FDI has been a matter of great interest for a long time and for all the countries. Since 1980s FDI has expanded strongly, expansion making FDI even more important than trade as a vehicle for international economic integration.
FDI can play a crucial role in furthering development of developing nations; even developed economies are no exception to it.
What constitutes FDI has been a difficult aspect, partly because of the complex nature of it. The definition has changed considerably over the years. As early as 1937, the US Department of Commerce defined it as,
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“All foreign equity interests in those American Corporations or enterprises which are controlled by a person or group of persons domiciled in a foreign country.”
The control was the main criterion for the foreign inward investment, but what constituted control was not specified.
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In a subsequent publication in 1953, however, the control was defined on the basis of four investment categories, only some of which would still constitute measures of FDI.
According to WTO,
“FDI occurs when an investor based in one country (the home country) acquires an asset in another country (the host country) with the intent to manage the asset.”
The current definition of FDI as endorsed by the IMF (1993) and the OECD (1996) have shifted their emphasis from ‘control’ to ‘lasting interest’ by a “direct investor” in an entity resident in a country other than that of the investor (“direct investment enterprise”).
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Lasting interest refers to long term relationship between the investor and the direct investment enterprise and a significant degree of influence on the management of the enterprise.
The world Investment Report of the UNCTAD supports the phenomenon of lasting interest along with control i.e., exerting a significant degree of influence on the management of investment enterprise (which includes a subsidiary, an associate or a branch).
Despite an effort by international agencies to arrive at a universally accepted definition of FDI, the definitions and measurements differ from country to country. For example, in the US, 10% equity stake would indicate foreign ownership, whereas in the UK the threshold is at 20% or more equity stake.
Not only the limits, but also there are differences in compilation of FDI inflows, particularly among developing countries.
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To illustrate the Reserve Bank of India projections of FDI contain following discrepancies:
i. The undistributed profits which are invested in the affiliates in the host country are not counted as actual FDI inflows.
ii. The overseas commercial borrowings (like financial leasing, trade credits, grants, bonds, etc.) are excluded of FDI inflows.
iii. According to IMF guidelines, if a non-resident initially buys 10% or more equity through portfolio route but buys additional shares in subsequent transactions and now holds investment over 10%, these additional shares will be regarded as part of FDI. However, many FIIs’ holding well over 20% equity in the shape of American Depository Receipts (ADRs) and Global Depository Receipts (GDRs) do not form part of FDI.
According to the International Finance Corporation’s World Environment Survey 2002, the FDI gap between India and China is not as large as suggested by the official figures, if Indian statistics remove the discrepancies as given above.
It will be correct at this stage to make a distinction between FDI and Portfolio Investment. First, the FDI involves the transfer of package of assets or intermediate products, which includes financial capital, management, and organisational expertise, technology, entrepreneurship, incentive structures, values and cultural norms, and access to markets across national boundaries; the portfolio investment involves only transfer of financial capital. Second, unlike arm’s-length trade in assets and intermediate products, FDI does not involve any change in ownership.