Recently the global business environment has been experiencing a surge in Foreign Direct Investment (FDI), in particular in the emerging economies. Select an emerging economy of your choice; critically evaluate the impact of inward FDI on this country using the various arguments cited in the literature. (10 marks)
Ans – After independence in 1947, the Indian government decided to adopt the socialist regime i.e. it decided to become a centrally planned economy. In a centrally planned economy, as the name suggests, the government has control over the factors of production and makes use of these according to some pre – decided plan. Also, the private sector plays little or no role. Its role in the development of the country’s economy is decided by the government. Russia is an example of a centrally planned or socialist economy.
At the time of independence, the idea of having a socialist economy was thought to have great merit. The government would control all factors of production and be able to distribute the wealth and resources of the country equitably among the people, thus avoiding concentration of wealth. However, this plan failed because the government could not carry out the economic activities in the manner that they had been planned. The loan from the World Bank started increasing, India’s Balance of Payments position started becoming more and more unfavorable. A peak was reached in 1991 when India had just about enough balance to buy resources for 1 month. At this time, the Finance Minister Mr. Manmohan Singh, decided to introduce some changes in the economic structure of the country so as to combat the challenges faced by the Indian economy. He declared India to be a mixed economy wherein both public and private sectors coexist with each other. Also, he introduced the 3 golden rules of – Liberalization, Privatization, Globalization.
Privatization involved opening up of several key industries to the private sector also. The no. of industries in which the private sector could not operate was reduced to 5.
Liberalization involved the removal of unnecessary restrictions that had been placed on the Indian companies e.g. Indian companies got automatic approval from the government for foreign technology transfer agreements.
Globalization refers to integrating of the country’s economy with the world economy, thus making the world one huge market such that every country could be a market for another country’s products or the source of raw materials for another country’s products.
It was Liberalization that opened the path to FDI for the country. FDI, also known as Foreign Direct Investment, involves the injection of foreign funds into an enterprise. The enterprise should have its headquarters or its country of origin must be different than that of the investing country. FDI can also be defined as the investment of foreign assets into domestic equipment, organizations and structures. However, investment is domestic stock market by foreign investor is not considered to be a part of FDI.
In contrast to the investments made in the equity of a company, FDI is thought to be very useful because of its durability. Unlike in the former case wherein investor can stop investing at the first sign of an adverse situation, in FDI, investment is constant irrespective of whether situation is adverse or favorable.
When investors invest a certain amount of money in the domestic company, they get some shares as proof of their investment. If the investors get ownership of 10 % or more of the ordinary shares of the company, they are granted management rights and voting rights in the company.
Foreign direct investment (FDI) is defined as an investment involving a long-term relationship and reflecting a lasting interest and control by a resident entity in one economy (foreign direct investor or parent enterprise) in an enterprise resident in an economy other than that of the foreign direct investor (FDI enterprise or affiliate enterprise or foreign affiliate). FDI implies that the investor exerts a significant degree of influence on the management of the enterprise resident in the other economy. Such investment involves both the initial transaction between the two entities and all subsequent transactions between them and among foreign affiliates, both incorporated and unincorporated.
Depending on the direction of flow of money, FDI can be classified as follows –
a) Inward FDI – This involves the investment of foreign capital in domestic / local resources. The investor and the company being invested in should have different countries of origin. The factors responsible for growth of inward FDI are grants, low interest rates and tax breaks.
b) Outward FDI – This involves the investment of domestic capital in foreign resources. In this, government gives the backing against all / any associated risk. This is also known as Direct Investment Abroad.