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Foreign Direct investment:

Foreign direct investment is a category of cross-border investment associated with a resident in


one economy having control or a significant degree of influence on the management of an
enterprise that is resident in another economy.
MOTIVES FOR DIRECT FOREIGN INVESTMENT
MNCs commonly consider direct foreign investment because it can improve their profitability
and enhance shareholder wealth. They are normally focused on investing in real assets such as
machinery or buildings that can support operations, rather than financial assets. The direct
foreign investment decisions of MNCs normally involve foreign real assets and not foreign
financial assets. When MNCs review various foreign investment opportunities, they must
consider whether the opportunity is compatible with their operations. In most cases, MNCs
engage in DFI because they are interested in boosting revenues, reducing costs, or both.
Revenue-Related Motives
The following are typical motives of MNCs that are attempting to boost revenues:
Attract new sources of demand: MNCs commonly pursue DFI in countries experiencing
economic growth so that they can benefit from the increased demand for products and services
there. The increased demand is typically driven by local peoples higher income levels. Higher
income allows for higher consumption, and higher consumption within the country results in
higher income. Many developing countries, such as Argentina, Chile, Mexico, Hungary, and
China, have been perceived as attractive sources of new demand. Many MNCs have penetrated
these countries since barriers have been removed.
EXAMPLE China has been a major target for MNCs because of its economic growth and
rapidly increasing income. Siemens recently invested $190 million in China. Other MNCs such
as Ford Motor Co., United Technologies, General Electric, Hewlett-Packard, and IBM have also
invested more than $100 million in China to attract demand by consumers there.
Enter profitable markets: When an MNC notices that other corporations in its particular
industry are generating very high earnings in a particular country, it may decide to sell its own
products in those markets. If it believes that its competitors are charging excessively high prices
in a particular country, it may penetrate that market and undercut those prices. A common
problem with this strategy is that previously established sellers in a new market may prevent a
new competitor from taking away their business by lowering their prices just when the new
competitor attempts to break into this market.
Exploit monopolistic advantages: Firms may become internationalized if they possess
resources or skills not available to competing firms. If a firm possesses advanced technology and
has exploited this advantage successfully in local markets, the firm may attempt to exploit it

internationally as well. In fact, the firm may have a more distinct advantage in markets that have
less advanced technology.
EXAMPLE In recent years, Google acquired businesses in Canada, China, Finland, Greece,
Israel, South Korea, Spain, and Sweden. It is effective at using its technology to improve the
capabilities of other businesses. In this way, it expands its technology internationally.
React to trade restrictions: In some cases, MNCs use DFI as a defensive rather than an
aggressive strategy. Specifically, MNCs may pursue DFI to circumvent trade barriers.
EXAMPLE Japanese automobile manufacturers established plants in the United States in
anticipation that their exports to the United States would be subject to more stringent trade
restrictions. Japanese companies recognized that trade barriers could be established that would
limit or prohibit their exports. By producing automobiles in the United States, Japanese
manufacturers could circumvent trade barriers.
Diversify internationally: Since economies of countries do not move perfectly in tandem over
time, net cash flow from sales of products across countries should be more stable than
comparable sales of the products in a single country. By diversifying sales (and possibly even
production) internationally, a firm can make its net cash flows less volatile. Thus, the possibility
of a liquidity deficiency is less likely. In addition, the firm may enjoy a lower cost of capital as
shareholders and creditors perceive the MNCs risk to be lower as a result of more stable cash
flows.
EXAMPLE Several firms experienced weak sales because of reduced U.S. demand for their
products. They responded by increasing their expansion in foreign markets. AT&T and Starbucks
pursued new business in China. Cisco Systems expanded substantially in China, Japan, and
South Korea.
Cost-Related Motives
MNCs also engage in DFI in an effort to reduce costs. The following are typical motives of
MNCs that are trying to cut costs:
Fully benefit from economies of scale: A corporation that attempts to sell its primary product
in new markets may increase its earnings and shareholder wealth due to economies of scale
(lower average cost per unit resulting from increased production). Firms that utilize much
machinery are most likely to benefit from economies of scale.
EXAMPLE Newark Co. has developed technology to create software. The development costs
are high, but once the software is created, there is very little cost of distribution. Newark realized
that its development of technology would only be feasible if it could sell a very large amount of
software that it develops. However, it had already expanded throughout the United States and
had limited growth potential there. It decided to created subsidiaries in foreign countries that

could sell software there. In this way, it was able to increase its total production, which allowed it
to reduce its average cost of production.
Use foreign factors of production: Labor and land costs can vary dramatically among
countries. MNCs often attempt to set up production in locations where land and labor are cheap.
Due to market imperfections such as imperfect information, relocation transaction costs, and
barriers to industry entry, specific labor costs do not necessarily become equal among markets.
Thus, it is worthwhile for MNCs to survey markets to determine whether they can benefit from
cheaper costs by producing in those markets.
EXAMPLE Mexico has been a major target for MNCs that are seeking to reduce their cost of
production. Many U.S.based MNCs, including Black & Decker, Eastman Kodak, Ford Motor
Co., and General Electric, have established subsidiaries in Mexico to achieve lower labor costs.
Asia has also attracted much direct foreign investment. Honeywell has joint ventures in countries
such as Korea and India where production costs are low and has also established subsidiaries in
Malaysia. Genzyme Corp. recently invested about $100 million in China for research and
development and biotechnology production.
Use foreign raw materials: Due to transportation costs, a corporation may attempt to avoid
importing raw materials from a given country, especially when it plans to sell the finished
product back to consumers in that country. Under such circumstances, a more feasible solution
may be to develop the product in the country where the raw materials are located.
Use foreign technology: Corporations are increasingly establishing overseas plants or
acquiring existing overseas plants to learn about unique technologies in foreign countries. This
technology is then used to improve their own production processes and increase production
efficiency at all subsidiary plants around the world.
EXAMPLE Cisco recently planned a $1 billion investment into Russia to create innovative
business ideas. Cisco has previously invested heavily in India and other markets to tap into
unique technologies and innovation.
React to exchange rate movements: When a firm perceives that a foreign currency is
undervalued, the firm may consider DFI in that country, as the initial outlay should be relatively
low.
EXAMPLE Wyoming Co. is a distributor of ski equipment that wants to expand its business into
snowmobiles. Most of the production would be exported to Canadian retail stores and invoiced
in dollars. It anticipates that the Canadian dollar will weaken against the U.S. dollar over the next
several years, which would increase the cost to Canadian stores that purchase its exports. Its
main competitor of this new business would be a firm in Canada. Wyoming Co. decides to
acquire the firm in Canada rather than export products to Canada. Consequently, it can avoid the
adverse exchange rate effects, and in fact can benefit.

Factors Affecting Foreign Direct Investment


Capital flows resulting from DFI change whenever conditions in a country change the desire of
firms to conduct business operations there. Some of the more common factors that could affect a
countrys appeal for DFI are identified here.
Changes in Restrictions: During the 1990s, many countries lowered their restrictions on DFI,
thereby resulting in more DFI in those countries. Many U.S.based MNCs, including Bausch &
Lomb, Colgate-Palmolive, and General Electric, have been penetrating less developed countries
such as Argentina, Chile, Mexico, India, China, and Hungary. New opportunities in these
countries have arisen from the removal of government barriers.
Privatization: Several national governments have recently engaged in privatization, or the
selling of some of their operations to corporations and other investors. Privatization is popular in
Brazil and Mexico, in Eastern European countries such as Poland and Hungary, and in such
Caribbean territories as the Virgin Islands. It allows for greater international business as foreign
firms can acquire operations sold by national governments. Privatization was used in Chile to
prevent a small group of investors from controlling all the shares and in France to prevent a
possible reversion to a more nationalized economy. In the United Kingdom, privatization was
promoted to spread stock ownership across investors, which allowed more people to have a
direct stake in the success of British industry. The primary reason that the market value of a firm
may increase in response to privatization is the anticipated improvement in managerial
efficiency. Managers in a privately owned firm can focus on the goal of maximizing shareholder
wealth, whereas in a state-owned business, the state must consider the economic and social
ramifications of any business decision. Also, managers of a privately owned enterprise are more
motivated to ensure profitability because their careers may depend on it. For these reasons,
privatized firms will search for local and global opportunities that could enhance their value. The
trend toward privatization will undoubtedly create a more competitive global marketplace.
Potential Economic Growth: Countries that have greater potential for economic growth are
more likely to attract DFI because firms recognize that they may be able to capitalize on that
growth by establishing more business there.
Tax Rates: Countries that impose relatively low tax rates on corporate earnings are more likely
to attract DFI. When assessing the feasibility of DFI, firms estimate the after-tax cash flows that
they expect to earn.
Exchange Rates: Firms typically prefer to pursue DFI in countries where the local currency is
expected to strengthen against their own. Under these conditions, they can invest funds to
establish their operations in a country while that countrys currency is relatively cheap (weak).

Then, earnings from the new operations can periodically be converted back to the firms
currency at a more favorable exchange rate.

Challenges to FDI
Governments are less anxious to encourage DFI that adversely affects locally owned companies,
unless they believe that the increased competition is needed to serve consumers. Therefore, they
tend to closely regulate any DFI that may affect local firms, consumers, and economic
conditions.
Protective Barriers: When MNCs consider engaging in DFI by acquiring a foreign company,
they may face various barriers imposed by host government agencies. All countries have one or
more government agencies that monitor mergers and acquisitions. These agencies may prevent
an MNC from acquiring companies in their country if they believe it will attempt to lay off
employees. They may even restrict foreign ownership of any local firms.
Red Tape Barriers: An implicit barrier to DFI in some countries is the red tape involved,
such as procedural and documentation requirements. An MNC pursuing DFI is subject to a
different set of requirements in each country. Therefore, it is difficult for an MNC to become
proficient at the process unless it concentrates on DFI within a single foreign country. The
current efforts to make regulations uniform across Europe have simplified the process required to
acquire European firms.
Industry Barriers: The local firms of some industries in particular countries have substantial
influence on the government and will likely use their influence to prevent competition from
MNCs that attempt DFI. MNCs that consider DFI need to recognize the influence that these local
firms have on the local government.
Environmental Barriers: Each country enforces its own environmental constraints. Some
countries may enforce more of these restrictions on a subsidiary whose parent is based in a
different country. Building codes, disposal of production waste materials, and pollution controls
are examples of restrictions that force subsidiaries to incur additional costs. Many European
countries have recently imposed tougher antipollution laws as a result of severe problems.
Regulatory Barriers: Each country also enforces its own regulatory constraints pertaining to
taxes, currency convertibility, earnings remittance, employee rights, and other policies that can
affect cash flows of a subsidiary established there. Because these regulations can influence cash
flows, financial managers must consider them when assessing policies. Also, any change in these
regulations may require revision of existing financial policies, so financial managers should
monitor the regulations for any potential changes over time. Some countries may require
extensive protection of employee rights. If so, managers should attempt to reward employees for
efficient production so that the goals of labor and shareholders will be closely aligned.

Ethical Differences: There is no consensus standard of business conduct that applies to all
countries. A business practice that is perceived to be unethical in one country may be totally
ethical in another. For example, U.S.based MNCs are well aware that certain business practices
that are accepted in some less developed countries would be illegal in the United States. Bribes
to governments in order to receive special tax breaks or other favors are common in some
countries. If MNCs do not participate in such practices, they may be at a competitive
disadvantage when attempting DFI in a particular country.
Political Instability: The governments of some countries may prevent DFI. If a country is
susceptible to abrupt changes in government and political conflicts, the feasibility of DFI may be
dependent on the outcome of those conflicts. MNCs want to avoid a situation in which they
pursue DFI under a government that is likely to be removed after the DFI occurs.
International Portfolio Investment:
Portfolio investment is defined as cross border transactions and positions involving debt or
equity securities, other than those included in direct investment or reserve assets. Investment
fund shares or units (i.e., those issued by investment funds) that are evidenced by securities and
that are not reserve assets or direct investment are included in portfolio investment.

Motives for International Portfolio Investment


International investments can be included in an investment portfolio to provide diversification
and growth opportunities. International portfolios allow investors to further diversify their assets
by moving away from a domestic portfolio. This type of portfolio can carry increased risk due to
potential economic instability arising from emerging markets, but can also bring increased
stability through investments in industrialized and more stable markets. Due to the integration of
global financial markets, many companies already have operations in more than one country. The
reasons behind investing internationally are as follows:
a. Diversification Diversification is an indispensable investing principle. Diversification is a
technique that reduces risk by allocating investments among various financial instruments,
industries and other categories. Most investment professionals agree that, although it does not
guarantee against loss, diversification is the most important component of reaching long-range
financial goals while minimizing risk. International portfolio investment spreads investment risk
among foreign companies and markets.
b. Potential for Growth It takes the advantages of the potential for growth in some foreign
economies, particularly in emerging. There are many underdeveloped markets that are in the
middle of large periods of growth. If investors can successfully identify these regions of the
globe, they could bring in a substantial return on their investment.

c. Many Different alternatives- In today's investment market, there are many different options
for investors to choose from if they want to get involved with international investment like
mutual funds, exchange traded funds (ETFs), and a number of other investment vehicles.

Factors affecting International Portfolio Investment


The desire by individual or institutional investors to direct international portfolio investment to a
specific country is influenced by the following factors:
Tax Rates on Interest or Dividends: Investors normally prefer to invest in a country where the
taxes on interest or dividend income from investments are relatively low. Investors assess their
potential after-tax earnings from investments in foreign securities.
Interest Rates: Portfolio investment can also be affected by interest rates. Money tends to flow
to countries with high interest rates, as long as the local currencies are not expected to weaken.
Exchange Rates: When investors invest in a security in a foreign country, their return is affected
by (1) the change in the value of the security and (2) the change in the value of the currency in
which the security is denominated. If a countrys home currency is expected to strengthen,
foreign investors may be willing to invest in the countrys securities to benefit from the currency
movement. Conversely, if a countrys home currency is expected to weaken, foreign investors
may decide to purchase securities in other countries.
Challenges in International Portfolio Investments:
According to the SEC, there are several categories of international investments risk, such as,
changes in currency exchange rate, dramatic changes in market value, political, economic, and
social events, lack of liquidity, less information, reliance on foreign legal remedies, and different
market operations. However, due to its attractiveness of return, international investing is an
essence in todays business world.
International investing has some special risks that have been discussed below
1. Changes in currency exchange rates:
Foreign companies trade and pay dividends in the currency of their local market. When the
exchange rate between the foreign currency of an international investment and the U.S. dollar
changes, it can increase or reduce your investment return. When buying or selling investment
abroad, investors need to convert the money he gets from the local currency into U.S. dollars.
During a period when the foreign currency is strong compared to the U.S. dollar, this strength
increases investment return because foreign earnings translate into more dollars. If the foreign

currency weakens compared to the U.S. dollar, this weakness reduces investment return because
earnings translate into smaller number of dollars.
2. Spectacular changes in market value:
Foreign markets, like all markets, can experience dramatic changes in market value. One way to
reduce the impact of these price changes is to invest for the long term and try to ride out sharp
upswings and downturns in the market. Individual investors frequently lose money when they try
to "time" the market in the United States and are even less likely to succeed in a foreign market.
When investors time the market, they have to make two smart decisions -- deciding when to
get out before prices fall and when to get back in before prices rise again.
3. Political, economic and social risks:
Political risk is sometimes defined as a country's willingness to maintain a hospitable climate for
outside investments. Economic risk, on the other hand, is the ability of a country to pay its debts.
The economic and political states of a country are codependent. If the economy of a country is
strong but its political state is hostile -- or vice versa-- it ceases to be appealing to foreign
investors. The political decisions made in a country may result in its instability, causing the
weakening of the economy and creating losses for both local and foreign investors. It is difficult
for investors to understand all the political, economic, and social factors that influence foreign
markets. These factors provide diversification, but they also contribute to the risk of international
investing.
4. Deficiency in of liquidity:
Foreign markets may have lower trading volumes and fewer listed companies. They may only be
open a few hours a day. Some countries restrict the amount or type of stocks that foreign
investors may purchase. The investors may have to pay premium prices to buy a foreign security
and have difficulty finding a buyer when they want to sell.
5. Dependence on Foreign Legal Remedies:
Legal processes in one country may not necessarily apply to the other country in which
investment is based if investors encounter a problem with an investment made abroad. In such
cases investors will be forced to rely on available legal remedies in the company's home country,
which may prove expensive.
6. Insufficient Information:
Many foreign companies do not provide investors with the same type of information. Acquiring
up-to-date information about a foreign company can not only take time and money, it also often
difficult to come by. As a result, many foreign investors cannot make informed decisions about
their investments of choice. Additionally, some companies may post their information in their
local language and not in English. Foreign investors therefore have the added cost of translating
this information to English in an attempt to get all the necessary fact about the investment.
7. Different market operations:

Foreign markets often operate differently from the major U.S. trading markets. For example,
there may be different periods for clearance and settlement of securities transactions. Rules
providing for the safekeeping of shares held by custodian banks or depositories may not be as
well developed in some foreign markets, with the risk that investors shares may not be protected
if the custodian has credit problems or fails.

Scenario of FDI in Bangladesh:


Foreign Direct Investment (FDI) Information of FDI Inflow is collected and compiled from
half-yearly Enterprise Survey of Bangladesh Bank. Figure 14.1 presents the trend in FDI inflows
from 2002 to 2013. The FDI inflow recorded US$1,599.2 million in 2013 which was US$1,292.6
million in 2012.

Major components of Foreign Direct Investment (FDI) are presented in the Table 14.1. The table
shows that reinvestment is the main component of FDI inflow, followed by equity and intracompany borrowing.

FDI Inflow to Bangladesh by Components

Figure shows the sector-wise distribution of foreign and joint venture projects during FY 201314.

Form the Figure it is observed that the service sector comprises the major share of registration
(79.26%) percent. Other important sectors are engineering (11.17%), agro-industry (3.54%) and
textile industry (2.94%).

Country wise Joint Venture and Foreign Investment: The sources of foreign and joint venture
projects registered in FY 2013-14 were 24 countries/economies from different regions of the
world. Proposed amount of investment in South-East Asia is the highest, followed by South, East
and West Asia, European Union, North America and CIS region. The source-wise distribution of
the BOI-registered new projects from FY 2006-07 to FY 2013-14 (52 countries) is presented in
Table below.
(In
Million
US
Dollar)