What is FDI (Foreign Direct Investment) ?

FDI or Foreign Direct Investment is the practice of international businesses investing in countries other than their home country. In recent months, there has been much debate over whether opening up of economies to foreign direct investment is good for developing countries.

Further, foreign direct investment is seen by many old timers as surrendering the sovereignty of the country though the younger generation views it as a blessing for the economy.

Whatever be the stance, it cannot be denied that with the global economy being integrated so tightly, developing countries have no choice but to allow foreign direct investment. However, they can have some restrictions on which sector to invest and how much profit can be repatriated.

Impact of Foreign Direct Investment on Developing Countries

Many developing countries do not have the necessary resources at their disposal to develop some sectors and hence, they permit foreign capital to invest in these sectors. Of course, they also ensure that sectors like defense and other sectors that have national security implications are kept off the list of sectors in which foreign direct investment is allowed.

For many countries, opening up of their economies results in benefits since they need the dollars as well as because they might not have the expertise to commence productive activities in these sectors.

Finally, foreign direct investment can be used to pay for expensive imports and encourage exports as well. After all, every developing country (except those with large oil reserves) needs to pay for its oil imports in dollars and hence foreign direct investment helps to earn precious dollars.

Downsides of Foreign Direct Investment on Developing Countries

There are many downsides to allowing Foreign Direct Investment into the developing countries. However, the developing countries benefit because of inflow of dollars and much needed capital, which is not available domestically, there is scope for outflow of dollars as well since the foreign companies typically repatriate a part or whole of their profits back to their home countries. This is the reason why developing countries must think twice before allowing blanket foreign direct investment. To circumvent this, many developing countries typically restrict foreign direct investment into sectors that badly need capital and where the developing country does not have expertise.

Further, the fact that many developing countries have capital controls on the capital account (which is to restrict wholesale repatriation of both profits and investment) and relax the current count where only profits and that too a percentage of it is repatriated.

Closing Thoughts

The key point here is that no country can be isolated from the global economy in this day and age. Hence, it is in the interest of developing countries to allow foreign direct investment though some safeguards can be put in place as discussed above. Of course, the best path would be to not have a blanket ban on foreign investment nor to allow 100% foreign investment.

In this respect, countries like India and China have showed the way on how to attract investment and at the same time not fall prey to the phenomenon of capital flight that happened to East Asian economies in 1998.