Recently, Inter-ministerial body FIPB today cleared seven proposals envisaging foreign investment of Rs 100 crore.
How does FDI operate in India? While the country allows FDI in most sectors through the automatic route, in certain segments considered sensitive for the economy and security, the proposals have to be first cleared by FIPB.
FDI in the country grew by 29 per cent to USD 40 billion in 2015-16 as against USD 30.94 billion in the previous financial year. In context of this progress, it is valuable to take a look at two kinds of FDI-Greenfield project and Brownfield project-and understand its various implications on the economy.
What are Greenfield and Brownfield Projects?
In a nutshell, Greenfield and Brownfield projects are two different types of foreign direct investments, or FDI. Greenfield projects occur when a parent entity begins a new venture by constructing new facilities in a country outside their headquartered country. Brownfield projects occur when an entity or government purchases an existing facility to begin new production.
There are several benefits of choosing to build its own new facility rather than purchase or lease an existing one. The primary reason is that a new facility offers the maximum design flexibility and efficiency to meet the project’s needs. An existing facility forces the entity to adjust based on the present design.
New facilities are typically much less costly to maintain than used facilities. If the entity wants to advertise its new operation or attract employee force, new facilities also normally tend to be more favourable.
The clear advantage of a brown-field project strategy is that the building is already constructed. The costs of starting up may be greatly reduced. The time devoted to construction can be avoided as well.
If the existing national or municipal government requires licenses or approvals, the brown-field facility may already be “up to code.” In cases where the facility previously supported a similar production process, brown-field projects can be a real coup for the right entity.
Brown-field projects run the risk of leading to buyer’s remorse. It is rare that an entity looking to engage in FDI finds a facility with the type of capital equipment and technology to suit its purposes completely. If the property is leased, there may be limitations on what kinds of improvements can be made.
Knowing the differences between Greenfield and Brownfield FDI is very important in the context of developing countries like India. An important (and sensitive) thing to remember about Brownfield investment is that it led to acquisition of domestic companies by MNCs.
Volkswagen: A Case Study
Many companies are moving to east European countries to lower their production costs because labour expenditures in these countries are much smaller than in their home countries. Those advantages are achieved through foreign direct investments (FDI) like Brownfield and Greenfield investments. Besides lower production costs, FDI often offer other advantages than just cost savings, such as entry to other markets. Volkswagen (VW) started a joint venture (JV) with Skoda before they acquired their partner and this gave the German car manufacturer the possibility to enter a new market and already having a network in this area.
These clusters offer the focal company knowledge, know-how and other advantages that companies, which are not located in these areas, do not have access to. While Brownfield investments have other advantages like a fast entry to the new market, Greenfield investments can sometimes overweigh those advantages, depending on the company’s strategy. VW started a Greenfield investment in Russia’s Kaluga last year because of the Russian’s market potential and they want to make sure that they are located in this country, which offers advantages like lower taxes.
In a similar situation to that of Russia and its market ventures into the East European country (as in the case of Volkswagen discussed above), the Indian economy progresses and allows for more FDI, the Greenfield/Brownfield debate continues to rage on and may decide effectively the direction the economy heads towards. What is required in this situation is great degree of transparency and carefully weighing the pros and cons of both Greenfield and Brownfield and choosing according to the demands of the situation.
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