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Foreign Direct Investment: FDI Full Form, Meaning & Types

If you are interested in the numbers and statistics related to the Indian economy, you might have already heard that our economy expanded by 4.4% y-o-y in the last quarter of 2022. While sectors like manufacturing, finance, and real estate witnessed a dip, others witnessed a rebound, particularly in mining, farm, and utilities.

Look at it from a business perspective – a company grows with time by increasing sales and a loyal customer base. If the reach was limited to a particular country or region and the growth rate seems to have reached a plateau, what should be the next big step toward business growth? Even in layman’s terms, it would be about expanding the business reach to target customers living in foreign countries. This is where the concept of FDI partially stems from.

In this post, we will help you understand FDI meaning in detail.

What is Foreign Direct Investment (FDI)?

FDI full form is Foreign Direct Investment, and it refers to the process or act of purchasing an ownership stake in a foreign organisation. In general, this business term is used to describe the decision of a company to acquire a substantial stake in a business that is located in a foreign region. It also includes the business decision to buy a foreign company outright as a part of global business expansion.

Typically, foreign direct investment meaning for businesses is about taking a controlling stake in foreign-based firms and becoming actively involved in their management. The key to FDI is the control factor that is based on the intent of influencing the foreign firm’s operations. This is what sets FDI apart from that of passive foreign portfolio investment. Besides this, reinvesting the profits earned from overseas operations in overseas subsidiaries are also a part of FDI.

From around the world, the United States and China have been the top recipients of foreign direct investment.

How Does Foreign Direct Investment Work?

Companies that consider making foreign direct investments finalise target firms or projects in world economies having a skilled workforce. They also include above-average growth prospects and FDI-related government regulations in their checklist before making the decision. You should also know that FDI goes beyond capital investment solely and includes equipment, technology, and management provisions. As mentioned above, FDI’s key feature is to establish a certain level of control over a foreign-based business.

The economic liberalisation that began in India after the 1991 crisis, pushed the FDI toward a steady increase and it has not looked back since then. India now forms a part of the top 100 countries in the world on the EODB (Ease of Doing Business) index. Even certain sectors like Agriculture & Animal Husbandry, come under FDI’s 100% automatic route segment.

You should also know that:

● The net amount involved with FDI is quite substantial. In 2021 alone, $1.8 trillion worth of foreign direct investments were made. In terms of FDI outflow, the U.S. led the world and was followed by Japan, China, and the U.K.

● FDI can be made in several ways, such as opening a foreign subsidiary or associate company, acquiring a significant stake in a foreign business, or merger or joint ventures.

● The minimum threshold for FDI to gain controlling interest is a 10% ownership stake as defined by the Organisation for Economic Cooperation and Development (OECD).

● For India, FDI has been a significant monetary source backing the economic development of the nation.

● The net inflow of FDI in India as a % of GDP is 1.4 in 2021 as per the World Bank’s Data.

Types of Foreign Direct Investment

FDI is mainly classified into three types, which are:

Horizontal FDI

In this type of FDI, a company establishes or chooses the same type of business in a foreign country as the one it operates in its home country. Example - a U.S.-based microchip manufacturer buying a small-scale chip manufacturing firm in India.

Vertical FDI

This is where a business entity chooses to acquire a complementary firm established in a foreign nation. A good example of this would be an Indian packaging product manufacturer acquiring an interest in a company based in China that supplies raw materials for production.

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Conglomerate FDI

This is one of the types of FDI in which a company invests in a foreign-based business that is completely unrelated to the one it operates in the native region. Since the investing firm does not have much knowledge or expertise in the new vertical, this happens in the form of a joint venture.

Examples of Foreign Direct Investment

As mentioned above, foreign investments can take a wide variety of shapes and forms, including acquisitions, mergers, or partnerships. As a whole, they indicate the business growth strategy for a multinational exposure by keeping in mind various related regulatory concerns.

Given below are some of the recent investments in India that serve as good examples in this category: ​

1. The computer software and hardware industry in our country received US$3,427 million as FDI during the first quarter of 2022.

2. The defence manufacturing sector in India received foreign direct investments of US$61.91 million in the month of May 2022.

3. Generali - the Italian major in the financial services sector acquired a 25% stake in an Indian insurance company named Future Generali India Insurance for US$161.92 million.

4. The renewable energy sector in India attracted an FDI of US$1.03 billion in FY 2021-22.

However, according to the SEBI guidelines, the overall investment in overseas markets from the mutual fund industry is collectively capped at US$7 billion. Each fund house is authorised to have maximum exposure to FDI to the mark of US$1 billion (except the schemes that invest in ETFs). These industry-specific limits were about to be crossed in 2022. This made SEBI issue a guideline asking all mutual fund houses to suspend foreign investment inflow and existing *SIPs were also halted for the time being.

*Note: SIP stands for Systematic Investment Plan, wherein you can regularly invest a fixed amount at periodical intervals and aim for benefits over a period of time through power of compounding.

Additional Read:​What is Power of Compounding?

What are the Advantages and Disadvantages of FDI?

Given below are a few advantages of FDI:

Technological advancements

FDI also brings with it evolving technologies to foreign countries along with business management ideas. This way, the employees of the recipient organisation get to learn efficient, innovative ways to work and achieve business goals. In fact, developing countries like India encourage FDI to finance the establishment of new infrastructure and create jobs for the workforce. On the other hand, MNCs benefit from expanding their reach to international consumers.

Improved standard of living

Due to foreign direct investments, the living standard of the recipient nation increases. It can also make the lenders liable to pay significant taxes, which in turn benefit the citizens of the recipient countries.

Stable lending for the long term

FDI can also eliminates the volatility related to the hot money - capital that is transferred frequently with the intent of maximum capital gains. The long-term investment contracts help solve this problem.

Some of the disadvantages of such investments are:

Lack of ethical standards

Some investors may be seeking access to foreign markets for immoral reasons like seeking maximum value from the external business subsidiary without adding any real value in return. A lending business having a significant stake in a company after FDI approval could cut off less-profitable verticals from the operations. ​

Excess regulations

FDI involves oversight and regulation through multiple governments at both ends, which could lead to high political risk.

Accepting FDI in a nation is more of a political and economic decision. The business entities can also participate in these investments under predefined regulations. A good understanding of FDI-related laws can help a business grow further in both regional and international markets.

Additional Read:How to Invest During Rising Interest Rates?

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Disclaimer:
This is an investor education and awareness initiative by Nippon India Mutual Fund.
Helpful information for investors: All Mutual Fund investors have to go through a one-time KYC (know your Customer) process. Investors should deal only with registered mutual funds, to be verified on SEBI website under 'Intermediaries/ Market Infrastructure Institutions'. For redressal of your complaints, you may please visit www.scores.gov.in . For more info on KYC, change in various details & redressal of complaints, visit mf.nipponindiaim.com/investoreducation/what-to-know-when-investing This is an investor education and awareness initiative by Nippon India Mutual Fund.

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