Understanding FDI: What it means for India?

Foreign Direct Investment or FDI is any investment made by a foreign country in the domestic assets such as companies, organizations, buildings and factories. It provides foreign capital, funds, expertise and job opportunities to the host nation.

FDI flows to developing countries stood at $354 billion in 2009.  UNCTAD’s FDI prediction for 2011 is between $1.3 trillion and $1.5 trillion.

India not Happy about FDI

Foreign Direct Investment into India totaled only $23.7 billion during 2010-11 (according to UNCTAD). India is not much enthusiastic about FDI investments. At present, the country only allows 100% FDI in single-brand retail trade like Fendi, Jimmy Choo etc.

It was also reluctant to FDI in multi-brand retailers like Wal Mart, Carrefour etc. until recently. Currently, the government has allowed a 51% FDI in this sector.

India fears such FDIs could harm the domestic economy rather than uplift it. The main argument against multi-brand retailers is that it could destroy small retailers and manufacturers. Experts predict about 4 crore people will lose their employment once FDI in retail sector is allowed.

Benefiting from FDI

Those who support FDI claim that the country which accepts FDI will benefit economically; increased job opportunities, higher standards of living and better infra structure are some of the positive that flows from FDI. A visible impact of FDI on the growing economy is that it gets a quick supply of money.

To back their claim they site the example of “The Asian Tiger” economies such as China, South Korea, Singapore and the Philippines that benefited from FDI in to their economy. In the case of China FDI has really been a better step for improving the economy. Chinese economy has welcomed FDI since 1970 and the investment rose to a whopping $274.6 billion in 2010 (according to UNCTAD).

There are positives that India can benefit from by more FDI flows. Farmers tend to get higher prices for their products by direct purchase by these retail houses. Middlemen are notorious for keeping the prices given to farmers low. Big retail companies will find direct purchasing profitable thus farmers will get a better deal for their products. Consumers also stands to gain as prices will go down due to direct purchase and competition.

Though the inward FDI is showing a decline in India, it is estimated that Indian will soon be the source of outward FDI to other countries. Most of the outward investments are in the areas where India is successful i.e. Auto, IT, telecom to name a few. Outward FDI by Indian companies was $43 billion in 2010-2011.

Why Companies Opt to Invest in Foreign Countries?

Companies go for FDI looking for cheaper resources and better operational benefits for production. This resource seeking FDIs eventually makes huge profit by moving their entire production line to the new country.

Companies look for optimizing the available opportunities and economies. And that result in transfer of strategic assets. This form of FDI aims at improving the overall efficiency.

A company that goes for Foreign Direct Investment could possibly enjoy many incentives in the new country. Some of the tax benefits or concessions like low corporate tax and income tax rates could invariably boost the company’s profit.

Furthermore, the investing company could get hold on special economic zones and enjoy special tariffs. They could gather financial subsidies to improve the working environment. Some of them enjoy free land for setting up company and easy loans for renovations.

Different Types of FDI

There are generally two types of FDI, outward FDI and inward FDI. Any investment made by a country in other countries will account for outward FDI. Where as, all the FDIs invested by other countries in that country is called inward FDI.

These two forms account for the net FDI of the country. It could be either positive or negative. Both inward and outward FDIs are regulated by the governments of respective countries.

The FDIs are categorized into vertical and horizontal based on how the subsidiary company works in par with the parent investor.

Vertical FDIs happen when a corporation owns some share of the foreign enterprise. The local enterprise could either be supplying the input or selling finished goods to the parent corporation. The subsidiary here helps the parent company to grow more.

When the MNCs kick off similar business operations in different countries it becomes horizontal Foreign Direct Investment. It is actually a cloning that is happening here. Both the countries enjoy the same share of growth.

How FDI is done?

A foreign country may carry out FDI in different ways depending on the requirement. An investment made by a country can be regarded as FDI is the company acquires 10% of the voting shares of the domestic company.

This could be achieved by incorporating an existing subsidiary or a wholly owned company. Or it could be done by acquiring majority of shares of an associated company.

Some companies go for a merger or acquisition of a completely different company. A few others happen by enrolling in an equity joint venture with other investors or companies. Overall the aim of these is to grab a quick 10% voting power.

Government Imposes Riders on FDI

India is divided when it comes to the question of FDI in retail. The decision by the government to allow FDI into the retail sector brought sharp criticism from the opposition. The question of losing jobs and break down of small business is a sensitive issue and needs to be addressed.

However the government has subjected foreign companies to some restrictions to protect the neighborhood stores. These include a minimum investment of $100 million of which 50% investment done in back-end infrastructure. The companies must also procure 30% of materials from small domestic industries. In addition, the companies can set up shop only in cities with a population of 1 million.

The impact of these policies will take time to show. Till the meantime we can only hope this decision will generate jobs and find alternatives employment opportunities for those who have lost because of this.

(A detailed review of the growth of FDI in India can be found at Department Of Industrial Policy & Promotion website. )

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4 Responses to “Understanding FDI: What it means for India?”

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