, is an investment made in a business by an entity from a foreign country. This entity can be a company or an individual. The primary characteristic of FDI is that it represents a degree of direct control that the investor possesses with regards to their stake, rather than just facilitating a transfer of funds. FDI is one of the most vital channels for international direct investments and acts as an indicator of a nation’s socio-economic and political stability.
The different types of FDIs are horizontal FDI, vertical FDI, conglomerate FDI and platform FDI.
Here are a few different ways in which FDIs can be used to penetrate overseas markets:
Foreign direct investments are a critical driver for business expansion, economic growth, trade relations, new employment opportunities, managerial expertise, technological advances and better infrastructure.
Platform FDI is the final type of foreign direct investment. In this case, the investor’s business works towards expansion in a foreign country, with the ultimate aim of exporting the manufactured products to a completely different, third country. For example, a clothing brand based in North America may outsource their manufacturing process to a developing country in Asia, and sell the finished goods in Europe.
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