The International Monetary Fund (IMF) defines Foreign Direct Investments (FDI) as an investment made to acquire lasting interest in enterprises operating outside of the economy of the investor. In other words, FDI comprises activities that are controlled and organized by firms outside of the nation in which they are headquartered and where their principal decision makers are located.
In the context of the manufacturing sector, FDI is conventionally thought of in terms of branch plant or subsidiary company operations that are controlled by parent companies based in another country.
Difference Between Foreign Portfolio Investment (FPI) and Foreign Direct Investments (FDI)
Foreigners’ investment in a country’s capital market is known as foreign portfolio investment. The basic difference between FDI and FPI is that in case of FDI, the investor acquires lasting interest in the company where it has invested. But in case of FPI, the investor does not have any managerial representation in the board of directors of the company. In other words, foreign direct investors have the management of the firms under their control; but this is not the case for foreign portfolio investors.
FDI is a category of cross border investment made by a resident in one economy (the direct investor) with the objective of establishing a ‘lasting interest’ in an enterprise (the direct investment enterprise) in an economy other than that of the direct investor.
The motivation of the direct investor is a strategic long term relationship with the direct investment enterprise to ensure a significant degree of influence by the direct investor in the management of the direct investment enterprise.
Types of FDI:
FDI can be of two broad types, viz. (a) greenfield investments and (b) through merger and acquisition activities.
Greenfield investment is defined as the establishment of a completely new operation in a foreign country. Greenfield FDI refers to investment projects that entail the establishment of new production facilities such as offices, buildings, plants and factories.
In Greenfield Investment, the investor uses the capital flows to purchase fixed assets, materials, goods and services, and to hire workers for production in the host country. Greenfield FDI thus directly adds to production capacity in the host country and, other things remaining the same, contributes to capital formation and employment generation in the host country.
Secondly, FDI can also be through Merger and Acquisitions with existing firms in the destination country (FDI through M&A). Such cross-border M&As involve the partial or full takeover or the merging of capital, assets and liabilities of existing enterprises in a country by a firm from other countries.
The target company that is being sold and acquired is affected by a change in owners of the company. There is no immediate augmentation or reduction in the amount of capital invested in the target enterprise at the time of the acquisition.
If for example, an Indian company is acquired by an US company, capital would flow into India from the USA to the owners of the company, but not to the company itself. So, there is no immediate addition to the productive capacity. However, there can be efficiency gains in the medium term through transfer of technology, better management, better market access etc.
FDI Investments in India:
To calculate FDI flows, RBI includes equity capital, reinvested earnings (retained earnings of FDI companies) and ‘other direct capital’ (inter-corporate debt transactions between related entities).
Detailed statistics about FDI inflows to India, including monthly flows and sectoral breakups are available on the website of Department of Industrial Policy and Promotion (www.dipp.nic.in). This website also contains a manual of FDI which gives the detailed procedural information about investing in India through the FDI route.
Prem is an investment counsellor and founder of TheFinanceConcept and MonetaEdu. He is a graduate in Finance and at TheFinanceConcept, he share his views and opinions about latest developments on financial world.