Foreign Direct Investment



Foreign Direct Investment (FDI) is capital provided by a foreign direct investor, either directly or through other related enterprises, where the foreign investor is directly involved in the management of the enterprise. Development of a new business or acquisition of at least 10% interest in a domestic company or a tangible assets, (purchase of bond & stock). "Foreign direct investment is the transfer by a multinational firm of capital, managerial, and technical assets from its home country to a host country".

FDI has three components: equity capital, reinvested earnings and intra-company loans. FDI flows are recorded on a net basis (capital account credits less debits between direct investors and their foreign affiliates) in a particular year. Outflows of FDI in the reporting economy comprise capital provided (either directly or through other related enterprises) by a company resident in the economy (foreign direct investor) to an enterprise resident in another country (FDI enterprise). Inflows of FDI in the reporting economy comprise capital provided (either directly or through other related enterprises) by a foreign direct investor to an enterprise resident in the economy (called FDI enterprise).

Foreign direct investment (FDI) includes significant investments by foreign companies, such as construction of production facilities or ownership stakes taken in U.S. companies. FDI not only creates new jobs, it can also lead to an infusion of innovative technologies, management strategies, and workforce practices. 'The ultimate flow of foreign involvement is direct ownership of foreign- based assembly or manufacturing facilities. The foreign company can buy part or full interest in a local company or build its own facilities. If the foreign market appears large enough, foreign promotion facilities offer distinct advantages. First, the firm secures cost economies in the form of cheaper labor or raw material, foreign government incentives, and freight savings. Second, the firm strengthens its image in the host country because it creates jobs. Third, the firm develops the recent relationship with the government, customers, local suppliers, and distributors, enabling it to adapt its product better to the local environment. Forth, the firm retains full retain over its investment and therefore can develop manufacturing and marketing policies that serve its long-term international objectives. Fifth, the firm assures itself access to the market in case the host country starts insisting that locally purchased goods have domestic content."

Types of Foreign Direct Investment

Multinational Corporation

A country that maintains significant operation in multiple countries but manages them from the base in the home country.The MNC's are playing an important role in economic development of developing countries. First, the investment made by MNC's help in filling the saving investment gap. Secondly, it fills the foreign exchange or trade gap. Thirdly, the govt. of the developing countries is able to fill up the reserves gap by taxing the profits of MNC's. Fourthly, MNC's fill the gaps in management entrepreneurship, technology and skills in the developing countries.

Transnational Corporation

A country that maintains the significant operation in more than one country but decentralize management to the local country.

Strategic alliance

An approach to going global that involves partnerships between an organization and a foreign company in which both share knowledge & resources in developing new products or building production facilities. t is an agreement typically between a large company with established products & channel of distribution and an emerging technology company with a promising research and development program in areas of interest to the larger company. In exchange for its financial support, the larger established company obtains a stake in the technology being developed by the emerging company. Today, strategic alliance is common place in the biotechnology, information technology & the software industries

Joint venture

An approach going global that is a specific type of strategic alliance in which the partners agree to form an independent organization for some business purpose.

They can be of two types:

A contractual joint venture between firms is usually for a specific project, such as manufacturing a component or other product for a fixed period of time. In equity joint venture is when firms hold an equity stake in the setting up of a joint subsidiary, again to produce a good or a service, for example Toyota and General Motors formed the subsidiary NUMMI to manufacture cars in the United States.

The percent of sales method for preparing pro forma financial statement are fairly simple. Basically this method assumes that the future relationship between various elements of costs to sales will be similar to their historical relationship. When using this method, a decision has to be taken about which historical cost ratios to be used.

Neoclassical Economic Theory of FDI

Neoclassical economic theory propounds that FDI contributes positively to the economic development of the host country and increases the level of social wellbeing [Bergten, et al. (1978)]. The reason behind this argument is that the foreign investors are usually bringing capital in to the host country, thereby influencing the quality and quantity of capital formation in the host country. The inflow of capital and reinvestment of profits increases the total savings of the country. Government revenue increases via tax and other payments [Seid (2002)]. Moreover, the infusion of foreign capital in the host country reduces the balance of payments pressures of the host country.

The other argument favouring the neoclassical theory is that FDI replaces the inferior production technology in developing countries by a superior one from advanced industrialised countries through the transfer of technology, managerial and marketing skills, market information, organisational experience, and the training of workers.

The MNCs through their foreign affiliates can serve as primary channel for the transfer of technology from developed to developing countries. The welfare gain of adopting new technologies for developing countries depends on the extent to which these innovations are diffused locally.

The proponents of neoclassical theory further argue that FDI raises competition in an industry with a likely improvement in productivity; Bureau of Industry Economics. Rise in competition can lead to reallocation of resources to more productive activities, efficient utilization of capital and removal of poor management practices. FDI can also widen the market for host producers by linking the industry of host country more closely to the world markets, which leads to even greater competition and opportunity to technology transfer

It is also argued that FDI generates employment, influences incomes distribution and generates foreign exchange, thereby easing balance of payments constraints of the host country; Sornarajah; Bergten, et al.. Furthermore, infrastructure facilities would be built and upgraded by foreign investors. The facilities would be the general benefit of the economy.

The Guidelines on the Treatment of Foreign Direct Investment incorporates the neoclassical theory when it recognises:. that a greater flow of direct investment brings substantial benefits to bear on the world economy and on the economies of the developing countries in particular, in terms of improving the long-term efficiency of the host country through greater competition, transfer of capital, technology and managerial skills and enhancement of market access and in terms of the expansion of international trade.

Kennedy (1992) has noted that host countries became more confident in their abilities to gain greater economic benefits from FDI without resorting to nationalization, as the administrative, technical and managerial capabilities of the host countries increased.

Reference :

Financial Management – Prasanna Chandra
Management Accounting – M.Y. Khan and P.K. Jain
Advanced Accountancy – S.M. Shukla
Financial Statements – Royal Classic Group






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