What Is a Foreign Direct Investment (FDI)?
A foreign direct investment (FDI) is a purchase of an interest in a company by a company or an investor located outside its borders.
Generally, the term is used to describe a business decision to acquire a substantial stake in a foreign business or to buy it outright in order to expand its operations to a new region. It is not usually used to describe a stock investment in a foreign company.
- Foreign direct investments (FDI) are substantial investments made by a company into a foreign concern.
- The investment may involve acquiring a source of materials, expanding a company's footprint, or developing a multinational presence.
- As of 2020, the U.S. is second to China in attracting FDI.
Foreign Direct Investment
How Foreign Direct Investments (FDI) Work
Companies considering a foreign direct investment generally look only at companies in open economies that offer a skilled workforce and above-average growth prospects for the investor. Light government regulation also tends to be prized.
Foreign direct investment frequently goes beyond capital investment. It may include the provision of management, technology, and equipment as well.
A key feature of foreign direct investment is that it establishes effective control of the foreign business or at least substantial influence over its decision-making.
In 2020, foreign direct investment tanked globally due to the COVID-19 pandemic, according to the United Nations Conference on Trade and Development. The total $859 billion global investment compares with $1.5 trillion the previous year.
And, China dislodged the U.S. in 2020 as the top draw for total investment, attracting $163 billion compared to investment in the U.S. of $134 billion.
Foreign direct investments can be made in a variety of ways, including opening a subsidiary or associate company in a foreign country, acquiring a controlling interest in an existing foreign company, or by means of a merger or joint venture with a foreign company.
The threshold for a foreign direct investment that establishes a controlling interest, per guidelines established by the Organisation of Economic Co-operation and Development (OECD), is a minimum 10% ownership stake in a foreign-based company.
That definition is flexible. There are instances in which effective controlling interest in a firm can be established by acquiring less than 10% of the company's voting shares.
Types of Foreign Direct Investment
Foreign direct investments are commonly categorized as horizontal, vertical, or conglomerate.
- With a horizontal direct investment, a company establishes the same type of business operation in a foreign country as it operates in its home country. A U.S.-based cell phone provider buying a chain of phone stores in China is an example.
- In a vertical investment, a business acquires a complementary business in another country. For example, a U.S. manufacturer might acquire an interest in a foreign company that supplies it with the raw materials it needs.
- In a conglomerate type of foreign direct investment, a company invests in a foreign business that is unrelated to its core business. Since the investing company has no prior experience in the foreign company's area of expertise, this often takes the form of a joint venture.
Examples of Foreign Direct Investments
Foreign direct investments may involve mergers, acquisitions, or partnerships in retail, services, logistics, or manufacturing. They indicate a multinational strategy for company growth.
They also can run into regulatory concerns. U.S. company Nvidia has announced its acquisition of ARM, a U.K.-based chip designer. In August 2020, the U.K.'s competition watchdog had announced an investigation into whether the $40 billion deal would reduce competition in industries reliant on semiconductor chips.
FDI in China and India
China's economy has been fueled by an influx of FDI targeting the nation's high-tech manufacturing and services.
Meanwhile, relaxed FDI regulations in India now allow 100% foreign direct investment in single-brand retail without government approval. The regulatory decision reportedly facilitates Apple's desire to open a physical store in the Indian market. Thus far, the firm's iPhones had only been available through third-party physical and online retailers.
What Is the Difference Between FDI and FPI?
Foreign portfolio investment (FPI) is the addition of international assets to the portfolio of a company, an institutional investor such as a pension fund, or an individual investor. It is a form of portfolio diversification, achieved by purchasing the stocks or bonds of a foreign company.
Foreign direct investment (FDI) requires a substantial investment in, or the outright acquisition of, a company based in another country.
FDI is generally a larger commitment, made to enhance the growth of a company.
Both FPI and FDI are generally welcome, particularly in emerging nations. Notably, FDI involves a greater responsibility to meet the regulations of the country that hosts the company receiving the investment.
What Are the Advantages and Disadvantages of Foreign Direct Investment (FDI)?
FDI can foster and maintain economic growth, both in the recipient country and in the country making the investment.
Developing countries have encouraged FDI as a means of financing the construction of new infrastructure and the creation of jobs for their local workers.
On the other hand, multinational companies benefit from FDI as a means of expanding their footprints into international markets.
A disadvantage of FDI, however, is that it involves the regulation and oversight of multiple governments, leading to a higher level of political risk.
What Are Some Examples of Foreign Direct Investment (FDI)?
One of the largest examples of Foreign Direct Investment (FDI) in the world today is the Chinese initiative known as One Belt One Road (OBOR).
This program, sometimes referred to as the Belt and Road initiative, involves a commitment by China to substantial FDI in a range of infrastructure programs throughout Africa, Asia, and even parts of Europe.
The program is typically funded by Chinese state-owned enterprises and organizations with deep ties to the Chinese government.
Similar programs are undertaken by other nations and international bodies, including Japan, the United States, and the European Union.