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International Business Management Unit 5

Sikkim Manipal University Page No. 90

Unit 5 Foreign Investments Types and Motives

Structure:

5.1 Introduction

5.2 Foreign Investment Explained

5.3 Advantages of Foreign Direct Investment

5.4 Types of Foreign Investments

Foreign Direct Investment

Foreign Portfolio Investment

5.5 Motives for Foreign Investment

Political motives

Economic motives

Competitive motives

5.6 Summary

5.7 Glossary

5.8 Terminal Questions

5.9 Answers

5.10 Caselet

5.1 Introduction

Foreign investment has emerged as a potent tool to ensure rapid economic

development of the countries as developing countries like India lack thecapital domestically.

In the previous unit you understood how important it is for an international

manager to understand and apply cross cultural management. You also

gained an idea about the kind of differences that may exist in different

cultures.

In this unit, we will discuss the aspect of finance including Foreign direct

investment (FDI) and portfolio investments.

Foreign investment means the investor invests in foreign countries/

companies instead of putting the money in a local company in expectation ofgood returns. For the country which is attracting investment, the investor is a

foreign investor.

Foreign investor can be mainly of two types one who is interested in

making long term commitment for investment in the form of Joint Ventures

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with local companies oracquiring/ purchasing the local company or starting

the Green Field Projects in order to tap the countrys innate potential in thedesired areas of economic activity. This becomes FDI. The second type is

the one who may also invest in the secondary markets of the country with

expectation of good returns; however, the tenure of such investments is

short term and cyclical in nature. Such investments are popularly known as

Foreign Portfolio Investment and can be in the form ofDepository Receipts

orForeign Currency Loans orInstitutional Investments.

The foreign investor can influence the management of companies in which

he has made an investment. The foreign direct investor may have a varying

amount of stake in the invested company. Such stakes by foreign investors

in a foreign company can be as low as 10% or may also cross 49% of theshares or stock ownership. India allows different levels of foreign

stockholding in different areas of industry/services sectors. For example, the

Reserve Bank of India allows foreign equity only up to 26% in insurance

sector, 51% in banking sector; 51% in organised retail sector and only 50%

in specific mining sector. It totally forbids FDI in mining of iron and

manganese. In telecom sector, India allows 74% foreign investment and in

port sector, it allows 100% foreign investment. Foreign direct investors

always try to seek to have a controlling stake in the entity invested; on the

other hand portfolio investment in stocks/companies are likely to produce

good returns or likely to have very good growth rate in particular years.

Objectives:

After reading this unit, you should be able to:

understand the meaning of foreign investments and understand

advantages of foreign investment for a growing economy like India.

understand the importance of foreign investment and discuss the

various types of foreign investment.

list the advantages of direct foreign investment viz a viz foreign portfolio

investment.

discuss the meaning and significance of Green Field Investment.

explain the meaning of joint venture and mergers and how are they used

by companies in expanding their operations to global markets.

understand the depository receipts, especially about American

Depository Receipts and Global Depository Receipts.

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analyse the role of foreign institutional investment for a country like

India. understand the Foreign Currency convertible bonds and their utility in

capital financing for a country.

analyse the motives behind the foreign investment decision by a foreign

investor.

5.2 Foreign investment explained

FDI in todays globalised era plays an extraordinary and growing role in the

expansion and diversification of global business particularly for developing

countries like India which lacks capital back home for efficient and proper

management of physical and manpower resources. Foreign investments

help the company in accessing new markets, exploring new marketing

channels, exploring cheaper production facilities in low cost destinations,

accessing new and advanced technology, planning differentiated high

quality products, upgradation of skills and financing for future forays.

Foreign investment also benefits the host country or the foreign firm by

investing which provides a source of new technologies, capital, processes,

products, organisational technologies and management skills. Foreign

investment has been used like catalyst by developing countries for strong

impetus to economic development.

Foreign investment, in its classic definition, is defined as a company from

one country making a physical investment into building a factory in another

country. In an era of global economic liberalisation, privatisation and

globalisation, the definition of foreign investment has been broadened to

include the acquisition of a lasting management interest in a company or

enterprise outside the investing firms home country. As such, foreign

investment in another country or foreign firm may take many forms, such as

a direct acquisition/purchase of a foreign firm, completely new construction

of a facility in form of green field investments, or investment in a joint

venture with foreign firm. Foreign investment may also be in the form ofstrategic alliance with a foreign firm with attendant input of

technology/technical knowhow, licensing of intellectual property, or entering

into management contract or turnkey projects.

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Activity 1

Find out the sector specifc caps/ceilings put up by the government ofIndia for various sectors/industries in India for FDI?

Hint: open the website https://www.iaccindia.com and read Manual for

Policy of Foerign Investment in India

5.3 Advantages of Foreign Direct Investment

With waves of globalisation taking place in global economy with the

formation of World Trade Organisation (WTO), developed and developing

nations are competing for foreign investment in their respective economies.

Foreign investment is said to have played an important factor for spurring

the development of a nation. This is particularly more important in the

context of a developing country like India which has abundance of other two

factors of production i.e. land and labour. However it lacks the capital to tap

the innate potential of its physical resources. Following are some of the

advantages due to which nations give emphasis to their economic

development.

a. Easier integration into global economy: A developing country like

India is keenly interested to have foreign investment in their economy as

it can gain greater access and foothold in other economies of the world.

Foreign investor may manufacture the products that may be meant forglobal markets resulting in greaterexports of the country and improving

the employment scenario in the country.

b. Upgradation in technology and advancement in technical

knowhow: Foreign investment facilitates the transfer of advanced level

of technology mainly from developed countries to developing countries.

Thus, less developed countriess and developing countries can have

world-level technology and technical know-how to process their physical

and non physical resources. Foreign expertise mainly coming from

developed countries can be of immense use in upgrading the existing

technical processes in the least developed or developing countries. Forexample India has got access to nuclear technology by signing the deal

with Nuclear Supplier Group; thus having an access to advanced

nuclear technology form countries like France, USA, Russia, Britain,

Germany and Japan. India has also been benefited with advanced
https://www.iaccindia.com/https://www.iaccindia.com/

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technology in areas of ports, ship building, power sector, energy sector

and telecommunication in the recent year.c. Increased competition improved productivity: Foreign investment

from the foreign players brings in advances in technology, technical

knowhow and processes. This helps in increasing competition and

resultant productivity in the domestic economy of the developing

country. As a catalysing effect, its competitors in the domestic markets

also start improving their technology or start tying up with foreign players

in search of technology. It acts as a spill over effect in improving the

productivity in a particular sector or sub sectors of the industry. Each

company tries to stay competitive so as to retain the market share and

sales turnover.d. Improvement in human development skills: There comes a

significant improvement in human resources skills of the country that

attracts foreign investment as its employees get exposure to globally

valued skills. Foreign investors come with improved skill set to perform

in a particular industry. Thus the host country is benefitted from the

training and skills upgradation of the foreign investor. For example in the

automobile sector in India, Japan has contributed various aspects on

quality improvement of the employee.

Some of the other advantages of foreign investment are access to a larger

market for foreign investor in the host country. Foreign investor also has

other advantages of tapping the potential of a cheap and skilled labour,

making effective use of raw material and other physical resources in the

host country. Foreign investor also has the benefit of expansion in capacity

thus generating economies of scale and optimisation in costs along with

gaining diversification in different product categories.

Self Assessment Questions 1

1. Foreign investment is the investment by foreign compay/ individual in

Indian company/industry/sector. (True/False)

2. Foreign Investment is of two types direct and portfolio investment.

(True/False)

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3. Identify the correct answer. Which of the following is not result of

foreign investment ________________.a) Improvement in human development skills.

b) Increased competition improved productivity.

c) Grants/donation to Indian companies.

d) Easier integration into global economy.

5.4 Types of foreign investments

Different authors have classified foreign investment in different parameters.

However, the most commonly acceptable method of classifying the foreign

investment is that of FDI and Foreign Portfolio Investment.

FDI is done by making a capital investment into green fields and real estate

projects such as opening of new factories, infrastructure projects like

road/rail construction etc., setting up new financial companies like banks or

insurance firms etc. The types of FDI can be in:

a) Completely new projects known as green field investment.

b) Sick industrial unit which needs complete restructuring and these are

known as brown field investment.

If a foreign investor acquires an existing and running Indian unit, it is refered

to as acquisition and when foreign investor join hands with local firms to

manufacture in an agreed proportion, the same is known as joint venture.

Foreign portfolio investment, on the other hand, is an investment by foreign

investor in the countrys/regions financial instrument, such as investment in

bond market or stock investing. The various types of portfolio investment

include the buying of depository receipts in the form of Global Depository

Receipts/American Depository Receipts/Indian Depository Receipts etc.

Portfolio investment forms the major chunk by making investment in the

existing stocks of the local companies in stock exchanges by Foreign

Institutional Investors, popularly known as FIIs. Foreign portfolio investment

can also be in the form of Foreign Currency Convertible Bonds, popularly

known as FCCBs. Foreign direct and portfolio investment is diagrammed

and discussed as under:

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5.4.1 Foreign Direct Investment

FDI is an important component of a country's national financial accounts.

Foreign direct investment is an investment by foreign investors into the

assets of the host countrys structures, real estate, roads, ports, rail, plants

and machinery, equipment, financial institutions such as opening a new

bank/insurance company and sometimes in organisations like investment in

Indian Premier League (IPL) by foreign counties. FDI does not include

foreign investment into the stock markets of host countries that is separately

treated as portfolio investment. FDI for any country of the world is thought to

be more useful and beneficial than the investment being made in the

equity/stocks of host country companies. Portfolio investment in any form is

potentially hot money which can leave the host country at any stage if

investor realises that there are sign of trouble in the host country. FDI in

contrast is for long term, durable and is generally more useful. It is

completely unaffected by the conditions in the host country.

So, FDI flows are usually preferred over other forms of external finance

because they are non-debt creating, non-volatile and their returns dependon the performance of the projects financed by the investors. Any

developing or emerging country like India will always try to attract more

investment that is non volatile, non debt creating and returns on which are

purely dependent on the performance of the project financed. FDI in India, in

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particular, has been very helpful in the orderly development of international

trade, transfer of technical knowhow and knowledge, upgradation of skillsand advancements in technology. Different types of FDIs are elaborated as

under:

a. Greenfield Investments: When the FDI comes into new facilities or

expansion of existing facilities, it is known as green field investment.

Greenfield investments are most welcome in any country of the world,

be it developed or developing as the primary target of green field

investments is to create new production capacity and jobs, transfer

technology and know-how in the host country. Brown field investments,

on the other hand refer to the purchasing of an existing production or

business facility that has become sick or its products do not havesignificant demand in the markets or its sales are on decline due to

variety of factors like obsolete technology, higher unit cost, poor

distribution etc. Such a firm is acquired by companies or government

agencies for the purpose of starting new product or service production

activity. This type of investment does not involve construction of plant

operation facilities.

Green field investments also establish linkages from the place of

production to the global marketplace. Green field investments are ideal

for generating increased employment in the host country at higher

wages, upgrading research facilities and overall process of economicdevelopment of the host country. However, some critics say that

efficiencies generated in host country through Greenfield investments

include the loss of market share for competing domestic firms.

Greenfield investments also result in perceived profits and losses to

foreign multinationals. Profits generated by multinationals may be

repatriated to home country, thus making the host countrys job

immensely tough by putting a recurring and continuous load of outflow of

hard currency from host countries.

b. Mergers and acquisitions: Mergers and acquisition can happen in

several ways like transfer of existing assets from local firms to foreign

firms whereby local firm sell its assets to foreign firm. Due to waves of

globalisation, there is a trend for consolidation of business through

measures such as cross-border mergers which helps in establishing a

new legal entity by combining the assets and operation of firms from

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different countries. Cross-border acquisition on the other hand refers to

a situation when the control of assets and operations is transferred froma local to a foreign company, whereby the local company becomes an

affiliate of the foreign company. Mergers and acquisitions are not an

attractive option from the point of view of the host country as mergers

and acquisitions do not provide major long term benefits to the local

economy. In most of the cases, the owners of the local firm are paid in

stocks by the acquiring firm, meaning that no FDI in terms of hard

money is realised by the host country. In WTO era due to consolidation

of global business among trade enthusiastic nations, the mergers and

acquisitions have become a significant form of FDI and India also has

many such deals in the recent past. For example Hutch-Vodafone deal,

Coca Cola-Parle acquisition, HLL-UHL deal etc. Mergers and

acquisitions are mostly used by multinationals and transnational

companies in making FDI in emerging markets.

c. Joint ventures: A joint venture is a sort of business agreement in which

two or more parties agree to establish and develop a new entity for a

finite time with the objective of making profits, increased sales, and

expansion of firms long term goal. The risks, responsibility,

management and profits of the contributing parties will be equal to the

proportion of capital they have contributed to form this new entity. Joint

ventures are popular in the economies that are opening themselves upfor foreign investment and wish to provide a level playing field to

domestic business vis a vis foreign players. Joint ventures are also

popular whereby one party has the specialisation in technology or

technical knowhow or management or can contribute capital and other

party has supplement to the efforts of first party in this business

endeavour.

As business operations have become complex and integrated in

globalised era, parties may agree to have Joint venture agreement that

is limited by guarantee whereby the role of either party is limited to the

share of ownership that each party contributes to such venture. Othertypes of joint venture, which are popular in India, are when two or more

parties contribute capital, technology, market expertise, distribution

channel or even brand image and both the parties have equally invested

in the project in terms of money, time, and efforts. In high risks or

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controlled economies, joint ventures are the best way to make an entry

or to diversify into such markets. A joint venture can be the best way toensure success of smaller projects which are just foraying into new

business markets/segments and even for established corporations. For

green field projects in areas such as power, port, cement, steel, oil,

automobiles etc., when the cost of starting new projects is generally

high, a joint venture allows both parties to share the burden of the

project, as well as the resulting profits. For high gestation periods

projects, joint venture are the best way to start with.

There are problems associated with joint venture projects. Foremost is

the commitment and willingness of all the parties to work cooperatively,

sincerely and enthusiastically for the successful commissioning,execution and completion of project. As decisions are taken by all

associated parties, 100% commitment to venture is important. Moreover;

parties to joint venture must be complementary to each other thus

compensating for weaknesses of other parties. Joint venture will be

unsuccessful if both the parties are strong in one area and both are

weak in same area.

Lack of coordination, communication and misunderstanding can destroy

a joint venture relationship. Hence, joint venture parties must create a

dedicated mechanism for smooth functioning through coordinated

planning, execution, command and control of all functional areas of

operations. Synchronised communication strategy should be in place so

that both parties, act in tandem for the future of the partnership, suitable

returns and sustainability of the joint venture. Joint venture parties must

be honest, sincere, loyal and have integrity in the system to make the

joint venture operations a success.

Activity 2

Find out the data for FDI in various sectors; sources of investment and

volume of such investments.

Hint: Refer www.unctad.org/en/docs/wir2011overview_en.pdf and read

World Investment Report

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5.4.2 Foreign Portfolio Investment

Portfolio investment means the investment in secondary market of acountry. It refers to any collection of financial assets such as securities and

stocks, debentures and bonds and cash. Portfolio investment in any country

is highly knowledge based decision and one needs to plan, forecast and

judge the potential sectors, segments, companies and industries to invest in

order to maximise returns. Portfolios investments in todays liberalised

environment can be held by individual investors or can be managed by

financial professionals, hedge funds, insurance companies, banks and other

financial institutions. Portfolio investment, in any country is made on the

basis of followings principles:

a. Global Depository Receipt (GDR): Depository receipts are

negotiable certificates and are issued by a countrys bank against a

certain number of shares held in its custody. Such stocks are traded

in the stock exchange of another country. Depository receipt may be

of different types: most popular are Global Depository Receipts

(GDR)/European Depository Receipts/American Depository Receipts

(ADR) and International Depository Receipts. Depository receipts

entitle the shareholders to all associated dividends and capital gains

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that come from such investments. Depository receipts can be bought

and sold like any other securities in stock exchanges. Such tradingflexibility of depository receipts allows investors in any country to buy

shares of any other country without losing the income.

A company planning for global forays and requiring capital may optto issue a GDR to obtain greater exposure in the global market. GDR

issues allow the company to have increased liquidity in key markets

where it operates. This helps to boost its prestige in the local market

as company stocks are traded internationally. GDRs help the

company to have broader shareholder base and provide a platform

to expatriates a chance or opportunity to invest in their home

countries. Depository receipts are also popular as it helps firms to

raise capital globally specially in a scenario where there are tight

regulatory norms in the country for allowing foreign investments.

For information technology companies in India, most populardepository instrument has been the ADR. ADRs are usually referred

to as the financial magic as it delivers the world to the doors of US

investors. ADRs were introduced for the first time by the investment

house of JP Morgan in 1927. ADRs are always priced in US dollars

whereby a US bank or financial institution places a certain amount of

stock of a foreign company into its depositary which allows US

investors to buy shares in that collection of stocks.

b. Foreign Institutional Investors: Foreign institutional investors (FII)

are the organisations which pool large sums of money and invest

such funds usually in the secondary markets of a country.

Investment usually follows into securities, real estate property and

other investment assets in a country. FII may also get registered as

companies in target security markets so as to invest their profits to

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some degree in these types of assets. In India, there are norms for

such companies underQualified institutional investors norms issuedby SEBI.

RBI guidelines regarding eligibility criteria to be get registered as FII

in India is tabled as under:

Eligibility to get Registered As Foreign Institutional Investor InIndia

Entities and fundsBroad based fund on behalfof investors

a. Pension funds

b. Mutual funds

c. Insurance companiesd. Investment trusts

e. Banks

f. University funds

g. Endowments

h. Foundations

i. Charitable trusts and societies

a. Asset managementcompanies

b. Institutional portfoliomanagers

c. Trustees

d. Power of attorney holders

Source: Reserve Bank of India

FII usually make an investment into banks, insurance companies,

retirement or pension funds, real estate funds; hedge funds,

investment advisors and mutual funds. FIIs have high level ofexpertise in planning, executing and controlling such funds in the

target markets as they act on behalf of other investors who cannot

directly participate in emerging and growing markets due to lack of

knowledge, expertise and time. For instance a government

employee gets Contributory Provident Fund from his employer which

is deposited in a fund called CPF fund. A team of financial experts

will invest such funds into stocks securities, bonds and insurance so

as to broaden the portfolio of investments in many companies. Thus,

the risk is spread to many portfolio. If one company fails, it will be

only a small part of the whole fund's investment. If returns are higherdue to careful planning of the financial team it becomes the gain of

CPF fund.

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FII Investment In India

All values in INR croreFinancial Year Equity Debt Total

1992-93 13.4

2002-03 2,527.2 162.1 2,689.3

2006-07 25,235.7 5,604.7 30,840.4

2007-08 53,403.8 12,775.3 66,179.1

2008-09 -47,706.2 1,895.2 -45,811.0

2009-10 110,220.6 32,437.7 142,658.3

2010-11 110,120.8 36,317.3 146,438.1

2011-12 (till Aug31, 2011) 2,367.6 8,186.2 10,553.8

Source: Securities & Exchange Board of India

When investment takes place at larger scale in stock market of the

emerging and growing country, FII can have a lot of influence in the

management of companies as they are entitled to exercise the voting

rights in a company. From the table above, it is clear that FIIs in

recent years in India have been playing a greater role in fulfilling the

short term capital needs of corporate/companies etc. and have

contributed to foreign exchange reserves handsomely. Due to

European economic crisis, there has been a flight of capital from

India, putting pressure on Indias foreign exchange reserves and onincreased volatility of rupees. SEBI now has allowed FIIs to invest in

mutual funds also.

c. Foreign Currency Convertible Bonds (FCCB): FCCBs are a

popular mode of investment. FCCBs are convertible bond which are

issued by a country in a currency other than its own. By using

FCCBs, a country can raise the capital in the form of a foreign

currency which may be vital for funding its overseas investments.

This ensures short term loans and leveraging its capital

requirements. They are called freely convertible as such bonds act

like a debt as well as equity instrument. Like any bonds in themarket, it makes regular coupon and principal payments to investor

and at the same time give an opportunity to convert them into equity

or stock of the company. Indian companies have used FCCBs a lot

especially in financing their overseas acquisitions in recent years.

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Accordingly to Ministry of Finance, Government of India; Foreign

Currency Convertible Bonds means bonds issued in accordance withthis scheme and subscribed by a non-resident in foreign currency

and convertible into ordinary shares of the issuing company in any

manner, either in whole, or in part, on the basis of any equity related

warrants attached to debt instruments.


4. Portfolio Investment is better for a country in the long run. (True/False)

5. India does not allow Green field investment in India? (True/False)

6. Which of the the following is not the route for portfolio investment in a

country?

a) Foreign Institutional Investor.

b) Joint Venture.

c) Depository Receipts.

d) Foreign Currency Convertibale Bonds.

5.5 Motives for foreign investments

Motives for foreign investments have always been a debatable subject due

to a variety of historical reasons. Communist/social model of economic

development has questioned the need of foreign investment for speeding up

the economic growth and countrys overall economic development. As Indiahas a historical legacy of colonisation, economic planners at the time of

independence in 1947 were not in favour of allowing foreign investment into

the country. Such a perception changed when country got into economic

crisis in 1991 and it was learnt that a country like India will have to allow

foreign capital as it is not endowed with capital domestically. For smoother,

systematic and synergised economic development of the country, foreign

investment was allowed in almost all areas except the sectors with strategic

interests. How far foreign investment has helped India or what has been the

foreign investment on any other such countries has been a debateable,

complex and unclear subject. The level of foreign investment to be allowed

has also been a topic of arguments because the country may lose its

economic sovereignty to foreigners.

Other school of thought propounds that free flow of capital is beneficial for

the country as it promotes an efficient allocation of countrys economic

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resources. It has been found that for shorter periods and within a given

country or region, the impact of foreign investment has been mixed. Themost immediate impact of foreign investment has been the creation of more

jobs and employment opportunities within the immediate locality. In the long

run, foreign investment helps in increasing competition, production-intensive

nature of economy and higher productivity. Foreign investment acts as a

catalyst for generating additional economic activity especially in countries

which are deficient in capital resources, however are rich in land and labour

like India. All these developments lead to the development of a robust

services sector, thus leading to greater economic activity in general and

higher per capita income in particular. The host country may have reasons

for allowing or not allowing foreign investment into country. Similarly,

investor country may also have certain motives when deciding upon a

foreign investment decision. Motivations for foreign investment for any

country can be broadly classified and understood in three broad categories,

discussed as under:

5.5.1 Political motives

Countries, usually do not allow foreign investment mainly because of

political motives. Countries which have a colonial past are usually

apprehensive of foreign investment and are convinced that it is in their best

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interest to not allow import from abroad. For example, India did not liberalise

its market to open it to foreign competition. This is due to the governmentsfear of foreign investment. In recent times, Burma is the best example of a

country that has not opened its market for foreigners, fearing sovereign

issues and negative impact to indigenous industry. There may be

disadvantages in not allowing imports as goods from abroad may be

cheaper and this will help in controlling inflation, will be cost competitive and

of better quality. Governments, especially in developing and least developed

countries are of the opinion that it is in the interest of their country to protect

domestic jobs from the perceived threats of losing sovereignty as a result of

nationalism or xenophobia.

Foreign companies that are denied the right to export to such countriesusually plan for foreign investment as it can help in alleviating the fear of job

loss, import servicing, pressure on foreign exchange etc. They can

penetrate such markets by agreeing to manufacture or at least assemble

goods within the target country. They may even agree to establish

themselves as the local production hub, thus catering to adjoining markets

resulting in exports from such country. India has allowed investment in

areas where the foreign investor has come not only to cater to domestic

market but also to export to nearbyemerging and adjoining markets. This

has helped in increasing country exports. For example automobile sector,

pharma companies, engineering companies, telecom sector etc. Investingcountries use such tactics to overcome restrictions on imports such as

quotas, tariffs, and import duties. Local productions in the host country also

mitigate the concerns for employment loss and nationalistic pride.

5.5.2 Economic motives: Most notable motives for seeking or planning

foreign investment are economic factors. Some companies plan foreign

investment in the expectation that they can obtain substantial economies of

scale and scope in emerging and developing markets. Conglomerates are

usually convinced to invest abroad as they desire to reap benefits in areas

such as research and development, marketing, distribution, financing, and

production by operating at volumes that can be justified only by a worldwide

market.

In addition to economies of scale, companies also plan their foreign

investments in many countries as they desire to overcome the shortages

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and imperfections of domestic markets for factors of production. Sometimes

the local population cannot provide sufficient numbers of technicians andengineers, or particular raw materials may be unavailable or overpriced in

local markets. For example, American companies have invested in Indias

Information Technology sector as India has a demographic dividend of a

large pool of labour force at very competitive cost. Similarly pharmaceutical

multinational companies in Japan are looking at India as it produces most

cost competitive generic drugs and is also a good market for health care

products.

5.5.3 Competitive motives

Another important motive for making or seeking foreign investment is the

competitive advantages that the company will enjoy in foreseeable future intarget markets. Competitive motives for foreign investment are resultant of

economic and political motives. A company may make foreign investment in

overseas markets for which there are no immediate economic or political

gains. However, the company may get benefitted in the long run from such

markets due to a variety of reasons. Prime motive for making overseas

investment with competitive motive is to secure the future business

opportunity against the threat of existing or potential competition.

Companies usually invest in emerging markets as they may desire to

increase their international market share or production even though this

effort may be apparently unprofitable at that moment. In cases where

companies have antidumping cases due to export of goods at prices that

are below the cost of production, they may be interested to make an

investment to penetrate/operate in such potential markets. Another example

of competitively motivated direct foreign investment decision are merger and

acquisition by foreign company in the host country as it desires to get

access to foreign technology/brand image, established distribution channel

etc. Tata Sky deal can be quoted as an example of competition seeking

investment. Tatas investment in Jaguar is another good example as Tata

Automobile wished to increase its presence in higher segments/established

markets of Europe at the cost of existing gains.

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Activity 3

What shall be the impact of foreign investment on Indias retail sector? Hint: Referwww.iimk.ac.in/wto/seminar/KakaliMajumdar.doc and read

docuemtn on Impact of FDI on Indias retail trade

5.6 Summary

Foreign investment has emerged as a potent tool to ensure rapid

economic development of the countries in globalised era as developing

countries like India lack the capital domestically. In cases when an

investor invests his capital in the foreign countries/companies in

expectation of good returns rather than putting his money in a local

company, it is known as foreign investment. For the country which isattracting the investment, the investor is known as foreign investor.

Foreign investment, in its classic definition, is defined as a company

from a country making a physical investment by building a factory in

another country.

Following are the motives for making an investment in the foreign

country.

Easier integration into global economy.

Upgradation in technology and advancement in technical knowhow

is increased.

Competition improved productivity.

Improvement in Human Development Skills.

FDI is done by making a capital investment into green fields and real

estate projects such as opening of new factories, infrastructure projects

like road/rail construction etc, setting up financial companies like banks

or insurance firms etc.

Roughly the types of FDI can be investment in completely new project

known as green field investment or an investment by a foreign investor

in sick industrial unit which needs complete restructuring known as

brown field investment.

If a foreign investor acquires an existing and running unit, it is refereed

as acquisition and when foreign investor shares the hand with local firm

to manufacture sometimes in an agreed proportion it is known as joint

venture.
http://www.iimk.ac.in/wto/seminar/KakaliMajumdar.dochttp://www.iimk.ac.in/wto/seminar/KakaliMajumdar.dochttp://www.iimk.ac.in/wto/seminar/KakaliMajumdar.doc

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Foreign portfolio investment, on the other hand, is an investment by the

foreign investor in the countrys orregions financial instrument, such asinvestment in bond market or stock investing. The various types of

portfolio investment include buying of depository receipts in the form of

Global Depository Receipts/American Depository Receipts /Indian

Depository Receipts etc. Portfolio investment forms a major chunk by

making investment in the existing stocks of local companies in stock

exchanges by Foreign Institutional Investors, popularly known as FIIs.

Foreign portfolio investment can also be in the form of Foreign Currency

Convertible Bonds; popularly known as FCCBs. Motives for making

foreign investment can be any of the followings:

Political motives. Economic motives.

Competitive motives.

5.7 Glossary

Green field investment: An investment in completely new project.

Brown f ield investment: An investment by foreign investor in a sick

industrial unit in India needing complete restructuring for revival.

Acquis i t ion: A foreign investor acquiring an existing and running Indian

unit.

Joint venture: A business agreement in which two or more than parties

agree to establish and develop a new entity for a finite time with the

objective of making profits; increased sales; and expansions of firms long

term goal.

American Depository Receipt: A stock that trades in the United States but

represents a specified number of shares in a foreign corporation.

Global Depository Receipt: A bank certificate that is issued in more than

one country for shares in a foreign company. The shares are held by a

foreign branch of an international bank. The shares trade as domestic

shares, but are offered for sale globally through the various bank branches.Foreign Currency Convert ib le Bond: A type of convertible bond that

is issued in a currency different than the issuer's domestic currency. In other

words, the money being raised by the issuing company is in the form of

a foreign currency.

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5.8 Terminal Questions

1. What do you mean by foreign investments? Discuss by giving relevantexamples.

2. Define foreign investment. What are various types of foreign

investment?

3. What are the advantages of making an investment in the foreign

country?

4. What is green field investment? Why is it considered the best option for

a developing country like India?

5. Differentiate between any two of the followings?

a. ADR and GDR.

b. Green field and brown field investment.

c. Foreign direct and portfolio investment.

d. Joint venture and merger.

6. Define portfolio investment. Discuss the various types of portfolio

investment with relevant examples.

7. What do you mean by direct foreign investments? What are the

advantages of direct investment over the portfolio investments?

8. Discuss the increasing role of foreign institutional investor for a country

like India.

9. Write short notes on any two of the followings:a. Joint Ventures.

b. Mergers and Acquisition.

c. Foreign Currency Convertible Bonds.

d. Foreign Portfolio Investment.

10. What are some of the motives behind the foreign investment decision

of the investor? Explain with relevant examples.

5.9 Answers


1. True

2. True

3. C

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4. False5. False

6. B

Terminal Questions

1. Refer to sec 5.2 of the chapter



4. Refer to sec 5.4.1 sub para A entitled as Green Field Investment.

5. a. sec 5.4.2 of the chapter, sub para A

b. sec 5.4.1, sub para A

c. sec 5.4.1 and 5.4.2 of the chapterd. sec 5.4.1 refer to section B and C

6. Refer to sec 5.4.2 of the chapter

7. Refer to sec 5.4

8. Refer to sec 5.4.2 of the chapter

9. a. Refer to sec 5.4.1, Section C

b. Refer to sec 5.4.1 Section B

c. Refer to sec 5.4.2 Section C

d. Refer to sec 5.4.2

10. Refer to para 5.5 of the chapter.

5.10 Caselet

Case: Impact of FDI on Indias automobile sector

India, in an open economy era, is fast emerging as a regional hub for

automobile sector with the entry of leading players into Indian market.

Indian automobile sector in the recent past has been one of the best

performing sectors of Indian economy. India attracted quite a number of

FDIs in automobile sector as its domestic market is very attractive. It is

fast emerging as a hub for exports to regional and global markets

especially for Africa, Middle East, South East Asia, SAARC countries and

Europe. India allowed 100% FDI under automatic route to automobile

sector, which has a turnover of over $11.5 billion in the Indian auto

industry and over $ 3 billion in the auto parts industry. 100% FDI is also

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allowed under automatic route for manufacturing automobiles and

components. No additional licenses are required for Indian automobilecompanies except what is mandated under the law for any company for

doing business. Import regime including policy has been liberalised

allowing the import of auto components without any special licenses and

restrictions.

As a result, Indias automobile industry has witnessed an 18% growth

even in years of economic slowdown. Entry of foreign players along with

foreign investment in India has provided Indian automobile industry

advantages such as access to advanced technology, cost-effectiveness,

and efficient manpower. In addition to this, foreign investment in

automobile sector facilitated the growth of a well-developed andcompetent Auto Ancillary industry along with automobile testing and R&D

centres. The automobile sector in India ranks third in manufacturing three

wheelers and second in manufacturing two wheelers. Some of the

opportunities provided to Indian auto sector due to foreign investment are

diagrammed as under:

Discussion Questions:

1. Discuss the benefits of FDI to Indian industry and customers.

2. What is the current scenario of automobile industry in India?

3. Discuss the role of foreign investment in Indias growth.

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References:

InternationalFinancialManagement; PG Apte; Fourth Edition; Tata Mc-Grawhill

Multinational Business Finance; Global Edition; 12th Edition David

Eiteman, Arthur Stonehill, Michael Moffett; Sep 2009, Pearson

publication

Reports: India Brand Equity Fund 2011

Foreign Direct Investment: Analysis of Aggregate Flows; Assaf Razin &

Efraim Sadka; Princeton University Press

Foreign direct investment in India; Volume 4, Issue 93 of OECD Working

papers ; Author Kelly A. Johnson ; Publisher O.E.C.D, 1996 Manual On Foreign Direct Investment In India- Policy and Procedures;

MAY-2003 Secretariat for Industrial Assistance; Department of Industrial

Policy and Promotion; Ministry of Commerce and Industry; Government

of India

Foreign Investment in India : 1947-48 to 2007-08; By Niti Bhasin; NewCentury Publications; 2008

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