Question

International economics exam Question: Please explain widely all the questions related with FDI:

a) Explain the determinants of the FDI.

b) use real examples to support your answer.

Answer 1

A foreign direct investment (FDI) is an investment in the form of a controlling ownership in a business in one country by an entity based in another country. It is thus distinguished from a foreign portfolio investment by a notion of direct control.

Determinants of FDI are in the following ways:

1. International openness:

Expected correlation: Positive

Economic Justification: Both vertical and horizontal investments may be negatively affected by protectionist barriers.

2. GDP:

Expected correlation: Positive

Economic Justification: Domestic income accounts to the aggregate demand for goods. It is also increased by vertical FDI.

3. Domestic market size:

Expected correlation: Positive

Economic Justification: FDI prefer to locate in countries where they can market their products. Such an effect should be larger for horizontal FDI rather than for vertical investments. It can be proxied with the area of the host country.

4. Labour Cost:

Expected correlation: Negative

Economic Justification: It is a major local cost component for foreign investors.

5. Intensity in R&D:

Expected correlation: Positive

Economic Justification: Technologically advanced productions may be located to countries that developed a technological comparative advantage.

6. Productivity of labor:

Expected correlation: Positive

Economic Justification: It is a benchmark measure for the efficiency of labor.

7. Rate of employment:

Expected correlation: Positive

Economic Justification: It is pro cyclical.

8. Infrastructure endowments:

Expected correlation: Positive

Economic Justification: Important part for business environment which fosters economic growth.

In India,FDI is strictly prohibited in following industries:

1. Atomic Energy Generation
2. Any Gambling or Betting businesses
3. Lotteries (online, private, government, etc)
4. Investment in Chit Funds
5. Nidhi Company
6. Agricultural or Plantation Activities (although there are many exceptions like horticulture, fisheries, tea plantations, Pisciculture, animal husbandry, etc)
7. Housing and Real Estate (except townships, commercial projects, etc)
8. Trading in TDR’s
9. Cigars, Cigarettes, or any related tobacco industry

• India emerged as the top recipient of greenfield FDI Inflows from the Commonwealth, as per a trade review released by The Commonwealth in 2018.

Some of the recent significant FDI announcements are as follows:

• In October 2019, French oil and gas giant Total S.A. have acquired a 37.4 per cent stake in Adani Gas Ltd for Rs 5,662 crore (US$ 810 million) making it the largest Foreign Direct Investment (FDI) in India’s city gas distribution (CGD) sector.
• In August 2019, Reliance Industries (RIL) announced one of India's biggest FDI deals, as Saudi Aramco will buy a 20 per cent stake in Reliance's oil-to-chemicals (OTC) business at an enterprise value of US$ 75 billion.
• In October 2018, VMware, a leading software innovating enterprise of US has announced investment of US$ 2 billion in India between by 2023.
• In August 2018, Bharti Airtel received approval of the Government of India for sale of 20 per cent stake in its DTH arm to an America based private equity firm, Warburg Pincus, for around $350 million.
• In June 2018, Idea’s appeal for 100 per cent FDI was approved by Department of Telecommunication (DoT) followed by its Indian merger with Vodafone making Vodafone Idea the largest telecom operator in India
• In May 2018, Walmart acquired a 77 per cent stake in Flipkart for a consideration of US$ 16 billion.
• In February 2018, Ikea announced its plans to invest up to Rs 4,000 crore (US$ 612 million) in the state of Maharashtra to set up multi-format stores and experience centres.