82  Foreign Direct Investment

82.1 Concept

Foreign Direct Investment (FDI) = cross-border investment by a resident in one economy with the objective of obtaining a lasting interest (≥ 10 % equity) in an enterprise resident in another economy — IMF / OECD definition. John H. Dunning is the most cited theorist.

82.2 FDI vs FPI

TipFDI vs FPI
Dimension FDI FPI (Foreign Portfolio)
Equity threshold ≥ 10 % < 10 %
Intent Control / strategic Passive returns
Horizon Long-term Short / medium
Volatility Low High (hot money)
Examples Greenfield, M&A Stocks, bonds, FIIs

82.3 Types of FDI

TipFDI types
  • Horizontal — same industry abroad (Toyota US plant).
  • Vertical — backward (raw materials) / forward (distribution).
  • Conglomerate — unrelated business.
  • Greenfield — build new facility.
  • Brownfield / Acquisition — buy existing.
  • Inward — coming into country.
  • Outward — going out of country.

82.4 FDI Theories

TipMain FDI theories
  • Hymer (1960) — Market imperfections; firm-specific advantages.
  • Vernon’s PLC (1966) — investment follows product maturity stage.
  • Buckley & Casson — Internalisation (1976) — internalise across borders.
  • Dunning’s OLI / Eclectic Paradigm (1977-1988) — Ownership · Location · Internalisation.
  • Uppsala Model — Johanson & Vahlne (1977) — incremental, gradual.
  • Born Globals — Knight & Cavusgil (1996).
  • LLL — Linkage, Leverage, Learning — Mathews (2002) for emerging markets.
  • Spring-board Theory — Luo & Tung (2007) — emerging-market firms use intl as springboard.

82.5 Dunning’s OLI Paradigm

TipOLI components
  • O — Ownership advantages — proprietary tech, brand, mgmt skills.
  • L — Location advantages — host-country factors (resources, market, costs, infrastructure).
  • I — Internalisation advantages — reasons to internalise (vs license).

If only O → license/export. If O+I → license risky → contract / FDI. If O+L+I → FDI is optimal.

82.6 Costs and Benefits of FDI

TipFDI benefits to host
  • Capital inflow.
  • Technology and know-how transfer.
  • Employment generation.
  • Tax revenues.
  • Spillovers to local firms.
  • Export competitiveness.
  • Improved corporate governance.
TipFDI costs to host
  • Crowding out of local firms.
  • Profit repatriation.
  • Loss of sovereignty.
  • Cultural homogenisation.
  • Race to bottom — tax/labour.
  • Strategic-sector concerns — defence, telecom.

82.7 India’s FDI Policy

TipIndia FDI policy
  • Pre-1991: FDI restricted (FERA 1973).
  • 1991 reforms: Manmohan Singh; sector liberalisation.
  • FEMA 1999 — replaced FERA.
  • Two routes:
    • Automatic route — no prior approval; up to permitted caps.
    • Government route — DPIIT approval required.
  • DPIIT — Department for Promotion of Industry and Internal Trade.
  • Sector caps:
    • 100 % automatic: most manufacturing, single-brand retail, IT, infrastructure.
    • 74 % automatic: defence.
    • 100 % auto (B2B e-commerce, no inventory model).
    • 49 % auto: insurance (now 74 %), private banks.
    • 26 % cap on print media.
  • Prohibited sectors: lottery, gambling, tobacco mfg, chit funds, real-estate (residential), railway operations.
  • Press Note 3 (2020) — all neighbouring-country FDI via government route.
  • FDI inflow: ~$72 bn FY 21-22, ~$70 bn FY 22-23.
  • Top sources: Mauritius, Singapore, USA, Netherlands, Japan.
  • Top sectors: Services, Computer Software, Telecom, Trading, Construction.

82.9 Modern Trends

TipModern FDI trends
  • Reshoring / Friend-shoring.
  • Green FDI / climate finance.
  • PLI Scheme (2020) attracting electronics, semiconductors, EVs.
  • OECD Pillar 2 — 15 % global minimum tax (since 2024).
  • Investment screening — strategic sectors.
  • Geopolitical de-risking — China-decoupling.
  • DPI exports as soft-FDI.
  • Indian outbound FDI — Tata, Reliance, Adani, Sun Pharma.

82.10 Practice Questions

Q 01DefinitionEasy

FDI is defined by IMF/OECD as ownership of at least:

  • A10 %
  • B25 %
  • C51 %
  • D100 %
View solution
Correct Option: A
≥10 % equity for FDI; less is FPI.
Q 02OLIMedium

OLI Paradigm is by:

  • AJohn Dunning
  • BHymer
  • CVernon
  • DBuckley
View solution
Correct Option: A
Dunning Eclectic 1977-1988.
Q 03HorizontalEasy

Toyota setting up a plant in the US is:

  • AHorizontal FDI
  • BVertical FDI
  • CFPI
  • DConglomerate
View solution
Correct Option: A
Same industry abroad.
Q 04DPIITMedium

India's FDI policy is administered by:

  • ADPIIT
  • BRBI
  • CSEBI
  • DCCI
View solution
Correct Option: A
Department for Promotion of Industry and Internal Trade.
Q 05FEMAMedium

FEMA replaced:

  • AFERA
  • BFCRA
  • CSEBI Act
  • DBanking Act
View solution
Correct Option: A
FERA 1973 → FEMA 1999.
Q 06MauritiusMedium

Historically top source of FDI to India:

  • AMauritius
  • BUSA
  • CChina
  • DRussia
View solution
Correct Option: A
Mauritius (tax-treaty routing).
Q 07HymerHard

Market imperfections theory of FDI (1960) is by:

  • AStephen Hymer
  • BDunning
  • CVernon
  • DBuckley
View solution
Correct Option: A
Stephen Hymer (1960).
Q 08UppsalaHard

Uppsala Model is by:

  • AJohanson & Vahlne
  • BMathews
  • CKnight
  • DLuo
View solution
Correct Option: A
Johanson & Vahlne (1977).
Q 09Defence capHard

FDI cap in defence sector (automatic route, current) is:

  • A26 %
  • B49 %
  • C74 %
  • D100 %
View solution
Correct Option: C
74 % automatic; above via government route.
Q 10Press Note 3Hard

Press Note 3 (2020) requires FDI from neighbouring countries to come via:

  • AGovernment route
  • BAutomatic route
  • CSEZ route
  • DBanned
View solution
Correct Option: A
Targeted China-FDI post-Galwan; April 2020.
Q 11UNCTADMedium

Annual reference report on FDI is by:

  • AUNCTAD
  • BWTO
  • CIMF
  • DOECD
View solution
Correct Option: A
World Investment Report — UNCTAD.
Q 12BuckleyHard

Internalisation theory (1976) is by:

  • ABuckley & Casson
  • BDunning
  • CHymer
  • DVernon
View solution
Correct Option: A
Peter Buckley & Mark Casson.
Q 13LLLHard

LLL framework for emerging-market firms is by:

  • AJohn Mathews
  • BLuo & Tung
  • CDunning
  • DHymer
View solution
Correct Option: A
Linkage, Leverage, Learning (Mathews 2002).
Q 14FPIEasy

FPI in India is regulated mainly by:

  • ASEBI
  • BDPIIT
  • CCCI
  • DFSSAI
View solution
Correct Option: A
SEBI (Foreign Portfolio Investors regulations 2019).
Q 15Born globalsHard

"Born globals" research is by:

  • AKnight & Cavusgil
  • BVernon
  • CBuckley
  • DUppsala
View solution
Correct Option: A
Gary Knight & S. Tamer Cavusgil (1996).

82.10.1 Advanced Format Questions

AR 1Assertion-ReasonHard

A: FDI implies lasting interest.
R: IMF defines lasting interest as ≥ 10% equity stake.

  • ABoth true; R explains A
  • BBoth true; R does not explain A
  • CA true, R false
  • DA false, R true
View solution
Correct Option: A
S 1Statement-basedMedium

FDI theories: (i) Hymer. (ii) Vernon. (iii) Buckley-Casson. (iv) Dunning OLI.

  • AAll four
  • B(i) and (ii) only
  • C(iii) and (iv) only
  • D(iv) only
View solution
Correct Option: A
S 2Statement-basedHard

Indian FDI features: (i) FEMA 1999. (ii) DPIIT nodal. (iii) Press Note 3 (2020). (iv) Sector caps.

  • AAll four
  • B(i) and (ii) only
  • C(iii) and (iv) only
  • D(i), (ii), (iii) only
View solution
Correct Option: A

82.11 Quick Recall

ImportantQuick recall
  • FDI ≥ 10 % equity (IMF/OECD); FPI < 10 %.
  • Types: Horizontal · Vertical · Conglomerate · Greenfield · Brownfield/M&A · Inward/Outward.
  • Theories: Hymer (1960) · Vernon PLC (1966) · Buckley-Casson Internalisation (1976) · Dunning OLI (1977-88) · Uppsala (Johanson-Vahlne 1977) · Born Globals (Knight-Cavusgil 1996) · LLL (Mathews 2002) · Springboard (Luo-Tung 2007).
  • OLI: Ownership · Location · Internalisation.
  • Pros: capital · tech · jobs · taxes · spillovers · exports · governance.
  • Cons: crowding out · repatriation · sovereignty · culture · race-to-bottom.
  • India: FERA 1973 → FEMA 1999 · DPIIT · automatic vs government route · sector caps · Press Note 3 (2020) for neighbours · top sources Mauritius/Singapore/USA/Netherlands/Japan.
  • Reports: UNCTAD World Investment Report.
  • Modern: Reshoring · Green FDI · PLI (2020) · OECD Pillar 2 (15 %) · investment screening · DPI as soft-FDI · Indian outbound (Tata, Reliance, Adani).