Foreign direct investment is an investment made by an entity living outside the country where the investment is being made by either buying a company there or expanding its business in the domestic country.
Foreign direct equity inflows are significant drivers of economic growth and are generally preferred over other means of external finance because FDI inflows do not create debt, are non-volatile and their returns depend on the performance of the projects financed by the foreign investors.
FDI, apart from contributing to the economic growth of a country, also facilitates the inflow of new technology, managerial expertise, new ideas, skills, knowledge, more employment, and improved infrastructure.
Foreign direct investment (FDI) in India was introduced in the 1991 under the Foreign Exchange Management Act (FEMA) implemented by the then finance minister, Dr. Manmohan Singh. It commenced with the baseline of 1 billion dollars in 1990.
India, today is considered as an important destination for foreign direct investment. The major sectors that attract overseas investment are telecommunications, construction activities, and computer software and hardware.
There are three types of foreign direct investment.
- Horizontal FDI: this type of FDI arises when a firm replicates its home country based business activities in the same value chain in the country where the investment is being made.
- Vertical FDI: this type arises when a company through foreign direct investment moves upstream or downstream in varied value chains.
- Platform FDI: this type arises when FDI from a source country into a destination country is carried out with the purpose of exporting to a third country.
Methods of foreign direct investment
The foreign direct investor may obtain voting power of an enterprise in an economy through any of the following methods:
- By the means of including a fully owned subsidiary or firm anywhere
- By obtaining shares in an associated company
- Via a merger or an acquisition of a firm that is not related
- By taking part in an equity joint venture with another investor or company
In 1997, India permitted foreign direct investment in cash and carry wholesale. This mean that any foreign investment into the country required government approval. However, in 2006, the prior approval requirement was relaxed and automatic permission was put into place.
Foreign investment in an Indian company can be done in the following ways, permitted by the Foreign Exchange Management Regulations:
- As an integrated entity by incorporating a company under the Companies Act, 1956 through
- Joint ventures; or
- Wholly owned subsidiaries
- As an office of a foreign entity through
- Liaison Office / Representative Office
- Project Office
- Branch Office