What are the types of Foreign Direct Investment?

Ashish M. Shaji

10 May, 2021

FDI or Foreign Direct Investments is one of the most vital sources of direct investments in countries. Unlike the Foreign Portfolio Investment, an investor in a country holds a controlling stake of any business or organization in a foreign land that receives the investment. FDI also indicates about a country’s political and socio-economic stability. In this article, we shall discuss about FDI and the types of foreign direct investment.

A brief overview of FDI

Foreign investments may be either organic or inorganic. In case of organic investments, a foreign investor pumps in funds to expand and accelerate the growth in established businesses. In case of inorganic investments, an investing entity buys a business in their target country. 

In a developing economy like India and parts of South East Asia, Foreign Direct Investments provide a much needed boost to businesses that are in poor financial condition. The Indian government employed different measures to make sure that massive chunks of investments come into the nation across sectors like defence, telecom sector, PSU^[1] and IT sector.

As FDI is a non-debt financial resource, it has the capability to be a major driver for economic development in the country. With globalization and internationalization, FDI has been made a reality.

However, scholars believe that foreign investments shall continue to snowball considering the following factors:

• It gave control over companies in a foreign land;
• It has helped businesses to overthrow monopolistic practices;
• Considering market imperfections, such investments helps companies with a cushioning effect in case of a sharp and unpredictable fall in the business activity. 

Types of Foreign Direct Investment

There are different types of Foreign Direct Investment. Let’s discuss its types in this segment.

• Horizontal FDI

Horizontal FDI is the first of its type. This is observed when a business expands and enters a foreign country through the FDI route without changing its core activities. It is also the most common type of FDI. An example of this type of FDI would be McDonald’s investing in an Asian country to increase number of stores in the region.

• Vertical FDI

Vertical FDI is another form of FDI. This FDI occurs when an investment is done within a typical supply chain in a company and which may or may not belong to the same industry. When vertical FDI occurs, a business invests in an overseas firm which supplies or sells products. An example of vertical FDI would be if McDonald’s purchases a large scale meat processing plant in a European country to boost its meat supply chain in the target country.

• Conglomerate FDI

A transaction is called Conglomerate FDI when investments are made in two different companies of different industries. As such, the foreign direct investment is not directly linked to the investors business. An example in this case would be when the US retailer Walmart invests in TATA motors, Indian automobile manufacturer.

• Platform FDI

Among the types of Foreign Direct Investment, Platform FDI means the expansion of a business to a foreign country, but everything that is manufactured there is exported to a third country. This form of FDI is seen in trade-free zones of FDI hungry countries. For example- The French Perfume brand Chanel set a manufacturing plant in the US and exported products to countries in Asia and other parts of Europe. 

If you wish to invest through FDI, then it’s important to know about different types of Foreign Direct Investment with examples. With FDI, the money invested can be utilized to initiate a new business in a foreign land or to invest in an existing business in a foreign land.

What are the advantages and disadvantages of these types of Foreign Direct Investment?

There are advantages as well as disadvantages of FDI. Let’s take a look at both these sides of FDI.

Advantages-

• With increased FDI, businesses benefit through tax breaks or incentives and an ability to further diversify;
• For a country that gets FDI, benefits such as more excellent employment opportunities, access to latest technologies and modern management methods etc., can be enjoyed.
• FDI can help in creating a level of dependency among countries which will keep peaceful atmosphere.

Disadvantages-

• Big corporations take over market, and this causes local businesses to lose out. One of the examples is Walmart;
• There is a risk of profit repatriation which means that profits generated in India won’t enter the domestic economy;
• FDI can affect the exchange rates of a country.

Conclusion

FDI has been a crucial driver of the economic growth and also been an important source of non-debt finance for India’s economic development. Therefore there should be a robust and easily accessible FDI regime. Once the pandemic subsides and the economy opens up fully, analysts predict for a flood of different types of Foreign Direct Investment.

Read our article: A Complete Overview of Foreign Direct Investment Compliance under FEMA