FOREIGN DIRECT INVESTMENT

FOREIGN DIRECT INVESTMENT

• Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market in a foreign country. Once a firm undertakes FDI it becomes a multinational enterprise

• FDI is undertaken by firms so that they can take advantage of resources that are either unavailable in the home country or because these resources are available at costs lower than those in their home country.

• The firm has significant control of its foreign operation and can affect managerial decisions of the foreign operation. It usually involves participation in management, joint-venture, transfer of technology and expertise.

TYPES OF FDI

BY DIRECTION

1.INWARD FDI

2.OUTWARD FDI

BY TARGET

1. GREENFIELD INVESTMENT

2. MERGERS AND ACQUISITIONS

3. JOINT VENTURE

Inward FDI: Inward FDI for an economy can be defined as the capital provided from a foreign direct investor residing in a country, to that economy, which is residing in another country. Here, investment of foreign capital occurs in local resources.

Flow of Inward FDI may face restrictions from factors like restraint on ownership and disparity in the performance standard.

EXAMPLE: General Motors decides to open a factory in Malaysia. They are going to invest some capital. That capital is inward FDI for Malaysia.

Outward FDI:

When investment is made by a domestic company in the foreign country than there is outflow of FDI from domestic country toforeign country. Foreign direct investment, which is outward, is also referred to as “direct investment abroad”.

Outward FDI faces restrictions under a host of factors as described below:

•Industries related to defence are often set outside the purview of outward FDI to retain government's control over the defense related industrial complex.•Subsidy scheme targeted at local businesses.•Government policies, which lend support to the phenomenon of industry nationalization

•Indian Companies can set up:-•100% subsidiary abroad•Joint venture abroad.

•How much investment:• Max outward FDI restricted to 3 times of net worth as per

last audited balance sheet.• Subscribe to share capital of foreign country• Outward remittances to foreign country to subscribe to share • Capital;or/&• Export of machinery, manpower, management ;or/&• Export of technical know how.

No restrictions on repatriation of profitsECB can be raised for outward FDI

FEMA Guidelines on Outward FDI

FIPB

•FIPB is in Ministry of Commerce•Commerce Ministry chairman is Chairman of FIPB•Application on plain paper along with project report to be submitted to FIPB•FIPB powersof sanction upto Rs.600 crores•Project of more than 600 crores will go to CCFI, “IMG”

GREENFIELD INVESTMENT

•A form of foreign direct investment where a parent company starts a new venture in a foreign country by constructing new operational facilities from the ground up. In addition to building new facilities, most parent companies also create new long-term jobs in the foreign country by hiring new employees.

•Developing countries often offer prospective companies tax-breaks, subsidies and other types of incentives to set up green field investments. Governments often see that losing corporate tax revenue is a small price to pay if jobs are created and knowledge and technology is gained to boost the country's human capital.

•A related term to Greenfield Investment which is becoming popular is Brownfield Investment, where a site previously used for a "dirty" business purpose, such as a steel mill or oil refinery, is cleaned up and used for a less polluting purpose, such as commercial office space or a residential area.

MERGERS AND ACQUISITIONS

1.1. HorizontalHorizontal• A merger in which two firms in the same industry combine.A merger in which two firms in the same industry combine.• Often in an attempt to achieve economies of scale and/or Often in an attempt to achieve economies of scale and/or

scope.scope.2.2. VerticalVertical

• A merger in which one firm acquires a supplier or another firm A merger in which one firm acquires a supplier or another firm that is closer to its existing customers.that is closer to its existing customers.

• Often in an attempt to control supply or distribution channels.Often in an attempt to control supply or distribution channels.3.3. ConglomerateConglomerate

• A merger in which two firms in unrelated businesses combine.A merger in which two firms in unrelated businesses combine.• Purpose is often to ‘diversify’ the company by combining Purpose is often to ‘diversify’ the company by combining

uncorrelated assets and income streamsuncorrelated assets and income streams4.4. Cross-border (International) M&AsCross-border (International) M&As

• A merger or acquisition involving a Indian and a foreign firm, A merger or acquisition involving a Indian and a foreign firm, either the acquiring or target company.either the acquiring or target company.

JOINT VENTURE

–A joint venture is here defined as shared ownership in a foreign business

–Some advantages of a MNE working with a local joint venture partner are:

•Better understanding of local customs, mores and institutions of government

•Providing for capable mid-level management

•Some countries do not allow 100% foreign ownership

•Local partners have their own contacts and reputation which aids in business.

However, joint ventures are not as common as 100%-owned foreign subsidiaries as a result of potential conflicts or difficulties

IMPORTANCE OF FDI

•FDI provides ready resource for the growth of the economy. For capital starved country, FDI could be a boon. Generating funds internally may require much time and also FDI is motivated bylong term profit considerations of the investors.

•The enhanced money inflow from overseas means that the country can import more goods that are basic to the building of the economy.This is particularly important for developing country.

•FDI acts as the nucleus around which other businesses can grow. For example, toyota motors have established their automobile plants in India and they source fraction of parts from local firms.

ADVANTAGES OF FDI

•Foreign Direct Investment plays a pivotal role in the development of India's economy. It is an integral part of the global economic system.

•FDI ensures a huge amount of domestic capital, production level, and employment opportunities in the developing countries, which is a major step towards the economic growth of the country.

•Foreign Direct Investments have opened a wide spectrum of opportunities in the trading of goods and services in India both in terms of import and export production.

•FDI has also ensured a number of employment opportunities by

aiding the setting up of industrial units in various corners of India.

DISADVANTAGES OF FDI

•One of the most important disadvantages of foreign direct investment is that the economically backward section of the host country is always inconvenienced when the stream of foreign direct investment is negatively affected.

• The differences of language and culture that exist between the country of the investor and the host country could also pose problems in case of foreign direct investment.

•Adverse effects on the balance of payments, when a foreign subsidiary imports a substantial number of its inputs from abroad, there is a debit on the current account of the host country’s balance of payments.

TRENDS IN FDI

There has been a marked increase in both the flow and stock of FDI

in the world economy over the last 30 years.

FDI has grown more rapidly than world trade and world output

because:

• The general shift toward democratic political institutions and free

market economies has encouraged FDI

• The globalization of the world economy is having a Positive

impact on the volume of FDI as firms undertake FDI

FDI AND ECONOMIC DEVELOPMENT

Foreign direct investment (FDI) is considered to be the lifeblood and an important vehicle for economic development as far as the developing nations are concerned. The important effect of FDI is its contribution to the growth of the economy.

FDI has an impact on country's trade balance, increasing labour standards and skills, transfer of new technology and innovative ideas, improving infrastructure, skills and the general business climate.

FDI also provides opportunity for technological transfer and up gradation, access to global managerial skills and practices, optimal utilization of human capabilities and natural resources, making industry internationally competitive, opening up export markets, providing backward and forward linkages and access to international quality goods and services.

FDI INCENTIVES

Types of FDI Incentives• Fiscal Incentives - to reduce tax burden of foreign investors.• Financial Incentives - grants given by government• Other Incentives - like subsidized infrastructure, market preference, preferential foreign exchange rates.

FDI AND FII

Both FDI and FII is related to investment in a foreign country. FDI or Foreign Direct Investment is an investment that a parent company makes in a foreign country. On the contrary, FII or Foreign Institutional Investor is an investment made by an investor in the markets of a foreign nation.

In FII, the companies only need to get registered in the stock exchange to make investments. But FDI is quite different from it as they invest in a foreign nation.

The Foreign Institutional Investor is also known as hot money as the investors have the liberty to sell it and take it back. But in Foreign Direct Investment, this is not possible. The Foreign Direct Investment is considered to be more stable than Foreign Institutional Investor.

FDI POLICY IN INDIA

• Foreign direct investment (FDI) has become an integral part of national development strategies for almost all the countries globally. Its global popularity and positive output in augmenting of domestic capital, productivity and employment; has made it an indispensable tool for initiating economic growth for nations.

• India is evolving as one of the ‘most favored destination’ for FDI in Asia and the Pacific (APAC). It has displaced US as the second-most favored destination for foreign direct investment (FDI) in the world after China.

• FDI in India has contributed effectively to the overall growth of the economy in the recent times. FDI inflow has an impact on India's transfer of new technology and innovative ideas; improving infrastructure, a competitive business environment.

India has among most liberal and transparent policy on FDI among the emerging economies. FDI upto 100% is allowed under the automatic route in all sectors except the following which require prior approval of government:

• Manufacturing of tobacco products and its substitutes.• Manufacturing of electronic aerospace and defence equipments.• Manufacturing of item exclusively meant for small scale industries with more than 24% FDI.• Proposals in which the foreign collaborator has an existing joint venture, technology transfer, trade mark in India in same field.

FDI POLICY:

FDI Policy contd:An ongoing review of the FDI policy is carried out so as to initiate more liberalization. Change in sectoral policy/sectoral equity cap is notified from time to time through Press Notes. This is done by the Secretariat for Industrial Assistance (SIA) in the Department of Industrial Policy & Promotion. Policy announcement by SIA are subsequently notified by RBI under FEMA.

• FDI Policy permits FDI up to 100 % from foreign/NRI investor without prior approval in most of the sectors including the services sector under automatic route.• FDI in sectors/activities under automatic route does not require any prior approval either by the Government or the RBI.• The investors are required to notify the Regional office concerned of RBI of receipt of inward remittances within 30 days of such receipt. They will have to file the required documents with that office within 30 days after issue of shares to foreign investors.

PROHIBITED SECTOR UNDER FDI

FDI is not permissible in the following cases:

• Gambling and Betting.• Lottery Business.• Business of chit fund.• Housing and Real Estate business.• Atomic Energy.• Agricultural or plantation activities and plantations(other than

Tea plantations).• Retail Sector

INDUSTRIAL LICENSING POLICY

Industrial Licenses are regulated under the Industries (Development & Regulation) Act, 1951. The requirements of Industrial license has been progressively reduced. At present industrial license for manufacturing is required only for the following:

• Industries retained under compulsory licensing.• Items reserved for small scale sector.

-> An industrial undertaking is defined as a small-scale unit if the capital investment in plant and machinery does not exceed Rs 10 million. A small scale unit can not have more than 24 per cent equity in its paid up capital from any industrial undertaking, either foreign or domestic.

FDI STATISTICS IN INDIAFDI STATISTICS IN INDIA

FDI INFLOWS MONTH WISE DURING YEAR 2010

SECTORS ATTRACTING HIGHEST FDI INFLOWS

SHARE OF TOP INVESTING COUNTRIES