How does foreign direct investment feature in the balance of payments?

Foreign direct investment (FDI) features in the balance of payments as part of the financial account.

In more detail, the balance of payments is a record of all economic transactions between the residents of a country and the rest of the world in a given period. It is divided into three main accounts: the current account, the capital account, and the financial account. Foreign direct investment (FDI) is recorded under the financial account, which captures the net change in ownership of national assets.

FDI refers to the net inflows of investment to acquire a lasting management interest in an enterprise operating in an economy other than that of the investor. It is the sum of equity capital, reinvestment of earnings, other long-term capital, and short-term capital as shown in the balance of payments. This series shows net inflows (new investment inflows less disinvestment) in the reporting economy from foreign investors, and is divided into net inflows for foreign direct investors and for foreign institutional investors.

FDI can be both inward and outward. Inward FDI, also known as inbound FDI, refers to direct investment into a country from foreign entities, and is a credit to the financial account. Outward FDI, also known as outbound FDI, refers to direct investment by domestic entities into foreign countries, and is a debit to the financial account.

The impact of FDI on the balance of payments depends on whether it is inward or outward FDI. Inward FDI can improve the balance of payments by providing a source of foreign currency, particularly if the investment is in export-oriented industries. On the other hand, outward FDI can worsen the balance of payments if it leads to a net outflow of currency. However, if the outward FDI generates returns in the form of dividends or profits, it can improve the balance of payments in the long run.

In conclusion, FDI plays a crucial role in the balance of payments. It can both improve and worsen the balance of payments, depending on whether it is inward or outward FDI, and whether it generates returns in the form of dividends or profits.