What is Foreign Investment?
Foreign Investment refers to domestic companies investing in foreign companies with the objective of gaining stake and seeking active participation not only day-to-day operations of the business and but also for key strategic expansion. Suppose if an American company invests its capital in an Indian company then it will be called foreign investment.
Types of Foreign Investment
There are two types –
#1 – Foreign Direct Investment (FDI)
When a company/financial institutionFinancial InstitutionFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. /individuals invest in other countries and own more than 10% of stake in a company then it is called foreign direct investmentForeign Direct InvestmentA foreign direct investment, or FDI, is a financial investment made by an individual or an organization in a business based in another country. In such investment, an organization or an individual owns a minimum of ten percent of the shares of a foreign firm.. It gives the investor controlling power and he can also influence the companies operation and process. There is one more way of direct investment which is opening plants, factories, and offices in another country.
There are two types of foreign direct investment:
1 – Horizontal Investment
When an investor establishing the same type of business in a foreign country in which he operates in his country or when two companies of the same business but operating in different countries merge with each other then it is called a Horizontal investment. This type of investment is done by the company for gaining market share and becoming a global leader.
2 – Vertical Investment
When companies of one country merge with the company of another country or acquire the company of another country but both the company are not in the same business rather they are related with each other like manufacturing company of one country acquire the business of another country who is supplying raw material for production. This type of investment is done by the company for removing the dependency on others and achieving economies of scale.
#2 – Foreign Indirect Investment
When a company/financial institutions/individuals invest in another country by buying stocks of companies that are trading in foreign stock exchange but their investment does not cross the 10% of the stock in a single company.
Methods of Foreign Investment
There are two methods or strategies for this investment:
- Greenfield Investment: –Greenfield Investment: -Greenfield investments are a type of foreign direct investment where a company starts its operation in the other countries as its subsidiary and invests in the construction of offices, plants, sites, building products, etc. thereby managing its operations and achieving the highest level of the controls over its activities. In this strategy, the company starts its business operation in another country from zero means they have to set up their own factory, plant, and offices. For e.g., Domino’s and McDonald’s are US-based companies that have started his business in India from zero now they are leading in there segment.
- Brownfield Investment: –Brownfield Investment: -Brownfield investment is the capital invested in the existing infrastructure or production facilities to develop a new production line. It is common in foreign direct investments and initiated through lease, merger, or acquisition of a production division. In this strategy, the company does not start its business from scratch rather go by merger or acquisition like recently Walmart inc of US has acquired the Flipkart which is an Indian company and gets all the assets and liability of the Flipkart.
Routes of Foreign Investment
Below are the two routes –
- Automatic route: – In Automatic route foreign company/institutions does not require any approval of the government or any agencies for making an investment in another country.
- Approval route:- In approval route foreign company/institutions requires to get approval from government or any specified body of that country where they want to invest.
Advantages of Foreign Investment
- The creation of employment is a major advantage because when an investment will come then manufacturing will increase and the service sector will also improve.
- It provides access to the market of another country.
- It enhances the infrastructure of the country and helps in developing the backward area by setting up industries or plants.
- It also helps in enhancing the technologies and operational practices by sharing knowledge with each other.
- An increase in export, when manufacturing will boost by foreign investment then its export of the country will also increase.
- Increase in income and more job opportunity will arise and at the same time, wages of an employee also increase which result into increase in national per capita income.
Disadvantages of foreign investment are as below:
- It is a risk or hindrance to domestic investment.
- Exchange rates are a very crucial factor, always there is a risk in foreign investment if exchange rates are highly fluctuating.
- Risk of the political environment because of the political environment of the country where investment is done because foreign investment depends upon many foreign policies and regulations which may change because of political conditions.
- Loss of control over the business, as there is a chance that a domestic company can lose its control on business and all the profit earned by the company will go out of the country.
- Risk for domestic or small traders, since foreign investment, come in great volume and their main motive is to gain the market share first without thinking about the profit & loss and they start selling their product in less than the market price and even below the cost, in such scenario, there is a chance that domestic or small trader will not survive and their business will shut down.
Foreign investment is just an investment but this is coming from another country. Since the investment is coming from the cross border, therefore, it’s required more rules & regulations is applicable to foreign investment. It is beneficial for developing country because it helps in building infrastructure, creating employment, knowledge sharing and increasing the purchasing power, at the same time it is required for the developed country also because they want to expand their business and for that, it is required to go beyond to his country.
In the era of globalization, foreign investment plays a very important role in business expansion. On the other hand, it is harmful to small and domestic businesses because they don’t have so many funds to survive against these big companies.
This has been a guide to Foreign Investment and its definition. Here we discuss types, methods, and routes of Foreign Investment along with advantages and disadvantages. You can learn more about financing from the following articles –