Meaning of FDI / International trade and Foreign Direct Investment (FDI)
Introduction to FDI
International trade and Foreign Direct Investment (FDI) are the two most important international economic activities integrating the world economy. With the increase in the mobility of factors of production across countries, FDI has become an integral part of a firm’s strategy to expand international business.
FDI is the largest source of external finance for developing countries. At present, inward stock of FDI amounts to about one-third of the developing countries’ Gross Domestic Product (GDP), compared to merely 10 percent in 1980.
FDI plays a crucial role in the development process of host economies. It also has a significant role in enhancing exports of the host country. It is estimated that the sales from foreign-owned facilities are about double the value of world trade.
FDI not only serves as a source of capital inflow into host economies, but also helps to enhance the competitiveness of the domestic economy through transferring technology, strengthening infrastructure, raising productivity, and generating new employment opportunities.
FDI has often been viewed as a threat by host countries due to the capacity of transnational investing firms to influence economic and political affairs. Many developing countries often fear FDI as a modern form of economic colonialism and exploitation, similar to their previous unpleasant experiences with colonial powers.
Yet, FDI flows are generally preferred to other forms of external finance because these are non-debt creating, non-volatile, and the returns depend on the performance of the project financed by the investors.
FDI is considered superior to other types of capital flows
due to various reasons:
(i) Firms entering a host country through FDI have a long-term perspective in contrast to foreign lenders and portfolio investors. Therefore, FDI flows are less volatile and easier to sustain at the time of economic crisis.
(ii) Debt inflows may finance consumption whereas FDI is more likely to be used to improve productivity.
(iii) Since FDI provides more than just capital by offering access to internationally available technologies, management know-how, and marketing skills, it is likely to have a strong impact on economic growth.
A firm has to evaluate various options to cater to foreign markets and select the most appropriate mode of international business expansion.
Geographical distances of markets or resources, especially for low value products, make it more attractive to get into manufacturing operations overseas. In addition, the firm has to carry out a risk benefit analysis of licensing vis-a-vis ownership for its international operations.
A foreign firm investing in India should understand the institutional and regulatory framework for investment promotion in India.
