Foreign Direct Investment (FDI)

What Is a Foreign Direct Investment (FDI)?

A category of cross-border investment where an investor residing in one economy has an ongoing interest in and establishes significant influence over a company residing in another economy is Foreign Direct Investment (FDI). For example, a company in America can help a newly established company in India reach its goals through its investments. 

The ownership of 10% or more voting rights in a company in one economy by an investor residing in another country portrays such a relationship. FDI is a key component of international economic integration as it creates stable and lasting links between economies. 

FDI is an important medium to transfer technology across countries. It facilitates trade globally through access to foreign markets. It is a crucial tool for economic development. This group covers indicators like the in and out values of equity, flows, and income, broken down by partner country and sector, with foreign direct investment limits.

How Does Foreign Direct Investment (FDI) Work?

Through FDI, companies and government targets projects in economies better than theirs to hunt skilled labour and offer good growth prospects. Foreign Direct Investment (FDI) brings not only equity inflows but also managerial know-how, technical know-how, new employment opportunities, improved infrastructure, and new technologies into an economy.

Foreign investors can invest in India through either of the two routes: the automatic route or the government route.

Automatic routes do not require prior government approval. This means that foreign investors do not have to go through the government or various ministries to invest in a country’s companies. Government routes have stricter rules and regulations than automatic routes. 

The whole process of finding the right investor for your business in India can be confusing. It can command a lot of effort and time and is an expensive commodity. The best solution, in this case, is to contact an FDI agency.

Types of Foreign Direct Investment

There are four types of Foreign Direct Investment
1.    Horizontal FDI: Horizontal FDI mainly revolves around investing funds in foreign companies in the same industry as the FDI investor owns or operates. Here a company invests in another company located in another country and produces similar goods. 

2.    Vertical FDI: This FDI type refers to when the investment is within the typical supply chain of companies that may or may not be in the same industry. Therefore, when vertical direct investment occurs, companies invest in foreign companies that can supply or sell their products. Vertical FDI is further classified into backward vertical integration and forward vertical integration. 

3.    Conglomerate FDI: When companies invest in two completely different companies in completely different industries, the transaction is known as a conglomerate FDI. Therefore, FDI is not directly related to the investor's business. 

4.    Platform FDI: In Platform FDI, the company goes abroad, but the manufactured products are exported to a third country.
 

Examples of Foreign Direct Investment

Now that you know the FDI meaning and types of FDI, let’s get into some practical examples.

●    A Spain-based Zara could invest in or acquire Fab India, an Indian company that makes products similar to Zara. Since both companies belong to the same goods and apparel industry, the FDI classification is horizontal FDI.
●    A Swiss coffee producer, Nescafé, can invest in coffee plantations in countries such as Brazil, Colombia, and Vietnam. This type of FDI is known as backward vertical integration because the investment firm buys the suppliers of its chain of supply. On the other hand, when a company decides to invest in another company, higher than its position in the supply chain, it is known as forward vertical integration. For example, an Indian coffee company wants to invest in a Thai food brand.
●    US retailer Walmart can invest in Indian automaker TATA Motors as a conglomerate FDI.
●    French perfume brand Chanel has established manufacturing facilities in the United States and exports its products to the United States, Asia, and the rest of Europe, which falls under the platform FDI.

Difference between Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI)

Methods of Foreign Direct Investment

Broadly, there are two methods to execute a foreign direct investment (FDI):

●    Greenfield investment
●    Brownfield investment

In the greenfield investment strategy, the company starts business from scratch in another country. For example, Domino's and McDonald's are US-based companies that started from scratch in India. They are now leaders in their respective segments. On the other hand, in the brownfield investment strategy, the company does not build the business from scratch. Instead, they chose the path of mergers or acquisitions. 

FDI Advantages and Disadvantages

Advantages of Foreign Direct Investment include-

●    FDIs usually increase manufacturing activity and improve the service sector. Thus creating more employment opportunities 
●    Provides exclusive market access in other countries
●    Builds industries and factories to improve the country's infrastructure and help underdeveloped areas develop
●    It also helps improve technology and operational practices through knowledge sharing
●    Exports increase when foreign investment boosts production
●    Income and employment opportunities will increase, thereby the per capita income of the population

Disadvantages of FDI include the following.

●    It poses risks and hinders domestic investment
●    Fluctuations in exchange rates can make foreign investments risky
●    It depends on the country's ever-changing political environment, foreign policy, and regulations
●    Domestic companies may lose control of their business and profits
●    The incentive to gain market share through foreign investment can lead to large losses for domestic and small traders

FDI has a positive impact on developing countries. However, there are some potential risks. Adverse selection and distressed selling can lead to destruction. Leverage can affect the advantage and limit its true benefits. Also, a high share of foreign direct investment in a country's total capital inflows may reflect the weakness rather than the strength of that country's institutions. Policy recommendation to improve the investment climate of both the foreign and domestic climate is necessary for developing countries.

Permissible sectors for FDI in India

Foreign Direct Investment (FDI) in India is allowed across various sectors, either through automatic route or with government approval. Under 100% automatic route, sectors such as Agriculture, Air Transport Services, Airports, Automobiles, Biotechnology (Greenfield), & Pharmaceuticals (Greenfield) allow foreign investment without prior government approval. Additionally, up to 100% FDI is allowed in sectors like Insurance, Medical Devices, & Pension with specified limits under automatic route. Certain sectors like Defence, Air Transport Services, & Telecom Services permit up to 49% FDI under automatic route, with further investments requiring government approval. Indian government has also outlined specific sectors, including Banking (Public Sector), Print Media, & Multi-Brand Retail Trading, where FDI is permitted up to defined limits under government route. This structured approach ensures balanced & regulated inflow of foreign investments across India's diverse economic sectors.

Which are Prohibited Sectors under FDI

List of prohibited sectors:
•    *Lottery Business including Government/ Private lottery, online lotteries etc.
•    Chit Funds
•    Trading in Transferable Development Rights (TDR)
•    Manufacturing of Cigars, cheroots, cigarillos, & cigarettes (tobacco or tobacco substitutes)
•    Gambling & betting including casinos*
•    Nidhi Company
•    **Real Estate Business or Construction of Farm Houses
•    Sectors not open to private sector investments – atomic energy, railway operations (other than permitted activities mentioned under consolidated FDI Policy)

* Foreign technology collaboration in any form including licensing for franchise, trademark, brand name, management contract is also prohibited for Lottery Business & Gambling & Betting activities

** Real estate business shall not include development of town shops, construction of residential/ commercial premises, roads or bridges & Real Estate Investment Trusts (REITs) registered & regulated under SEBI (REITs) Regulations, 2014.

What are Reporting Requirements under FDI?

Under Indian Constitution, Foreign Direct Investment (FDI) is regulated by Foreign Exchange Management Act (FEMA) of 1999 & Consolidated FDI Policy issued by Department for Promotion of Industry & Internal Trade (DPIIT). 

Companies receiving FDI must report inflow within 30 days using Advanced Remittance Form (ARF). 
After allotting shares, they must file Form FC-GPR within 30 days. Additionally, annual returns on Foreign Liabilities & Assets (FLA) must be submitted by July 15 each year. 

Any transfer of shares between residents & non-residents must be reported using Form FC-TRS within 60 days. 
These requirements ensure transparency & compliance with constitutional & regulatory norms, facilitating smooth FDI operations in India.