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What are the pros and cons of FDI?

Ashish M. Shaji

| Updated: Jun 14, 2021 | Category: FEMA

pros and cons of FDI

Foreign Direct Investments are usually made in open economies having skilled workforce and growth prospect. It doesn’t just bring in money but also technology, skills and knowledge. So what is FDI, and what are the pros and cons of FDI? We shall find out in this article.

What do you mean by FDI or Foreign Direct Investment?

FDI is when a company takes controlling ownership in a business entity in some other country. With FDI, foreign companies are involved directly with the day to day operations in the other country. It brings money, knowledge, skills and technology with it.

FDI occurs when an investor establishes the foreign business operations or acquires foreign business assets, including establishing the ownership or controlling interest in the foreign company.

FDI in India

FDI plays a significant role in the economic development in India. Economic liberalization happened in India in the wake of 1991 crisis, and thereafter FDI has increased steadily in the country.

FDI enters India through the following route:

FDI in India
  • Automatic route;
  • Government route.

In case of automatic route, the non-resident or the Indian company doesn’t require the prior approval from the Reserve Bank or Government of India for FDI.

In case of the government route, prior approval from the government or the RBI is needed. Activities/sectors that are not covered under the automatic route are covered under the government route.

Moreover, there are a few industries where foreign direct investment is strictly prohibited under any route.

Pros and Cons of FDI

Investors who desire to engage in any form of FDI should weigh the investment advantages and disadvantages. In this segment, we shall discuss the pros and cons of FDI for India.

Pros

  • Economic growth

The creation of jobs is one of the biggest pros when we study about the pros and cons of FDI. This is also the reason why more nations would want to attract FDI. FDI enhances the manufacturing and services sector, which creates jobs and reduces unemployment in the country. With increased employment, higher incomes are generated, thus equips the masses with more buying power, boosting the overall economy of the country.

  • Human Capital Development

Human capital involves knowledge and competence. Employees can gain skills through training and experience, and it boosts the education and human capital of a country. It can train human resources in other sectors and companies.

  • Technology

The targeted countries and businesses can access latest financing tools and technologies and also operational practices from across the globe. The induction of new technologies results in enhanced efficiency and effectiveness of an industry.

  • Increase in exports

Goods produced by FDI have global markets and not just domestic consumption. Creation of 100% export oriented units helps to assist FDI investors in increasing exports from other countries.

  • Stability in exchange rate

The flow of FDI translates into a continuous flow of foreign exchange, thereby helping the country’s central bank to maintain a high reserve of foreign exchange, which results in stable exchange rates.

  • Improved capital flow

Those countries with limited domestic resources require inflow of capital, and also, for nations with limited opportunities, capital inflow is beneficial to raise funds[1] in global capital markets.

  • Creation of a competitive market

With the entry of foreign organizations in domestic marketplace, FDI can create a competitive market environment and also break domestic monopolies. With a healthy competitive environment, firms continue to enhance their processes and product offerings, thus fostering innovation. Consumers also gain access to a wide range of competitively priced products.

  • Import substitution

India imports many sophisticated types of equipment. If such companies that produce this equipment establish production facilities in this country, then these can become a substitute for imported equipment.

Cons-

  • Hindrance of domestic investment

Sometimes FDI can become hindrance to domestic investment. With FDI, local companies may start losing interest to invest in their domestic products.

  • Political risks

Political turmoil can hamper the investors.

  • Negative exchange rates

FDI can also affect exchange rates to the advantage of one country and detriment to another.

  • High costs

If you invest in foreign countries, you will find that it is more expensive than when you export goods. Therefore sufficient money is required to set up operations.

  • Economic non-viability

The FDI could be capital intensive from the investors point of view, it may be risky or, at times, may be economically non-viable.

  • Expropriation

With constant political changes, it can lead to expropriation. In such cases, those countries’ government will control investors’ property and assets.

  • Economic colonialism

Many countries, or at least those countries with the history of colonialism, worry about that FDI can cause some kind of modern-day economic colonialism whereby host countries are exposed and are vulnerable to the exploitation from foreign companies.

Conclusion

From the above points, it’s clear that FDI plays a significant role in the overall development of the country. However, there are certain disadvantages also that can’t be overlooked. The pros and cons of FDI should be weighed before investing.

Read our Article: Can Commercial Property in India be purchased by an NRI?

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Ashish M. Shaji

Ashish M. Shaji has done his graduation in law (BA. LLB) from CCS University. He has keen interests in doing extensive research and writing on legal subjects especially on criminal and corporate law. He is a creative thinker and has a great interest in exploring legal subjects.

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