Foreign Investment

Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Foreign Investment?

Foreign investment occurs when foreign companies invest in domestic companies and seek active participation in their day-to-day operations and key strategic expansion. For example, if an American company invests in an Indian company, it will be a foreign investment.

Foreign-Investment

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Very often, large global multinational companies try to expand their opportunities and gain market share by collaborating or investing in another country’s businesses. It might be done directly or indirectly and might lead to control of business ownership or assets of the target company. The process helps both the countries and companies to expand and grow.

Key Takeaways

  • Foreign investment is a process through which international companies invest in another country, gain stakes, increases employment in that country, and manifest globalization by trade expansion.
  • Foreign investments can be of two types, Foreign Direct Investment and Foreign Indirect Investment. FDI is when a company invests in a business in India, owning more than 10% of its stake. However, FII is when a company invests in a business in India by buying its shares/stocks, which can’t cross over 10% stakes. 
  • The two strategies for foreign investments are greenfield investments and brownfield investments. Greenfield investments mean companies start their business operations in another country from scratch. In comparison, companies choose to invest through mergers and acquisitions in a brownfield investment. 

Foreign Investment Explained

Foreign investment refers to investment from another country. Since it comes from cross-border, more rules and regulations are required. It is beneficial for developing countries because it helps build infrastructure, create employment, share knowledge, and increase purchasing power. At the same time, it is also required in a developed nation for business expansion.

In globalization, foreign investment policy plays a vital role in business expansion. It helps the foreign investor to gain advantage of the cheap labor, raw material or geographical facilities to expand the business. But on the other hand, it harms small and domestic businesses because they have insufficient funds to compete against giant corporations. It also encourages steady movement of cash flows within nations.

However, there is also the risk of foreign investment enterprise taking control of the business operations of the domestic company. If the stake is very high, the foreign company will be able to influence the day-to-day working of the domestic company.

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Types

There are two types of foreign investment policy

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#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. read more, or individual invests in foreign countries and owns more than 10% of a company’s stake, it is referred to as a foreign direct investmentForeign Direct InvestmentA 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. It gives the investor controlling power and influence over the companies’ operations and processes. Another way of gaining foreign direct investments is opening plants, factories, and offices in another country.

There are two types of foreign direct investment:

1 – Horizontal Investment

When an investor establishes a similar type of business in a foreign country or when two companies of the same industry (operating in different countries) merge, it is known as horizontal investment. A company pursues this kind of investment to gain market share and become a global leader.

2 – Vertical Investment

It refers to when a company of one country acquires or merges with a firm in another country, irrespective of their business fields. For example, a manufacturing business of one country acquiring the supplier of raw materialsRaw MaterialsRaw materials refer to unfinished substances or unrefined natural resources used to manufacture finished goods.read more for production of another country. A company indulges in this type of investment to remove the dependency on others and achieve economies of scaleEconomies Of ScaleEconomies of scale are the cost advantage a business achieves due to large-scale production and higher efficiency. read more.

#2 – Foreign Indirect Investment

When a foreign investment enterprise, financial institution, or an individual invests in another country by buying stocks of companies trading in the foreign stock exchange, it is known as foreign indirect investment. However, the said investment should not cross over 10% of the stock in a single company.

Strategies

There are two methods or strategies for this investment:

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  1. 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.read more: – In this strategy, the company starts its business operationBusiness OperationBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company's goals like profit generation.read more in another country from scratch. For example, Domino’s and McDonald’s are US-based companies that started their business in India from zero. Currently, they are leading in their segments.
  2. 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.read more: – In this strategy, the company does not create its business from scratch. Instead, they choose mergersMergersMerger refers to a strategic process whereby two or more companies mutually form a new single legal venture. For example, in 2015, ketchup maker H.J. Heinz Co and Kraft Foods Group Inc merged their business to become Kraft Heinz Company, a leading global food and beverage firm.read more or acquisitionsAcquisitionsAcquisition refers to the strategic move of one company buying another company by acquiring major stakes of the firm. Usually, companies acquire an existing business to share its customer base, operations and market presence. It is one of the popular ways of business expansion.read more. Recently, another US-based company, Walmart Inc acquired Flipkart, an Indian company, thus acquiring all its assets and liabilities. 

Routes

Below are the two routes of acquiring foreign investment funds

  1. Automatic route: In the automatic course, foreign companies/institutions do not require any approval of the government or any agencies for investing in another country.
  2. Approval route:- In the approval route, foreign companies/institutions require approval from government or any specified body of the country where they want to invest.

Note: A nation’s government decides which business investment can come via the automatic or approval route. Generally, if a country’s government wishes to boost its economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more, they allow direct foreign investment funds.

Example

Let us assume that Blueline Industries, an US based pharmaceutical company is trying to expand its business globally. Thus, has purchased stakes in Cloud Pharma, which has a chain of hospitals in the Asian countries like India, Singapore, Hong Kong, Thailand, etc. This collaboration will help them to sell their own products like medicines and surgical equipments, to these countries through Cloud Pharma and also understand the market and analyse the types of products that are rising in demand or the business opportunities that have not yet been explored in these countries.

From the above example, we see that Blueline Industries is a foreign company investing in the domestic company in the above mentioned countries and making use of the opportunity to expand its business.

Advantages

Let us look at the importance of foreign investment.

Disadvantages

Apart from the importance of foreign investment, there are some disadvantages also as given below.

  • It poses a risk or causes a hindrance to domestic investments.
  • Fluctuation in exchange rates can make foreign investment risky.
  • It depends on the political environment, foreign policies and regulations that keep changing in a country.
  • The domestic company can lose its control over business and the profit earned.
  • The motive of gaining market share through foreign investments may cause domestic and small traders to incur massive losses. 

Foreign Investment Vs Domestic Investment

  • Foreign investment has the capacity to generate higher paid jobs with better facilities than the domestic investment.
  • The former gives the domestic economy asccess to intenational market.
  • Investment of foreign companies enhance and maximise the use of resources and benefits that the domestic investment market creates in an economy.
  • Entry of foreign companies in the domestic economy helps developing countries in getting a better and more advanced industrial base and achieve a competitive level in exports.

Frequently Asked Questions (FAQs)

Are foreign investments taxable?

Tax laws depend from nation to nation and vary dramatically. Many nations either don’t charge capital gains tax or exclude overseas investors from paying it. However, many do. For instance, Italy takes 26% of whatever proceeds a non-resident makes from selling its stock.

What are foreign investments portfolio?

A grouping of assets, such as stocks, bonds, and cash equivalents, is referred to as a foreign portfolio investment. Investors directly hold the investments in their portfolio, or financial experts may manage it.

Is there an institute that supports foreign investments around the world?

Yes, World Trade Organization is a global organization that regulates and facilitates international trade activities in the world. It also emphasizes free and fair mercantile exchanges through liberalization and creates a structure that enforces trade rules.

This has been a guide to what is Foreign Investment. We explain its types with example, advantage, disadvantage & strategies. You can learn more about financing from the following articles –

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