Foreign Direct Investment is a type of investment when a company or a rich individual in a foreign country invests in another country by starting a new business or investing in a domestic company.  

When an investor invests through FDI, the investor usually gains controlling stake or management control in the domestic company which allows them to run the business according to their strategy and takes part in the daily management decisions.

FDI is not like FPI (Foreign Portfolio Investors) because FDI is for the long term wherein they set up manufacturing plants, expand the business, generate employment, achieve operational efficiency, etc. In this blog, we decode FDI and its real-world impact.

Different types of FDI

Horizontal FDI

Horizontal foreign direct investment (FDI) is the most common type of foreign direct investment. In this kind of FDI, a foreign company will establish its presence in another country by investing in a domestic company of that country. This domestic company would most probably be doing business in the same industry as the foreign company.

The foreign company will focus on setting up new operations or manufacturing plants in another country and expand its current business model. The foreign company does this because they would like to maintain standards in operation across various geographies and leverage their proven strategies in the new country. The investment is also aimed at increasing its global footprint by gaining access to new markets and increasing the customer base. It would also source raw materials domestically, cutting back on costs and improving efficiency. This also helps the foreign company navigate trade restrictions and tariffs by establishing a local presence.

Vertical FDI

The second type of FDI is Vertical foreign direct investment (FDI) wherein a foreign company invest in a company that adds value and strengthens its supply chain. This company could be in any sector or industry and the investment is made to control various stages of production. There are two types of vertical FDI and they are backward vertical integration and forward vertical integration.

In backward integration, a foreign company will invest in a company that supplies raw materials. For example, a global tea brand in the UK would invest in a tea estate farm in India or Sri Lanka as part of their backward integration.

In forward integration, a foreign company invests in a company which is closer to the end consumer. For example, a contract manufacturing company of cellphones acquiring a well-known cellphone brand.  

Conglomerate FDI

In this type of FDI, a foreign company, mostly a conglomerate, will buy a company or invest in a company that is totally unrelated to its current business. For example, an airport operator buying a cement company.  This type of FDI is risky because the foreign company is entering into a new sector

Why does FDI matter?

In this globalized and interconnected world, FDI plays an important role in boosting global economy and uplifting low-income and developing nations. It helps in transfer of knowledge and technology and reduces brain drain. FDI improves trade between two nations and relationship between two nations. This will have a positive impact on geopolitical stability and global prosperity.  

For Host Countries

Host countries are those countries which receive FDI. Countries that are underdeveloped would need FDI because it brings in the much-needed capital as well boosts the local economy. Though these nations have the human capital, they do not have the expertise to improve their economy. Once investment comes in through FDI, employment is generated, infrastructure gets a boost, people are upskilled and trained in new technologies, proven management strategies are implemented and the overall economy starts growing. When foreign companies invest in host countries, it increases competition in the domestic economy and gives tough competition to domestic monopolies.  

For Home Countries

Home countries are those countries from where companies will invest in host countries. Companies from home countries invest abroad to gain access to new markets, access local resources, diversify their revenue streams and reduce production costs. This will also have an impact on their net profit. FDI also allows businesses from home countries to scale their operations, be competitive globally and improve their position in the world of business.

Conclusion

Foreign direct investment is a key driver in today’s globalized economy that helps in overall economic growth, employment generation, encouraging competition, transfer of new and advanced technology, implementing industry-best management standards, valuable expertise, etc. leading to stronger international trade. For companies looking to grow worldwide and for nations looking to develop faster, FDI becomes extremely important and it also boosts investor confidence on emerging markets.