Full-Form of FDI (Foreign Direct Investment)
This full form of FDI or foreign direct investment can be better understood as an investment that is made by a company or an individual belonging to one country into the shares and securities of another company that operates in a different country, and businesses that make FDI is labeled as MNCs (multinational companies) or MNEs (multinational enterprises).
What are the Benefits of FDI?
There are numerous benefits of foreign direct investment. Both multinational companies and foreign countries can reap the benefits arising out of FDI. Sometimes, either of the two might derive benefits from foreign direct investmentsForeign Direct InvestmentsA 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., 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 into 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 for the purpose of 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 the purpose of cost reduction. It helps in the development of upcoming industries. It also exposes the local and national governments, individuals, and local entities to new business opportunities, practices, economic concepts, management techniques, and technology to help develop local entities and industries.
One of the most powerful ways for nations to encourage higher foreign direct investments is through trade agreements. North Atlantic Free Trade Agreement is one of the finest examples of trade agreements. It is the only 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 the year 2012.
Types of FDI
Typically speaking, there are just two types of foreign direct investment. However, 2 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 as export-platform foreign direct investment.
How does it Work?
This plays a significant role with respect to 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 its production cost, maximize its production, gain competitive advantage, make more profits, get better exposure, and so on.
The foreign company and host country that is receiving investments can also gain access to advanced technologies, new skills, and 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 into a host country while FII is made by a company 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.
- FII is a short term investment, and as a result of this, it flows only in the secondary markets. FDI is more stable as compared to FII. 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.
- Foreign direct investments can competitive advantage prevailing in a nation. This can adamantly lower down the 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. of a country 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 the profits that were earned by them in the host country. This often results in the larger capital to flow out of the host country.
It is an investment done 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. , 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. can sometimes be a drawback too.
This has been a guide to the Full Form of FDI – Foreign Direct Investment. Here we discuss what the benefits of FDI are, how does it work along with types, example, and disadvantages. You may refer to the following articles to learn more about finance –