5  Foreign direct investment (FDI) and Foreign portfolio investment (FPI); Types of FDI, Costs and benefits of FDI to home and host countries; Trends in FDI; India’s FDI policy

5.1 Concept of Foreign Investment

When residents of one country acquire financial or real assets in another country, the flow is called foreign investment. The IMF’s Balance of Payments Manual divides it into two main categories on the basis of control and purpose: Foreign Direct Investment (FDI) — investment giving the investor effective managerial control over the host enterprise (≥ 10 % voting equity) — and Foreign Portfolio Investment (FPI) — investment in financial assets without the intent of management control.

TipThree IMF Categories of Cross-Border Investment
Category Defining feature Threshold Time horizon
Foreign Direct Investment Lasting interest and management control ≥ 10 % voting equity Long-term
Foreign Portfolio Investment Pure financial return; no control < 10 % voting equity Short-to-medium term
Other Investment Loans, banking flows, trade credit n.a. Variable

5.2 Forms of FDI

FDI can take several legal and operational forms.

TipForms of FDI
Form Description Indian illustration
Greenfield investment Setting up a new enterprise from scratch Hyundai’s plant in Sriperumbudur
Brownfield investment Acquiring or upgrading an existing facility Tata Steel’s acquisition of Corus
Cross-border M&A Buying or merging with a foreign firm Walmart-Flipkart
Joint venture with majority equity Partnership with a local firm; foreign partner > 10 % Maruti Suzuki
Reinvested earnings Foreign affiliate’s profits ploughed back Many MNC subsidiaries in India

A separate distinction: horizontal FDI replicates home-country activity abroad (Toyota making cars in the US); vertical FDI moves a stage of the value chain abroad (backward to secure inputs, forward to secure distribution); conglomerate FDI is unrelated to existing business.

5.3 Routes of FDI in India

The Government of India routes FDI proposals through two channels:

  • Automatic route — no prior government approval; investor files post-investment intimation with RBI. Most sectors fall here, with sectoral caps.
  • Government route — prior approval from the relevant administrative ministry. Sensitive sectors: defence (above 74 %), broadcasting content, print media, any investment from a country sharing a land border with India (Press Note 3 of 2020).

A negative list prohibits FDI altogether: gambling, lottery, atomic energy, chit funds, Nidhi, tobacco manufacture, real-estate trading (other than construction development), railway operations (with exceptions).

5.4 Theories of FDI

Why do firms invest abroad rather than simply export or license? Five strands of theory answer:

5.4.1 Hymer’s Monopolistic Advantage Theory (1960)

Stephen Hymer (PhD thesis 1960, published 1976) argued that a firm investing abroad must possess firm-specific advantages — superior technology, brand, marketing skill, scale economies — strong enough to overcome the liability of foreignness.

5.4.2 Vernon’s Product Cycle Theory (1966)

Already discussed in trade theories. As a product matures, production migrates from the innovator country to lower-cost economies; FDI is the vehicle.

5.4.3 Internalisation Theory — Buckley & Casson (1976)

Peter Buckley and Mark Casson (The Future of the Multinational Enterprise, 1976) — when markets for an intermediate good or knowledge fail, the firm internalises the transaction by setting up a wholly-owned subsidiary. FDI is a response to market failure in licensing or arm’s-length trade.

5.4.4 Aliber’s Currency Areas Theory (1970)

Robert Aliber linked FDI to currency strength: firms based in strong-currency countries can borrow more cheaply on world markets and therefore invest abroad more competitively than host-country firms.

5.4.5 Dunning’s Eclectic Paradigm — OLI (1977 onward)

John Dunning’s eclectic / OLI paradigm synthesises earlier theories. A firm undertakes FDI when all three OLI advantages are present:

TipDunning’s OLI Paradigm
Letter Advantage Illustrative content
O Ownership Firm-specific advantage — patents, brand, technology, management skill
L Location Host-country advantage — cheap labour, market size, raw material, tax incentive
I Internalisation Gain from in-house production rather than licensing; protects know-how

When only O is present → license. O + I without L → export. Only O + L + I all present → FDI.

flowchart LR
  O[Only O] --> Lic[License]
  OI[O + I] --> Exp[Export]
  OLI[O + L + I] --> FDI[Foreign Direct<br/>Investment]
    classDef default fill:#003366,color:#ffffff,stroke:#ffcc00,stroke-width:3px,rx:10px,ry:10px;

5.5 Dunning’s Four Motives for FDI

Dunning (1993) classified FDI motives:

TipFour Motives for FDI
Motive What the investor seeks Illustration
Market-seeking Access to host-country market Suzuki in India to sell to Indian consumers
Resource-seeking Cheaper or unique inputs Oil majors in Middle East; mining in Africa
Efficiency-seeking Lower cost of production; scale Nike outsourcing manufacture to Vietnam
Strategic asset-seeking Acquire technology, brands, R&D capability Tata Motors’ acquisition of Jaguar Land Rover (2008)

Mnemonic: MRES (Market, Resource, Efficiency, Strategic-asset).

5.6 Benefits and Costs to the Host Country

TipFDI — Host-Country Benefits and Costs
Benefits Costs
Capital inflow without debt obligation Profit repatriation drains foreign exchange
Transfer of technology and know-how Crowding-out of domestic firms
Employment generation Pressure on local labour standards
Managerial and skill upgrade Possible suppression of indigenous R&D
Export earnings and BoP support Sovereignty and regulatory concerns
Increased competition and consumer choice Cultural erosion in some sectors
Tax revenue and ancillary cluster development Transfer-pricing and tax-base erosion

5.7 Benefits and Costs to the Home Country

TipFDI — Home-Country Benefits and Costs
Benefits Costs
Higher returns from foreign operations Loss of domestic employment (“hollowing out”)
Access to foreign markets and resources Outflow of capital
Geographic diversification of risk Possible technology transfer to potential rivals
Strengthens home-country firms’ global position Tension with host-country regulators

5.8 Foreign Portfolio Investment (FPI)

FPI is the purchase of financial securities — equity below the 10 % threshold, government and corporate bonds, derivatives — by non-residents. FPI flows are managed by Foreign Portfolio Investors (FPIs), a SEBI category since 2014 (FPI Regulations, now 2019) that replaced the older FIIs / Sub-Accounts / QFIs.

Three features:

  • No managerial control — investor seeks return, not control.
  • High liquidity and reversibility — can exit overnight; hence “hot money”.
  • Sensitivity to global cues — US Fed rate decisions, risk-on/risk-off cycles, currency moves drive flows.

5.9 FDI vs FPI — Comparison

TipFDI vs FPI
Dimension FDI FPI
Objective Lasting interest and management control Financial return only
Equity threshold (IMF norm) ≥ 10 % < 10 %
Time horizon Long-term Short-to-medium
Reversibility Difficult, costly Easy, instant
Volatility Low High
Effect on real economy Builds capacity, employment, technology Provides liquidity, deepens markets
Sensitivity to global cues Moderate Very high
Indian regulator DPIIT + sectoral ministries + RBI SEBI + RBI

5.11 India’s FDI Policy

India progressively liberalised after 1991. The current framework rests on:

  • Consolidated FDI Policy by DPIIT (latest version periodically issued).
  • FEMA 1999 and Foreign Exchange Management (Non-Debt Instruments) Rules 2019.
  • Press Notes by DPIIT — Press Note 3 of 2020 introduced the land-border restriction.
TipIndicative FDI Caps and Routes (Selected Sectors)
Sector Cap Route
Most manufacturing 100 % Automatic
Single-brand retail 100 % Automatic (with conditions on local sourcing)
Multi-brand retail 51 % Government
Insurance 74 % Automatic (since 2021)
Defence Up to 74 % Automatic; beyond → Government
Banking — Private 74 % Automatic up to 49 %; Government beyond
Telecom 100 % Automatic (since 2021)
Civil aviation — Scheduled 100 % Automatic up to 49 %; Government beyond
Print media — News 26 % Government
Broadcasting content Various Mostly Government

(Caps update periodically; specific conditions apply per sector.)

5.12 Practice Questions

Q 01 FDI vs FPI Easy

Which of the following is not a feature distinguishing FDI from FPI?

  • AFDI carries managerial control; FPI does not
  • BFDI is long-term; FPI is short-term
  • CFDI is more reversible than FPI
  • DFDI is less volatile than FPI
View solution
Correct Option: C
FDI is less reversible than FPI — FPI can exit overnight through the secondary market.
Q 02 IMF Threshold Easy

As per the IMF benchmark, the minimum equity holding that classifies an investment as FDI is:

  • A5 per cent of voting power
  • B10 per cent of voting power
  • C25 per cent of voting power
  • D51 per cent of voting power
View solution
Correct Option: B
The IMF/OECD benchmark for FDI is 10 per cent of voting equity.
Q 03 Forms Easy

Which of the following is not a form of FDI?

  • AGreenfield investment
  • BCross-border merger and acquisition
  • CReinvested earnings of a foreign affiliate
  • DPurchase of 4 per cent equity in a listed foreign firm with no board representation
View solution
Correct Option: D
A < 10 % stake without control is FPI, not FDI.
Q 04 Theorists Medium

Match the FDI theorist with the central proposition:

Theorist Proposition
(i) Stephen Hymer (a) OLI — Ownership, Location, Internalisation
(ii) John Dunning (b) Strong-currency firms can invest abroad more cheaply
(iii) Buckley & Casson (c) FDI requires firm-specific monopolistic advantages
(iv) Robert Aliber (d) Internalisation as a response to market failure
  • A(i)-(c), (ii)-(a), (iii)-(d), (iv)-(b)
  • B(i)-(a), (ii)-(c), (iii)-(b), (iv)-(d)
  • C(i)-(d), (ii)-(b), (iii)-(a), (iv)-(c)
  • D(i)-(b), (ii)-(d), (iii)-(c), (iv)-(a)
View solution
Correct Option: A
Hymer — monopolistic advantage; Dunning — OLI; Buckley & Casson — internalisation; Aliber — currency areas.
Q 05 OLI Medium

Match each component of Dunning's OLI with its content:

OLI Content
(i) Ownership (a) Cheap labour, large market, raw material at host site
(ii) Location (b) Patents, brand, management skill possessed by the firm
(iii) Internalisation (c) Gains from in-house production over licensing
  • A(i)-(b), (ii)-(a), (iii)-(c)
  • B(i)-(a), (ii)-(b), (iii)-(c)
  • C(i)-(c), (ii)-(b), (iii)-(a)
  • D(i)-(b), (ii)-(c), (iii)-(a)
View solution
Correct Option: A
O = firm-specific advantages; L = host-country advantages; I = in-house gains.
Q 06 Motive Medium

"Tata Motors acquires Jaguar Land Rover in 2008 to gain access to its design capability, brand and global dealer network." This is best classified, in Dunning's typology, as:

  • AMarket-seeking
  • BResource-seeking
  • CEfficiency-seeking
  • DStrategic asset-seeking
View solution
Correct Option: D
Acquiring a brand, design and distribution network is strategic asset-seeking.
Q 07 Routes Medium

Under Press Note 3 of 2020, FDI from countries sharing a land border with India requires:

  • AAutomatic approval
  • BPrior Government approval
  • CSEBI clearance only
  • DNo FDI is permitted at all
View solution
Correct Option: B
All FDI from land-border countries (China, Pakistan, Bangladesh, Nepal, Bhutan, Myanmar, Afghanistan) requires Government route approval, regardless of sector.
Q 08 Prohibited Medium

FDI in India is prohibited in which of the following?

  • AInsurance
  • BTelecom
  • CLottery and gambling
  • DSingle-brand retail
View solution
Correct Option: C
Prohibited sectors include lottery, gambling, chit funds, Nidhi, atomic energy, tobacco manufacture, real-estate trading, railway operations (except permitted).
Q 09 Caps Medium

The FDI cap in the Indian insurance sector was raised in 2021 to:

  • A26 %
  • B49 %
  • C74 %
  • D100 %
View solution
Correct Option: C
The Finance Act 2021 raised the cap to 74 % under the automatic route.
Q 10 FPI Easy

FPI in India is regulated by:

  • ADPIIT
  • BSEBI and RBI
  • CIRDAI
  • DPFRDA
View solution
Correct Option: B
SEBI (FPI Regulations 2019) regulates the FPI category; RBI handles forex aspects.
Q 11 Hot money Easy

The expression "hot money" most closely refers to:

  • AFDI inflows
  • BFPI inflows that can reverse quickly
  • CCurrency in circulation
  • DBlack money
View solution
Correct Option: B
FPI is sometimes called "hot money" for its speed of reversal.
Q 12 Types Medium

A pharmaceutical MNC sets up a new R&D-and-manufacturing campus in Hyderabad. This is:

  • ABrownfield FDI
  • BGreenfield FDI
  • CFPI
  • DCross-border M&A
View solution
Correct Option: B
A new facility built from scratch is greenfield FDI.
Q 13 Sources Hard

After the 2016 protocol revision of the India-Mauritius DTAA, the largest single source of FDI in India by inflow value has typically been:

  • AUSA
  • BSingapore
  • CJapan
  • DUK
View solution
Correct Option: B
Singapore has overtaken Mauritius as the top FDI source since the 2016 DTAA protocol shifted treaty benefits.
Q 14 Motives sequence Hard

Arrange Dunning's four FDI motives in the order in which a typical multinational's foreign operations historically expand:

(i) Resource-seeking
(ii) Market-seeking
(iii) Efficiency-seeking
(iv) Strategic asset-seeking

  • A(i), (ii), (iii), (iv)
  • B(ii), (i), (iv), (iii)
  • C(iv), (iii), (ii), (i)
  • D(iii), (iv), (i), (ii)
View solution
Correct Option: A
Textbook order: Resource → Market → Efficiency → Strategic asset, reflecting deepening internationalisation.
Q 15 Host Benefit Easy

Which of the following is not typically a benefit of FDI to the host country?

  • ACapital inflow without debt obligation
  • BTechnology transfer
  • CProfit repatriation
  • DEmployment generation
View solution
Correct Option: C
Profit repatriation is a cost to the host country (forex outflow), not a benefit.
Q 16 Home Cost Medium

The "hollowing out" concern relates to FDI's effect on the:

  • AHost country's exchange rate
  • BHome country's domestic employment
  • CHost country's tax revenue
  • DWTO compliance
View solution
Correct Option: B
When home-country firms move production abroad, domestic employment in the home country may fall — the "hollowing-out" concern.
Q 17 Theorists Medium

Match the FDI theory with its principal author:

Theory Author
(i) Monopolistic Advantage Theory (a) John Dunning
(ii) Eclectic / OLI Paradigm (b) Buckley & Casson
(iii) Internalisation Theory (c) Robert Aliber
(iv) Currency Areas Theory (d) Stephen Hymer
  • A(i)-(d), (ii)-(a), (iii)-(b), (iv)-(c)
  • B(i)-(a), (ii)-(b), (iii)-(c), (iv)-(d)
  • C(i)-(c), (ii)-(d), (iii)-(a), (iv)-(b)
  • D(i)-(b), (ii)-(c), (iii)-(d), (iv)-(a)
View solution
Correct Option: A
Hymer (1960), Dunning OLI (1977+), Buckley & Casson (1976), Aliber (1970).
Q 18 FEMA Medium

The legal framework governing FDI in India is provided by:

  • AFERA 1973
  • BFEMA 1999 and Non-Debt Instruments Rules 2019
  • CCompanies Act 2013 only
  • DSEBI Act 1992 only
View solution
Correct Option: B
FEMA 1999 plus the FEM (Non-Debt Instruments) Rules 2019 (notified by MoF, administered by RBI) constitute the operating legal framework. FDI Policy is consolidated by DPIIT.
Q 19 Defence Hard

FDI in defence is permitted up to which limit under the automatic route?

  • A26 %
  • B49 %
  • C74 %
  • D100 %
View solution
Correct Option: C
Defence: up to 74 % under automatic route; beyond, under government route (where it leads to access to modern technology).
Q 20 FII / FPI Medium

The SEBI category "Foreign Portfolio Investor" (FPI) was introduced to replace which of the following older categories?

  • AFIIs, Sub-Accounts and QFIs
  • BADRs and GDRs only
  • CNRIs and PIOs
  • DSEZs and EOUs
View solution
Correct Option: A
The SEBI (FPI) Regulations 2014 (now 2019) consolidated FIIs, Sub-Accounts and QFIs into the single FPI category.

5.13 Quick Recall

ImportantQuick recall
  • FDI = lasting interest + management control; IMF threshold ≥ 10 % voting equity. FPI = pure financial return; no control; < 10 %.
  • Forms of FDI: Greenfield, Brownfield, Cross-border M&A, Joint venture, Reinvested earnings; Horizontal / Vertical / Conglomerate.
  • Routes in India: Automatic (no prior approval) vs Government (prior approval). Press Note 3 of 2020 — land-border countries → Government route.
  • Prohibited FDI: lottery, gambling, atomic energy, chit funds, Nidhi, tobacco, real-estate trading, railways (with exceptions).
  • Theories: Hymer (monopolistic advantage), Vernon (product cycle), Buckley & Casson (internalisation), Aliber (currency areas), Dunning (OLI eclectic).
  • Dunning’s OLI: O + L + I. Only O → license; O + I → export; O + L + I → FDI.
  • Dunning’s four motives: Market, Resource, Efficiency, Strategic asset — mnemonic MRES.
  • FPI = “hot money” — fast reversal.
  • Indian regulators: DPIIT + sectoral ministry + RBI for FDI; SEBI + RBI for FPI.
  • FEMA 1999 + Non-Debt Instruments Rules 2019 + Consolidated FDI Policy.
  • Sectoral caps (selected): Insurance 74 % (since 2021), Defence 74 % automatic, Telecom 100 %, Single-brand retail 100 % automatic, Multi-brand 51 % Government.
  • Top FDI sources: Singapore (since 2017), Mauritius, USA, Netherlands, Japan.
  • 2008 — Tata Motors acquires JLR = textbook strategic-asset-seeking FDI.