Full Form of FDI (Foreign Direct Investment)

What are the Benefits of FDI?

There are numerous benefits of foreign direct investment. Both multinational companies and foreign countries can reap the benefits of FDI. Sometimes, either of the two might derive benefits from foreign direct investmentsForeign Direct InvestmentsA foreign direct investment (FDI) is made by an individual or an organization, into a business located in a foreign country. The host nation receives job creation prospects, advanced technology, a higher standard of living, infrastructural development, and overall economic growth.read more, and sometimes both of them together. The advantages of foreign direct investments for multinational enterprises are –

  • Access to National and International Markets – This is a perfect way for an organization or an individual to enter international markets.Access to Important Resources – It can also allow an individual or an organization to access a country’s natural resources like fossil fuels and precious metals. For example, oil-selling companies often tend to make foreign direct investments in developing oil fields.Lowers Production Costs – Foreign direct investments can help in lowering production costs. FDI gives companies the leverage to outsource their production work to companies operating from different countries for cost reduction. It helps in the development of upcoming industries. It also exposes the local and national governments, individuals, and entities to new business opportunities, practices, economic concepts, management techniques, and technology to help develop local entities and industries.

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Example

One of the most powerful ways for nations to encourage higher foreign direct investments is through trade agreements. The North Atlantic Free Trade Agreement is one of the finest examples of trade agreements. It is the largest free trade agreement in the world. North Atlantic Free Trade Agreement increased foreign direct investment between the U.S., Canada, and Mexico to a whopping 452 billion dollars in 2012.

Types of FDI

Typically speaking, there are just two types of foreign direct investment. However, two other types of FDI have also been observed. These types are provided with an explanation below –

#1 – Horizontal Foreign Direct Investment

This company expands its national operations internationally. The company will conduct the same activities but not in its own country. It will continue the activities in a host country.

#2 – Vertical Foreign Direct Investment

In this type of foreign direct investment, a company expands its national operations internationally by opting for a varied supply chain level. This means that the company performs different activities in the host country, but all these activities remain related to the primary business.

#3 – Conglomerate Foreign Direct Investment

A company gains acquisition of an unrelated business in a host country. However, this may seem uncommon since it requires the company to overcome two barriers to gaining entry.

#4 – Platform Foreign Direct Investment

A company enters an international market, and the outputs derived from the foreign business operations are exported to another country. This is also termed an export-platform foreign direct investment.

How does it Work?

This plays a significant role concerning making cross border investments. This can offer an organization or individual access to newer markets, access to new and updated technologies, and whatnot. FDI can also enable an organization or an individual to learn new skills, lower production costs, maximize production, gain a competitive advantage, make more profits, get better exposure, and so on.

The foreign company and host country receiving investments can also gain access to advanced technologies and new skills. They can also lay the foundation for the same to have economic development.

Difference between FDI and FII

  • There is a vast difference between FDI and FII. FDI stands for foreign direct investment, while FII stands for foreign institutional investors. FDI is made by a parent entity in a host country, while a company makes FII in a foreign country’s financial markets. FDI is a long-term investment, and as a result of this, it flows only in the primary marketsPrimary MarketsThe primary market is where debt-based, equity-based or any other asset-based securities are created, underwritten and sold off to investors. It is a part of the capital market where new securities are created and directly purchased by the issuer.read more.FDI is more stable as compared to FII. FII is a short-term investment, and as a result, it flows only in the secondary marketsSecondary MarketsA secondary market is a platform where investors can easily buy or sell securities once issued by the original issuer, be it a bank, corporation, or government entity. Also referred to as an aftermarket, it allows investors to trade securities freely without interference from those who issue them.read more. FDI can enter and exit the stock market very easily, while entering and exiting the stock market is not easy in the case of FII.

Disadvantages

  • Foreign direct investments can create a competitive advantageCompetitive AdvantageCompetitive advantage refers to an advantage availed by a company that has remained successful in outdoing its competitors belonging to the same industry by designing and implementing effective strategies that allow the same in offering quality goods or services, quoting reasonable prices to its customers, maximizing the wealth of its stakeholders and so on and as a result of which the company can make more profits, build a positive brand reputation, make more sales, maximize return on assets, etc.read more prevailing in a nation. This can adamantly lower a country’s comparative advantageComparative AdvantageIn order to determine comparative advantage, the opportunity cost of each item from each country needs to be calculated. Then, on a comparative table, these costs are plotted to get the comparative advantage.read more if the foreign ownership of entities happens in strategically important and hypersensitive industries.Investors making Foreign direct investments might not add any value to the business but might hamper its operations at the same time. Foreign investors might sell the unprofitable segments of an entity to local and low-grade investors.Foreign investors can even misuse the entity’s collateral securities to obtain local loans, and that too at lower costs. It might also happen that foreign investors may not reinvest but might reissue the funds back to the holding company.Profit repatriation is another drawback of foreign direct investment. FDI disallows companies from reinvesting their profits in the host country. This often results in the larger capital flowing out of the host country.

Conclusion

It is an investment made by a company or an individual in a company’s financial securities that operate in a different country. It allows the companies to gain access to new markets, new technological advancements, skills, minimize production costs, boost profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. read more, and whatnot. For the host country, it means the development of its overall economy. However, the volatile nature of the holding companyHolding CompanyA holding company is a company that owns the majority voting shares of another company (subsidiary company). This company also generally controls the management of that company, as well as directs the subsidiary’s directions and policies.read more can sometimes be a drawback too.

This has been a guide to Full Form of FDI – Foreign Direct Investment. Here we discuss what the benefits of FDI are, how it works along with types, examples, and disadvantages. You may refer to the following articles to learn more about finance –

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