All you need to know about Growth and Quality of Foreign Direct Investment (FDI)

Growth and Quality of FDI

Foreign Direct Investment (FDI) has long been recognized as a critical driver of economic growth and development for countries around the world. It brings in capital, technology, and managerial expertise, which can stimulate domestic industries, create employment opportunities, and foster innovation. However, not all FDIs are created equal. While the quantity of FDI inflows is often emphasized, the quality of these investments plays a significant role in determining their impact on a host country’s economy. In this article we will discuss about Growth and Quality of FDI.

Meaning of Foreign Direct Investment (FDI)

FDI is a method of cross-border investment. An investor, often known as a resident, is a person or company who makes an investment in another country in order to gain ownership. Foreign Direct Investment (FDI) is a significant source of investment for economic growth and development. Foreign Companies may invest directly in the country’s private sectors. FDI primarily consists of “merger, amalgamation, acquisition, and reinvestment of earned profit.”

FDI refers to the inflow of money, skills, expertise, knowledge, and technology. An economy with growth prospects and skilled labour draws greater FDI. Under the Foreign Exchange Management Act, 1999 (FEMA), the Department of Promotion of Industry and International Trade (DPIIT) regulates FDI in India.

India draws huge FDI due to its low labour costs and active business climate. Following the 1991 economic crisis, India saw a significant increase in FDI. FDI is a critical component of every economy’s economic development and stability.

Different types of FDI

There are two forms of FDI:

• Horizontal FDI: Horizontal FDI entails developing the same corporate activities in another country. Under this type of FDI, a company invests in another company in a foreign nation, where both companies manufacture identical products.
• Vertical FDI: Vertical FDI entails expanding firm operations in another country but for separate supply chains. Vertical FDI is further subdivided into backward and forward vertical integration.

Other types of FDI include:

• Conglomerate: In this sort of FDI, corporations engage in a variety of operations in a foreign country, such as entering a new country and entering an altogether new market.
• Platform: In this sort of FDI, corporate operations expand in another country before exporting to a third.

FDI Routes in India 

In India, there are two types of FDI routes:

• Automatic route: FDI is permitted without the need for previous approval from the government or the Reserve Bank of India. Under the Automatic Routes, the Application is not necessary.
• Government route: Foreign direct investment is permitted with the approval of the government. The foreign investor must submit their FDI proposal through the DPIIT-managed Foreign Investment Facilitation Portal.

Foreign Direct Investment Provisions

The GOI has yet to release a detailed definition of the scope of News Release 3 and the criteria for reviewing the News Release 3 application. However, the Indian government has gradually changed its FDI stance. More specifically:

The long-awaited change increased the automatic route ceiling for foreign direct investment in insurance companies from 49% to 74%.

Non-investors will have more influence on Indian insurers, but increasing FDI limits will be subject to new conditions. The criteria to be Indian is included, but not limited to).

Residents, limits based on the appointment of independent directors to insurance company boards of directors, and the capacity to pay dividends)

Foreign direct investment (FDI) caps in the telecommunications sector (through automated methods) boost other significant structures, most notably liquidity. Furthermore, insurance sector procedural improvements aimed at decreasing the insurance sector’s regulatory burden.

Growth and Quality of FDI: Growth Factor of FDI

Growth of FDI refers to the increase in the amount of foreign investment flowing into a country over time. A growing FDI inflow is generally seen as a positive sign for the host economy. It brings in additional capital, creates job opportunities, and stimulates economic activity. Higher FDI inflows can also lead to the transfer of advanced technologies, knowledge, and managerial practices, which can enhance productivity and competitiveness in the domestic market.

The growth of FDI is influenced by various factors. These include the economic and political stability of the host country, market size, skilled labor availability, infrastructure, ease of doing business, regulatory environment, and investment incentives offered by the government. Countries that are able to attract and retain FDI tend to experience higher economic growth rates and increased industrialization.

However, the quantity of FDI alone is not enough to ensure sustainable development. The quality of FDI is equally important.

Growth and Quality of FDI: Quality Factor of FDI

Quality of FDI refers to the extent to which foreign investment contributes to long-term sustainable development, technology transfer, and knowledge spillovers in the host country. High-quality FDI goes beyond capital infusion and actively contributes to the host economy’s human capital development, innovation, and industrial upgrading.

To attract high-quality FDI, countries need to focus on creating an enabling environment. This includes investing in education and skill development, promoting research and development activities, fostering innovation and entrepreneurship, strengthening intellectual property rights protection, and developing robust infrastructure. These factors are critical for maximizing the positive spillover effects of FDI and ensuring long-term benefits for the host economy.

Measuring FDI Quality

While FDI quantity is commonly measured by the volume of investment inflows, assessing FDI quality is more complex. Several indicators help gauge the quality of FDI and its potential impact on host economies:

• Technology Transfer: The extent to which foreign investors bring advanced technology and expertise to the host country is crucial. Technology transfer can lead to increased productivity, improved product quality, and the development of new

industries. Collaborative research and development initiatives and knowledge spill-overs from MNCs to domestic firms are also indicators of high-quality FDI.

• Linkages and Spillover Effects: Strong linkages between foreign affiliates and local firms are indicative of quality FDI. When foreign firms integrate with domestic supply chains, it leads to technology and knowledge diffusion, skill development, and increased productivity among local businesses. Additionally, spillover effects occur when knowledge and skills acquired from MNCs are shared with local companies, contributing to their growth and competitiveness.
• Employment and Human Capital Development: FDI can be a catalyst for job creation and human capital development. High-quality FDI brings not only capital but also managerial expertise and specialized skills. This helps in the transfer of knowledge, the development of a skilled workforce, and the upgrading of local labor markets.
• Sustainable Development: Quality FDI takes into account environmental sustainability and social responsibility. Investments that prioritize environmentally friendly practices, resource efficiency, and community development contribute to long-term sustainable growth.

Factors Influencing FDI Quality

The following are the factors influencing FDI Quality:

• Institutional Framework: A well-functioning legal and regulatory framework, protection of property rights, and effective enforcement of contracts are vital for attracting high-quality FDI. Transparent and predictable policies create an enabling environment that fosters investor confidence.
• Education and Research Institutions: The presence of quality educational institutions and research centers facilitates the development and dissemination of knowledge. This attracts FDI seeking skilled labor and collaboration opportunities, contributing to higher-quality investments.
• Infrastructure Development: Adequate physical infrastructure, such as transportation networks, power supply, and telecommunications, is essential for attracting quality FDI. Modern infrastructure enables efficient operations, reduces production costs, and improves connectivity to global markets.
• Investment Promotion Strategies: Proactive investment promotion agencies that identify and target high-quality investment opportunities can help attract the right kind of FDI. These agencies play a crucial role in providing information, assisting investors, and creating a conducive business environment.

The Link between FDI and Economic Growth

FDI has the potential to significantly impact the host country’s economic growth. It brings in much-needed capital for investment in physical infrastructure, technology, and human capital, which stimulates production, job creation, and consumption. FDI inflows can also foster innovation and entrepreneurship, leading to the development of new industries and the upgrade of existing ones. Moreover, the presence of MNCs can enhance a country’s export competitiveness, as they often bring global networks, marketing expertise, and access to international markets. These factors collectively contribute to higher productivity, increased foreign exchange earnings, and ultimately, economic growth.

Conclusion

In conclusion, both the growth and quality of FDI are vital for the economic development of a country. While the growth of FDI brings in capital, creates jobs, and stimulates economic activity, the quality of FDI determines its long-term impact on the host economy. Governments and policymakers should focus not only on attracting higher FDI inflows but also on creating an enabling environment that fosters high-quality FDI. By doing so, countries can maximize the benefits of foreign investment and pave the way for sustainable economic growth, technological advancement, and improved living standards.

If you want to learn more about the growth and quality of FDI, contact our experts at Legal Window.