What is Foreign Direct Investment & Types of FDI| Espresso

Explained:Different Types of FDI

You must have heard of the term “Foreign Direct Investment” or FDI several times. It is one of the three major types of foreign investment in India; the other two are Foreign Portfolio Investment (FPI) and Foreign Institutional Investment (FII).

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In this article, we will explain the FDI in detail and the types of FDI with examples. Let’s get started.

What is Foreign Direct Investment (FDI)?

Foreign Direct Investment or FDI refers to investment made by an individual or a company in another company or business in a foreign country. Unlike foreign portfolio investment, FDI is characterised by the transfer of funds and business control.

There are many ways in which an investor or a company can make a foreign direct investment. Some of these ways include:

  • Mergers and acquisitions
  • Acquiring large-volume stocks of a foreign company
  • Starting a joint venture with an overseas firm
  • Starting a subsidiary firm to conduct business in a foreign country

What are the Different Types of FDI in India?

There are two primary types of foreign direct investment in India: horizontal and vertical FDI. However, two other types of FDI have also emerged in recent years – conglomerate FDI and platform FDI.

Below, we have explained all four types of FDI with examples:

1.Horizontal FDI

Horizontal FDI is the most common type of FDI. In a horizontal FDI, a company invests its funds in a foreign company belonging to the same industry or business. Here, a company invests in another company located in a different country but produces similar goods.

An example of horizontal FDI is Spain-based company Zara investing in the Indian company Fab India, which produces similar products as Zara. Both these companies belong to the merchandise and apparel industry.

2.Vertical FDI

Vertical FDI is another common type of FDI which occurs when a company invests in the supply chain of a foreign company, which may or may not belong to the same industry. Through vertical FDIs, a company looks to invest in a foreign company that might become its supplier or buyer. Vertical FDIs are further classified into backward vertical integrations and forward vertical integrations.

For example, McDonald’s – an American fast-food company – might invest in a meat processing company in India to bolster its meat supply chain. Since an investing company invests in a supplier company, which is ranked lower in the supply chain, this type of FDI is known as backward vertical integration.

Conversely, if a company invests in a foreign company that is ranked higher in the supply chain, it is the forward vertical integration. For example, McDonald’s investing in Connaught Plaza Restaurants Private Limited, where it sells its products in India.
Also Read: Foreign Exchange Market

3.Conglomerate FDI

Conglomerate FDI occurs when a company invests in a foreign company belonging to an entirely different industry. As such, the company in which the investment is made has no direct link with the company that has invested. The idea behind the conglomerate FDI is to add more business niches or start a completely new business in a foreign country.

The example of the conglomerate FDI includes US-based retailer Walmart investing in Tata Motors, an Indian automobile manufacturer.

4.Platform FDI

The last type of FDI on this list is platform FDI. It occurs when a company expands its base in a foreign country only to export the output to a third country. In other words, the investing company uses the foreign country as a platform to manufacture its products and then exports them to other countries.

For example, almost all luxury fashion brands manufacture their products in countries like Bangladesh, Thailand, and Vietnam and then export them to their target countries, such as France, Spain, etc.

To Conclude

If you want to invest through FDI, it's prudent for you to know the different types of FDI. A developing country like India offers some great opportunities to foreign investors to invest in Indian companies and generate large profits.

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Frequently Asked Questions

FDI limit in India is different for different industries. For example, 20% FDI is allowed in the banking and public sector, 49% FDI is allowed in broadcasting and content services, and 100% FDI is allowed in core investment companies and the retail food industry.

Despite many benefits, there are some disadvantages of FDI as well. It can result in the displacement of local businesses, especially in developing countries like India and Brazil. On the other hand, it can also lead to profit repatriation.

FDI can be beneficial for both the investor and the host country. The investor can use FDI to diversify its market, lower production costs, and increase its consumer base. At the same time, it helps in economic development and employment generation for the host country.