Foreign Direct Investment

St. Xavier's Catholic College of Engineering, Chunkankadai, Nagercoil

Foreign Direct Investment

The foreign direct investment is profitable both to the country receiving investment

(foreign capital and funds) and the investor. For the investor company FDI offers an exclusive

opportunity to enter into the international or global business, new markets and marketing

channels, elusive access to new technology and expertise, expansion of company with new or

more products or services, and cheaper production facilities. While the host country receives

foreign funds for development, transfer of new profitable technology, wealth of expertise and

experience and increased job opportunities. The investing company may make its overseas

investment in a number of ways - either by setting up a subsidiary or associate company in the

foreign country, by acquiring shares of an overseas company, or through a merger or joint

venture. The accepted threshold for a foreign direct investment relationship, as defined by the

OECD, is 10%. That is, the foreign investor must own at least 10% or more of the voting stock or

ordinary shares of the.

An example of foreign direct investment would be an American company taking a

majority stake in a company in China. Another example would be a Canadian company setting

up a joint venture to develop a mineral deposit in Chile.

The most profound effect has been seen in developing countries, where yearly foreign

direct investment flows have increased from an average of less than $10 billion in the 1970s to

a yearly average of less than $20 billion the 1980s. From 1998 to 1999 itself, FDI grew from

$179 billion to $208 billion and now comprise a large portion of global FDI. According to

UNCTAD, spurred on by mergers and acquisitions and the internationalization of production in a

range of industries, inward FDI for developing countries rose from $481 billion in 1998 to $636

billion in 2006.

Types

Horizontal FDI arises when a firm duplicates its home country-based activities at the

same value chain stage in a host country through FDI.

Platform FDI

Vertical FDI takes place when a firm through FDI moves upstream or downstream in

different value chains i.e., when firms perform value-adding activities stage by stage in a

vertical fashion in a host country.

Whereas Horizontal FDI decrease international trade as the product of them is usually aimed at host country, the two other types generally act as a stimulus for it.

Methods

The foreign direct investor may acquire voting power of an enterprise in an economy

through any of the following methods:

By incorporating a wholly owned subsidiary or company

By acquiring shares in an associated enterprise

Through a merger or an acquisition of an unrelated enterprise

Participating in an equity joint venture with another investor or enterprise

Trends in Foreign Direct Investment (FDI)

Historically, FDI has been directed at developing nations as firms from advanced

economies invested in other markets, with the US capturing most of the FDI inflows. While

developed countries still account for the largest share of FDI inflows, data shows that the stock

and flow of FDI has increased and is moving towards developing nations, especially in the

emerging economies around the world.

Aside from using FDIs as investment channel and a method to reduce operating costs,

many companies and organizations are now looking at FDI was a way to internationalize. FDIs

allow companies to avoid governmental pressure on local production and cope with

protectionist measures by circumventing trade barriers. The move into local markets also

ensures that companies are closer to their consumer market, especially if companies set up

locally-based (national) sales offices.

In recent years, FDI has been used more as a market entry strategy for investors, rather

than an investment strategy. Despite the decline in trade barriers, FDI growth has increased at

a higher rate than the level of world trade as businesses attempt to circumvent protectionist

measures through direct investments. With globalization, the horizons and limits have been

extended and companies now see the world economy as their market.

One of the advantages of foreign direct investment is that it helps in the economic

development of the particular country where the investment is being made.

An example of this can be seen in some countries in the East Asian region. It was

observed during the 1997 Asian financial crisis that the amount of foreign direct investment

made in these countries was held steady while other forms of cash inflows suffered major

setbacks. Similar observations have also been made in Latin America in the 1980s and in Mexico

in 1994-95.

Additionally for investors, FDI provides the benefits of reduced cost through the

realization of scale economies, and coordination advantages, especially for integrated supply

chains. The preference for a direct investment approach rather than licensing and franchising

can also been viewed in terms of strategic control, where management rights allows for

technological know-how and intellectual property to be kept in-house.

Advantages of FDI

Integration into global economy - Developing countries, which invite FDI, can gain

access to a wider global and better platform in the world economy.

Economic growth - This is one of the major sectors, which is enormously benefited from

foreign direct investment. A remarkable inflow of FDI in various industrial units in India

has boosted the economic life of country.

Trade - Foreign Direct Investments have opened a wide spectrum of opportunities in the

trading of goods and services in India both in terms of import and export production.

Products of superior quality are manufactured by various industries in India due to

greater amount of FDI inflows in the country.

Technology diffusion and knowledge transfer – FDI apparently helps in the outsourcing

of knowledge from India especially in the Information Technology sector. Developing

countries by inviting FDI can introduce world-class technology and technical expertise

and processes to their existing working process. Foreign expertise can be an important

factor in upgrading the existing technical processes.

For example, the civilian nuclear deal led to transfer of nuclear energy know-how

between the USA and India.

Increased competition - FDI increases the level of competition in the host country.

Other companies will also have to improve on their processes and services in order to

stay in the market. FDI enhanced the quality of products, services and regulates a

particular sector. Linkages and spillover to domestic firms- Various foreign firms are now

occupying a position in the Indian market through Joint Ventures and collaboration

concerns. The maximum amount of the profits gained by the foreign firms through

these

Joint venture is spent on the Indian market.

Human Resources Development - Employees of the country which is open to FDI get

acquaint with globally valued skills.

Employment - FDI has also ensured a number of employment opportunities by aiding

the setting up of industrial units in various corners of India.

Retail Industry:

Definition of Retail

In 2004, The High Court of Delhi defined the term ‘retail’ as a sale for final consumption

in contrast to a sale for further sale or processing (i.e. wholesale). A sale to the ultimate

consumer.

Thus, retailing can be said to be the interface between the producer and the individual

consumer buying for personal consumption. This excludes direct interface between the

manufacturer and institutional buyers such as the government and other bulk customers

retailing is the last link that connects the individual consumer with the manufacturing and

distribution chain. A retailer is involved in the act of selling goods to the individual consumer at

a margin of profit.

Division of Retail Industry – Organized and Unorganized Retailing

The retail industry is mainly divided into:-

1) Organized and

2) Unorganized Retailing

Organized retailing refers to trading activities undertaken by licensed retailers, that is,

those who are registered for sales tax, income tax, etc. These include the corporate-backed

hypermarkets and retail chains, and also the privately owned large retail businesses.

Unorganized retailing, on the other hand, refers to the traditional formats of low-cost

retailing, for example, the local kirana shops, owner manned general stores, paan/beedi shops,

convenience stores, hand cart and pavement vendors, etc.

The Indian retail sector is highly fragmented with 97 per cent of its business being run

by the unorganized retailers. The organized retail however is at a very nascent stage. The sector

is the largest source of employment after agriculture, and has deep penetration into rural India

generating more than 10 per cent of India’s GDP

Overview

Retail industry, being the fifth largest in the world, is one of the sunrise sectors with

huge growth potential and accounts for 14-15% of the country’s GDP. Comprising of organized

and unorganized sectors, Indian retail industry is one of the fastest growing industries in India,

especially over the last few years.

According to the Global Retail Development Index 2012, India ranks fifth among the top

30 emerging markets for retail. The recent announcement by the Indian government with

Foreign Direct Investment (FDI) in retail, especially allowing 100% FDI in single brands and

multi-brand FDI has created positive sentiments in the retail sector.

Most of the world’s largest retailers positioned in the top half of the list moved very

little in their rankings, if at all. Wal-Mart is still, by far, the largest retailer in the world. France’s

Carrefour is still in second position. Germany’s Metro AG overtook the United Kingdom’s Tesco

chain and claimed the third position on the list. The top retailers in the top countries managed

to maintain relative stability on the global retailing stage. There were a few big notable shifts in

the world’s largest retailers, however. Iceland fell off the list completely after its Baugur group

became a recession casualty.

Russia fell from the fifteenth position to the 107th position, the largest drop for any one

country. China’s ranking fell from 63rd to 90th position, and a new largest retailer emerged in

that country. Spain, Finland, Chile, South Korea, and Brazil also had new retail companies

assume the position of being their country’s largest retailer.

Emerging Areas

Some sectors that occupy a prominent position with the retail industry are:

Apparel Retail: Everybody understands the impact of fashion and textiles on the

environment. Almost $19.5 billion were spent on online apparel shopping in the year

2009 and increasing since then.

Fashion & Lifestyle Retail: In India the vast middle class and its almost untapped retail

industry are the key attractive forces for global retail giants wanting to enter into newer

markets, which in turn will help the retail to grow faster.

Food & Beverage Retail: Backed by huge potential and changing lifestyles, the food and

beverage retail market is growing at a robust 30-35 per cent per year.

Pharmaceutical Retail: Driven by therapies like anti-diabetic, vitamin, anti-infective and

dermatology, it accounted for a robust 15% growth in 2011.

E-commerce or E-tailing – the next big revolution: With the advent of e-commerce in

the retail industry, retail stores are facing stiff competition from e-stores. The rising

demand for e-shopping has lead to a new debate cropping up in the world.

Foreign Direct Investment in Retail Industry

Retailing is one of the world’s largest private industries. Liberalizations in FDI have

caused a massive restructuring in retail industry. The benefit of FDI in retail industry

superimposes its cost factors. Opening the retail industry to FDI will bring forth benefits in

terms of advance employment, organized retail stores, availability of quality products at a

better and cheaper price. It enables a countries product or service to enter into the global

market. FDI is not allowed in the retail sector and this is the reason why many prominent global

players like Dominos, Levis, Lee, Nike, Adidas, TGIF, Benetton, Swarovski, Sony, Sharp, and

Kodak etc are entering the retail market via licensee or franchisee. The opening up of the

economy to FDI in the retail sector is also expected to generate employment. FDI can be a

blessing instead of curse only if it produces backward linkages relating to production and

manufacturing. It may also, in the process help to push up domestic production as well as

exports.

In the present scenario, 51% Foreign Direct Investment is permitted in India only

through single brand retailing. The international retailers are entering the market through

licensees just as Wal-Mart has entered through the franchisee, Bharti Enterprises, while

Carrefour runs wholesale stores. Tesco on the other hand has a tie-up with the Tata group and

supports the Indian firm in the running of Star Bazaar chain of retail outlets.

Cheaper production facilities:

FDI will ensure better operations in production cycle and distribution. Due to

economies of operation, production facilities will be available at a cheaper rate thereby

resulting in availability of variety products to the ultimate consumers at a reasonable

and lesser price.

Availability of new technology:

FDI enables transfer of skills and technology from overseas and develops the

infrastructure of the domestic country. Greater managerial talent inflow from other

countries is made possible. Domestic consumers will benefit getting great variety and

quality products at all price points.

Long term cash liquidity:

FDI will provide necessary capital for setting up organized retail chain stores. It is

a long term investment because unlike equity capital, the physical capital invested in the

domestic company is not easily liquidated.

Lead driver for the country’s economic growth:

FDI would create a competition among the global investors, which would

ultimately ensure better and lower prices thus benefiting people in all sections of the

society. There would be an increase in the market growth and expansion. It will increase

retail employment and suppress untrained manpower and lack of experience. It will

ensure better managerial techniques and success. Higher wages will be paid by the

international companies. Urban consumers will be exposed to international lifestyles.

FDI Success story China:

China is the world’s largest FDI recipient, and has used it deftly to increase its exports. It

started off with an FDI investment of $19 billion in 1990, and reached $300 billion in 1999. 40

retailers now have a secured approval in the Chinese market. FDI has created an encouraging

effect in both traditional as well as modern formats of retail business in China.

Carrefour from France, Tesco from England, Metro from Germany, and Wal-Mart from

US have entered the Chinese retail sector and has uplifted the country’s economy. Initially

during 1992, China allowed FDI only in a few selected cities and also restricted the ownership

by 26 percent. Later on as the exports of the country progressively increased, by 2002, the

Government increased the FDI cap to 49 percent. China continues to hit new records. More

than 28 million people and approximately 10 percent of Chinas total population are working in

companies funded with FDI.

China, in fact, is a really interesting example of how it transformed Wal-Mart USA. As China

ramped up its own manufacturing sector, through subsidies, special economic zones and other

perks, as many as 15,000 Chinese suppliers were serving Wal-Mart China in 2010; the company

had expanded its presence to 352 supermarkets in 130 cities across China. Exports to the US

amounted to $60 billion annually. Wal-Mart China now claims that 95 per cent of its goods sold

in China are sourced locally.

FDI opens new doors for Franchising:

Restrictions on FDI are considered as trade barriers as they deny direct market access to

foreign firms. Retail giants who are at their wings, seeking entry into foreign market look for

other available alternatives. These restrictions on the global retailers regarding the inflow of

Foreign Direct Investment, leads them towards acquiring the market entry through franchises.

Thus, countries which offer promising market potentialities for retail growth offers substantial

growth in the franchising sector as well.

In a major reform drive and signaling that it is shrugging off its policy paralysis, the

government has pushed through the move that will allow 51% foreign direct investment in

multi-brand retail. It has also relaxed norms for foreign direct investment in the aviation sector,

allowing international airlines to invest in domestic peers and cleared a slew of other reform-

oriented measures - an increase of foreign direct investment in some broadcasting services

from 49% to 75% and disinvestment in four key profit-making public sector units.

Importantly - and the government has underscored this provision - the policy allows

state governments to decide whether to allow FDI in multi-brand retail or not. So, the

government says, if some parties don't want the FDI, they can make that choice. The Trinamool

Congress, wants the decision withdrawn. It has already said it will not implement it in West

Bengal, which Mamata Banerjee rules.

AT Kearney (a globally famous international management consultancy) recognized India

as the second most alluring and thriving retail destination of the world, among other thirty

growing and emerging markets. At present, other profitable retail destinations of the world are

China and Dubai of Asia. Diverse foreign direct investment in Indian retail is greatly cherished

by most of the major and leading retailers of USA and European countries, including Wal-Mart

(USA), Tesco (UK), Metro (Germany), and Carrefour (France). Liberalization of trade policy and

loosening of barriers and restrictions to the foreign investment in the retail sector of India, have

collectively made the FDI in retail sector quite easy and smooth. Our services are easily and

economically available for the following ways of FDI in Indian retail.

The FDI in India’s retail business can be made through any of the following routes:

Joint Ventures

Franchising

Sourcing of Supplies from small-scale sector

Cash and Carry Operations

Non-Store Formats

Recent News on FDI in India

Metro AG and Shorite are already in operation. Foreign retailers are in search of

investing in wholesale. Wal-Mart as we have mentioned has already joined the retail market of

India. Geant is also expected to start its retailing operations soon in India hence we may

conclude that FDI in retailing in India would require the creation of additional jobs to

compensate the resulting job loss. It would result in the reduction in the Kirana shops and Retail

Stores. The consumers can benefit from such exposures; it would enhance quality, improve on

the supply chain, increase exports, so on and so forth.

Bottlenecks to FDI in Retail Industry

According to the Land and Property laws only the Indians have the right to land and

property in India and this law has in a a way inhibited the entry of the foreign players in India.

Again the labour laws are so designed that the store workers can be protected, quite contrary

to the requirements of the modern formats. The tax structure of India is also unfavorable for

the foreign players. The corporate tax rate for the domestic companies is 36.59% whereas it is

41.82% for the foreign companies. The changing sales tax as well as the Value Added Tax is also

not favorable in the case of international companies.

Similarly, foreign investment in the automobile industry ended the long wait for outdated

scooters and cars and led to leading global companies vying to sell the latest models in India.

When Pizza Hut, Domino's, McDonald's, Wimpy, Burger King, KFC and other such

international brands were allowed, there were orchestrated demonstration in many cities; they

were painted as anti-people and anti-Indian enterprises. We were told Haldirams,

Bikanerwalas, Nirulas, Nathus and their ilk will vanish.

All these Indian chains have multiplied their outlets, diversified their production line,

upgraded their packing and presentation, and are doing roaring business. In fact, some of the

largest MNCs like McDonald's, Pizza Hut and Domino's have been forced to Indianise their

offerings. Where else in the world would you find a McDonald burger with paneer and potato

patties and coriander sauce?

While many starve, millions of tonnes of grain rot for want of adequate storage

facilities. Ask how farmers in Punjab feel when their produce is not picked up and lies unsold.

Can they negotiate higher prices? When the mercury rises, fruit don't last more than two days.

Small grocery shops realize the value of home delivery; small stores also reduce a rupee

or two on most items. This demand-and-supply relationship will remain unchanged

notwithstanding the entry of bigwigs like Tesco, Carrefour and Wal-Mart.

Conclusion

FDI offers an exclusive opportunity to enter into the international or global business,

new markets and marketing channels, elusive access to new technology and expertise,

expansion of company with new or more products or services, and cheaper production

facilities. While the host country receives foreign funds for development, transfer of new

profitable technology, wealth of expertise and experience, and increased job opportunities. But

there are also disadvantages like all the small shops, stores and vegetable vendor who sits on

almost every street corner will suffer when his customers move over to the big stores.

Neighborhood stores that sell provisions may soon be similarly squeezed.

References

Apte P.G., International Financial Management, Tata McGraw Hill, 2008.

P.Subba Rao., International Business, Himalaya Publishing House, 2008.

http://www.fibre2fashion.com/industry-article/7/604/fdi-in-retailing1.asp

http://www.economywatch.com/business-and-economy/indian-retail-industry-fdi.html