Foreign Exchange, FDI & External Debt (Part – I)

Foreign Direct Investment (FDI) refers to the process by which a company or individual from one country invests directly in assets or businesses in another country, to establish lasting interest and influence. This type of investment usually involves acquiring significant stakes, establishing subsidiaries, or forming joint ventures in the host country.
FDI is a vital engine for economic growth and development globally. It brings capital, technology, job opportunities, and expertise to the host country while offering companies the chance to expand their markets. However, it also comes with challenges, such as market domination by large multinational firms and environmental concerns..

Foreign Direct Investment can be undertaken through different methods. These methods, commonly referred to as Greenfield and Brownfield investments, reflect different approaches to entering foreign markets and expanding business operations.
Greenfield Investment: This method involves establishing a new operation or business from the ground up in the host country, such as building new plants, offices, or manufacturing facilities. This allows investors to have full control over the business's setup and operations.
Brownfield Investment: In contrast, a Brownfield investment occurs when a foreign investor acquires or merges with an existing company in the host country. Rather than starting a new business from scratch, the investor uses existing infrastructure and operations to expand their presence in the market.

• Gold currency: While gold has historically been used as a form of currency and can be a store of value, it is not considered a currency in the modern sense. Gold's price fluctuates based on market conditions, making it a commodity rather than a stable currency.
• Soft currency: Soft currency refers to the currency of a country with a weak or unstable economy, characterized by high inflation and frequent fluctuations in value. It is not widely accepted for international transactions and is not considered a reliable store of value.
• Hard currency: Hard currency is the opposite of soft currency. It is a currency that is widely accepted in international trade and is seen as a stable store of value due to the economic and political stability of the issuing country. Examples of hard currencies include the US dollar, Rupee, Japanese yen, and the euro.

Large-scale capital flight is often mentioned as a prime con- tributing factor to the foreign-debt Problem of developing countries. Capital flight can drive up the interest costs as there is reduced money supply in the system. Thus, it may increase the interest cost of firms with existing External Commercial Borrowings (ECBs). Hence, statement 2 is correct. Devaluation of domestic currency has an adverse impact on the issuance of ECBs in the short and long run. Devaluation of domestic currency increases the currency risk as- sociated with ECBs (as mostly are foreign currency denominated). For example, INR depreciation vis-à-vis USD could pose difficulty in debt servicing by the borrowing entities, having exposures in USD. Hence, statement 3 is incorrect.

• A Tobin tax is levied on the international flow of short-term capital or hot money which are very speculative.
• The aim of a Tobin tax was to generate stability in currency markets.
• The Tobin tax proposed by James Tobin in 1972 in the form of a currency transaction tax.
• India has a variant of the Tobin tax called the Securities Transaction Tax (STT). It was introduced in 2004 and is levied on every transaction of securities listed on the stock exchanges and mutual funds.
  Need of Tobin Tax
• The short-term capital flows (movement of international investable money) are highly unstable due to being speculative.
• Frequent inflows and outflows of short-term capital create management problems for many emerging markets central banks like the RBI in India.
• Tobin tax prevents the movement of volatile short term capital flows or hot money which are very speculative.