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Definition: Foreign direct investment is of growing importance to global economic growth. This is especially for developing and emerging market countries. FDI from investors in developed areas like the EU and the U.S. provide funding and expertise to help smaller companies in these emerging markets to expand and increase international sales. Until recently, Southeast Asia was the greatest beneficiary of FDI. However, as of 2011, Latin America and the Caribbean pulled ahead, receiving a 35% increase in FDI. The developed world also receives its fair share of cross-border investment, but of a different nature. Most of this is mergers and acquisitions between mature companies. These already-global corporations are engaged in restructuring or refocusing on core businesses. However, it gets recorded as FDI. This type of investment is more about maintenance, and less about making great stride in economic growth. (Source: UNCTAD, Annual FDI Report)

What Exactly Is Foreign Direct Investment?

The International Monetary Fund defines FDI as when one individual or business owns 10% or more of a foreign companys capital. Every financial transaction afterwards is considered by the IMF as an additional direct investment. If an investor owns less than 10%, it is considered as nothing more than an addition to his/her stock portfolio. With only a 10% ownership, the investor may or may not have the controlling interest in the foreign business. However, even with just 10%, the investor usually has significant influence on the company's management, operations and policies. For this reason, most governmental agencies want to keep tabs on who is investing in their country's businesses. (Source: Definitions of Foreign Direct Investment: A Methodological Note, Maitena Duce1, Banco de Espaa2, July 31, 2003)

Advantages of Foreign Direct Investment

Foreign direct investment has many advantages for both the investor and the recipient. One of the primary benefits is that it allows money to freely go to whatever business has the best prospects for growth anywhere in the world. That's because investors aggressively seek the best return for their money with the least risk. This motive is color-blind, doesn't care about religion or form of government. This gives well-run businesses -- regardless of race, color or creed -- a competitive advantage. It reduces (but, of course, doesn't eliminate) the effects of politics, cronyism and bribery. As a result, the smartest money goes to the best businesses all over the world, bringing these goods and services to market faster than if unrestricted FDI weren't available. Investors receive additional benefits. Their risk is reduced because they can diversify their holdings outside of a specific country, industry or political system. Diversification always increases return without increasing risk.

Businesses benefit by receiving management, accounting or legal guidance in keeping with the best practices practiced by their lenders. They can also incorporate the latest technology, innovations in operational practices, and new financing tools that they might not otherwise be aware of. By adopting these practices, they enhance their employees' lifestyles, helping to create a better standard of living for the recipient country. In addition, since the best companies get rewarded with these benefits, local governments have less influence, and aren't as able to pursue poor economic policies. The standard of living in the recipient country is also improved by higher tax revenue from the company that received the foreign direct investment. However, sometimes countries neutralize that increased revenue by offering tax incentives to attract the FDI in the first place. Another advantage of FDI is that it can offset the volatility created by "hot money." Short-term lenders and currency traders can create an asset bubble in a country by investing lots of money in a short period of time, then selling their investments just as quickly. This can create a boom-bust cycle that can wreak economies and political regimes. Foreign direct investment takes longer to set up, and has a more permanent footprint in a country.

Disadvantages of Foreign Direct Investment

Too much foreign ownership of companies can be a concern, especially in industries that are strategically important. Second, sophisticated foreign investors can use their skills to strip the company of its value without adding any. They can sell off unprofitable portions of the company to local, less sophisticated investors. Or, they can borrow against the company's collateral locally, and lend the funds back to the parent company. (Source: IMF, Finance and Development Magazine, Prakash Loungani and Assaf Razin, How Beneficial Is Foreign Direct

FDI In Agriculture:
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Benefits of FDI on farming

Blessed by nature, India is the second largest, globally, in farm output. But a huge quantity of the produce remains unutilised due to improper collection mechanism, inadequate infrastructure and processing capacity. According to the official estimate, more than 70 per cent of our fruits and vegetables perish before being consumed. Although India is traditionally an agro-based and agro-dependent economy, the average per-hectare yield of agricultural and horticultural crops is lower than the global average. Farm technology that is used on Indian soil hasn't yet caught up with that used by some other countries.

Banks and financial institutions are not too enthusiastic to lend to farmers, who still depend on local money lenders, and get a raw deal in return, decade after decade. Rural moneybags now actually play different roles during different hours of the day and night, varying from that of a seller of farm inputs, buyer of farm produce, employer for non-agricultural tasks and, at times, even that of a local politician. As a result of this bleak scenario, most farmers are small and poor. But the chain of traders, right from the farm level agent, up to the wholesale market level merchant, doesn't share this poverty with the farmers. On the other end of the value chain is the consumer. She pays a price that is a multiple of what the grower receives. It is also much higher when compared, on the Purchasing Power Parity basis, with what her counterpart in a developed country pays. This is the current state of affairs of agriculture in India. How long should it continue? Many of the economic ailments of the poorer countries have already disappeared, or are in the process of becoming extinct, as a result of the liberalisation, privatisation, and globalisation initiatives introduced 20 years ago. Telecommunication, construction, IT-enabled services and audio-visual transmission are shining examples of how India is competing with the developed countries. But agriculture has remained an untouchable fragmented sector. Too long, we have embraced the mantra of small is beautiful. The time has come to say size matters.

Foreign Direct Investment (FDI) in retail has the potential to give a ray of hope. It is a proven fact that reducing a value chain results in substantially lowering the gap between what the producer receives at one end and what the consumer ultimately pays at the other. However, some members in the middle part of the value chain will fade away. Some others won't, but will probably earn less than before. And at their cost, a new member, namely, a large, organised retailer, will enjoy long-term financial and strategic benefits. Contrary to the clamour made by some political parties, unorganised retail will neither fade nor become unviable due to the diverse nature, habits and culture of Indian consumers, even in large cities. The main advantage of FDI in retail can be the much-desired and much-awaited reforms in the farm sector, if the Government and the international retailers play their cards sensibly. Due to direct collaboration with the farmer, correct marketable varieties in required quantities can be grown. Contract farming can give security and cash to farmers, and pull them away from the

clutches of their multi-faced money lenders. If individual farmers are bundled together by a resourceful retailer, the group can enjoy economy of scale, modern farm technology, and assistance in capital investment to boost yields. In fact, modernisation has become essential because rural labour has been migrating to cities rapidly. Already, farm labour is either unavailable or too expensive. Of course, there are serious riders. Retail houses under the FDI scheme must exhibit patience, customise their supply chain management models to suit tricky Indian conditions, and place long-term interest before short-term profits and quarterly results. Indian farmers have been conservative due to a variety of historical factors and socio-cultural traditions. And now, the younger of them, must fearlessly shed the negative attitude towards change, and participate wholeheartedly in the new process of market-driven and technology-based farming. (The author is an independent management consulting professional.)




FDI simply refers to the act of investing capital in a business enterprise that operates overseas and in a foreign country. The party making the investment could be an individual, a business corporation, or maybe even a group of companies, and the enterprise that receives the investment will definitely benefit from this. What this ultimately means though, is that the party making the investment has a long-lasting interest in the other party, and they also get a say in matters regarding the functioning of that enterprise. The minimum voting rights, or shares of an enterprise, that a foreign investor is supposed to control is 10%. This holds relevant in cases where a foreign investor opens up a whole new business operation in another country after collaborating with a local player (Green-Field investment), or it simply merges with a local enterprise for the same purpose. In addition to this, FDI is also carried out either horizontally (with an enterprise in the same industry with market expansion as the sole purpose) or vertically (with the aim of sharing resources like capital and expertise). In effect, this is like any regular enterprise that invites investments and then grants the donor of that investment a certain degree of control in the enterprise, along with a share of profits as well, even though this depends on the policy of profit repatriation in that country. The only difference here is that the investor is actually a foreign party. As a result of this, different rules, policies and governing factors come into play in such a scenario. Both the parties involved derive many benefits from such an arrangement. On the other hand, both parties also suffer some disadvantages due to this process, so they have to take a decision after carrying out a balanced analysis. The Advantages of Foreign Direct Investment

The party making the investment is usually known as the parent enterprise, and the party invested in can be referred to as the foreign affiliate. Together, these enterprises form what is known as a Transnational Corporation (TNC), and here are some of the advantages of such an arrangement.

Many countries still have several import tariffs in place, so reaching these countries through international trade is difficult. There are certain industries that require to be present in international markets in order to succeed, and they are the ones who then provide FDI to industries in such countries, so that they can increase their sales presence there. Many parent enterprises provide FDI because of the tax incentives that they get. Governments of certain countries invite FDI because they get additional expertise, technology and products. So to welcome these benefits they provide great tax incentives for foreign investors, which ultimately suits all parties. Foreign investment reduces the disparity that exists between costs and revenues, especially when they are calculated in different currencies. By controlling an enterprise in a foreign country, a company is ensuring that the costs of production are incurred in the same market where the goods will ultimately be sold.

Different international markets have different tastes, different preferences and different requirements. By investing in a company in such a country, an enterprise ensures that its business practices and products match the needs of the market in that country specifically. Though this is not such a big factor, some markets prefer locally produced goods due to a strong sense of patriotism and nationalism, making it very hard for international enterprises to penetrate such a market. FDI helps enterprises enter such markets and gain a foothold there. From the foreign affiliate's point of view, FDI is beneficial because they get advanced resources and additional capital at their disposal. Something like this is always welcome, and it also helps strengthen the political relationships between various nations. Disadvantages of Foreign Direct Investment


While all these advantages are well and good, the fact is that there are certain cons that come along with them as well. Every industry, and every country, deals with these cons differently, and are also affected in varying degrees, so they are not meant to discourage foreign investors in any way. But every parent enterprise should be aware of these points.

Foreign investments are always risky because the political situation in some countries can change in an instant. The investor could suddenly find his investment in serious jeopardy due to several different reasons, so the risk factor is always extremely high. In certain cases, political changes could lead to a situation of 'Expropriation'. This refers to a scenario where the government can take control of a firm's property and assets, if it feels that the enterprise is a threat to national security. Many times, the cultural differences between different countries prove insurmountable. Major differences in the philosophy of both the parties lead to several disagreements, and ultimately a failed business venture. So it is necessary for both the parties to understand each other and compromise on certain principles. This point is directly related to globalization as well. Investing in foreign countries is infinitely more expensive than exporting goods. So an investor should be prepared to spend a lot of money for the purpose of setting up a good base of operations. This is something that parent enterprises know and are well prepared for, in most cases. From the point of view of foreign affiliates, FDI is ill-advised because they lose their national identity. They have to deal with interference from a group of people who do not understand the history of the company. They have unreal expectations placed on them, and they have to handle several cultural clashes at the same time.

Enterprises go down this path after carefully studying the advantages and disadvantages of foreign direct investment, so they are always well prepared for the worst. When handled properly, FDI can prove to be beneficial to both the parties, and the economies of both the party's countries as well. But if it goes wrong, then things can get very ugly for everyone involved as well. So this is a double-edged sword that needs to be handled with lots of caution.