Need for FDI in developing countries
Foreign Direct Investment’s Impact on Developing Countries
Need for FDI in developing countries: Because many developing nations lack the required resources to develop certain industries, they allow foreign money to engage in certain areas. Of course, they also guarantee that industries with national security implications, such as defence, are excluded from the list of areas where foreign direct investment is permitted.
Many nations gain from opening their economies since they need funds and may lack the knowledge to begin profitable enterprises in certain industries. Finally, foreign direct investment may be utilised to offset the cost of costly imports while also encouraging exports. After all, every developing nation (save those with substantial oil reserves) must pay for its oil imports in dollars, thus foreign direct investment aids in the accumulation of hard currency.
Foreign Direct Investment’s Negative Impact on Developing Countries
Allowing foreign direct investment into developing nations has a number of drawbacks. However, developing nations gain from inflows of dollars and much-needed capital that is not accessible locally. Outflows of dollars are also possible since international corporations often repatriate a portion or all of their earnings back to their home countries.
This is why developing nations should be cautious about admitting all foreign direct investment. To avoid this, many developing nations impose restrictions on foreign direct investment in industries where money is desperately needed but where the developing country lacks expertise. Furthermore, many emerging nations maintain capital restrictions on the capital account (which prohibit wholesale repatriation of both profits and investment) and should loosen the existing count, which only repatriates earnings, and only a portion of them.
Need for FDI in developing countries
What does this mean for underdeveloped countries?
For developing nations, FDI has become a significant source of private foreign money. It differs from other main forms of external private capital flows in that it is primarily driven by the investors’ long-term expectations for profit in industrial operations over which they have direct control.
Foreign bank lending and portfolio investment, on the other hand, are not invested in activities controlled by banks or portfolio investors, who are often motivated by short-term profit considerations that can be influenced by a variety of factors (for example, interest rates) and are prone to herd behaviour. The trend of bank lending and portfolio equity investment, on the one hand, and FDI, on the other, to Asian nations hit by financial instability in 1997, exemplifies these differences: In 1997, FDI flows to the five most impacted nations remained positive in all instances and only marginally decreased for the group as a whole, although bank loan and portfolio equity investment flows fell substantially and even turned negative.
While FDI is primarily used to invest in manufacturing facilities, it has a considerably higher impact on developing nations. Not only may FDI increase investible resources and capital creation, but it can also be used to transfer production technologies, skills, inventive capacity, organisational and management practises, and access worldwide marketing networks across places.
Enterprises that are part of transnational systems (consisting of parent firms and affiliates) or are directly linked to such systems through nonequity arrangements are the first to benefit, but if the environment is favourable, these assets can also be transferred to domestic firms and the wider economies of host countries. The higher the ability of local companies to catch spillovers (that is, indirect impacts) from the presence of and competition from foreign enterprises, the more likely the qualities of FDI that increase productivity and competitiveness will spread. Policies important in these cases, as well as in attracting multinational firms to situate their operations in a given country in the first place.
Foreign Investment’s Advantages
As a result, the fact that developing nations favour FDI becomes evident when one examines the deep and long-term character of these flows. This isn’t to say that investments in the stock and bond markets aren’t welcome. Because many developing nations have huge current account deficits that must be paid with dollars, this is the case. To put it another way, current account deficits are the difference between a country’s imports and exports, and since many developing nations buy more than they sell, a method to fund the deficit is required.
This is made feasible through bond and equity investments. FDI, on the other hand, is ideal for creating employment and laying the groundwork for future development. Furthermore, FDI has the extra benefit of transferring technology and expertise to emerging nations, which is helpful to them. As can be seen from this reasoning, both FDI and hot money are desirable to developing nations in terms of their utility.
Foreign Investment’s Drawbacks
The disadvantages of these investments are that whenever there is a crisis, such as the recent economic crisis or the Asian financial crisis of 1997, there tends to be outward flows of foreign capital as panicked investors flee developing country markets, fearing that their investments will be eroded by the crisis. This is the most significant disadvantage of foreign investment.
Furthermore, FDI or capital investment may leave developing nations if they have complete capital account convertibility, or the ability for foreign corporations to swiftly convert their holdings in native currencies to their home currency, which is often the US dollar. As a result, governments must fully comprehend the ramifications of FDI and Hot Money before committing to open up their economies. Indeed, as China’s and India’s experiences show, emerging nations must gradually open up their economies and carefully regulate hot money flows in order to survive currency shocks and liquidity shortages.