Foreign direct investment (FDI) has far and wide become a perfect example or catchphrase for investment that is well-organized and efficient coupled with high wages, job creation, and technological transmissions (Artige & Nicolini, 2006). The industrial and economic policies of most governments in the world have welcomed the process of liberalization, globalization, and privatization, and at the same time endorsed liberal policies to attract FDI flows in their country. When a direct investor undertakes a task of capital operation or transaction in a foreign direct investment enterprise to get hold of a long-lasting curiosity or inquisitiveness in this foreign firm it is called Foreign Direct Investment. It sets a long-standing relationship between a host economy and a foreign investor who is interested to invest in this host economy.
Balance of Payments (BOP) accounts broadly comprise the current account and capital account. Former records imports and exports of goods and services together with unilateral transfers. On the other hand, latter records all such transactions between residents of a country and rest of the world which cause a change in the asset or liability status of the residents of a country or its government (Jain & Ohri, 2010). There are three forms of capital account: Foreign investment, loans, and banking account transactions. As far as foreign investment is concerned, it has two sub-components: Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FFI). FDI point out to purchasing an asset in the rest of the world thereby allowing the control over that asset. On the other hand, Foreign Portfolio Investment is purchasing an asset in the rest of the world but without allowing the control over that asset.
Almost all developing economies of the world depend upon Foreign Direct Investment directly or indirectly and therefore, it is a vital source of their existence and activeness. It is preferred to Foreign Portfolio Investment, partly because returns from Foreign Direct Investment are accompanied by or linked to the performance of the real economy and partly for the reason that it is less volatile as compared to Foreign Portfolio Investment. Foreign Direct Investment is considered a very important tool for the transformation of the domestic process of production as it bridges the technological gap (Raghavan & Kumar, 2011). It can make up not only for shortages in the availability of savings and foreign exchange but also for faults in a domestic entrepreneurial capacity. In developing economies where investment activities are sluggish, the role of FDI is very important for it has a role in directly stimulating investment activity in the country. Therefore, it is imperative upon these economies to strike a careful balance among the different components or determinants of FDI without crowding out domestic entrepreneurship. But, this goal can be achieved if we succeeded in striking an equilibrium in the balance of payments. One of the biggest shortcomings of Foreign Portfolio Investment is that it is pro-cyclical in nature thereby meaning that it is observed once the balance of payments (BOP) standing is robust and decays with every fleeting day of the balance of payments or when it deteriorates. Therefore, it put the accent on or bring out the direction of movement of the balance of payments which can cause severe macroeconomic instability, especially in the aggregate income, output, and employment.
Foreign exchange markets indicate the markets for domestic currencies of different countries in the world whose aim and objective is nothing but the facilitation of international trade and investment. In a country like ours, where we have very poor foreign exchange markets, an open FPI system transfers the vulnerability of speculative movements, which can lead to serious disturbance in the economy by shaking the macroeconomic variables.
In a country like ours where FDI inflows continued to be by and large of the equity variety, comprehensive and spread across a range of economic activities like financial services, manufacturing, banking services, information technology services, and construction, it is pertinent upon the government and policy makers to highlight the role of FDI in the growth and development prospects and work on growing FDI substantially on both gross and net terms.
There are some important issues that should be raised when FDI is to be studied. One question is to know what attracts FDI. What are the perks that foreign firms look for when hunting for FDI? What are the determinants of FDI? Whether the host economy benefits from capital import? What are the incentives and the prospects of FDI? Such questions may be addressed by carrying out holistic theoretical and empirical cum econometric analysis on FDI and its determinants.
Binish Qadri is ICSSR Doctoral Fellow, Department of Economics, Central University of Kashmir, Guest Faculty, NIFT, Srinagar;