Foreign Direct

Investment

By

Dr. JUNAID
 Lecture Plan
• Understand the Meaning & Nature of
FDI
• Justify the Need for FDI
• Explian The theories of FDI
• Describing the factors impacting FDI
• Explaining India’s share in FDI

Reference: K. Aswathapa, International

Business, 3rd Ed. Pg 92-102
Types of International Business

Export-import trade
Foreign direct
investment (FDI)

Licensing

Franchising

Management contracts
 FDI- Meaning & Concept
Meaning:
Foreign direct investment occurs when a firm invests
directly in facilities to produce and /or market a product
in a foreign country.
• FDI refers to purchase of significant number of shares
of foreign company in order to gain certain degree of
‘Management Control’ .
FDI- Defining Components:
---- invest directly in facilities
---- in a foreign country
---- producing or marketing a product
 FDI- Nature
Nature of FDI is Different in Different Countries

• In other words the countries set different thresholds

for FDI
• Most countries set the thresholds between 10-25
percent of equity ownership. (US-10%)

The UN’s World Investment Report defines the FDI

beyond equity control, they say; the FDI contains
three components:
1.Equity Capital
2.Re-Invested Earnings and
3.Intra-company loans
 FDI- Nature in India
Nature of FDI is Different in India:
In India FDI covered few more routs than the equity
roots; It includes following:
1.RBI’s automatic approval route for equity holding up
to 51%
2.Foreign Investment Board’s discretionary approvals
for large projects with equity holding greater than
51%.
3.Acquisition of shares (since 1996)
4.RBI’s NRI schemes, and
5.External Commercial borrowings
 FDI- Nature in India
Undoubtedly the Indian definition is different from IMF
and WIR:

IMF Definition:
• External commercial Borrowings.
• Reinvested earnings, and
• Subordinated debts

WIR (World Inv. Rept.) Definition:

• Reinvested earnings, and
• Subordinated debts

The WIR excludes the External commercial Borrowings.

FDI- Nature - CONCLUSION:
Ideally the FDI for a recipient country should be
reflected in:
1.Capital Formation
2.Formation of New Firms & factories
3.Increase in Foreign equity holdings in the existing
firms, and
4.Mergers and Acquisitions of existing firms &
factories:
Why FDI? – Justification of need
1. Traditionally; FDI filling gap between:
• Domestically available supplies of savings
• Foreign Exchange
• Government Revenue
• Human Capital Skills
AND
• The desired level of these resources.
• To achieve Growth & development Targets.
2. MNCs May proved as Nucleus of Growth in the
country.
3. FDI generates healthy competitions – certainly lifts
up the standard of output
4. Locational Advantages often attract the FDI
5. The Political Vulnerability
FDI - THEORIES
Market
Imperfections

Eclectic
PLC

FDI

Internationali Market Power

zation

Different Approaches of the investors

 FDI- Theories
PLC (Product Life Cycle) Approaches:
• The Company will start Export
during its II, III and IV Phases of
the PLC

• The theory identifies 4 stages

1. Intro-New Product
2. Growth
3. Maturing
4. Decline
The Investment will take
place in 2 & 3 Stages of
PLC
FDI- Theories
2. Market Imperfection Approach:
• This theory / approach is result of Imperfection
in the market (e.g. Trade Barriers)
 If a firm finds high cost in foreign country’s
franchising or licensing or supply agreement,
They will prefer to go for FDI & Vise-a-versa
3. Eclectic (Misc) Theory / Approach: Advocated by
John Dunning:
• The theory advocates the LOCATION attracts FDI
– because: FDI will occur when these three
conditions will uniquely combined:
 Advantage of Ownership –Unique comp. Adv.
 Adv of Location and
 Internationalization
 FDI- Theories
4. Market Power model:
• This model states that a firm seeks to establish a
dominant market presence in the industry by
undertaking FDI
• Enhance the Profit
• Achievement of vertical integration
Backward Integration-
with, procurement (SC)

Forward Integration- with,

retailer & Distributors
FDI- Theories
5. Internationalization Approach/theory of FDI:
• Propounded by BUCKLEY & CASSON.
• It based on two principles:

1. Cost of Internationalization outweighs the

benefits, and

2. The FDI likely to reduce the imperfection of

internationalization, unlikely in Licensing or
exporting.
FDI- The Factors Influencing
1. Supply Factors
2. Demand Factors
3. Government Factors
1. Supply Factors: 2. Demand Factors:
 Product Costs  Customer access
 Logistics  Follow Clients
 Resource Availability  Follow Rivals
 Access to technology  Exploitation of
Competitive
3. Government Factors: advantages
 Economic Priorities
 Avoidance of Trade Barriers
 Economic development incentives
FDI- Continue ……. 9/2/2011
FDI- Continue …….
In this Class we will cover up:
• Forms of FDI
• Costs and Benefits of FDI
• Extent of FDI –Worldwide Trends
• Extent of FDI in India
• Areas of FDI – Allowed / Not Allowed in India
• Efforts to enhance/encourage the FDI
 Forms of FDI-
The Forms Includes:
• Purchase of Existing Assets

• New investment in property, plant and equipment

• Participation in Joint Venture with local partner

• Transfer of Many types of assets; HR, Technology

etc

• Export of Goods for equity

• Through Trading in Equity

 Costs & Benefits of FDI-
• C& B for the Home Country
• C& B for the Host Country

For Home: Benefits

• Inflow of Foreign Currencies
• Increases Export of Machinery, Equipments, tech.
etc.
• Increased Industrial Activities in home countries
• Learning skills advantages for home firms
For Home: Costs
• Employment of resources reduces; land and labour
• Current account position of the home country
suffers as FDI is substitute for direct Exports.
 Costs & Benefits of FDI-
• C& B for the Home Country
• C& B for the Host Country
For Host: Benefits
• Resource Transfer Effects
• Employment Effects
• BOP Effects
For Host: Costs
• Intensifying Competitions
• Dangerous for Infant industries/firms
FDI- Continue …….
Figures In Billion Dollar & Percentage

Source: UNCTAD; WIR’ 2005

Figures In Billion Dollar

Source: UNCTAD; WIR’ 2005

Figures In Billion Dollar

Source: UNCTAD; WIR’ 2005

FDI- India’s Share

Number of Cross Borer deals: Number

of mergers and acquisitions
Year No. of cross border deals
2002 28
2003 49
2004 60
2005 136
2006 190
2007 121
FDI- India’s Share
Monetary Term

(Fig: Million Dollar US)

2001-2002 709
2003-2004 1494
2005-2006 2679
2006-2007 35*
* figure in billion

Source: RBI Report 2007

IMPLICATIONS OF FDI FOR
BUSINESS
Implications:
• Location Specific Advantages -Indicates the flow of FDI in

order to take the advantage of Mineral and other basic

resources in foreign countries

• If the costs of transportation is minimum, it would be

preferable for the companies for export

• If the cost of transportation and trade barriers are

significant,
it would be preferable to go for FDI

• The firm can go for licensing if the know-how is not

valuable
IMPLICATIONS OF FDI FOR
BUSINESS
Cost of Transportation & Tariffs Export
Low
High

Is Know-how amendable for NO FDI

licensing

Yes
Is Tight control over foreign Yes FDI
operation
No
Can know-how be protected by NO FDI

Yes
Then Licensing
Few Measures to ATTRACT FDI
1992 – Foreign firms obtained automatic rights over
international brand name.
1993 –Requirement for industrial licensing in specified
(white goods / entertainment / electronics) abolished
1994 –1.Banks allowed to set their own rates for
lending.
2. Companies allowed to issue preferential equity
to FIIs
1996 –1. Overseas pension funds, charities, foundations

qualify as FIIs.
2. FIIs allowed to invest in unlisted firms.
3. FIIs allowed to invest in 100% of funds
(earlier 30%) in debt instruments
Few Measures to ATTRACT FDI
1998 –Further concessions to FFIs, now allowed to
invest in Govt. securities, Treasury bills, listed
and unlisted debt securities.
2000 -100% foreign equity allowed in infrastructure
projects –ports, roads, highways

2002 –Limited FDI in print media permitted.

Further Changes:
1. Indian companies can make overseas investments by
market purchase of foreign exchange without prior
approval of RBI up to 100% of their net worth.
(previous limit was USD 100 M, or less than 50% of
their net worth)
 Few Measures to ATTRACT FDI
2. Annual Limit to invest abroad has raised from USD
50 M to 100 M.

3. Overseas investments are allowed to be funded up to

100% by American Depositary Receipts / General
Depositary Receipts proceeds. (earlier 50%).

4. Overseas investments are opened to registered

partnership firms that offers professional services.

5. Overseas investors are permitted to invest abroad in

areas unrelated to their business at home.
 Areas where FDI is not permitted:
Two routs of FDI

1. Automatic routs: (where RBI approval is required)

2. Non-automatic routs (where approval from Govt. is
required)
Areas Where FDI is not Allowed and Why?:
 Gambling & Betting – (Illegal -Social protection)
 Lottery Business –(Immature Society}
 Business of Chit Fund –(Immature Society)
 NIDHI Company –(To Protect the small scale industries)
 Housing and Real Estate Business (Except for the development of township,
infrastructural development)
 Trading in TDRs (Transferable Development Rights) –The max funds should be
invested in our country
 Retail Trading –(Don’t want to loose the control over basic goods)
 Atomic Energy –(Defense Purpose)
 Agriculture or plantation activities [Exceptions: floriculture, horticulture,
development of seeds, animal husbandry ] –Immaturity in sector
Assignment:
Q: What is FDI? Discuss needs, benefits,
trends and factors for inflow & outflow
of FDI in reference to INDIA.

Date of Submission : 21st Feb’2011

Format : Hand
Written
Word Limit : Not < 2000 W

Note: Put your sign & date on

submission list.
THE END