Foreign Direct Investment (FDI)

Consistent economic growth, de-regulation, liberal investment rulse, and operational flexibility are all the factors that help increase the inflow of Foreign Direct Investment or FDI.

FDI or Foreign Direct Investment is any form of investment that earns interest in enterprises which function outside of the domestic territory of the investor.

FDIs require a business relationship between a parent company and its foreign subsidiary. Foreign direct business relationships give rise to multinational corporations. For an investment to be regarded as an FDI, the parent firm needs to have at least 10% of the ordinary shares of its foreign affiliates. The investing firm may also qualify for an FDI if it owns voting power in a business enterprise operating in a foreign country.
Types of Foreign Direct Investment: An Overview

FDIs can be broadly classified into two types: outward FDIs and inward FDIs. This classification is based on the types of restrictions imposed, and the various prerequisites required for these investments.

An outward-bound FDI is backed by the government against all types of associated risks. This form of FDI is subject to tax incentives as well as disincentives of various forms. Risk coverage provided to the domestic industries and subsidies granted to the local firms stand in the way of outward FDIs, which are also known as “direct investments abroad.”

Different economic factors encourage inward FDIs. These include interest loans, tax breaks, grants, subsidies, and the removal of restrictions and limitations. Factors detrimental to the growth of FDIs include necessities of differential performance and limitations related with ownership patterns.

Other categorizations of FDI exist as well. Vertical Foreign Direct Investment takes place when a multinational corporation owns some shares of a foreign enterprise, which supplies input for it or uses the output produced by the MNC.

Horizontal foreign direct investments happen when a multinational company carries out a similar business operation in different nations.

Foreign Direct Investment is guided by different motives. FDIs that are undertaken to strengthen the existing market structure or explore the opportunities of new markets can be called “market-seeking FDIs.” “Resource-seeking FDIs” are aimed at factors of production which have more operational efficiency than those available in the home country of the investor.

Some foreign direct investments involve the transfer of strategic assets. FDI activities may also be carried out to ensure optimization of available opportunities and economies of scale. In this case, the foreign direct investment is termed as “efficiency-seeking.” Definition of Foreign Direct Investment

Foreign direct investment is that investment, which is made to serve the business interests of the investor in a company, which is in a different nation distinct from the investor's country of origin.

A parent business enterprise and its foreign affiliate are the two sides of the FDI relationship. Together they comprise an MNC. The parent enterprise through its foreign direct investment effort seeks to exercise substantial control over the foreign affiliate company. 'Control' as defined by the UN, is ownership of greater than or equal to 10% of ordinary shares or access to voting rights in an incorporated firm. For an unincorporated firm one needs to consider an equivalent criterion.

Ownership share amounting to less than that stated above is termed as portfolio investment and is not categorized as FDI.
Classification of Foreign Direct Investment

Foreign direct investment may be classified as Inward or Outward. Foreign direct investment, which is inward, is a typical form of what is termed as 'inward investment'. Here, investment of foreign capital occurs in local resources.

The factors propelling the growth of Inward FDI comprises tax breaks, relaxation of existent regulations, loans on low rates of interest and specific grants. The idea behind this is that, the long run gains from such a funding far outweighs the disadvantage of the income loss incurred in the short run. Flow of Inward FDI may face restrictions from factors like restraint on ownership and disparity in the performance standard.

Foreign direct investment, which is outward, is also referred to as “direct investment abroad”. In this case it is the local capital, which is being invested in some foreign resource. Outward FDI may also find use in the import and export dealings with a foreign country. Outward FDI flourishes under government backed insurance at risk coverage.
Outward FDI faces restrictions under a host of factors as described below:

Tax incentives or the lack of it for firms, which invest outside their country of origin or on profits, which are repatriated
Industries related to defense are often set outside the purview of outward FDI to retain government's control over the defense related industrial complex
Subsidy scheme targeted at local businesses
Lobby groups with vested interests possessing support from either inward FDI sector or state investment funding bodies
Government policies, which lend support to the phenomenon of industry nationalization

Foreign direct investment may be further classified by their set target. The areas here are Greenfield investment and Acquisitions and Mergers.

Greenfield investments involve the flow of FDI for either building up of new production capacities in the host nation or for expansion of the existent production facilities of the host country. The plus points of this come in form of increased employment opportunities, relatively high wages, R&D activities and capacity enhancement.

The flip side comes in the form of declining market share for the domestic firm and repatriation of profits made to a foreign country, which if retained within the country of origin could have led to considerable capital accumulation for the nation.

Multinationals mostly rely on mergers to bring in FDI. Until 1997 mergers and acquisitions accounted for around 90% of FDI flow to the US economy. FDI flow through acquisitions does not render any long run advantage to the economy of the host nation as under Greenfield investments.

Some other types of foreign direct investment in vogue are termed as Horizontal FDI, Forward Vertical FDI, Vertical FDI and Backward Vertical FDI.
FDI has helped the Indian economy grow, and the government continues to encourage more investments of this sort – but with $5.3 billion in FDI in 2004 India gets less than 10% of the FDI of China.

Foreign direct investment (FDI) in India has played an important role in the development of the Indian economy. FDI in India has – in a lot of ways – enabled India to achieve a certain degree of financial stability, growth and development. This money has allowed India to focus on the areas that may have needed economic attention, and address the various problems that continue to challenge the country.

India has continually sought to attract FDI from the world’s major investors. In 1998 and 1999, the Indian national government announced a number of reforms designed to encourage FDI and present a favorable scenario for investors.

FDI investments are permitted through financial collaborations, through private equity or preferential allotments, by way of capital markets through Euro issues, and in joint ventures. FDI is not permitted in the arms, nuclear, railway, coal & lignite or mining industries.

A number of projects have been announced in areas such as electricity generation, distribution and transmission, as well as the development of roads and highways, with opportunities for foreign investors.

The Indian national government also provided permission to FDIs to provide up to 100% of the financing required for the construction of bridges and tunnels, but with a limit on foreign equity of INR 1,500 crores, approximately $352.5m.

Currently, FDI is allowed in financial services, including the growing credit card business. These services include the non-banking financial services sector. Foreign investors can buy up to 40% of the equity in private banks, although there is condition that stipulates that these banks must be multilateral financial organizations. Up to 45% of the shares of companies in the global mobile personal communication by satellite services (GMPCSS) sector can also be purchased.

By 2004, India received $5.3 billion in FDI, big growth compared to previous years, but less than 10% of the $60.6 billion that flowed into China. Why does India, with a stable democracy and a smoother approval process, lag so far behind China in FDI amounts?

Although the Chinese approval process is complex, it includes both national and regional approval in the same process.

Federal democracy is perversely an impediment for India. Local authorities are not part of the approvals process and have their own rights, and this often leads to projects getting bogged down in red tape and bureaucracy. India actually receives less than half the FDI that the federal government approves.

Poverty in India

Poverty in India is reducing but it is still a major issue. Rural Indians depend on unpredictable agriculture incomes, while urban Indians rely on jobs that are, at best, scarce.

Since its independence, the issue of poverty within India has remained a prevalent concern. According to the common definition of poverty, when a person finds it difficult to meet the minimum requirement of acceptable living standards, he or she is considered poor.

Millions of people in India are unable to meet these basic standards, and according to government estimates, in 2007 there were nearly 220.1 million people living below the poverty line.

Nearly 21.1% of the entire rural population and 15% of the urban population of India exists in this difficult physical and financial predicament. The following chart presents the poverty situation:
The division of resources, as well as wealth, is very uneven in India – this disparity creates different poverty ratios for different states. For instance, states such as Delhi and Punjab have very low poverty ratios. On the other hand, 40-50% of the populations in Bihar and Orissa live below the poverty line.

The poverty ratios illustrated here are divided in two types: urban and rural. Specific reasons for poverty vary in the urban and rural settings.

A number of factors are responsible for poverty in the rural areas of India. Rural populations primarily depend on agriculture, which is highly dependant on rain patterns and the monsoon season. Inadequate rain and improper irrigation facilities can obviously cause low, or in some cases, no production of crops.

Additionally, the Indian family unit is often very large, which can amplify the effects of poverty. Also, the caste system still prevails in India, and this is also a major reason for rural poverty – people from the lower casts are often deprived of a number of facilities and opportunities. The government has planned and implemented poverty eradication programs, but the benefits of all these programs have yet to reach the core of the country.
The phenomenal increase in the city populations is the main reason for poverty in the urban areas of India. A major portion of this additional population is due to the migration of the rural families from villages to cities. This migration is mainly caused by poor employment opportunities in villages. This situation is exacerbated by the fact that there are few job opportunities in the urban areas of India.

Since 1970, the Indian government has implemented a number of programs designed to eradicate poverty, and has had some success with these programs. The government has sought to increase the GDP through different processes, including changes in industrial policies. There is also a Public Distribution System, which has been somewhat effective so far. Other programs include the Integrated Rural Development Programme, Jawahar Rozgar Yojana, the Training Rural Youth for Self Employment (TRYSEM) and to the credit of the government, other on-going initiatives.