Foreign Direct Investment (FDI) and Trade
FDI is an important factor in global economy. Foreign trade and
FDI are closely related. In developing countries like India, FDI in the natural
resource sector, including plantations, increases trade volume. Foreign
production by FDI is useful to substitute foreign trade. FDI is also influenced
by the income generated from the trade and regional integration schemes.
FDI is helpful to accelerate the economic growth by facilitating
essential imports needed for carrying out development programmes like capital
goods, technical know-how, raw materials and other inputs and even scarce
When the export earnings of a country are not sufficient to
finance for imports, FDI may be required to fill the trade gap.
FDI is encouraged by the factors such as foreign exchange
shortage, desire to create employment and acceleration of the pace of economic
development. Many developing countries strongly prefer foreign investment to
imports. However, the real impact of FDI on different sections of an economy
(say India) may differ. It could be a boon for some as well as bane for others.
This may be discussed in the class – room. Large demand for USD, generated by
IMF and World Bank policies (FUND – BANK POLICIES), help the USD to gain value
continuously. This is one of the hidden agenda of Fund – Bank policies.
FDI means an investment in a foreign country that involves some
degree of control and participation in management. It corresponds to the
investment made by a multinational enterprise in a foreign country. It is
different from portfolio investment, which is primarily motivated by short term
profit and it does not seek management control.
Foreign Portfolio Investment (FPI) means the entry of funds into a
nation where foreigners deposit money in a nation’s bank or make purchase in
the stock and bond markets, sometimes for speculation. FPI is part of capital
account of BoP.
FDI has the following objectives.
1. Sales Expansion
2. Acquisition of resources
4. Minimization of competitive risk.
Foreign Institutional Investment (FII) is an investment in hedge
funds, insurance companies, pension funds and mutual funds. Foreign
institutional investment is a common term in the financial sector of India. For
example, a mutual fund in the United States can make investment in an
Foreign investment mostly takes the form of direct investment.
Hence, we deal here with the foreign direct investment.
The important advantages of foreign direct investment are the
FDI may help to increase the investment level and thereby the
income and employment in the host country.
Direct foreign investment may facilitate transfer of technology to
the recipient country.
FDI may also bring revenue to the government of host country when
it taxes profits of foreign firms or gets royalties from concession agreements.
A part of profit from direct foreign investment may be ploughed
back into the expansion, modernization or development of related industries.
It may kindle a managerial revolution in the recipient country
through professional management and sophisticated management techniques.
Foreign capital may enable the country to increase its exports and
reduce import requirements. And thereby ease BoP disequilibrium.
Foreign investment may also help increase competition and break
If FDI adds more value to output in the recipient country than the
return on capital from foreign investment, then the social returns are greater
than the private returns on foreign investment.
By bringing capital and foreign exchange FDI may help in filling
the savings gap and the foreign exchange gap in order to achieve the goal of
national economic development.
10. Foreign investments may
stimulate domestic enterprise to invest in ancillary industries in
collaboration with foreign enterprises.
11. Lastly, FDI flowing into
a developing country may also encourage its entrepreneurs to invest in the
other LDCs. Firms in India have started investing in Nepal, Uganda, Ethiopia
and Kenya and other LDCs while they are still borrowing from abroad. Larger FDI
to India comes from a small country (Mauritius).
The following criticisms are leveled against foreign direct
Private foreign capital tends to flow to the high profit areas
rather than to the priority sectors.
The technologies brought in by the foreign investor may not be
appropriate to the consumption needs, size of the domestic market, resource
availabilities, stage of development of the economy, etc.
Foreign investment, sometimes, have unfavorable effect on the
Balance of Payments of a country because when the drain of foreign exchange by
way of royalty, dividend , etc. is more than the investment made by the foreign
Foreign capital sometimes interferes in the national politics.
Foreign investors sometimes engage in unfair and unethical trade
Foreign investment in some cases leads to the destruction or
weakening of small and medium enterprises.
Sometimes foreign investment can result in the dangerous situation
of minimizing / eliminating competition and the creation of monopolies or
Often, there are several costs associated with encouraging foreign
The early 1990s witnessed reforms in the economic policy. This
helped to open up Indian markets to FDI. FDI in India has increased over the
years. In India, FDI has been advantageous in terms of free flow of capital,
improved technology, management expertise and access to international markets.
financial sector (banking and non-banking)
hospitality and tourism
software and information technology.
Arms and ammunition
coal and lignite and
mining of iron, manganese, chrome, gypsum, sulphur, gold,
diamonds, copper etc.,
FDI inflow in India has increased from $ 97 million in 1990-91 to
$5,535 million in 2004-2005. It amounted to $32,955 million in 2011-2012.
UNCTAD’s World Investment Report 2018 reveals that FDI to India declined to $40
billion in 2017 from $44 billion in 2016.