FDI Advantages and Disadvantages

What is Foreign Direct Investment?

Foreign Direct Investment, often abbreviated as FDI is defined as an investment made by an individual or an organisation in one country into a business located in another. Apart from money, FDI brings with it knowledge, technology, skills and employment.

Advantages of FDI

The following are the key advantages of foreign direct investment in India

1. FDI stimulates economic development

It is the primary source of external capital as well as increased revenues for a country. It often results in the opening of factories in the country of investment, in which some local equipment – be it materials or labour force, is utilised. This process is repeated based on the skill levels of the employees.

2. FDI results in increased employment opportunities

As FDI increases in a nation, especially a developing one, its service and manufacturing sectors receive a boost, which in turn results in the creation of jobs. Employment, in turn, results in the creation of income sources for many. People then spend their income, thereby enhancing a nation’s purchasing power.

3. FDI results in the development of human resources

FDI aids with the development of human resources, especially if there is transfer of training, technology and best practices. The employees, also known as the human capital, are provided adequate training and skills, which help boost their knowledge on a broad scale. But if you consider the overall impact on the economy, human resource development increases a country’s human capital quotient. As more and more resources acquire skills, they can train others and create a ripple effect on the economy.

4. FDI enhances a country’s finance and technology sectors

The process of FDI is robust. It provides the country in which the investment is occurring with several tools, which they can leverage to their advantage. For instance, when FDI occurs, the recipient businesses are provided with access to the latest tools in finance, technology and operational practices. As time goes by, this introduction of enhanced technologies and processes get assimilated in the local economy, which make the fin-tech industry more efficient and effective.

5. Second order advantages

Apart from the above points, there are a few more we cannot ignore. For instance, FDI helps develop a country’s backward areas and helps it transform into an industrial centre. Goods produced through FDI may be marketed domestically and also exported abroad, creating another essential revenue stream. FDI also improves a country’s exchange rate stability, capital inflow and creates a competitive market. Finally it helps smoothen international relations.

Disadvantages of FDI

Like any other investment stream, there are merits and demerits of FDI as well, which are mostly geo-political. For instance FDI can:

• hinder domestic investments and transfer control of domestic firms to foreign ones
• risk political changes, exposing countries to foreign political influence 
• influence exchange rates. 
• Influence interest rates
• Overtake domestic industry if they cannot compete 
• Unchecked FDI can make a country vulnerable to foreign elements like digital crime (e.g. issue of Huawei)

However, in comparing FDI advantages and disadvantages, it is quite apparent that the benefits outweigh the cons. If you wish to know more about FDI in India, reach out to an Angel One Expert.

FDI in India – The routes for investments

Having defined foreign direct investment, let’s understand its role and investment routes in India.

FDI is considered a significant source of investment that aids India’s economic development. India started witnessing economic liberalisation in the wake of the economic crisis of 1991, after which FDI increased steadily in the country.

Routes through which FDI occurs in India

There are two common routes through which India gets Foreign Direct Investments.

1. The automatic route

The automatic route is when an Indian company or Non-Resident does not need any prior permission from the RBI or the Indian government for foreign investment in India. Several sectors come under the 100 per cent automatic route category. The most common ones include industries such as agriculture and animal husbandry, airports, air-transport services, automobiles, construction companies, food processing, jewelry, health care, infrastructure, electronic systems, hospitality, tourism, etc. There are also a few sectors in which 100 per cent automatic route foreign investments are not permitted. These include insurance, medical devices, pension, power exchanges, petroleum refining, and security market infrastructure companies.

2. The government route

The second route through which FDIs occur in India is through the government route. If FDI occurs through the government route, the company intending to invest in India must seek prior government approval mandatorily. Such companies are required to fill and submit an application form through the Foreign Investment Facilitation portal, which enables them to obtain single-window clearance. The portal then forwards the foreign company’s application to the respective ministry that holds the discretion to approve or reject the application. The ministry consults the Department for Promotion of Industry and Internal Trade or DPIIT before accepting or rejecting the foreign investment application. Once approved, the DPIIT issues the Standard Operating procedure as per the existing FDI policy, paving the path for foreign direct investment in India.

Like the automatic route, the government route also permits up to 100 per cent FDI. Here is a sector and per cent wise break-up as permitted under the government route

Apart from the sectors mentioned above, 100 per cent FDIs can also occur through government sectors such as core investment companies, food products, retail trading, mining, and satellite establishments and operations.

Sectors in which FDI is prohibited in India

While foreign direct investments are permitted through several sectors, as mentioned above, there are specific sectors and industries wherein FDI is strictly prohibited, irrespective of the automatic or government route. These include:

1. Atomic Energy Generation
2. Gambling, betting businesses, and lotteries
3. Chit fund investments
4. Agricultural and plantation activities (excluding fisheries, horticulture and pisciculture, tea plantations, and animal husbandry)
5. Real estate and housing (excluding townships and commercial projects)
6. TDR trading
7. Products manufactured by the tobacco industry such as cigarettes and cigars

FIIs/FPIs investment limit in India

FIIs, NRIs (Non-resident Indians), and PIOs (Persons of Indian Origin) can buy shares/debentures of the companies listed on the Indian stock exchange through PIS (Portfolio Investment Scheme). However, SEBI and RBI have set an investment limit for them in the listed Indian companies to limit the influence of these foreign investors on the company, and financial markets, and to save the economy from the potential damage if FIIs flee from the Indian market in a mass. The below infographic will help you understand the ceiling limit for FIIs/NRIs/PIOs.

As an investor, you should also know that the overall ceiling limit can be raised as mentioned below after passing a special resolution for the same.

1. For FII investment, it can be raised to the sectoral cap of that particular industry
2. For NRIs, it can be raised to 24%

Before we proceed further, you must know the conditions you need to fulfil to purchase equity shares and convertible debentures of the company under PIS.

1. The total purchase of NRIs/PIOs should be within an overall ceiling limit of

1. 1. 24% of the paid-up equity capital of the company, or
   2. 24% of the total paid-up value of each series of convertible debenture

*Above condition is for both repatriation and non-repatriation basis 

Note: Investment on a repatriation basis means the amount received from the sale/maturity of the said investment can be sent to the source country. On the other hand, investment on a non-repatriation basis means the sale/maturity proceeds on the said investment couldn’t be sent to the source country. 

2. The investment made on a repatriation basis by an NRI/PIO in the equity shares and convertible debentures should not exceed 5% of the paid-up equity capital of the company or 5% of the total paid-up value of each series of convertible debenture

Monitoring investment limits from FIIs/NRIs/PIOs in the listed Indian companies

The investment limits or ceilings for FIIs/NRIs/PIOs in the listed Indian companies are monitored by the Reserve Bank of India (RBI) on a daily basis. For effective monitoring of the ceiling limit, the RBI has fixed a cut-off point that is 2 points lower than the actual limit. For instance, the ceiling limit for NRI is 10% so the cut-off point will be 8% of the company’s paid-up capital. Below mentioned are the steps taken by the RBI once the cut-off point is reached.

1. The RBI informs all the designated bank branches to not buy any more shares of the said company on behalf of FIIs/NRIs/PIOs without prior approval
2. If they wish to buy, they need to intimate RBI about the total number and value of shares/convertible debentures of the company they wish to buy
3. Once RBI receives intimation, it gives clearances to banks on a first-come-first-serve basis till the investment limit is reached
4. After the ceiling limit is reached, the company asks all designated bank branches to stop purchasing on behalf of FIIs/NRIs/PIOs
5. RBI informs the general public about this ‘stop purchase’ through a press release

Final note:

Foreign direct investments prove beneficial to both, the foreign company investing in India as well as to the country in which the investment is made. For the investing country, FDI translates to reduced costs whereas the country enabling the FDI can develop human resources, skills, and technologies. Common FDI examples include mergers and acquisitions, logistics, retail services, and manufacturing. If you need information on foreign investment opportunities in India, you can reach out to an Angel One Investment advisor.