How does FDI affect the Currency of a country.

Our nation has a limited resource of Foreign reserves and we are Net Importers. Net Importers means our Imports are more than our Exports. As being Net Importers we have to shell out Foreign reserves and buy the Imports, which is a burden on our economy.

Let’s have a quick flash back of the year of 2013, Rupee had reached to a level of approximately Rs.68 per Dollar. Rupee had depreciated to an all time low. The Current Account Deficit and Inflation were the Two main culprits that caused the Rupee depreciation. The appreciation in the Crude Oil prices and the depreciation of Rupee had a very drastic effect on our economy. Since then, the UPA government had started to focus on the Foreign Direct Investment (FDI).

Now what is Foreign Direct Investment (FDI)?

FDI in simple terms means, the investing company may make its overseas investment in a number of ways - either by setting up a subsidiary or associate company in the foreign country, by acquiring shares of an overseas company, or through a merger or joint venture.

The accepted threshold for a foreign direct investment relationship, as defined by the OECD, is 10%. That is, the foreign investor must own at least 10% or more of the voting stock or ordinary shares of the investee company. An example of foreign direct investment would be an American company taking a majority stake in a company in India.

Given the current economic scenario I feel that FDI is a better option than Importing. I will tell you why….. When we Import we have to pay in terms of Foreign exchange, it leads to an outflow of Foreign exchange from our nation to the other. When this is the case, the demand of the foreign currency increases, which leads to the appreciation of the Foreign currency and obviously the depreciation of our Home currency and the depreciation of our Home currency has various disastrous effects for the Domestic economy, specially for an economy who is a Net Importer.

It is Vice Versa in case of FDI.

In FDI the foreigners come in India and bring foreign reserves along with them, this leads to appreciation of our currency. To ask the foreign businesses to come and manufacture their products in India, brings investments in infrastructure and also leads to increase in employment in the country. So what happens is, while importing we bring the foreign products and pay in foreign currency, but in FDI, we still get the foreign products as the foreign companies use their technology to manufacture in India, but we do not need to pay in Foreign currency. Thus the import bills that used to reduce our Foreign reserves would now be saved due to FDI.

In a scenario where there is a liquidity crunch in the country, development through FDI seems to be the best option rather than shelling out the Foreign reserves.

So now we understand the reason why India is focusing extensively on getting Foreign Direct Investments, as it will lead to stabilization of the currency and to bring in investments to develop our economy.

-Pratik R. Shah

Source : https://www.facebook.com/theinvestmentjargon/posts/691686247582193