CIAO DATE: 04/04

The Role of Foreign Direct Investments

Abstract

Foreign direct investment (FDI) is a resident entity in one economy investing in an enterprise entity in another economy and thus obtaining a las ting inter est in an enter prise resident in another economy. Under the definition of the Inter national Monetary Fund in the fifth edition of the Balance of Payments Manual, foreign direct investment is at hand when a direct investor (non-resident) ow ns 10% or more of ordinary shares or voting power in the res ident (economic entity) of another country. The level of 10% is set arbitrarily because it is presumed that an investor with a higher ownerships hare has also a more significant influence in reaching decisions connected with managing a company. FDI is distinguished from other types of investments in that it is based on the fact that ther e is a permanent interest of the investor in the enterprise as well as interest in the management of the company. The IM F per mits the possibility of an individual country deciding subjectively whether or not a particular investment belongs to the gr oup of foreign direct investments. For example, if an investor owns more than 10% of an economic entity in a country but does not have an effective influence in the management of this entity, such an investment cannot be deemed FD I. Investors (non-residents) may be private or legal entities, groups of individuals or legal entities, gover nments or government agencies or any other similar foreign organisation that has a share in the domicile economic entity pursuant to the above def inition. O ne more characteristic of FDI is that the foreign investor reaches the decision on the investment on the highest, strategic level. In contrast, ther e are also portfolio investments, where the investor has no long term interest in the company that is taking part in reaching decisions. In its definition of portfolio investments the IMF includes shares, bonds, money market instruments and financial derivatives such as options as their basic instruments. Portfolio investments, in contrast to FDI, assume that an investment is conducted in an effort to maximise the value of the investor portfolio and achieve the expected yield against the least possible risk.

Foreign direct investments can be divided into two groups: greenfield investments and brownfield investments. Greenfield investments are all FDI through which new production assets are created, brownfield investments include all FDI through which existing plants and companies are acquired by taking control. The latter also includes foreign direct investments resulting from privatisation.

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