Previous Year Question
With reference to Foreign Direct Investment in India, which one of the following is considered its major characteristic?
It is the investment through capital instruments essentially in a listed company.
It is a largely non-debt-creating capital flow.
It is the investment which involves debt-servicing.
It is the investment made by foreign institutional investors in Government securities.
Correct Answer: B
Detailed Solution
Under Foreign Direct Investment, a foreign investor establishes a lasting economic interest and influence through investment in the equity instruments of an enterprise. Its major characteristic is, therefore, that it is generally a non-debt-creating capital flow.
Option (a) is incorrect. FDI is not confined to investment in listed companies. Under the FEMA framework:
investment by a person resident outside India in the equity instruments of an unlisted Indian company is FDI;
investment amounting to 10% or more of the fully diluted equity capital of a listed Indian company is treated as FDI; and
investment below 10% in a listed company is generally treated as Foreign Portfolio Investment.
Therefore, restricting FDI essentially to listed companies is incorrect.
Option (b) is correct. Equity-based FDI does not create a contractual obligation on the company to repay fixed principal and interest as in the case of a loan. The investor principally receives returns through:
dividends;
a share in retained earnings; and
appreciation in the value of shares.
Dividend payment depends on the company’s profits and decisions. It is not a compulsory payment comparable to fixed interest on external borrowing. FDI is consequently regarded as more stable than external debt and as a largely non-debt-creating inflow.
Under the broader IMF Balance of Payments methodology, certain inter-company debt between affiliated enterprises may also be recorded within a direct-investment relationship. Nevertheless, the principal and general character of FDI remains equity participation and non-debt-creating capital flow. The word “largely” accommodates this qualification.
Option (c) is incorrect. Debt servicing involves scheduled payment of principal and interest. It is a feature of External Commercial Borrowings, foreign loans and other debt instruments, rather than ordinary equity FDI.
Option (d) is incorrect. Investment by foreign portfolio investors in government securities is portfolio investment in debt securities. It does not provide a lasting ownership interest or management influence in a business enterprise and is therefore not FDI.