What is Foreign Direct Investment (FDI)?
Foreign Direct Investment (FDI) is an investment made by an investor in a business operating in another country. The investor (foreign investor) has control over the invested business. The Organization of Economic Corporation and Development’s (OECD) definition to ‘control’ is, owning at least 10% of the business. The investors who make these investments are usually multinational corporations (MNCs) and multinational enterprises (MNEs). An MNE may make a direct investment by establishing a new foreign enterprise which is known as a Greenfield investment.
What are the methods by which Foreign Direct Investments are made?
There are several ways by which an investment company makes an investment in other countries. For example, acquire voting stock (ownership of equity) in a foreign company, mergers, and acquisitions, Joint ventures with foreign companies, establishing a subsidiary of a domestic firm in a foreign country, etc.
Advantages of Foreign Direct investments
FDI has its advantages and disadvantages as well. Looking at it a little deeper, it is observed that companies that make the investments have advantages over the foreign country where the investment is made. The following are the benefits to the companies.
- It is quite difficult for foreign companies to enter into other country’s domestic markets. Hence, FDI has made the pathway for it. With FDI, foreign companies can gain access to domestic markets.
- FDI is a useful way to access the natural resources of other countries, such as precious metals and fossil fuels.
- Production companies are set up in developing countries by foreign MNCs and MNEs so as to reduce the cost of production.
Now, let’s look at some advantages for foreign countries.
- For startups in developing countries, FDI provides a tremendous amount of external capital for setting up their company. Hence, it leads to the economic growth of a nation.
- Local firms merge with foreign companies where they help these firms construct new industries in their countries.
Impacts of FDI
FDI plays an essential role in the growth and development of an economy. FDI does not just bring capital to the host country but brings new innovative technology to it as well. The MNEs look forward to investing more in Research and Development (R&D), which levels up the country’s technology. Also, as technology advances, there is a generation of employment opportunities. Going forward, with this technology in developing countries, they are able to produce high-quality goods which are capable of exporting. Hence, host countries tend to improve their level of exports. With this improvement in exports and money flow through FDI, the foreign exchange reserve increases in the host countries.
FDI has its hand in the GDP too. FDI improves the Gross Domestic Product (GDP) of an economy. It is due to the improved production and development of domestic firms, which has already been discussed in the previous section. With the GDP, the gross domestic capital formation (GDCF) is also seen to improve. As the host county’s domestic firms are seen grow drastically, its stock prices are also seen to outperform.
A Reliable source of information on FDI
Reports on FDI are essential to economists and investors. Therefore, there are web portals that provide data regarding FDI. The following are the links which show information on FDI for different countries. Each link contains information on the actual FDI data, historical data, high and low in a given period, chart representation, etc.
What do traders and investors care about FDI, and what are its impacts on the currency?
International investors keep a close eye on FDI data as they find it to be quite an essential and useful investing analysis tool. FDI creates higher growth rates in the host countries, which creates opportunities for investors to invest. Investors see FDI as a risk management tool as well. On a macro level, an increase in FDI causes problems to domestic labours and drain capital in the long run. Therefore, investors deeply look at both macroeconomic and microeconomic levels and then step forward.
Coming to the effect on the currency, an increase in FDI will increase the demand for the host country’s currency, and eventually, its exchange rate will rise. The primary factor affecting the demand in the host currency can be accounted for the improvement in the GDP of the country. Another reason for the demand in currency would be the increase in the level of foreign exchange reserves.
Frequency of release
Now we know the impacts and the usefulness of FDI in an economy. Therefore, the frequency of release of these reports matters too. The frequency is not the same for all countries and varies from monthly to yearly. Following is the data on how frequent the FDI reports are released.
Australia – released yearly.
Canada – every quarter.
Japan – released monthly.
Switzerland – every year.
UK – released quarterly.
The USA – released quarterly.
New Zealand – released quarterly.
Investing in foreign countries expands business relationships across the counties. The benefits are on both sides. FDI proves to be useful to the ones making the investment and the country where investment is made. FDI helps in the improvement of the GDP of the country and hence is a critical factor in the economic growth of a nation. In developing countries, FDI inputs have generated a good amount of employment. Therefore, FDI has shown its importance in the manufacturing sector, service sector, and the banking sector.