Risks in FDI

FDI Introduction
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 shortterm capital as shown in the balance of payments FDI is NOT permitted in the nuclear, railway, arms, coal and lignite or mining industries

Types of FDI
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.

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
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 Risks Classification

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

Classification cont.
Type of Risk Measures

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: Debt interest service ratios, debt/GDP ratios, The Risk arising from a decision by a foreign import coverage government to restrict capital movements. Restrictions could make it difficult to repatriate profits, dividends, or capital. Exchange Risk: Degree of over/under valuation of currency, An unexpected adverse movement in the relative inflation, interest rates, money exchange rate. Exchange risk includes an supply growth rate unexpected change in currency regime such as a change from a fixed to a floating exchange rate

Classification cont.
Type of Risk Location or Neighborhood Risk: Spillover effects caused by problems in a region, in a countrys trading partner, or in countries with similar perceived characteristics. Measures Geographic position, Trading partners, international trading alliances, size, borders, and distance from economically or politically important countries or regions

Sovereign Risk: Govt. repayment performance, potential A government becomes unwilling or unable costs to the borrowing government of debt to meet its loan obligations, or reneges on repudiation loans it guarantees. Sovereign risk can relate to transfer risk or political risks in various situations. Political Risk: Type of political structure, range & diversity Risk of change in political institutions of ethnic structure, civil or external strife stemming from change in government incidents control, social fabric, or other non-economic factor such as internal and external conflicts, expropriation risk

FDI Risks- Another Perspective

Investors Perspective : FDI may be exposed to risks ( e.g. fire ). Recipients Perspective : FDI may represent a risk ( e.g. oil spill ).

Prominent Cases

2010 BP/ Deepwater Horizon oil spill ( environmental damage ) 2010 Novartis / Wage inequality, discrimination ( labour law ) 2010 IBM, Fujitsu, Ford, GM, UBS, Barclays ( apartheid SA ) 2008 CS/ Soccer balls ( child labour ) 2006-08 TATA ( expropriation protests, Singur factory pullout ) 1990s Nike/ Apparel ( Sweat shops, HR issues )

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Typical FDI Risks

Typical FDI Risks cont.

Internal Threats Wage Inequality Excess working hours HR violations, complicity External Threats Financial crisis Sluggish demand Natural disasters

Toxic emissions
Violation of legal standards Project failure Bribery Lack of innovation Product liability issues

Global warming
Expropriation Freezing of assets Rapid technology change Civil war Cultural clash

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Reduction of FDI Risks

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.

FDI in Indian Retail Industry

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)

Concerns about 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

Benefits of 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

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