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Foreign Investment-Meaning and Composition/Constituents of Foreign Investment (FDI & FII)
Foreign investment refers to the investments made by the residents of one country in the financial assets and
production process of another country
...
Foreign Direct Investment is the process by which residents of one country (Source country) acquire the
ownership of assets for the purpose of controlling the production, distribution and other production activities
of a firm in another country i
...
(host country)
...
FDI is investment by non-resident entities like MNCs to carry out business activities in India
...
The
foreign investor usually takes a considerable stake or shareholding in the company and influences
management completely or partially, depending on his shareholding
...
Equity capital comprises equity in branches, all shares in subsidiaries and and other capital contributions
...
Reinvested earnings consist of the direct investor’s share of earnings not distributed as dividends by
subsidiaries or associates and earnings of branches not remitted to the direct investor
...
Other direct investment capital (or inter-company debt transactions) covers the borrowing and lending of
funds between direct investors and subsidiaries, branches and associates
...
For example, Toyota assembles motor cars in Japan and UK
...
Foreign Portfolio Investment is the investment by individuals/firms/ a public body in one country in
the financial instruments/assets eg
...
of another
country
...
Any investment above 10% is FDI
...
The
different components of FPI flows are Foreign Institutional Investors, Global/American Depository
Receipts and Offshore funds
...
eg
...
invest in less than 10% of the share or units of funds in India
...
FDI means real investment; whereas FPI is monetary or financial investment
...
In the case of FDI entry and exit is
relatively difficult whereas in FPI entry and exit is relatively easy
...
Resources
Companies invest in foreign countries to take advantage of abundant resources available in that country
...
Huge amount of FDI
comes to India, South Korea, China and Thailand to take advantage of cheap and skilled manpower
...
Foreign firms have invested and discovered new oil and gas fields in African countries like Uganda, Ghana,
Nigeria, Tanzania etc
...
Market Size
Market size depends upon the size and income of the population
...
If the market size is large, it means there will be more demand for goods and services
...
Therefore cost of production may fall due to
large scale production
...
Similarly countries
having huge population may attract more FDI
...
It receives huge amount of FDI
...
03
...
Similarly rules and
regulations governing entry as well operations of foreign investors, treatment given to foreign companies,
privatisation and liberalisation policy etc
...
Trade openness encourages FDI, whereas trade barriers reduce FDI flows in the country
...
When
developing country tries to open its economy to other countries, it will be able to attract more FDI
...
eg ‘Make in India’, Special Economic
Zone policy
...
04
...
This promotes
FDI
...
Moreover reliable transport, adequate power generation, insurance, a welldeveloped competent financial system encourages FDI
...
On the other hand, if the cost of following regulations and government intervention in the affairs of the
company is high, then FDI will not come to the country
...
Its
head office will be in the home country
...
Jacoby defines a multinational company as follows: “A
multinational corporation owns and manages business in two or more countries
...
The movement of private foreign capital
takes place through MNCs
...
A multinational corporation is known by various names such as: global enterprise, international enterprise,
world enterprise, transnational corporation etc
...
This means they have huge physical and financial assets in almost all
countries in which they operate
...
For
example, Apple has a market capitalization of 1 trillion dollars
...
(ii) Operates Through a Network of Branches:
MNCs have production and marketing operations in several countries
...
(iii) Degree of Control:
Though MNCs have many branches in different countries, they are controlled by the head office in its
country of origin
...
They keep on adding to their economic power through constant
mergers and acquisitions of companies in host/other countries
...
(vi) Professional Management:
A MNC employs professionally trained managers to handle huge funds, advance technology and
international business operations They are able to attract top talent due to their resources and reputation
...
This helps them
to capture the market and sell their products globally
...
Licensing
In this entry mode, a firm/manufacturer in one country gives/leases/sells the right to use its intellectual
property – technology, work methods, patents, copyrights, trademarks etc
...
The manufacturer/company in the foreign country (original/source country) is called ‘Licensor’ and the
manufacturer in India is called ‘Licensee’
...
The licensee
has exclusive right to produce and market the product in the given area for a certain period of time
...
Mostly MNCs enter into licensing arrangements with their
own foreign affiliates/subsidiaries or joint ventures
...
Microsoft Office, Candy Crush Game, Sports brands like FIFA
...
Disadvantage of Licensing is that Licensing fees are generally lower than the profits earned by a company
through direct investment
...
Franchising
Franchising is a specialised form of licensing under which a number of services are given by the franchisor
to the franchisee in return for a payment/fee
...
Trademarks, Brand, continuous support for advertising,
employee training, quality maintenance etc
...
Franchisee is given exclusive right to produce and sell in one area/country
...
eg
...
selling its syrup together with the right to use its
trademark and name to independent bottle companies in India
...
Donalds, Domino’s, Pizza Hut, SubWay and hotels like Hilton and Marriott
...
Franchisor
gets information about the culture, customs and market in the host country
...
Disadvantage is that trade or technology secrets given to local firms by a MNC may be leaked to other
competitive firms
...
Joint Ventures/ Collaborations
Two or more firms join together to form a new business entity/ company
...
There is sharing of ownership
...
It provides capital, latest technology, required human talent etc
...
In some sectors, 100% foreign ownership is not possible
...
The local partner understands the customs, culture and local environment
...
For eg: Japanese Car Maker Suzuki has expertise in technology to build automobiles
...
This led to the formation of ‘Maruti Suzuki’
...
The parties delay
decision making once a dispute arises
...
The local partner
must have good reputation
...
Merger and Acquisitions
Mergers & Acquisitions refers to the consolidation of companies
...
Post-merger, these separately owned firms become a single entity and
are jointly owned
...
Generally, companies of similar sizes undergo the process of merger
...
merger of Vodafone India with Idea Cellular of Aditya Birla Group to create Vodafone Idea
...
eg
...
Generally,
a stronger and a bigger company takes over a smaller and a less powerful one
...
4
A merger typically refers to a friendly deal between two firms, even if it is a complete buyout
...
Due to differences in culture, customs, values etc
...
Labour
problems may arise because of difference in pay structure, seniority, possibility of reduction of manpower
...
Detail procedures and regulatory
requirements exist in different countries for eg
...
5
...
A wholly owned subsidiary can be set up in a foreign
market in two different ways
...
The second option is the company may
acquire / purchase an established firm in another country and sell its products - acquisition
...
Single Brand Retail
Trading, telecommunication, coffee, rubber, cardamom, palm oil tree and olive oil tree plantations, Food
Product Retail Trading etc
...
have set up their production units in
India
...
Parent company will hold all subsidiary companies share capital
...
Subsidiary company has its own senior management
structure, products and customers
...
A foreign company setting up subsidiary in India may produce and sell different types of products
...
This
helps to diversify and manage risk
...
Huge investment has to be made to set up a subsidiary
in foreign country
...
Exchange Risk
Exchange risk refers to the changes in the exchange rate of the currency
...
A well performing domestic stock market,
a stable exchange rate and strong domestic economic growth attracts portfolio flows
...
For eg
...
If there is rupee depreciation the amount of dividend
received by the foreign investors in foreign currency will be less
...
2
...
It refers to policy and regulatory
framework in the country
...
ease of repatriating (taking back) dividends and capital, domestic capital
gains tax, stock and bond market regulations
...
When capital controls are less, more FPI will come to the country
...
FIIs are allowed to invest upto 10 percent in equity of
a company
...
Repatriation of profits is allowed for foreign companies
...
All these measures for liberalisation and globalisation of the
economy has encouraged FII in India
...
Level of Financial Sector development
A well- developed, diversified and regulated financial sector will attract FPI
...
Capital market reforms like improved
market transparency, automation and dematerialisation attract FPI
...
In India, reforms have been introduced to liberalise, regulate and enhance efficiency of financial markets
...
Screen
based trading on stock exchanges exist
...
4
...
If opportunities
to earn high rate of return in the form of interest, dividend and capital appreciation on capital invested
exist, then FPI will come to the country
...
Therefore, investors in these developed
countries invested in developing or emerging economies like India
...
This
promotes FPI
...
When FIIs
invest in India they bring dollars in the country
...
Therefore demand for rupee rises
...
g
...
Thus FIIs inflows leads to currency appreciation
...
This situation leads to excess
liquidity that is, too much money and less amount of goods
...
Similarly when FIIs withdraw capital from the markets/sell securities, they convert rupees into dollars
...
(When they sell
securities purchased in India it leads to rupee depreciation)
...
How
does FII influence the functioning of capital/ Role of FII in capital market
...
It encourages Indian
companies to invest, expand and make profits
...
FPI helps to achieve
a higher degree of liquidity in the stock markets, increase price-earning (PE) ratios and therefore reduces
cost of capital for investment
...
FIIs are professional bodies of asset managers and financial analyst
...
They increase competition and efficiency of financial
markets
...
(3) Improves Corporate Governance
FIIs are professional bodies of asset managers and financial analyst
...
FPI leads to more corporate governance, as more transparency and disclosure will
be required from companies by foreign investors
...
They encourage flow of savings
from developed to developing countries
...
Negative Impact of FPI on Capital Market
01
...
If suddenly FIIs start selling
shares etc
...
02
...
RBI sells rupee in the market
...
e
...
This in turn creates the problem of inflation
...
Problem to Small Investors
Foreign Portfolio Investors earn profit by investing in stock markets of emerging / developing countries
...
When FIIs buy
stocks, their prices will increase i
...
But when FIIs sell shares, stock market crashes
...
04
...
Therefore export of goods and services
may be less