Excel Books
14– 1 International Financial Management (2nd Edition) Madhu Vij
Part IV: Financial Management of the Multinational Firm
Foreign Direct Investment
C14
Copyright © 2003, Madhu Vij
Chapter
Foreign Direct Investment

Excel Books
14– 2 International Financial Management (2nd Edition) Madhu Vij
Part IV: Financial Management of the Multinational Firm
Foreign Direct Investment
C14
Copyright © 2003, Madhu Vij
Foreign Direct Investment (FDI) is investment made by a transnational
corporation to increase its international business. When firms become
multinational, they undertake FDI. It generally involves the establishment of
new production facilities in foreign countries to earn extra returns. The foreign
investment decision results from a complex interaction of factors that differ in
many ways from that governing the domestic investment decision. Foreign
investment is generally motivated by a complex set of strategic, behavioural
and economic and financial considerations. The evaluation process of foreign
investments is generally longer, more costly, less accurate and involves more
political and foreign exchange risks. Businesses and governments are
motivated to engage in FDI to (1) expand markets by selling abroad; and (2)
acquire foreign resources (e.g., raw materials, knowledge, production
efficiency, etc). In addition, governments may also be motivated to gain
political advantage.

Excel Books
14– 3 International Financial Management (2nd Edition) Madhu Vij
Part IV: Financial Management of the Multinational Firm
Foreign Direct Investment
C14
Copyright © 2003, Madhu Vij
Why do Firms Invest Abroad
1. New sources of demand
2. Existence of various market imperfections
3. Economies of scale
4. Use foreign raw material and foreign technology
5. Exploit monopolistic advantage
6. Diversify internationally
7. Political safety seekers
8. Knowledge seeking:

Excel Books
14– 4 International Financial Management (2nd Edition) Madhu Vij
Part IV: Financial Management of the Multinational Firm
Foreign Direct Investment
C14
Copyright © 2003, Madhu Vij
Internationalisation
Though the decision to invest abroad is motivated by some of the factors
identified earlier, the mere existence of some of the factors like competitive
advantage and market imperfections is not enough to guarantee foreign direct
investment. Firms exploit their advantages through traditional exports,
licensed production, joint ventures or strategic alliances. For foreign direct
investment to take place, competitive advantages must be firm specific and
not easily copied. Similarly, certain kinds of technology can be bought or
sometimes even copied.
Thus, for internationalisation to take place, the key factors are the control of
human capital and possession of proprietary information that can generate
new information through research in management, marketing and technology.
However, the theory lacks empirical verification.

Excel Books
14– 5 International Financial Management (2nd Edition) Madhu Vij
Part IV: Financial Management of the Multinational Firm
Foreign Direct Investment
C14
Copyright © 2003, Madhu Vij
How to Invest Abroad: Methods to Increase International Business
Direct Foreign Investment (DFI) is a common method of engaging in
international business. But this method is generally expensive and if, for some
reason, the project fails, the firms face a lot of difficulty in selling the plant. If a
firm is confident that it will survive the foreign market and competition then DFI
is the right way of investing abroad. However, there are several alternative
methods of entering foreign markets that are less risky and also involve a
smaller initial outlay than DFI.
The various alternatives are
i. A joint venture
ii. Mergers and acquisitions/Cross border acquisitions
iii. Licensing
iv. Franchising

Excel Books
14– 6 International Financial Management (2nd Edition) Madhu Vij
Part IV: Financial Management of the Multinational Firm
Foreign Direct Investment
C14
Copyright © 2003, Madhu Vij
The Indian Perspective
FDI is imperative to economic development of a country and has a direct
impact on its growth and prosperity. The presence of FDI is of definite help to a
country because it brings in new technology and management concepts that
help in optimum utilisation of resources. In addition, it also gives a better
access to information and monitoring capabilities. FDI links the host economy
with the global markets and factors economic growth. FDI has been widely
observed as one of the most positive forces in recent economic globalisation,
with the potential to transform the work by bringing more capital to capital
scarce economies and causing great changes in the productive structure of
developing economies.
Cont….

Excel Books
14– 7 International Financial Management (2nd Edition) Madhu Vij
Part IV: Financial Management of the Multinational Firm
Foreign Direct Investment
C14
Copyright © 2003, Madhu Vij
What FDI Requires
It has been observed that countries that attract FDI of large magnitude do not
treat money as a commodity. They regard FDI as an outcome of favourable
perceptions and as an outcome of unshakable confidence in the host country.
Some of the important factors which foreign investors take into consideration
when entering a country are:
a. Reliable access to economic information.
b. The level of corruption.
c. Stability of political and business environment.
d. Character of local market (size, growth potential) or the distance and the
access to neighbouring markets. Many foreign investors, mainly MNCs,
often invest in one country and use it as a stepping stone before
penetrating the neighbouring states.
e. The existence of good and quality infrastructure consisting of, among
others, advanced telecommunication and energetic network is an
advantage that may decide in the selection of a country.
f. Ability to meet and comply with internationally acceptable standards and
norms. Cont….

Excel Books
14– 8 International Financial Management (2nd Edition) Madhu Vij
Part IV: Financial Management of the Multinational Firm
Foreign Direct Investment
C14
Copyright © 2003, Madhu Vij
FDI is permitted under the following forms of investments
 Through financial collaborations.
 Through joint ventures and technical collaborations.
 Through capital markets via euro issues.
 Through private placements or preferential allotment.
FDI is not permitted in the following industrial sectors
 Areas and ammunition.
 Atomic Energy
 Railway Transport
 Coal and lignite
 Mining of iron, manganese, chrome, gypsum, sulphur, gold, diamonds,
copper and zinc.
Cont….

Excel Books
14– 9 International Financial Management (2nd Edition) Madhu Vij
Part IV: Financial Management of the Multinational Firm
Foreign Direct Investment
C14
Copyright © 2003, Madhu Vij
Cont….
Portfolio Investment
Foreign Portfolio Investment is subject to greater volatility due to shorter-term
commitments. An important point here is that private portfolio investment
inflows in emerging markets dropped sharply after the East Asian crisis.
Country-wise Analysis
Foreign direct investment (FDI) is an important avenue through which
investment takes place in India. The importance of FDI extends beyond the
financial capital that flows into the country. In addition, FDI can be a tool for
bringing knowledge and integration into global production chains which are the
foundation of a successful exports strategy.

Excel Books
14– 10 International Financial Management (2nd Edition) Madhu Vij
Part IV: Financial Management of the Multinational Firm
Foreign Direct Investment
C14
Copyright © 2003, Madhu Vij
Measures to attract more FDI inflows into the country
 Consider enactment of Foreign Investment Promotion Law that
incorporates and integrates aspects relevant to promotion of FDI.
 Urge States to enact special law relating to infrastructure.
 Empower FIP to give initial central level registrations and approvals.
 Sectoral FDI caps to be reduced to minimum and entry barriers
eliminated.
 Existing strategy for attracting FDI should be overhauled.
 Informational aspects of strategy should be defined in light of perceived
advantages and dis-advantages.
 Domestic policy reforms in power sector, urban infrastructure and real
estate development