Business

Environment

B.N. Ghosh

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 Chapter 37

Foreign Direct Investment

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 Learning Objectives
• The meaning of investment
• Determinants of foreign investment
• Types, forms, and theories of foreign investment
• Advantages and disadvantages of foreign investment
• The state of foreign investment in India
• Investment outflow from India

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 What is investment?
• Investment refers to that part of current output that makes a new
addition to the existing stock
of capital.

• The investment which is intended or planned is known as ex-ante

investment. The actual or realized investment is known as ex-post
investment.

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Determinants of Foreign Investment
• Investment depending on the real rate of
interest
• Level of uncertainty
• Favourable and stable exchange rate
• Profitability
• Political environment
• Size of the market
• Necessity of new products
• Possibility of innovations

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Determinants of Foreign Investment
• Consumers’ demand
• State policies
• Availability of capital and liquidity assets of
investors, and technology
• Cheap and disciplined labour
• Tax regime
• Easy repatriation
• Non-discrimination
• Security
• Better exports and imports
• Stable and favourable macroeconomic
fundamentals © Oxford University Press 2014. All rights reserved.
Types of foreign investment

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 Forms of Foreign Development
Investment
Horizontal
• In the case of horizontal FDI, the foreign investor undertakes the
same type and method of production.

Vertical
• In the case of vertical FDI, each stage of production is performed in
a country where the cost of production is the lowest.

Conglomerate
• In the case of conglomerate FDI, the FDI produces a product in the
host country, which is entirely new and it does not produce such
product in the home country.

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 Theories of foreign investment
• Perfect or Preferable Market Theory
• Market Perfection or Monopolistic Advantage
Theory
• Internalization Theory
• Exclusive Gain Theory
• Locational Optimum Theory
• International Product Life Cycle Theory
• Theory of Herd Behaviour
• Eclectic Theory - OLI
• Towards a New Theory: Capability-Connectivity
Theory
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 Capability-Connectivity Theory
Connectivity
Low High

Positive
High No Foreign
foreign
Investmen
investmen
t
t
Capability

Limited
prospect No foreign
of foreign investmen
Low investmen t
Low
t

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 Foreign investment in India
• Foreign investment has been given a significant role in
the growth dynamics of India especially after liberalization
and deregulation of the economy since 1991.

• Every year, different types of foreign investment

including portfolio investment and FDI are pouring into the
country.
• India is now regarded as the third most lucrative place
after China and USA for foreign investment as disclosed by
the respondents of the United Nations Development
Programme (UNDP) survey.

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Why Does India Want Foreign Direct
Investment
• To increase export earnings to reduce the balance of
payments problem
• To get the advantages of new and improved technology
• To get improved managerial skill from experienced
foreign firms
• To speed up the process of capital formation and
economic growth
• To reduce the dependency on foreign aid
• To increase development-oriented investment and
expertise

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Government Policy towards Foreign
Direct Investment
• The policy of the government with respect to repatriation of profits
and dividends and capital was based on stringent laws like the Foreign
Exchange Regulation Act (FERA) of 1973.

• According to this Act, for a foreign company or person, prior

permission from the Reserve Bank of India (RBI) was necessary to
conduct business, trade of industrial or commercial nature, and
purchasing shares of Indian companies.

• Before 1991, the government policy on foreign investment

maintained that foreign capital should not be allowed to enter into
those areas where it already existed.

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 Investment outflow from India
• It has been estimated by some foreign analyst that
India is the 21st largest outward investor in the
world. Two factors are especially responsible for this
development.

• First, economic liberalization does not restrict

outward investment, and,

• Second, many of the Indian companies over the

years during the period of globalization have
acquired international skill and competitiveness.
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 FDI
ADVANTAGE
• SUPPLIMENTS DOMESTIC
INVESTMENT STATUTORY
INDICATOR
• IMPROVED TECHNOLOGY
GREATER EFFICENCY
• COUNTRY COMPETITIVE
• REDUCE EXCHANGE GAP
• RISK REDUCTION
• HELPFUL IN NEGATIVE BoP
DISADVANTAGE
• OBSELETE TECNOLOGY
• LARGE PROFIT DRAIN
• DISHONEST PRACTICE
• COMPETITION CROWDED
OUT
• NO CARE FOR
EMPLOYMENT
• STRATEGIC INTEREST OF
COUNTRY AT STAKE