Foreign Direct Investment - Trends and Advantages

The United Nations Conference on Trade and Development (UNCTAD) reported in the end of October 2010, which Foreign Direct Investment (FDI) had significantly reduced in this year till now, as compared to the statistics for previous years.

The UNCTAD, established in 1964, has as its aim the participation of developing countries in the global economy to improve their economic status. It views foreign direct investment in developing countries as beneficial for the growth of these countries. It also gathers statistics and analyses various facets of the world economy.

According to the UNCTAD, foreign direct investment into developing economies would be totally the same as in 2009, dashing hopes of any increase this year as had been predicted previously.

The UNCTAD director of investment and enterprise division, James Zhan, also mentioned worries about further impact on FDI levels due attempts by countries to devalue their currency. The UNCTAD director expressed fears of a currency war where countries push down the value of their currency to attract more FDI. However, this can also affect a multinational company's profits.

According to statistics from Global Investment Trends Monitor, a global FDI analysis released periodically by the UNCTAD, foreign investments in the second quarter reduced by 25% compared to the previous quarter of 2010. Compared to the data for the same period in the year 2009, the investment levels had come down by 15%.

The Global Investment Trends Monitor noted increased FDI in Russia and China, and a decrease in FDI inflows in other developing countries. The levels of FDI in 2010 will remain much lower than what it was before the global financial crisis.

Why is Foreign Direct Investment (FDI) so important? How does it benefit both investors as well as the countries in which they have invested? Let's take a look at the concept of FDI in a global economy and some of the advantages of foreign direct investment. We will also review the FDI scenario in Chile as an example.

What is Foreign Direct Investment (FDI)?

Instead of investing in local businesses, putting money in a company functioning or incorporated in another country is foreign direct investment. For the country which is attracting the investment, the investor is a considered a "foreign direct investor". The foreign direct investor can have influence in the management of the companies invested in.

The foreign direct investor may have a varying amount of stake in the invested company - stakes can be as low as 10% or may also cross 49% of the shares or stock ownership. Some countries may have caps on the amount of equity a foreign direct investor may hold. For example, the Reserve Bank of India allows foreign equity only up to 50% in investment in specific mining sector in India. It totally forbids FDI in mining of iron and manganese.

The foreign direct investor seeks to have a controlling stake in the entity invested. This distinguishes it from an ordinary foreign investment.

The flow of capital from the foreign investor to the company invested in becomes an FDI inflow. FDI has three parts - equity capital investment, reinvested earnings and intra-company loans.

Advantages of Foreign Direct Investment

In the global economy today, we see many developing countries competing for foreign direct investment. FDI is said to be an important factor for spurring the development of a nation.

Let's take a look at some advantages of foreign direct investment to a host country:

• Integration into global economy - A developing country, which invites FDI, can gain a greater foothold in the world economy by getting access to a wider global market.
• Technology advancement - FDI can introduce world-level technology and technical know-how and processes to developing countries. Foreign expertise can be an important factor in upgrading the existing technical processes in a host country. For example, the civilian nuclear deal between India and the United States would lead to transfer of nuclear energy know-how between the two countries and allow India to upgrade its civilian nuclear facilities.
• Increased competition - As FDI brings in advances in technology and processes, it increases the competition in the domestic economy of the developing country, which has attracted the FDI. Other companies will also have to improve their processes and products in order to stay competitive in the market. Overall, FDI improves the quality of a products and processes in a particular sector.
• Improved human resources - Employees of a host country in which there is an FDI get exposure to globally valued skills. The training and skills upgradation can enhance the value of the human resources of the host country.

The advantages of foreign direct investment to the investor includes access to a larger market in the host country, ability to tap the potential of a cheap and skilled labour, making use of resources in the host country and pursuing growth goals by diversification and optimising costs.

Sample Case - Chile International Foreign Direct Investment

Chile has been in the news recently for the dramatic rescue of several miners trapped several hundred feet underground in a gold mine. The world praised the efficient manner in which the rescue was conducted. Many commentators also noted how the positive image would help Chile international foreign direct investment inflows.

Chile international foreign direct investment seeks to take advantage of the natural resources in the country. Chile has been an FDI-friendly nation in Latin America.

The Economic Commission for Latin America and the Caribbean (Eclac), an agency of the United Nations, reported that FDI in Chile was the third largest for South America, with an inflow of USD 8.03 billion.

The foreign direct investment in Chile in the year 2009 was USD 6.21 billion. FDI has continued in sectors such as mining. Factors such as the availability of raw materials have attracted FDI in the mining sector in Chile.