What Are the Different Kinds of Foreign Investment?
What Are the Different Kinds of Foreign Investment?

International investment or capital flows fall into four principal categories: commercial loans, official flows, foreign direct investment (FDI), and foreign portfolio investment (FPI).

Commercial loans, which primarily take the form of bank loans issued to foreign businesses or governments.

Official flows, which refer generally to the forms of development assistance that developed nations give to developing ones.

Foreign direct investment (FDI) pertains to international investment in which the investor obtains a lasting interest in an enterprise in another country. Most concretely, it may take the form of buying or constructing a factory in a foreign country or adding improvements to such a facility, in the form of property, plants, or equipment.

FDI is calculated to include all kinds of capital contributions, such as the purchases of stocks, as well as the reinvestment of earnings by a wholly owned company incorporated abroad (subsidiary), and the lending of funds to a foreign subsidiary or branch. The reinvestment of earnings and transfer of assets between a parent company and its subsidiary often constitutes a significant part of FDI calculations.

According to the United Nations Conference on Trade and Development (UNCTAD), the global expansion of FDI is currently being driven by over 65,000 transnational corporations with more than 850,000 foreign affiliates.

An investor’s earnings on FDI take the form of profits such as dividends, retained earnings, management fees and royalty payments.

Foreign portfolio investment (FPI), on the otherhand is a category of investment instruments that is more easily traded, may be less permanent, and do not represent a controlling stake in an enterprise. These include investments via equity instruments (stocks) or debt (bonds) of a foreign enterprise which does not necessarily represent a long-term interest.

Stocks:

  • dividend payments
  • holder owns a part of a company
  • possible voting rights
  • open-ended holding period

Bonds:

  • interest payments
  • ownership of bond rights only
  • no voting rights
  • specific holding period

While FDI tends to be commonly undertaken by multinational corporations, FPI comes from my diverse sources such as a small company’s pension or through mutual funds held by individuals.

The returns that an investor acquires on FPI usually take the form of interest payments or dividends.

Investments in FPI that are made for less than one year are distinguished as short-term portfolio flows. FPI flows tend to be more difficult to calculate definitively, because they comprise so many different instruments, and also because reporting is often poor. Estimates on FPI totals generally vary from levels equaling half of FDI totals, to roughly one-third more than FDI totals.

The difference between FDI and FPI can sometimes be difficult to discern, given that they may overlap, especially in regard to investment in stock. Ordinarily, the threshold for FDI is ownership of “10 percent or more of the ordinary shares or voting power” of a business entity (IMF Balance of Payments Manual, 1993).

Calculating Investment: Calculations of FDI and FPI are typically measured as either a “flow,” referring to the amount of investment made in one year, or as “stock,” measuring the total accumulated investment at the end of that year.

Until the 1980s, commercial loans from banks were the largest source of foreign investment in developing countries. However, since that time, the levels of lending through commercial loans have remained relatively constant, while the levels of global FDI and FPI have increased dramatically. Over the period 1991-1998, FDI and FPI comprised 90 percent of the total capital flows to developing countries. Over the period of 1996-2006, FDI and FPI outflows from the United States more than doubled (International Monetary Fund, 2007). Global FDI flows decreased significantly from 2007-2009 due to the Financial Crisis and finally started rising again in 2010, though have still not reached pre-crisis levels.

Similarly, when viewed against the tremendous and growing volume of FDI and FPI, the funds provided in the past by governments through official development assistance, or lending by commercial banks the World Bank or IMF, are diminishing in importance with each passing year. Therefore, when one talks about the recent phenomenon of globalization, one is referring in large part to the effects of FDI and FPI, and these two instruments will therefore be the primary focus of this Issue in Depth.


5 Source: http://www.imf.org/external/pubs/ft/gfsr/2007/02/

 

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