Ch-4 International Capital Movements Flashcards
Q1) what are some of the important components of foreign capital flow?
🔷 some of the important components of foreign capital flows are:
1) Foreign aid or assistance which may be:
(a) Bilateral or direct inter government grants
(b) Multilateral aid from many governments who pool funds to international organizations like the World Bank.
(c) Tied aid with strict mandates regarding the use of money or untied aid where there are no such restrictions.
(d) Foreign grants which are voluntary transfer of resources by government, institutions, agencies or organizations.
2) Borrowings which may take different forms such as:
(a) Direct inter government loans.
(b) Loans from international institutions (e.g. world bank, IMF, ADB)
(c) Soft loans for e.g. from affiliates of World Bank such as IDA
(d) External commercial borrowing, and
(e) Trade credit facilities
3) deposits from non resident Indians.
4) Investments in the form of:
(i) Foreign portfolio investment (FPI) in bonds, stocks and securities, and
(ii) Foreign direct investment(FDI) in industrial, commercial and similar other enterprises.
Q2) define foreign direct investment ( FDI ) ?
🔷Foreign direct investment is defined as a process whereby the resident of one country (i.e. home country) acquires ownership of an asset in another country (i.e. the host country) and such movement of capital involves ownership, control as well as management of the asset in the host country.
🔷Direct investment comprises not only the initial transaction establishing the relationship between the investor and the enterprise, but also all subsequent transactions between them and among affiliated enterprises, both incorporated and unincorporated.
🔷According to the IMF and OECD definitions, the acquisition of at least ten percent of the ordinary shares or voting power in a public or private enterprise by non resident investors makes it eligible to be categorized as foreign direct investment (FDI). India also follows the same pattern of classification.
🔷FDI has three components, viz., equity capital, reinvested earnings and other direct capital in the form of intra-company loans between direct investors (parent enterprises) and affiliate enterprises.
🔷Foreign direct investors may be individuals, incorporated or unincorporated private or public enterprises, associated groups of individuals or enterprises, governments or government agencies, estates, trusts, or other organizations or any combination of the above mentioned entities.
🔷The main forms of direct investments are: the opening of overseas companies, including the establishment of subsidiaries or branches, creation of joint ventures on a contract basis, joint development of natural resources and purchase or annexation of companies in the country receiving foreign capital.
🔷Direct investments are real investments in factories, assets, land, inventories, etc. and involve foreign ownership of production facilities.
🔷The investor retains control over the use of the invested capital and also seeks the power to exercise control over decision making to the extent of its equity participation.
🔷The lasting interest implies the existence of a long-term relationship between the direct investor and the enterprise and a significant degree of influence by the investor on the management of the enterprise.
🔷 FDI may be characterized as horizontal , vertical , conglomerate and two way direct foreign investments which are reciprocal investments.
Q3) what are the characterized of foreign direct investment ?
🔷Based on the nature of foreign investment, FDI may be categorized as horizontal, vertical or conglomerate.
1) A horizontal direct investment is said to take place when the investor establishes the same type of business operation in foreign country as it operates in its home country, for example, a cell phone service provider based in the United States moving to India to provide the same service.
ii) A vertical investment is one under which the investor establishes or acquires a business activity in a foreign country which is different from the investor’s main business activity yet in some way supplements its major activity. For example:
an automobile manufacturing company may acquire an interest in a foreign company that supplies parts or raw materials required for the company.
iii) A conglomerate type of foreign direct investment is one where an investor makes a foreign investment in a business that is unrelated to its existing business in its home country. This is often in the form of a joint venture with a foreign firm already operating in the industry as the investor has no previous experience.
🔷Yet another category of investments is ‘two- way direct foreign investments which are reciprocal investment between countries that occur when some industries are more advanced in one nation (for example, the computer industry in the United States), while other industries are more efficient in other nations (such as the automobile industry in Japan).
Q4) define foreign portfolio investment ( FPI ) ?
🔷 foreign portfolio investment is the flow of financial capital rather than real capital and does not involve ownership or control on the part of the investor.
🔷 Examples of foreign portfolio investment
A) the deposit of funds in an Indian or a British bank by an Italian company or
B) the purchase of a bond of a Swiss company by a citizen based in France.
C) when someone from US buys of share of Infosys
🔷 FPI let’s an investor purchase stocks , bonds or other financial assets in a foreign country through the mechanism of capital market.
🔷 These flows of financial capital have their immediate effects on balance of payments or exchange rates rather than on production or income generation.
🔷 Foreign portfolio investment is not concerned with either manufacture of goods or with provision of services.
🔷 Such investors also do not have any intention of exercising voting power or controlling or managing the affairs of the company in whose securities they invest.
🔷 The singular intention of a foreign portfolio investment is to earn a remunerative return through investment in foreign securities and is primarily concerned about the safety of their capital, the likelihood of appreciation in its value, and the return generated.
🔷 Following international standards, portfolio investments are characterized by lower stake in companies with their total stake in a firm at below 10%.
🔷 It is also noteworthy that unlike the FDIs , these investments are typically of short term nature, and therefore are not intended to enhance the productive capacity of an economy by the creation of capital asset .
🔷 Portfolio investments are , to a large extent , expected to be speculative .
🔷 Once investor confidence is shaken, such capital has a tendency to speedily shift from one country to another, occasionally creating financial crisis for the host country.
Q6) what are the reasons for foreign direct investment?
🔷 the increasing interdependence of national economies and the consequent trade relations and international industrial cooperation established among them.
🔷internationalisation of production and investment of transnational corporations in their subsidiaries and affiliates.
🔷desire to reap economies of large-scale operation arising from technological growth.
🔷desire to procure a promising foreign firm to avoid future competition and the possible loss of export markets.
🔷risk diversification so that recessions or downturn may be experienced with reduced severity.
🔷shared common language or common boundaries and possible saving in time and transport costs because of geographical proximity .
🔷necessity to retain complete control over its trade patents and to ensure consistent quality and service or for creating monopolies in a global context .
🔷promoting optimal utilization of physical human financial and other resources.
🔷desire to capture large and rapidly growing high potential emerging markets with substantially high and growing population.
Q7) what are the factors in the host country that discourage inflow of foreign investment? Or describe deterrents or discouragement to foreign direct investment in the country?
1) infrastructure lags
2) high rates of inflation
3) poor literacy
4) high rates of industrial disputes
5) low labour skills
6) Rigidity in the labour market
7) Bureaucracy and corruption
8) Unfavourable tax regime
9) Lack of security to life and property
10) Political instability
11) Exchange rate volatility
12) Poor track record of investments
13) Tough regulations
14) Lack of openness
15) Language barriers
16) Double taxation
Q8) what are the modes of foreign direct investment?
Foreign direct investment can be made in a variety of ways, such as:
🔷Opening of a subsidiary or associate company in a foreign country.
🔷Equity injection into an overseas company,
🔷Acquiring a controlling interest in an existing foreign company,
🔷 Mergers and acquisitions(M&A)
🔷Joint venture with a foreign company.
🔷 Green field investment (establishment of a new overseas affiliate for freshly starting production by a parent company).
Q9) many safeguards and performance requirements are put in place by developed and developing countries to improve the ratio of benefits to cost associated with foreign capital. What are they ?
A few examples are
1) domestic content requirements on inputs
2) Reservation of certain ki sectors to domestic firms .
3) requirement of a minimum percent of local employees.
4) ceiling on repatriation of profits.
5) local sourcing requirements
6) stipulation for full or partial export of output to earn scarce foreign exchange.
Q10) what are the benefits of foreign direct investment
🔷 international capital allows countries to finance more investment than can be supported by domestic savings.
🔷 Since FDI involves setting up of production base ( in terms of factories, power plants, etc ) it generates direct employment in the recipient country.
🔷 FDI not only creates direct employment opportunity but also, through backward and forward linkages generate indirect employment opportunities.
🔷 Foreign direct investment also promote relatively higher wages for skilled jobs.
🔷 The foreign investment projects would act as a source of new tax revenue which can be used for development projects.
🔷it is likely that foreign investments enter into industries in which scale economies can be realised so that consumer prices might be lowered.
