Risks in FDI

Foreign Direct Investment (FDI)  refers to the net inflows of investment 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.  It is the sum of equity capital, other long-term capital, and short- term capital as shown in the balance of payments  FDI is “NOT permitted” in the nuclear, railway, arms, coal and lignite or mining industries FDI Introduction

 Horizontal FDI Horizontal FDI refers to producing the same products or offering the same services in a host country as firms do at home. In horizontal FDI model, the main objective to be met is how best to serve the host market (abroad) E.g. Ford assembles cars in the United States. Through horizontal FDI, it does the same thing in different host countries such as the United Kingdom (UK), France, Taiwan, Saudi Arabia, and Australia.  Vertical FDI Vertical FDI arises when a multinational firm fragments the production process internationally, thereby locating each stage of production in the country where it can be done at the least cost.In vertical FDI models, the primary objective of a firm is how best to serve the domestic (home) market. Types of FDI

The foreign direct investor may acquire voting power of an enterprise in an economy through any of the following methods:  by incorporating a wholly owned subsidiary or company  by acquiring shares in an associated enterprise  through a merger or an acquisition of an unrelated enterprise  participating in an equity joint venture with another investor or enterprise. FDI Methods

The foreign direct investor may acquire voting power of an enterprise in an economy through any of the following methods:  by incorporating a wholly owned subsidiary or company  by acquiring shares in an associated enterprise  through a merger or an acquisition of an unrelated enterprise  participating in an equity joint venture with another investor or enterprise. FDI Methods

FDI risks are primarily country specific. FDI risks arise from variety of factors such as national differences in economic structures, policies, socio-political institutions, geography and currencies Following Risks are the principal hazards that affect the spatial and sectoral allocation of FDI:  Economic Risk  Political Risks  Transfer Risk  Exchange Rate Risks  Sovereign Risks  Location/Neighborhood Risks FDI Risks Classification

Classification cont. Type of RiskMeasures Economic Risk: A significant change in economic structure or growth rate that produces a major change in the expected returns of an investment Fiscal: Size & detail of govt. expenditures, tax policy, debt situation Monetary: Inflation, real and nominal interest rate. Industrial productivity, unemployment Transfer Risk: The Risk arising from a decision by a foreign government to restrict capital movements. Restrictions could make it difficult to repatriate profits, dividends, or capital. Debt interest service ratios, debt/GDP ratios, import coverage Exchange Risk: An unexpected adverse movement in the exchange rate. Exchange risk includes an unexpected change in currency regime such as a change from a fixed to a floating exchange rate Degree of over/under valuation of currency, relative inflation, interest rates, money supply growth rate

Classification cont. Type of RiskMeasures Location or Neighborhood Risk: Spillover effects caused by problems in a region, in a country’s trading partner, or in countries with similar perceived characteristics. Geographic position, Trading partners, international trading alliances, size, borders, and distance from economically or politically important countries or regions Sovereign Risk: A government becomes unwilling or unable to meet its loan obligations, or reneges on loans it guarantees. Sovereign risk can relate to transfer risk or political risks in various situations. Govt. repayment performance, potential costs to the borrowing government of debt repudiation Political Risk: Risk of change in political institutions stemming from change in government control, social fabric, or other non-economic factor such as internal and external conflicts, expropriation risk Type of political structure, range & diversity of ethnic structure, civil or external strife incidents

FDI Risks- Another Perspective Investor’s Perspective : FDI may be exposed to risks ( e.g. fire ). Recipient’s Perspective : FDI may represent a risk ( e.g. oil spill ).

Prominent Cases BP/ “Deepwater Horizon” oil spill ( environmental damage ) Novartis / Wage inequality, discrimination ( labour law ) IBM, Fujitsu, Ford, GM, UBS, Barclays ( apartheid SA ) CS/ Soccer balls ( child labour ) TATA ( expropriation protests, Singur factory pullout ) -1990’s Nike/ Apparel ( “Sweat shops”, HR issues )

Typical FDI Risks

Typical FDI Risks cont. Internal Threats External Threats Wage InequalityFinancial crisis Excess working hoursSluggish demand HR violations, complicityNatural disasters Toxic emissionsGlobal warming Violation of legal standardsExpropriation Project failureFreezing of assets BriberyRapid technology change Lack of innovationCivil war Product liability issuesCultural clash

In general, foreign investors reduce their exposure to risks by limiting the volume and direction of FDI using below strategies:  Hedging strategies -In hedging strategies, firms minimize risk either by diversifying holdings across products and places or by apportioning investments in capacity across places.  Internalization strategies -In internalization strategies, investors absorb would-be foreign production into existing facilities in the face of exchange rate and price uncertainty. Reduction of FDI Risks

 FDI in the retail sector in India is restricted.  In 2006 govt. eased the policy allowing 51% FDI through the single brand retail route.  Since then there has been an steady increase in FDI.  By middle of 2010 FDI in single brand stood at $ 195 million.  By 2013 total retail sales is expected to touch $ 535 billion (AT Kearney)  Indian retail sector is organized into three categories  Single brand retail  Multiple brand retail  Cash and carry (Wholesale retail) FDI in Indian Retail Industry

 Potential Impact of large foreign firms on employment losses  Retail sector is the second largest employer in India  Employs 7.2% of total workforce (33.1 million jobs)  Unfair competition resulting in large scale exit of incumbent domestic retailers, specially the small family-owned businesses  Domestic incumbent firms in the organized sector is an infant industry Concerns about FDI in Indian Retail Industry

 FDI can help in tackling Inflation especially in food prices  Technical know-how from foreign firms, such as warehousing technologies and distribution systems can improve supply chain efficiency in India particularly for agricultural products  Better linkages between supply and demand will improve price signals that farmers receive  Enhance agricultural and other exports Benefits of FDI in Indian Retail Industry

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