Foreign Investment

When a domestic investor decides to purchase assets in a foreign country

What is Foreign Investment?

Foreign investment is when a domestic investor decides to purchase ownership of an asset from a foreign country. It involves cash flows moving from one country to another in the middle of the transaction. If the stake is large enough, the foreign investor may be able to influence business strategy.

 

Foreign Investment

 

Summary

  • Foreign investment is when investors decide to purchase assets in a foreign area, resulting in the cash flow from one country to the next.
  • Foreign direct investments are long-term physical investments, such as plants, toll roads, and bridges within foreign countries.
  • Foreign indirect investments are when financial institutions trade equity stakes of foreign companies on the stock exchange.

 

Understanding Foreign Investments

Foreign investments are often made by larger financial institutions hoping to diversify their portfolio or expand operations for one of their current companies internationally. It is often considered a move for scaling purposes or a catalyst resulting in economic growth.

For example, some companies may expand their offices worldwide to reach global talent and connections. Examples would include Goldman Sachs, J.P. Morgan, Morgan Stanley, and other large corporations. In other cases, some companies may open facilities or operations to capitalize on cheaper labor or production costs offered in specific countries.

For textile companies in particular, such as retail production, many factories are located in China and Bangladesh despite focusing on North America – such as H&M or Zara – because material and labor are significantly cheaper there; thus, outsourcing would result in higher profitability. In other cases, some large corporations would frequently conduct business in areas that require the least amount of tax that must be paid.

 

Direct vs. Indirect Foreign Investments

Foreign investments are typically defined as either direct or indirect. Foreign direct investments are when investors purchase a physical asset such as a plant, factory, or machinery in a foreign country. In contrast, foreign indirect investments are when investors buy stakes in foreign companies that trade on their respective stock exchanges.

Generally speaking, direct foreign investments are more favored over indirect foreign investments because the assets they purchase are considered long-term. Therefore, they help boost the foreign country’s economy over time.

On the other hand, indirect foreign investments can be sold very quickly. Thus, the difference between the two stems from how much value the investment is capable of providing to the foreign country’s economy over time.

 

Commercial Foreign Investments and Official Flows

Beyond direct and indirect foreign investments, commercial foreign investments, and official flows are also two types of investing methodologies conducted internationally.

Commercial loans are essentially bank loans issued by a domestic bank to a foreign business or government. Similarly, official flows are various forms of development assistance that developing or developed countries receive from the domestic country.

 

The Role of Multilateral Development Banks

Multilateral development banks are financial institutions that invest in foreign assets in developing countries with the objective to stimulate and stabilize economic activity. Rather than focusing on profit, multilateral development banks invest in projects to support their respective country’s economic development.

An example may be infrastructure investments, such as toll roads or bridges in foreign countries, where the financing is composed of very low to zero interest debt. By doing so, it creates new industries and opportunities within that area.

For example, the World Bank may decide to invest in a toll road in South Africa with large amounts of debt but with very low interest. By doing so, the World Bank is not only opening the potential of new trade opportunities for South Africa, but it also enhances transportation activity and increases new job opportunities for the country.

 

Additional Resources

CFI offers the Certified Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:

  • International Monetary Fund (IMF)
  • Multilateral Development Bank (MDB)
  • Outsourcing
  • Multinational Corporation (MNC)

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