FOREIGN INVESTMENT RISK || TRAINER ANIL MAURYA

Objective of the E- BOOK 

  • To learn about the foreign investment risk   

Key Learnings from the E-BOOK 

1. Concept of Foreign Investment and Foreign Investment Risk

Foreign investments are of the following 2 types:

a. Direct investment: It means physical investment in other countries by purchasing machines, building, and factory.

b. Indirect investment: It means to purchase shareholdings and stakes in the companies operating in other countries. 

There are chances of losses in both the direct and indirect investments.

The chance of losses on foreign investment is known as foreign investment risk.

2. Types of Foreign Investment Risk

An investor has to bear the following type of risks in foreign investment:

a. Higher transaction cost: An investor need to pay the following additional charges while doing foreign investment:

i. Extra stamp duty

ii. Clearing fees

iii. Exchange fees

iv. Broker commission

b. Currency risk: The investment value also changes due to constant change in the exchange rates. This fluctuation creates chances of losses to the foreign investors.

c. Liquidity risk: A foreign investment always carries the risk of inability to urgently convert an investment into cash. There are very few chances of investment convertibility into cash without market price impact.

A foreign investor can avoid liquidity risk by regular monitoring of investment.

3. Factors Causing Foreign Investment Risk

a. Accounting and auditing standards

i. A company doing foreign investment needs to report financial investments as per accounting standards of the foreign country.  

ii. This requires conversion of foreign investment according to exchange rates and notional income or losses needed to be shown in the report.

iii. The company also requires making changes in the disclosures as per the accounting standards.

iv. The income statement gets impacted due to changes done as per the accounting standards. All this causes the risk to foreign investment as the changes impact profitability of the company.

 For example, as per old accounting standards investment cost is shown at purchase price whereas according to new accounting standards investment cost need to be shown at market value.

b. Nationalising the company

Nationalisation is the action of the government of a country for taking over the ownership and control of a privately owned company or industry.

Nationalisation is the primary risk factor for foreign investors.

Generally, developing countries do nationalisation to have control and dominance over foreign companies.

For example, former Prime Minister of India Indira Gandhi during her tenure has nationalised all the banks of India.

Foreign investors have the risk of nationalisation because the government can enforce nationalisation just by an announcement.

In the event of nationalization, the compensation that will be given out depends upon the whims of the government.

c. Taxation rules

 A foreign investor needs to pay tax on the income earned through investments according to the tax rules of that particular country.

The investors have a low income if the country has a high tax rate. So, the investors should search for countries having low tax rates.

For example, the Indian government in the Budget 2019 cut corporate tax to 25 percent to attract foreign investment in India.

Companies invest in the countries which are tax haven countries because they need to pay lower tax.

d. Political instability

The policy of government depends upon the political conditions of a country. The countries which do not have favourable political conditions are the reason for foreign investors to avoid that country.

Unstable political conditions cause a frequent change in the policies and accordingly companies need to change their policies for fulfilling compliances.

An increase in tax rate and labour minimum wage rate are examples of changes in government policies.

e. Regulatory issues

Foreign investments are directly linked to the regulatory cost of a country.

The countries having low regulatory costs attract high foreign investment.

The companies which invest in the countries with extra regulations have to devote significant time for compliance, bear increase cost and penalties, etc.

For example, the finance minister of India when announced for self-certification policy the chances of foreign investment increases due to simple compliances which is important for ease of business.

4. Mitigation of Foreign Investment Risk

The best ways to mitigate or avoid foreign investment risk are:

a. Do regular monitoring of the policies and regulations of the foreign country.

b. Check the following things before doing foreign investment in a foreign country:

  • Regulatory requirement
  • Taxation rules
  • Political conditions
  • Accounting Standards
  • Investment costs

c. Develop business plans as per compliances of the foreign country.

d. Do continuous monitoring to safeguard the investment.

Key Outcomes of the Video

  • Evaluate regulatory requirements of the country before doing a foreign investment  
  • Check taxation rules and political conditions to know the favourability of foreign investments
  • Develop business plans as per compliances of the foreign country      

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