Foreign direct investment occurs when a foreigner sets up or acquires the control of a production unit in our country. The foreigner transfers funds from his country to ours. Such transfer of funds constitutes credit entry in capital account of our balance of payments, e.g., investment by Samsung in India. Similarly, if an Indian transfers funds to a foreign country to acquire a capital asset abroad, it will constitute a debit entry in capital accounts of out balance of payments.

FDI can take different forms; among test the two important once are: (i) greenflies investment, and (ii) brown field investment.

(i)    Greenfield investment, Greenfield investment occurs when foreign capital sets up a new production unit in the host country; for example, setting up of a car-manufacturing plant in India by Honda Mortar Co. of Japan.
(ii)    Brownfield investment. Brownfield investment takes the form of a takeover in which a controlling interest in a firm previously controlled by residents is acquired by foreigners.

Portfolio investment constitutes transfer of funds between nations to acquire financial assets. Thus, if a foreign institutional investor purchases stocks of the Reliance Indentures LTD. On National Stock Exchange, foreign exchange will flow into India. It will be treated as a credit entry in the capital account of India’s balance of payments.

Likewise, if a foreign institutional investor sells off his holdings of Bajaj Auto Ltd.  on National Stock Exchange, he will receive payment in foreign exchange. This transaction will give rise to a debit entry in capital county of India’s balance of payments.

FDI and portfolio investment combined is referred to as the long-term capital element of the capital account.

Other investment in the capital account consists mainly of what are called short-term capital flows. These include transfers into overseas banks, and sales or purchases of short-term financial instruments, such as treasury bills.

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