FDI Meaning

What is a Foreign Direct Investment (FDI)?

A Foreign Direct Investment (FDI) can be defined as a purchase of an interest in a company by an investor who is located outside the borders of the company or by another company. Usually, FDI as a term is used to describe a business decision of acquiring a substantial stake in a foreign business.

FDI meaning can also indicate a decision to buy a foreign business with an aim of expanding its operations to a new region. It should be noted that the FDI meaning does not include the description of stock investment in a foreign company.

The Workings of Foreign Direct Investments (FDI)

Organizations that are considering a foreign direct investment usually start by looking at companies located in open economies. These companies should also offer a skilled workforce and above-average growth prospects to lure investors.

Beyond this, organizations also tend to prioritize light government regulations. The FDI meaning also includes the frequent above and beyond capital investments. This can also include the provision of management, equipment, and technology.

A key part of the FDI meaning refers to the fact that it establishes effective control of the foreign business. It can also refer to substantial influence over the organization’s decision-making process.

You might find it interesting to note that in 2020, the domain of foreign direct investment tanked all across the globe. This was mainly 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 in the previous year.

Further, China was successful in dislodging the United States of America in 2020 as the top draw for the total investment. In 2020, China attracted $163 billion compared to the investment of $134 billion done by the United States of America.

Special Considerations for Understanding FDI Meaning

You might be interested in learning the fact that foreign direct investments can be made in different ways. Some of these ways are:

• Opening a subsidiary company in a foreign country
• Opening an associate company in a foreign country
• Acquiring the controlling interest in an existing foreign company
• Getting a foreign company through a merger
• Getting into a joint venture with a foreign company

According to the guidelines established by the Organizations of Economic Co-Operation and Development (OECD), the threshold for foreign direct investment is a minimum of 10% ownership stake in the foreign-based company. This establishes a controlling interest.

It should also be noted that the FDI meaning in this regard is quite flexible. This means that there are instances in which the effective controlling interest in a firm has also been established by acquiring less than 10% of the foreign company’s voting shares.

Different Types of Foreign Direct Investment

To completely understand the FDI meaning, it is important to learn about the different types of FDI. According to experts, foreign direct investments can be categorized into the following types.

• Horizontal Direct Investment: With a horizontal direct investment, an organization establishes the same type of business operation in the foreign country as it has established in the home country. A good example of this is U.S-based cell phone providers purchasing a chain of phone stores in China.

• Vertical Investment: In the case of vertical investment, an organization acquired a complementary business in some other country. For example, an Indian organization might acquire an interest in a foreign company that supplies raw materials according to its needs.

• Conglomerate Investment: In a conglomerate foreign direct investment, the company will invest in a foreign business that is not related to the core business of the company. This is often done in the form of a joint venture as the investing company has no prior experience in the area of expertise of the foreign company.

The Difference Between FDI and FPI

Till now, we have looked at a lot of different aspects of the FDI meaning. However, one thing that hasn’t been considered till now is how FDI is different from FPI or Foreign Portfolio Investment. Let’s do that in this particular section.

Foreign portfolio investment can be defined as the addition of international assets to the portfolio of an organization. This could be an institutional investor like a pension fund or an individual investor. It can also be viewed as a form of portfolio diversification. This is achieved by purchasing the stocks or bonds of a foreign company.

On the other hand, the FDI meaning dictates that it requires a substantial investment in or an outright acquisition of a foreign company. This means that FDI is a larger commitment that is made to enhance the overall growth of the company.

If a holistic view is taken, then it is easy to understand that both FPI and FDI are beneficial. This is specifically true for emerging nations. However, it should still be noted that FDI involves a greater responsibility for meeting the regulations of the foreign country.

The Pros and Cons of Foreign Direct Investment

The pros of foreign direct investment are:

• FDI helps in fostering and maintaining economic growth. This is done in both the recipient country and in the country that is making the investment
• For developing countries, FDI is seen as a means of financing the construction of new infrastructure and jobs for local workers
• Multinational companies also benefit from FDI as a means of expanding their business in the international market

There are also some disadvantages of FDI. And the biggest disadvantage is the higher level of political risk. This is because FDI involves the regulation and oversight of multiple governments.