Chapter 05

Foreign Direct Investment

Foreign direct investment (FDI) is a category of cross-border investment. It is an investment
scheme where any particular firm or any such individual makes an investment in one country
(apart from their home country) into business interests located in another foreign country.
Usually, FDI occurs when an investor sets up a foreign business operation, or they acquire a
foreign business asset in any foreign company.

FDI is a key element in international economic integration because it creates stable and long-
lasting links between economies. FDI is an important channel for the transfer of technology
between countries, promotes international trade through access to foreign markets, and can be an
important vehicle for economic development. The indicators covered in this group are inward
and outward values for stocks, flows and income, by partner country and by industry and FDI
restrictiveness.

There are four main types of FDI,

 Horizontal FDI: The most well-known type is Horizontal FDI, which initially revolves
around the investment of funds in a foreign company that belongs to the same industry
and is either owned or operated by the FDI investor. In horizontal FDI, a company
invests in a different company which is located in a foreign country, where both
companies manufacture similar goods.

 Vertical FDI: Vertical FDI is another variety of foreign investments. A vertical FDI
happens when a particular asset is made within a regular supply chain in a said company,
which may or may not inevitably belong to the same industrial category. When a vertical
FDI takes place, a business invests in a firm located that may provide or sell its products.
Vertical FDIs can be further classified into two groups; such as forward vertical
integrations and backward vertical integrations.

 Conglomerate FDI: When specific individuals or companies make investments in two

entirely different companies belonging to completely different industries, the transaction
is termed as a conglomerate FDI. As such, the FDI is not connected directly to the
investor’s business or company.

 Platform FDI: The last type falling under foreign direct investment is called platform
FDI. In the instance of a platform FDI, a business extends into a particular foreign
country, but the commodities manufactured are exported to another different, third
country.

Importance of FDI
FDI is integral to investment plans. The solution to foreign direct investment or FDI is the factor
of control. Control depicts the intention of actively managing and influencing a foreign
company’s operations, which is the primary differentiating determinant between passive foreign
portfolio investment and an FDI.

Due to this reason, a 10% stake in the foreign company’s balloting stock is required to define
FDI. But there are situations where this principle is not always implemented. For instance, it is
probable to exercise control over more broadly traded firms despite owning a lower percentage
of voting assets.

 Foreign Direct Investment in Pakistan increased by 90.80 USD Million in February of

2022. source: State Bank of Pakistan
  Foreign Direct Investment in Pakistan averaged 158.21 USD Million from 1997 until
2022, reaching an all-time high of 1262.90 USD Million in June of 2008 and a record low
of -390.90 USD Million in October of 2018.

Advantages and Disadvantages of FDI

Balance of Payments:
The balance of payments is the record of all international trade and financial transactions made
by a country's residents. The balance of payments (BOP), also known as the balance of
international payments. It is a statement of all transactions made between entities in one country
and the rest of the world over a defined period, such as a quarter or a year. It summarizes all
transactions that a country's individuals, companies, and government bodies complete with
individuals, companies, and government bodies outside the country.
The balance of payments has three components:
The Current Account; measure international trade, net income on investments, and direct
payment. The current account includes transactions in goods, services, investment income, and
current transfers.
The Financial account; describes the change in international ownership of assets.
The Capital account; includes any other financial transactions that don't affect the nation's
economic output. It includes transactions in financial instruments and central bank reserves.
Narrowly defined, it includes only transactions in financial instruments. The current account is
included in calculations of national output, while the capital account is not
The sum of all transactions recorded in the balance of payments should be zero; however,
exchange rate fluctuations and differences in accounting practices may hinder this in practice.
Formula of the balance of payments is 

BOP = current account + capital account + financial account + balancing item = 0.

Special Considerations
Balance of payments and international investment position data are critical in formulating
national and international economic policy. Certain aspects of the balance of payments data, such
as payment imbalances and foreign direct investment, are key issues that a nation's policymakers
seek to address,
While a nation's balance of payments necessarily zeroes out the current and capital accounts,
imbalances can and do appear between different countries' current accounts. The U.S. had the
world's largest current account deficit in 2020, at $647 billion. China had the world's largest
surplus, at $274 billion.

 A balance of payments deficit means the country imports more goods, services, and
capital than it exports. It must borrow from other countries to pay for its imports.

 A balance of payments surplus means the country exports more than it imports. It
provides enough capital to pay for all domestic production. The country might even lend
outside its borders.
 Balance of Trade (BOT)
Balance of trade (BOT) is the difference between the value of a country's exports and the value
of a country's imports for a given period. Balance of trade is the largest component of a country's
balance of payments (BOP). Sometimes the balance of trade between a country's goods and the
balance of trade between its services are distinguished as two separate figures.

The balance of trade is also referred to as the trade balance, the international trade balance,
commercial balance, or the net exports.

Understanding the Balance of Trade (BOT)

The formula for calculating the BOT can be simplified as the total value of exports minus the
total value of its imports. Economists use the BOT to measure the relative strength of a country's
economy. A country that imports more goods and services than it exports in terms of value has a
trade deficit or a negative trade balance. Conversely, a country that exports more goods and
services than it imports has a trade surplus or a positive trade balance.

Balance of trade (BOT) = Value of Exports − Value of Import

Terms of trade (TOT)

Terms of trade (TOT) represent the ratio between a country's export prices and its import prices.
How many units of exports are required to purchase a single unit of imports? The ratio is
calculated by dividing the price of the exports by the price of the imports and multiplying the
result by 100%.

When more capital is leaving the country then is entering into the country then the country’s
TOT is less than 100%. When the TOT is greater than 100%, the country is accumulating more
capital from exports than it is spending on imports.

Terms of Trade Formula = (Index of Export Prices Index of Import Prices) x 100

Key Takeaways.

 Terms of trade (TOT) is a key economic metric of a company's health measured through
what it imports and exports.
 TOT is expressed as a ratio that reflects the number of units of exports that are needed to
buy a single unit of imports.1
 TOT is determined by dividing the price of the exports by the price of the imports and
multiplying the number by 100.1
 A TOT over 100% or that shows improvement over time can be a positive economic
indicator as it can mean that export prices have risen as import prices have held steady or
declined.1
Export prices might remain steady while import prices have decreased or they might have simply
increased at a faster pace than import prices. All these scenarios can result in an improved TOT.