Determinants

Determinants of FDI

The most important determining factor or the determinant for Foreign Direct Investment in an economy is the size and growth prospects of the economy based on the presumption that a big market in a country will definitely boost up sales and growth prospects of the company in the foreign land.

Other major factors include the following-

• Per Capita Income: The Per Capita income of the citizens plays a major role, the higher the per capita income more will be the spending rate assuming sound governance in the country, which will offer excellent opportunities for expansion.

• Infrastructural facilities: Infrastructural factors like railways and telecommunications are a major determinant for a company to get interested and invest on the host country, improvement in areas such as these will definitely boost up investor confidence.

• Labour force: Inexpensive labour force is also important in this regard, the BPO revolution and the exponential growth of the IT sector in India is primarily due to the availability of IT professionals working at wages less than the global standards.

• Economic Stability: When the economy is in a state of turmoil i.e. passing through a recessionary phase then its really hard to attract foreign players to invest in the domestic market as they longer feel safe and hence such a situation hampers FDI flows in a country.

• Foreign Investment Restrictions: The government might feel that by allowing the foreign investors to invest in production facilities will mean the outflow of capital from the country in the form of profits. This approach also constrains the flow of FDI into the country.

• Corruption cum lack of Transparency: Corruption deters several efficient players from investing as they are of the opinion (Stats by FICCI shows only 29% of FDI amount was approved between August 1999 and January 1999) that the clearance of their proposal is not performance or reputation oriented but under the table dealings. Hence the lack of transparency and bureaucracy deters them in entering such markets.

• Lack of Political Stability: Stable governance is much more attractive to attract FDI into the economy. This is because that each government has its own policy regarding FDI i.e. one might follow a liberal approach and the other a conservative one. Hence FDI inflows are in direct proportion to the political stability of the economy.

Apart from these there are two distinguishing factors affecting capital movements, viz.

• Pull factors: These are country specific in nature and reflect domestic opportunities and risks in an economy. Pull or domestic factors reflect the improved policies that increase the long run expected return, these include

¨      Liberalization of FDI

¨      Credible structural or macroeconomic policies

¨      Measures that increase the openness of the domestic financial market to foreign investors.

¨      Sustainable debt and debt service reduction ensuring timely repayments.

¨      Stabilization policies that affect the aggregate efficiency of resource allocation.

¨      Ability of the economy to absorb shocks from changes in international terms of trade.

• Push factors: These are global or exogenous factors which arise from the prevailing socioeconomic scenario across the world affected by major economic policies of developed nations. These factors include

¨      Lower foreign interest rates

¨      Recession abroad

¨      Herd mentality in the international capital markets.