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FDI and its Importance

Posted in Finance Articles, Total Reads: 40090 , Published on January 22, 2012

In the last two decades world has seen an extensive inflow of FDI or foreign direct investment into developing countries. More and more developing countries are competing with each other to attract this investment. Restrictions which were earlier in place on these investments are now being removed as the importance of FDI is being realized.

FDI has a major role to play in India’s economic development. The total FDI inflow in our country was US$27 billion in 2010-11. Over the past few years, many sectors have seen the growth of foreign investment. The Government is also coming out with new reforms to promote more and more of this investment.



What is FDI?

It refers to an investment made by a foreign individual or a company in the productive capacity of another country. It can be considered as the movement of capital across national frontiers in a manner that allows the investor to have a control over the investment. Firms that provide FDI are referred to as MNCs. The investors can invest in existing industries/business or can promote new industries. There can be two types of FDI- inward and outward. The cumulative of two, results in net FDI inflow. FDI is freely allowed in all the sectors except a few sectors, though in certain sectors FDI is not allowed beyond a ceiling.

Why is FDI needed?

FDI plays a major role in developing countries like India. They act as a long term source of capital as well as a source of advanced and developed technologies. The investors also bring along best global practices of management. As large amount of capital comes in through these investments more and more industries are set up. This helps in increasing employment. FDI also helps in promoting international trade. This investment is a non-debt, non-volatile investment and returns received on these are generally spent on the host country itself thus helping in the development of the country.

Some of the sectors that attract high FDI inflows in India are the hotel and tourism industry, insurance sector, telecommunication, real estate, retail, power, drugs, financial services, infrastructure and pollution control etc. FDI is not permitted in the following sectors:

  • Railways
  • Atomic energy
  • Defence
  • Coal and lignite

An investor has to take a decision regarding the following aspects while investing:

  • Exchange Rate - The stronger the foreign currency is in comparison to that of the host country, lesser will be the amount of investment required. In other words, depreciation of currency in the host country will lead to more investments.
  • Market Size - This refers to the GDP growth. Developing and emerging countries are more likely to attract investments.
  • Infrastructure - Investors will invest in a country if they think that the country has suitable infrastructure to support the business.
  • Tax regime - MNCs are subject to tax in both the parent as well as host country. The host country which attempts to reduce this double taxation of MNCs will attract more FDI.
  • Labour market conditions - The educational levels of the labour as well as the wage rates also play a major role in determining the flow of FDI.
  • Financial and economic stability
  • Political stability

Following are some of the sectors in our country which attract massive FDI investments:

Retail Sector

This industry accounts for 13% of country’s GDP. Retail outlets acts as an interface between the producers and the consumers of a good. Indian government liberalized FDI in 2005 in this sector to 100%, thus enabling foreign investors to set up retail companies in India.

Retail industry is divided into organised and unorganised sectors. Organised sectors include hypermarkets and retail chains whereas unorganised sector include local kirana shops (mom and pop stores). The latter is more prevalent in India. Due to massive development taking place, organised sector is increasing its foothold in the country. Since advanced technology and management structure is used with foreign investments the price of the goods in the organised retail industry falls and productivity of the firm increases. Today modern retail outlets provide everything from basic amenities to luxury goods. They also provide consumer with a wide variety. They have become the one-stop shop for customers. This trend is destroying the sales of unorganised retail sector. Therefore on one hand FDI helps in reducing prices of the manufactured goods and on the other, it is rendering our unorganized retail sector paralyzed. The government has recently made it mandatory for foreign investors in multi-brand retail sector to do their bulk sourcing from small farmers. With this move government is preventing wipe-out of shopkeepers and small retailers.

Manufacturing Sector

Government has allowed 100% FDI in this sector except in defence industry and cigarette manufacturing. Foreign investments in this sector will help in employment of semi-skilled labour by providing them with access to developed technology.

Real Estate, Construction Development and Tourism

Any country’s growth and development is determined by its infrastructure. Due to increasing population and migration of people from rural to urban areas, the real estate sector is booming. Tourism industry is one of the major earners of foreign exchange for the country. It has a huge potential for our economy. It is also one of the major sectors in employment. Large amount of investments are needed to build roads, bridges, infrastructure so as to promote overall economic development of the country.

Power Sector

Power is considered most crucial sector for development. Since public sector alone was not able to meet the demands, investments from private and foreign investors was encouraged. Power generation, transmission and distribution are main areas of consideration. India has a vast scope of development in hydel power, nuclear power, solar power, thermal energy as well as in wind energy. Renewable sources of energy require vast amount of investments for research and development.


FDI, thus on one hand helps in increasing the output through usage of advanced technology and management techniques and on the other it is a threat to local companies in the country. Government should take steps in the direction of integrating foreign investors with local businesses. This will help in overall economic development as well as preservation of country’s heritage. MNCs should be allowed to set up in such a manner that they help increase the standard of living of our country instead of sole profit making.

The Article has been written by Akriti Gupta of Welingkar Institute, Mumbai

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