8. (b) What is Foreign Direct Investment? Describe with suitable examples the different factors that influence Foreign Direct Investment.

What is Foreign Direct Investment (FDI)?

Foreign Direct Investment (FDI) is a cross-border investment where a resident of one country (the home country) obtains a lasting interest in and a significant degree of influence over the management of a business enterprise in another country (the host country). This influence is generally defined by an ownership stake of 10% or more of the voting power in the foreign company.

FDI is distinct from Foreign Portfolio Investment (FPI), which involves passive investments in financial assets like stocks and bonds without acquiring control. FDI can take various forms:

• Greenfield Investment: Establishing a completely new business operation or facility in a foreign country. E.g., a foreign car manufacturer building a new plant in India.
• Mergers and Acquisitions (M&As): Acquiring an existing company or merging with a local firm in the host country. E.g., Walmart acquiring a significant stake in a retail chain in another country.
• Reinvestment of Earnings: Plowing back profits earned from existing foreign operations into the host country.
• Intra-company Loans: Lending by parent companies to their foreign affiliates.

Factors Influencing Foreign Direct Investment

Numerous factors, broadly categorized as economic, political, and regulatory, influence the attractiveness of a country for FDI. These factors determine whether an investor will commit significant resources and establish a long-term presence.

1. Economic Factors:

• Market Size and Growth Potential: Large and rapidly growing domestic markets are highly attractive as they offer opportunities for higher sales and expansion.
  • Example: India's vast consumer base and projected GDP growth of 5.7% for FY 2023-2024 (OECD forecast) make it an appealing destination for market-seeking FDI.
• Availability and Cost of Resources: Access to affordable and high-quality raw materials, skilled labor, and low wage rates can significantly influence FDI decisions.
  • Example: Manufacturing companies often invest in countries with lower labor costs, such as Southeast Asian nations, to reduce production expenses.
• Infrastructure Development: Well-developed physical infrastructure (transport, telecommunications, energy) and institutional infrastructure (financial systems, legal framework) reduce operational costs and increase efficiency.
  • Example: Investments in logistics and digital infrastructure in India under schemes like the National Logistics Policy enhance its attractiveness for FDI in manufacturing and services.
• Economic Stability and Growth Prospects: Countries with stable macroeconomic conditions, low inflation, and consistent economic growth provide a predictable and profitable environment for investors.
  • Example: Emerging economies demonstrating strong and stable GDP growth typically attract more FDI.
• Exchange Rates: A stable and competitive exchange rate can make exports more attractive and asset purchases more affordable, though volatility can deter investment.
  • Example: A weaker local currency can make it cheaper for foreign companies to acquire assets or set up operations.
• Access to Regional and Global Markets: Investment in countries that are part of free trade agreements or have preferential trade access to larger markets can be highly beneficial.
  • Example: Companies investing in Ireland to gain access to the wider European Union market (Platform FDI).

2. Political Factors:

• Political Stability: A stable political environment reduces risks associated with policy reversals, social unrest, and expropriation, providing confidence to foreign investors.
  • Example: Countries experiencing frequent changes in government or civil unrest often see a decline in FDI, as investors fear for the safety of their assets.
• Government Policies and Incentives: Investor-friendly policies, including tax holidays, subsidies, preferential tariffs, Special Economic Zones (SEZs), and investment financial subsidies, actively encourage FDI.
  • Example: India's Production Linked Incentive (PLI) schemes in various sectors aim to attract foreign and domestic investments in manufacturing.
• Level of Corruption: High levels of corruption can deter FDI due to increased operational costs, uncertainty, and legal risks.
  • Example: Transparency International's Corruption Perception Index often correlates with FDI inflows, with less corrupt countries generally attracting more investment.
• Protection of Property Rights: Strong legal protection for intellectual property rights and physical assets reassures investors against theft or unauthorized use.
  • Example: Pharmaceutical companies prioritize countries with robust patent laws for R&D investments.

3. Regulatory and Legal Factors:

• Ease of Doing Business: Streamlined administrative procedures, clear regulations for starting businesses, obtaining permits, and repatriating profits reduce bureaucratic hurdles.
  • Example: Countries that improve their ranking in the World Bank's Ease of Doing Business report often experience increased FDI.
• Legal and Regulatory Framework: Transparent, predictable, and fair legal systems, including contract enforcement mechanisms and dispute resolution, are crucial for investor confidence.
  • Example: The presence of independent judiciary and adherence to international investment treaties provides a sense of security for foreign investors.
• Investment Restrictions and Liberalization: The openness of an economy to foreign investment, including caps on foreign equity, sectoral restrictions, and approval routes, directly impacts FDI inflows.
  • Example: India's liberalization of FDI policies, allowing 100% FDI through the automatic route in most sectors, has been instrumental in attracting foreign capital.
• Labor Laws: Flexible labor laws that allow for easier hiring and firing, while also protecting worker rights, can be attractive to investors.
  • Example: Regions with more flexible labor markets might attract manufacturing FDI compared to those with rigid labor regulations.

These factors interact in complex ways, and investors often weigh a combination of these elements when making FDI decisions. For instance, while low labor costs might be attractive, inadequate infrastructure or political instability could negate that advantage.