What is Foreign Direct Investment? Meaning, Importance & Types

Foreign Direct Investment (FDI) is now one of the key drivers of the globalisation of the economy, with profound impact on the development of countries, the expansion of businesses, and the transformation of markets. It is defined as an investment by an individual or a company in one country in a business interest situated in another country by establishing business operations or by acquiring tangible assets like factories, offices, or shares in local companies. Unlike portfolio investments, which only comprise financial securities, FDI entails a higher and more permanent investment, often granting the investor significant control over the host enterprise’s operations and decisions.

FDI is more than just a flow of capital in the modern economy. It aids in the transfer of technology, management skills, and access to global markets, and creates employment opportunities. For a business or commerce student, the reasons behind FDI are important to learn, as they involve a host of subjects like the influence of tariffs on international trade, economics, finance, and business strategy.

What does Foreign Direct Investment Mean?

Foreign Direct Investment is an investment made by an individual from one country into an enterprise located in a different country with the intention to exercise control over it. The International Monetary Fund (IMF) delineates FDI when a foreign investor possesses a minimum of 10% voting stake in the business entity.

Mere capital investment is different from FDI, which signifies a strategic relationship of the investor with the enterprise since he participate in management, technology, and operational decisions. FDI can manifest as building new infrastructure (greenfield projects) or acquiring existing companies (brownfield projects), or even joint ventures.

What are the Types of FDI?

FDI can be categorized in several ways:

1. Based on Investment Nature

• Greenfield Investment: Establishing new facilities or operations in a foreign country (e.g., Toyota setting up a new manufacturing plant in India).
• Brownfield Investment: Acquiring or merging with existing companies abroad (e.g., Walmart acquiring a stake in Flipkart).

1. Based on Business Motives

• • Horizontal FDI: A company invests in the same industry abroad as it operates at home (e.g., Starbucks opening outlets in China).
  • Vertical FDI: Investment in a foreign business that forms part of the company’s supply chain, either backward (suppliers of raw materials) or forward (distribution of products).

• Conglomerate FDI: Investment in a business unrelated to the company’s existing operations. 

1. Based on Entry Mode 

• Joint venture: Partnering with local firms to reduce risk and access market management. 
• Wholly-owned subsidiaries: The foreign investors retain 100% ownership and control. 

What Methods Come Under FDI?

The foreign direct investment may acquire the voting power of an enterprise in an economy through any of the following methods:

• By the incorporation of a wholly owned subsidiary or company anywhere.
• By the acquisition of shares in an associated enterprise
• Through the merger or acquisition of an unrelated enterprise 
• Participating in an equity joint venture with another investor. 

What are the Key Determinants of Foreign Direct Investment?

The key determinants of FDI are the size and growth prospects of the economy of a country in case of making FDI. Hymer suggested certain additional determinants of FDI because of criticism, along with the capital market imperfections assumption. These include:

Firm-specific advantages: When local investment was depleted, a firm could leverage its advantages attributable to market imperfections, which were potentially able to give the firm market power and a competitive edge. Additional research tried to describe how firms were able to monetize these benefits as licenses.

Elimination of conflict: conflict occurs when a company is already established in a foreign exchange market or intends to expand its business in the same market. He suggests that the remedy for this obstacle emerged in the shape of collusion, dividing the market with competitors or trying to gain direct control over production. It should, however, be kept in view that the elimination of conflict through the acquisition of control over operations will raise the market imperfections.

Tendency to develop an internationalization strategy to reduce risk: Based on his role, companies are defined with 3 decision-making levels: the day-to-day control, coordination of management decisions, and long-term planning and decision-making of strategy.

Hymer's importance in the field of international business and foreign direct investment stems from him being the first to theorize about the existence of multinational enterprises (MNE) and the reasons behind FDI beyond macroeconomic principles, his influence on later scholars and theories in international business, such as the OLI (ownership, location and internationalization) theory by John Dunning and Christos Pitelis which focuses more on transaction costs. Moreover, "the efficiency-value creation component of FDI and MNE activity was further strengthened by two other major scholarly developments in the 1990s: the resource-based (RBV) and evolutionary theories”.In addition, some of his predictions later materialized, for example, the power of supranational bodies such as the International Monetary Fund or the World Bank that increases inequalities, a phenomenon the United Nations Sustainable Development Goal 10 aims to address.

How is FDI important for Host Countries?

FDI is a powerful tool for economic development, especially for emerging economies like India, Brazil, and Vietnam. The significance can be understood through the following: 

• Capital Inflow: Provides the foreign capital for infrastructure and growth
• Generation of employment: Creates direct and indirect jobs in manufacturing, services, and supply chains. 
• Transfer of technology:Multinational Corporations (MNCs) bring in advanced technologies, research capabilities, and production methods. 
• Boost to reports: FDI often develops export-oriented industries, enhancing foreign exchange reserves.
• Improved Management Practices: Exposure to global standards encourages local firms to enhance efficiency. 

What are the Key Advantages of FDI to Investors?

Among the most visible examples of FDI in India was Walmart's $16 billion stake in Flipkart (2018). It was the world's largest e-commerce transaction, showcasing India's significance as a rising consumption market. Likewise, FDI in India's auto industry (e.g., Suzuki in Maruti Suzuki) not only revolutionized the sector but also generated jobs and increased export opportunities.

From the investor's side, FDI is just as useful:

• Access to New Markets: Facilitates avoiding trade restrictions and accessing domestic customer intelligence.
• Cost Benefits: Investors usually enjoy reduced manufacturing costs and readily available labor.
• Strategic Assets: Buying local companies offers instant access to distribution systems, brands, and natural resources.
• Diversification: Spreads business risk to various geographies and economies.

Disadvantages and Risks of FDI

Though FDI is generally touted, it does come with risks:

• Political Unrest: Abrupt changes in policies, trade barriers, or nationalization may harm foreign investors.
• Regulatory Barriers: Host nations tend to put limitations in place for safeguarding local industries.
• Cultural Differences: Misperceptions of local customs, consumer patterns, or labor practices can lead to conflicts.
• Profit Repatriation Issues: Host countries can place restrictions on sending back profits to the investor country.
• Risk of Economic Dependence: Excessive dependence on overseas investors might undermine indigenous entrepreneurship.

 

Did you know? Foreign Direct Investment is not just a capital cash flow—it is a force driving globalization, growth, and innovation. It provides opportunities for host nations to increase employment, infrastructure, and competitiveness, and for investors to gain access to new markets and resources. Yet, as with any economic instrument, it needs to be carefully handled so that the benefits are greater than the risks. For policymakers, students, and businesses alike, it is crucial to have an understanding of FDI to best deal with today's globalized world economy.

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Frequently Asked Questions (FAQs)

What is FDI and FPI (Foreign Portfolio Investment), and what is the difference between them?

FDI is associated with direct control and ownership in overseas business activities, while FPI entails financial investment in bonds or stocks but not managerial control.

What are the sectors that get the most FDI in India?

At present, India receives the largest FDI inflows in services, computer software & hardware, telecommunication, trade, and auto manufacturing sectors.

How does FDI influence employment?

FDI creates employment directly (in manufacturing facilities, offices, and projects) as well as indirectly (via supply chains, distribution networks, and support industries) and adds to overall economic expansion.