Type Of Foreign Direct Investment

Published Date: 02 Nov 2017

Foreign direct investment is defined as an investment, which is usually made to serve the business interests of the individual investors in a company, even if the investor is located in a different nation different from the investor's country of origin. The parent company through its foreign direct investment now exercises substantial control over the foreign affiliated company. As defined by the UN, ‘Control’ is owned by a company if it has greater than or equal to 10% of shares or has access to voting rights in an incorporated firm. Although most FDI ends up being 100% owned by a Multi-National Corporation (MNC), share of ownership amounts to less than 10% of ordinary shares is termed as portfolio investment and it is not categorized as FDI.

Foreign Direct Investment basically includes investments in the infrastructure development projects which include construction of bridges and flyovers, real estate development, retail sector, energy sector finance sector including banking and insurance services, etc. FDI has increased drastically in the past twenty years to become the most common type of capital flow across borders of both developed and developing economies. Foreign Direct Investment (FDI) flows are mostly preferred over other forms of finance or external investments because they do not create any debt, are less risky, non-volatile and the returns from them depend on the performance of the projects that are financed by the investors. FDI also encourages trade between various countries globally (international trade) and transfer of knowledge and technology. In the present world of increased competition and rapidly changing technology, FDI is considered to be very valuable.

Type of Foreign Direct Investment

Foreign direct investments are of various types. The classification of FDI is based on the restrictions imposed, and the various prerequisites that are required for these investments.

FDIs are classified into two types:

Outward Foreign Direct Investments and

Inward Foreign Direct Investments.

Outward Foreign direct investment is also known as direct investment abroad. Here the local capital is invested in foreign resource. Outward FDI may also be finding useful in the import and export dealings with any foreign country. An outward FDI is backed by that country’s government against all types of associated risks. This Outward FDI is always subject to certain tax incentives as well as disincentives of a variety of forms. Risk coverage that is provided to the local industries and subsidies that are granted to the domestic firms are considered as an obstacle in the way of outward FDI.

Outward FDI faces restrictions due to the following factors as described below:

ï‚· Tax incentives that invest outside their country of origin or on profits are repatriated.

ï‚· Industries that are related to defense are mostly set outside the purview of outward Foreign Direct Investment in order to retain government's control over the defense related industrial setup.

ï‚· Subsidies scheme is targeted at local businesses.

ï‚· Lobby groups with absolute interests possess support from either inward Foreign Direct Investment sector or state investment funding bodies.

ï‚· Government policies lend support to the domestic industry.

Inward Foreign direct investment is a form 'inward investment'. Here, investment of foreign capital generally occurs in local resources.

The factors that encourage the growth of Inward FDI comprises of tax breaks, relaxation of existent regulations, loans offered at low rates of interest, provision of specific grants and also the removal of restrictions and limitations. The inspiration behind inward FDI is that, the long term profits from such sort of funding outweighs the disadvantage of the income loss which is incurred in the short run. Inward FDI flows might also face certain restrictions from factors like restriction on ownership and difference in the performance standard.

Foreign Direct Investment in India

India being the third most attractive FDI destination in the world, after China and the United States which are ranked 1st and 2nd respectively. The country has a favourable foreign investment environment that provides freedom of entry, investment, location, choice of technology, import and export. Its policy structure provides clear guidelines for the entry, freedom of location, technological preference, production, Capital repatriation, etc. and a well-balanced package of fiscal incentives, which is specifically aimed of enhancing the flow of FDI.

India received around US$25 billion of FDI in the year 2007-08; this number rose to US$27 billion in the year 2008-09, highlighting India’s ability to remain durable and attract investment despite the global slowdown. Multinational firms have taken advantage of the country's increasingly prosperous consumer market. In the first nine months of 2009, FDI dipped by 26 per cent to $21.4 billion from $29 billion a year ago. The total FDI inflow into India in the fiscal year 2009-10 since 2001 has crossed the $100 billion mark. The total number of foreign technical collaborations has also been increasing in line with the rise of Foreign Direct Investment. In the year 2006-2007, exact FTC approval was 81 although in the beginning of the 2007-2008 this number rose to 40. Between 1991(August) to 2007(June) the number of FTC approval has reached up to 7,886.

FDI IN MALAYSIA

Malaysia’s rapid industrialization was largely the result of its early openness to the inflows of foreign direct investment (FDI). Before independence in 1957, Malaysian foreign direct investment activities were concentrated in mining, plantation agriculture, commercial enterprises and utilities. After its independence, the pattern of FDI changed as activities in existing sectors expanded and there was diversification into other agricultural crops and into manufacturing. During the 1960s, Malaysia’s

FDI policy focused on the development of import-substituting industries (ISIs). Later, during the 1970s, Malaysia switched to more export-oriented industries (EOIs) and, in particular, labour-intensive industries. Because Malaysia’s labor force was relatively inexpensive, educated and abundant, it fulfilled the needs of foreign firms (Tham 1997:1-2; Lin 1994; Sulong 1990). The Malaysian government has long considered manufacturing as the most dynamic sector and central to Malaysian economic development. A proactive industrial policy began with the establishment of the Federal Industrial Development Authority (FIDA) in 1965 by the Malaysian Government. FIDA was responsible for promoting and co- coordinating industrial development activities. In 1979, the Authority was renamed the Malaysian Industrial Development Authority (MIDA). From then on, MIDA has been the primary government agency responsible for the large flows of foreign investment into the manufacturing sector (MIDA 1996: 45). Realising FDI as an important source for Malaysia’s industrial development, the Government has initiated various incentives and liberal policies to promote foreign investments in the manufacturing sector. These include the enactments of Investment Incentives Act and Free Trade Zone Act, liberal policies on equity, tax incentives and so forth (Ministry of Finance Malaysia 2001:173-210)

From 1980 to 1989, the average annual FDI flow into Malaysia’s manufacturing sector was RM2.33 billion (nearly US$1 billion). In 1980, it was about RM0.73 billion (US$0.34 billion) but in 1990, it increased significantly to RM17.63 billion (US$6.5 billion). The share of FDI for the sector was 42.8 per cent in 1980 and it exceeded 50 per cent after 1990 (Tham 1997:18). In 1993, the United States (USA) and Japan provided more than 50 per cent of total FDI in the sector. In the year 2000, the USA, Japan, Netherlands, Singapore, Germany and Taiwan were among the major sources of FDI in Malaysia. For the period 1996~2000, proposed FDI in approved manufacturing projects totalled RM73.7 billion (US$19.4 billion). This amount constituted 53.8 per cent of total proposed capital investment (TPCI) that consists of both domestic and foreign investments (MIDA 2001).