Define Foreign direct investment (FDI)

Foreign direct investment (FDI) is a direct investment into production or business in a country by an individual or company of another country, either by buying a company in the target country or by expanding operations of an existing business in that country. Foreign direct investment is in contrast to portfolio investment which is a passive investment in the securities of another country such as stocks and bonds.

Broadly, foreign direct investment includes "mergers and acquisitions, building new facilities, reinvesting profits earned from overseas operations and intra company loans". In a narrow sense, foreign direct investment refers just to building new facilities. The numerical FDI figures based on varied definitions are not easily comparable.

FDI is defined as the net inflows of investment (inflow minus outflow) to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor. FDI is the sum of equity capital, other long-term capital, and short-term capital as shown the balance of payments. FDI usually involves participation in management, joint-venture, transfer of technology and expertise.

There are two types of FDI: inward and outward, resulting in a net FDI inflow (positive or negative) and "stock of foreign direct investment", which is the cumulative number for a given period. Direct investment excludes investment through purchase of shares. FDI is one example of international factor movements.

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What are the Functions of the Foreign Exchange Market?

The foreign exchange market performs the following important functions:

Transfer Function:

The basic function of the foreign exchange market is to facilitate the conversion of one currency into another, i.e., to accomplish transfers of purchasing power between two countries. This transfer of purchasing power is affected through a variety of credit instruments, such as telegraphic transfers, bank drafts and foreign bills.

In performing the transfer function, the foreign exchange market carries out payments internationally by clearing debts in both directions simultaneously, analogous to domestic clearings.

Credit Function:

Another function of the foreign exchange market is to provide credit, both national and international, to promote foreign trade. Obviously, when foreign bills of exchange are used in international payments, a credit for about 3 months, till their maturity, is required.

Hedging Function:

A third function of the foreign exchange market is to hedge foreign exchange risks. In a free exchange market when exchange rates, i.e., the price of one currency in terms of another currency, change, there may be a gain or loss to the party concerned. Under this condition, a person or a firm undertakes a great exchange risk if there are huge amounts of net claims or net liabilities which are to be met in foreign money.

Exchange risk as such should be avoided or reduced. For this the exchange market provides facilities for hedging anticipated or actual claims or liabilities through forward contracts in exchange. A forward contract which is normally for three months is a contract to buy or sell foreign exchange against another currency at some fixed date in the future at a price agreed upon now. No money passes at the time of the contract. But the contract makes it possible to ignore any likely changes in exchange rate.

The existence of a forward market thus makes it possible to hedge an exchange position.

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Define foreign exchange market

The foreign exchange market is a global decentralized market for the trading of currencies. The main participants in this market are the larger international banks. Financial centers around the world function as anchors of trading between a wide range of multiple types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies.

The foreign exchange market works through financial institutions, and it operates on several levels. Behind the scenes banks turn to a smaller number of financial firms known as “dealers,” who are actively involved in large quantities of foreign exchange trading. Most foreign exchange dealers are banks, so this behind-the-scenes market is sometimes called the “interbank market”, although a few insurance companies and other kinds of financial firms are involved. Trades between foreign exchange dealers can be very large, involving hundreds of millions of dollars. Because of the sovereignty issue when involving two currencies, Forex has little (if any) supervisory entity regulating its actions.

The foreign exchange market is unique because of the following characteristics:

1.    Its huge trading volume representing the largest asset class in the world leading to high liquidity;

2.   Its geographical dispersion;

3.   Its continuous operation: 24 hours a day except weekends, i.e., trading from 22:00 GMT on Sunday (Sydney) until 22:00 GMT Friday (New York);

4.   The variety of factors that affect exchange rates;

5.   The low margins of relative profit compared with other markets of fixed income; and

6.   The use of leverage to enhance profit and loss margins and with respect to account size.

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What are the effects of FDI inflows in case of Bangladesh

There are some positive and negative effects of Foreign Direct Investments. These are:-

Possible positive effects:

1.    Foreign direct investment (FDI) provides capital which is usually missing in the target country

2.   Long term capital is suitable for economic development

3.   Foreign investors are able to finance their investments projects better and often cheaper

4.   Foreign corporations create new workplaces

5.   FDI bring new technologies that are usually not available in the target country. There is empirical evidence that there are spill-over effects as the new technologies usually spread beyond the foreign corporations

6.   Foreign corporations provide better access to foreign markets Ex. Foreign corporations can provide useful contacts even for their domestic subcontractors

7.   Foreign corporations bring new know-how and managerial skills into the target country Again, there is a spill-over effects – as people leave the corporations they leave with the knowledge and know-how they accumulated

8.   Foreign corporations can help to change the economic structure of the target country

9.   With a good economic strategy governments can attract companies from promising and innovative sectors

Possible Negative effects:

1.    Foreign corporations may buy a local company in order to shut it down (and gain monopoly for example)

2.   “Crowding out” effect: We can see this effect if the foreign corporations target the domestic market and domestic corporations are not able to compete with these corporations

3.   Foreign corporations may cut working positions (privatization deals or M&A transactions)

4.   Foreign corporations have a tendency to use their usual suppliers which can lead to increased imports (no problem if the production is export driven)

5.   Repatriation of the profits can be stressful on the balance of payments

6.   The high growth of wages in foreign corporations can influence a similar growth in the domestic corporations which are not able to cover this growth with the growth of productivity- The result is the decreasing competitiveness of domestic companies.

7.   Missing tax revenues- If the foreign corporations receive tax holidays or similar provisions

8.   The emergence of a dual economy-The economy will contain a developed foreign sector and an underdeveloped domestic sector.

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