FDI Confidence Index - Economist Intelligence...

FDI Confidence Index®

Global Business Policy Council2005, Volume 8

The Global Business Policy Council is a strategic service that assists chief

executives in monitoring and capitalizing on macroeconomic, geopolitical,

socio-demographic and technological change worldwide. Council member-

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Global Business Policy Council

A.T. Kearney, Inc.

333 John Carlyle Street

Alexandria, Virginia 22314

U.S.A.

1 703 739 4714 telephone

1 703 739 4741 fax

www.atkearney.com

A.T. Kearney | FDI ConFIDenCe InDex 1

emerging market countries are the 1st and 2nd most attractive foreign direct investment (FDI) locations in the world. Led by China and India, emerging markets have achieved unprecedented levels of investor confidence. The United States dropped to 3rd place on corporate investors’ lists, but remains a strong FDI magnet. (It is too early to assess the possi-ble impact the controversy over the Dubai ports deal will have on the U.S. FDI market.) Western europe, other than the United Kingdom, lost FDI confidence due to increasing competition from emerging markets. But again, recent signs of intra-european market protectionism may have a negative impact on overall european FDI attractiveness. The FDI prospects for eastern europe appear brighter as investor confidence in Poland, Russia, Hungary, the Czech Republic, Turkey and Romania is rising. All of these coun-tries, except Poland, climbed to record high positions in the Index. Brazil and Mexico have regained lost ground. Investments in cross-border corporate deals rose 2 percent—the first increase since 2000. However, the FDI recovery may be clouded by corporations that want to continue to save money rather than invest it as concerns about the global

economy rise to the surface. Companies have accumulated record amounts of cash due to lingering fears of another possible economic down-turn, new interdependent business risks, and pressure from shareholders. However, this may change as the penchant for holding cash bumps against the pressure to expand overseas as the pace of cross-border mergers and acquisitions quickens. As companies make overseas investments, par-ticularly in R&D, several factors dominate their location decisions, including lower costs, higher-quality labor, protection of intellectual-property rights, reliable educational systems and sophisti-cated IT infrastructures. Developing countries in Asia and eastern europe are experiencing the larg-est increases in R&D investments as these coun-tries become integral to multinational companies’ global innovation processes. R&D investments in the industrialized world will continue, but at a less robust pace. The pace of offshoring will intensify, as all corporate functions, including R&D, shift overseas. These are among the major findings in A.T. Kearney’s year-end 2005 FDI Confidence Index® survey, which tracks the impact of likely political, economic and regulatory changes on the foreign direct investment intentions and

Foreign Direct Investment (FDI) is on the rise again. But the corporate savings overhang and investor pessimism about the global econ-omy could dull the recovery of cross-border corporate investment.

Concerns over corporate financial health, an unexpected economic downturn, shareholder activism, and the risks associated with engaging in FDI have caused investors to hoard cash over the past four years. As investors face more intense competition and the lure of higher returns overseas, they are cautiously unloading their accumulated war chests.

FDI ConFIDenCe InDex | A.T. Kearney�

preferences of the leaders of top companies around the world (see figure 1).1 over the past seven years, we have queried Ceos, CFos and other key decision-makers of the world’s largest 1,000 firms about their opin-ions of various FDI destinations and their invest-ment intentions. Responses from participating executives about their views of 68 countries,

which receive more than 90 percent of global FDI, reveal likely foreign direct investment flows and point to the factors that drive corporate decisions to invest abroad. Companies included in our survey are responsible for about 70 percent of global FDI flows and generate more than $27 trillion in annual revenues. These com-panies represent all major regions and sectors.

1 Foreign Direct Investment (FDI) includes investments in physical assets, such as plant and equipment, in a foreign country. Holdings of 10 percent or more equity in a foreign enterprise is the commonly accepted threshold between direct and portfolio investment as it demonstrates an intent to influence management of the foreign entity. The main types of FDI are acquisition of a subsidiary or production facility, participation in a joint venture, licensing, and establishment of a greenfield operation. The last is defined as a direct investment in new facilities or the expansion of existing facilities.

Figure 1FDI Confidence Index®

*First time in Index**Central Asia includes Azerbaijan, Belarus, Kazakhstan and Turkmenistan Source: A.T. Kearney

Top 25, December 2005

ChinaIndia

United StatesUnited Kingdom

PolandRussiaBrazil

AustraliaGermany

Hong KongHungary

Czech RepublicTurkeyFranceJapan

MexicoSpain

SingaporeItaly

ThailandCanada

Dubai/UAESouth Korea

Central Asia**Romania 1.017

1.030

1.036

1.039

1.040

1.050

1.055

1.072

1.075

1.080

1.082

1.097

1.133

1.136

1.157

1.208

1.267

1.276

1.336

1.341

1.363

1.398

1.420

1.951

2.197123456789

10111213141516171819202122232425

(1)(3)(2)(4)

(12)(11)(17)

(7)(5)(8)

(19)(14)(29)

(6)(10)(22)(13)(18)

(9)(20)(16)

(*)(21)(27)(42)

(#)

Maintained ranking

Moved up

Moved down

2004 ranking

Values calculated on a 0 to 3 scale High confidenceLow confidence

A.T. Kearney | FDI ConFIDenCe InDex �

Major FindingsIndia Joins China at the Center of theFDI Radar ScreenInvestor enthusiasm for China and India is at an all-time high, with roughly 45 percent of global investors more upbeat about China and India compared to last year.2 This is nearly twice the number recorded for the next three most positively viewed markets—Brazil, Poland and Russia. China achieved its highest-ever score in

this year’s Index, while India’s score has been surpassed only by China and the United States in previous years. China and India took the 1st and 2nd positions across nearly all broad sector categories (see figure 2). While China has held the top spot since 2002, strong investor interest in India is a more recent development. Despite India’s successful positioning as a business-processing and IT out-sourcing hub, these activities often translate into service-sector exports—rather than FDI flows

2 All references to “last year” in this paper refer to 2004. FDI flow figures are the latest statistics available from the United Nations Conference on Trade and Development (UNCTAD) for the year 2004.

Figure 2 China and India are the top FDI locations across all broad sectors

Source: A.T. Kearney

Percentage of investors with a more positive outlook

Percentage of investors with a more positive outlook

Manufacturing and primary

Financial and non-financial services

Telecommunications and utilities

Wholesale and retail

UnitedKingdom

UnitedKingdom

Japan

Hong Kong

Germany

Germany

Germany

Spain

Spain

Singapore

Mexico

Australia

Australia

United States

United States

United States

United States

RussiaPoland

Poland

Poland

Poland

HungaryUnited Kingdom

Czech Republic

Brazil

Brazil

ItalyGermany

India

India

India India

China

China

China

25%

25%

50%

Canada

Italy

France

China

Investor attractiveness Investor attractiveness

0%

0%

1.0 1.5 2.0 2.5 2.0 1.5 1.0


into India. Last year, India received just $5.3 billion in FDI, compared with China’s $60.6 billion. This is partly because China attracts more capital-intensive manufacturing and logis-tics functions (see figure 3). India has yet to build critical mass in FDI, mostly because it did not initiate investment-attracting reforms until 1991. By contrast, China’s pro-FDI regime has been in place since 1979. Indeed, China’s entire compet-itive manufacturing base has been largely estab-lished by foreign multinational companies. We expect this trend to continue over the next three years as more functions are sent overseas. India appears to be on the cusp of an FDI takeoff. We expect the country’s attractiveness to increase as long as the government maintains its focus on reforms, overcomes narrow business interests, and continues to address the country’s infrastructure, logistics and regulatory barriers.

The United States Drops to 3rd PlaceFor the first time since our study began in 1998,

the United States dropped from 2nd to 3rd most attractive future FDI location, as investors in the financial services and light manufacturing sectors express less interest in the U.S. market. Although the U.S. financial sector’s FDI inflows have been robust in recent years, the United States dropped to 6th place (from 2nd place last year) among investors from this sector. Roughly one-third of global insurance carriers are more negative about the U.S. market, perhaps due to the more than $70 billion in costs resulting from the country’s destructive hurricane season. Investors from the highly competitive light manufacturing segments (including electronics, food and textiles) are less likely to commit FDI in the United States, prefer-ring lower-cost, faster-growing emerging markets. China, India, Brazil, Russia, Poland, Mexico and Hungary take the first seven positions in the light manufacturing sector, with the U.S. coming in 8th, down from 3rd place last year. In 2004, the United States was the largest FDI recipient in the world—capturing $96 bil-

Figure 3China dwarfs India in FDI, in part because China attracts more capital-intensive functions


IT (design, supportand services)

Contact centers (callcenters, web centers)

Business processes(HR, finance, accounting)

R&D and engineeringKnowledge managementManufacturingDistribution and logistics

$60.6

$0

$10

$20

$30

$40

$50

$60

$70

$5.3

China India China India

Foreign direct investment ($ billions) Breakdown by business function

0%

10%

20%

30%

40%

50%

70%

100%

90%

80%

60%

Capital-intensivefunctions


lion. This was a strong rebound from the $56.8 billion the United States received in 2003. Based on estimates for the first half of 2005, the United States could again achieve 2004 levels of FDI. Indeed, the U.S. economy is unparalleled, having produced $12.5 trillion in GDP, three times that of Japan (the next largest market) and weather-ing unprecedented current-account deficits and a season of natural disasters. Investors in the primary sector, in telecom and utilities, and heavy manu-facturing—specifically high-technology and com-puter equipment firms—rank the United States among their top 5 most attractive FDI locations. The strength of the U.S. economy, particularly reflected in higher U.S. dollar exchange rates, is underscored by U.S. companies that are directing more investments overseas than ever before. Last year, U.S. companies sent approximately $229 billion overseas, thereby reinforcing the United States’ role as the primary source of FDI. For the first half of 2005, U.S. FDI outflows were nearly $60 billion, down from $108 bil-lion over the same period in 2004. This decline may be due to U.S. companies’ taking advantage of tax breaks on repatriated earnings under the Homeland Investment Act. Because the United States accounts for nearly one-third of total global FDI outflows, these tax-driven repatria-tions could have a moderating effect on global FDI flows in 2005.

FDI Prospects Dim for Western Europenot since 1999 have so few Western european

countries been among the top 10 FDI loca-tions. Between 2000 and 2004, Western europe held between 3 to 5 spots in the top 10; this year only two countries—the United Kingdom and Germany—remain in the top 10. While the United Kingdom held onto 4th place, Germany declined from 5th to 9th place, France moved from 6th to 14th, Italy went from 9th to 19th, and Spain dropped from 13th to 17th place. Manufacturing investors reported the strongest decline in preference for Western europe and are looking instead to China, India, Brazil, Russia, Poland and Mexico. In 2004, the eU-15 countries witnessed a 40 percent decline in FDI inflows—experiencing a six-year low of just $196 billion. Contributing to the decline were sluggish growth, disinvest- ments and substantial repayments of intra-firm credits by foreign affiliates to their parent firms overseas. This shift in investor sentiment may have been due, at least partly, to the rejection of the eU constitution by the electorates of France and the netherlands, two founding members of the european Union, and to the shifting political environment in Germany at the time of the survey.

Investment confidence soars forEastern Europeeastern european markets are enjoying a sharp increase in FDI confidence levels—with Poland (5th), Russia (6th), Hungary (11th), the Czech Republic (12th), Turkey (13th) and Romania

Investor enthusiasm for China and India is at an all-time

high, with roughly 45 percent of global investors more

upbeat about China and India compared to last year.


(25th) all rising in the rankings. All of these coun-tries, except Poland, registered historic highs. Investors rank Poland, Russia, Turkey, the Baltic States and the Czech Republic among the top 10 countries with the most upbeat outlooks. entry into the european Union means greater market access, fewer trade and investment barriers, and increased market stability. Also, in anticipation of eU entry, investor confidence extends to aspirant countries such as Romania and even Turkey—both of which rank among the top 25 markets for the first time this year. Increased investor inter-est in the region might also be attributed to rela-tively faster growth rates, lower corporate taxes, and favorable productivity levels that help offset rising costs. Communications industry investors are the most bullish on eastern europe—ranking Poland 1st, Hungary 2nd, the Baltic States 4th, the Czech Republic 5th, Slovakia 7th, Turkey 9th and Croatia 15th. FDI prospects in the eastern european telecommunications industry have been bolstered by industry liberalization and deregulation, low penetration rates of mobile phones, and grow-ing consumer markets. Although suffering some declines in cost competitiveness vis-à-vis other developing regions of the world, eastern european locations score well as FDI moves up the value chain to more knowledge-intensive investments. eastern europe is also viewed positively as an R&D location, offering both low costs and

strong scientific and engineering capabilities. nearly one-third of global investors are planning R&D-oriented FDI in eastern europe over the next three years.

Brazil and Mexico Regain Lost GroundBrazil reentered the 10 most attractive markets, taking 7th place in 2005 (up from 17th a year ear-lier). The country’s economic recovery and rising income levels have fueled interest from whole-sale and retail investors who rank Brazil as their 3rd most preferred destination globally. Financial services, telecommunications and utility inves-tors who previously soured on Brazil in the face of macroeconomic and regulatory instability are now rethinking the market. With debt and infla-tion under control, financial services investors rank Brazil 14th while telecommunications and utility investors rank it 16th. electronics manufacturers put Brazil in 6th place last year; this year, they consider the coun-try the 3rd most attractive market, behind China and India. Automotive companies maintain a strong interest in Brazil, ranking it 6th globally, although it fell one spot from 2004. Investors who are eager to meet global demand for a wide range of commodities are more confident in the Brazilian market. Their industries include chemicals, fabricated metal, industrial machinery, computer equipment, mining and raw material manufacturing.

on one hand, global investors want to hold cash surpluses to

weather the lean years and maintain shareholder confidence;

on the other, they do not want to forgo higher-return growth

opportunities overseas.


Mexico climbed to 16th place in the Index this year, up from 22nd in 2004—a rise pri-marily attributed to manufacturing investors. This year, Mexico ranks 6th and 8th among light and heavy manufacturers, up from 21st and 15th in 2004. Mexico is benefiting from a surge in global demand for commodities, as raw-material investors name Mexico their 8th preferred FDI location. The country’s most notable improvement is in the electronics sector where the country soared to 4th place from 21st. Throughout 2005, global electronics manufacturing firms were acquiring facilities and land along the U.S. border. This suggests the improvement in FDI into the maquiladora sector, recorded in 2004, will continue. overall, Mexican FDI inflows increased from $11.8 billion in 2003 to $17.9 billion in 2004.

The Savings Glut Will CloudGlobal FDI Recoveryoptimism concerning the global economy has waned. This year, 36 percent of executives say they are more optimistic about the global economy compared to 31 percent who are not. Last year, nearly 70 percent were more bullish on the global economy and 12 percent were negative. Since September 11, 2001, 65 percent of global investors from the world’s largest firms indicate they are building up significant cash reserves. In fact, U.S. companies alone accumu-lated more than $1 trillion in cash reserves during this period. The top reasons cited for piling up cash is “a desire to improve corporate balance sheets,” followed by “creating a cushion for the next economic downturn” and “limited invest-ment opportunities.” More than one-third (36 percent) of respondents cite shareholder pressure as the primary reason for increasing corporate sav-ings, while 18 percent attribute it to the difficulty in evaluating FDI risk (see figure 4).

The top-line growth imperative is again pushing many companies overseas. Global FDI inflows rose by 2 percent to $648 billion in 2004, which is the first positive change in FDI since 2000. This year, 54 percent of executives say they are planning to increase their foreign investments, the largest number since 2000. nearly half are building war chests for future investment oppor-tunities, which, if unlocked, could lead to an FDI surge. With a rise in cross-border mergers and acquisitions, pressure to identify overseas growth opportunities is conflicting with the rationale for

Figure 4 Primary reasons for increasing cash savings

Improve balance sheet

Cushion againstnext downturn

Limited investmentopportunities

Shareholder pressure

Increase in perceivedinvestment risks

Rising costs

Corporate governanceconcerns

Volatility inenergy prices

U.S. economicuncertainty

Difficulty evaluatinginvestment risk

Increased governmentregulation

Lack of new tech-nology or innovation

Weaker demand

Concerns aboutsecurity and terrorism

Concerns aboutexcess capacity

Percentage of total respondentsSource: A.T. Kearney

60%

38%

38%

36%

30%

20%

20%

19%

19%

18%

15%

14%

13%

11%

10%


holding cash. Global investors face a more com-plex FDI decision-making climate. on one hand, they want to hold cash surpluses to weather the lean years and maintain shareholder confidence; on the other hand, they do not want to forgo higher-return growth opportunities overseas.

Increased R&D Spending Will Occur in Developing Asian and Eastern European Countriesnearly half (48 percent) of global investors plan to increase R&D spending over the next three years, and only 3 percent plan to decrease such spending (see figure 5). Almost three-quarters of the increased R&D spend will be allocated to developing countries in Asia and eastern europe. Roughly one in five global investors plans to increase R&D investments in north America and Western europe, with about the same number planning to reduce R&D investments in the region. About 10 percent of global exec-utives plan to boost R&D spending in Latin American markets.

More R&D money is expected to go over-seas. Investors from north America and Western europe are the most eager to invest their R&D capital in developing Asia and eastern europe. As a result, the most significant cuts will occur in their home territories.

Cost and Quality Will Drive R&D Foreign InvestmentsMore than half of global investors choose R&D investment locations based on three attributes: lower R&D costs, availability and quality of local R&D labor, and intellectual-property protection. The quality of universities and research centers, and IT infrastructure came in 4th and 5th respectively. About one-third of investors consider regu-latory environment, reputation for creativity and innovation, and the ability to tailor products and services as the top attributes when considering an R&D investment location. Roughly 28 percent consider market size critical, while 26 percent view government R&D as the most important factor (see figure 6).

Figure 5Global R&D expenditures will shift to developing markets

Are you planning moreor less R&D investmentsover the next three years?

Investors planning more or less R&D expenditures overthe next three years, by region

More R&D expenditures

Less R&D expenditures


Asia Pacific(excluding

Japan)

EasternEurope

NorthAmerica

WesternEurope

LatinAmerica

JapanMore Less MiddleEast and

Africa

48% 50%

22% 20% 18%

10% 9% 7%0%

10%

20%

30%

40%

50%

0%

10%

20%

30%

40%

50%

3%5%

3%

23%18%

2%3%3%

Perc

enta

ge o

f tot

al re

spon

dent

s

Perc

enta

ge o

f tot

al re

spon

dent

s


Globalization of R&D Will Be a Balancing ActChina and India are the top two countries for future R&D investments, with slightly more than 40 percent of Ceos expecting to make such investments in these markets over the next three years. Almost one-third of global investors cite eastern european locations for R&D activities—with Poland and Russia leading the way. Investor preference for these slowly maturing R&D loca-tions says much about eastern europe’s future talent base, intellectual-property protection, the quality of educational and research communities, as well as infrastructure. The United States, the United Kingdom,

Japan and Germany trail China and India as preferred future R&D investment locations. As of 2003, the combined gross domestic expen-diture on R&D of these four industrialized countries amounted to approximately $520 bil-lion, compared with an estimated $26 billion spent in China and India. The United States and other developed nations will likely remain on the frontier of innovation in most fields, while certain features of the corporate R&D process will move to developing countries. one in 10 new R&D investments will likely go to Japan, which is second only to the United States in total national expenditure on R&D.

Figure 6 The most important attributes in determining R&D investment locations


Lower R&D costs

Availability and quality of local R&D labor

Intellectual property protection

Quality of universities and research centers

IT and local infrastructure

Regulatory environment

Reputation for creativity and innovation

Ability to tailor products and services

Proximity to customers

Presence of supporting industries

Local market size

Government R&D incentives

Openness to international trade

Presence of industry competitors

Proximity to manufacturing

Local firms’ R&D assets (such as patents)

Local firms’ R&D absorption capacity

Quality of life and environment

Bilateral investment treaties

Other

52%

51%

50%

46%

42%

36%

35%

29%

28%

28%

28%

26%

25%

19%

19%

16%

16%

15%

9%

3%

Percentage of total respondents

FDI ConFIDenCe InDex | A.T. Kearney10

Offshoring Intensifies, but the FDI Impact Will VaryThe move to offshore destinations continues: nearly 80 percent of global investors plan to locate corporate functions overseas over the next three years, compared to 66 percent in 2004 and 50 percent in 2003. Corporate investors will pursue offshoring opportunities more aggressively across all major functions (see figure 7). Information technology and call-center functions will see the highest levels of offshoring activity, with 67 percent and 50 percent of global investors expecting to offshore these functions, respectively. These are followed by business processes (for example, accounting, HR and R&D) at 41 percent. The business models for moving corporate functions offshore will include captive and joint venture (both of which result in FDI), as well as third-party outsourcing

and other non-FDI options (see figure 8). Concerns over quality control and IP pro-tection mean that some business processes and functions, including R&D, knowledge manage-ment and analytic functions, will occur primarily through captive business models or joint ventures. nearly 70 percent of future R&D offshoring will be through FDI, while the remaining offshore R&D activity will occur through third-party out-sourcing agreements or other non-FDI channels. The ability to protect intellectual property rights is central to whether or not the developing world can actually attract R&D investments. When sending certain business processes and functions offshore—specifically, informa-tion technology, call centers, distribution and logistics—global investors prefer to rely on third-party outsourcing contacts and other non-FDI operating models. For example, about 55

Figure 7IT and contact centers remain the highest areas for corporate offshoring


Information technology

Perc

enta

ge o

f tot

al re

spon

dent

s

Distribution and logistics

Knowledge management

Research and development

Business process outsourcing

Manufacturing

Contact centers

0%

10%

20%

30%

40%

50%

60%

70%

2003 2004 2005

A.T. Kearney | FDI ConFIDenCe InDex 11

percent of global investors plan to work with an outside provider when offshoring their IT functions. Despite the rapidly growing business process outsourcing (BPo) market, only 28 per-cent of global investors expect to turn to out-side service providers to handle functions such as human resources, and finance and account-ing. nearly 60 percent of investors favor using a captive or joint-venture business model to handle BPo functions. offshoring is not a simple site-provider selection process, particularly when it comes to sophisticated and sensitive functions. of global investors who have sent business processes off-shore, 60 percent say their expectations have been met or exceeded, 17 percent have been disap-pointed, and the rest are unsure. This may explain why roughly 75 percent of investors think estab-lishing and monitoring performance measures

in offshore locations is the most critical success factor in the offshore migration process. In addition to performance metrics, investors cite other less-measurable requirements for off-shore success. For example, 77 percent cite gaining senior-level commitment and rigorously research-ing and selecting an offshore location or vendor as extremely important to a successful offshore operation. empowering members of the program management team and holding them accountable for offshore initiatives is also important. Investors See Diminished Macro Risks, but Growing Micro RisksTraditional operational risks such as government regulation, and financial, political and social insta-bility, appear to be less threatening in 2005 com-pared to previous years. Just 38 percent of investors consider political and social disruptions as risks to

Figure 8Which operating model do you expect to use when offshoring?


R&D and engineering

Knowledge management and analytics

Business processes (HR, finance, accounting)

Manufacturing and assembly

Distribution and logistics

Contact centers (call centers, web centers)

IT (design, support and service

0% 20% 40% 60% 80% 100%

Non-FDI FDI

Other Third party Joint venture Captive

FDI ConFIDenCe InDex | A.T. Kearney1�

operations. Just two years ago, this number was 62 percent. Investors also indicate that country financial risk is less menacing. The risks have become more recognizable and most executives have developed a variety of sophisticated risk hedging, repackaging and shar-ing tools to deal with them. nonetheless, these risks are inherently unpredictable and the limits of coping mechanisms mean that the traditional “macro” risks remain among the leading hazards to operations. Micro risks, however, are becoming more threatening. Corporate governance, IT disruption, product quality, safety problems and employee fraud have all gained importance. Anxiety gener-ated from Sarbanes-oxley and the Basel II Accord have mixed with rising fears about information security.3 More than one-third of investors are worried about governance issues compared to 25 percent who were worried two years ago. nearly one-third of investors consider IT disruption as a threat to operations compared to only 19 per-cent in 2004 and 17 percent in 2003. In addition to the ongoing battle against computer viruses, a series of high-profile cases where customer infor-mation has been compromised has heightened investors concerns over information security. With companies aggressively outsourcing their IT and other functions to third parties, executives are encountering the downside of such arrangements, including less oversight and less control of quality and security.

Regional FindingsThe AmericasThe United States dropped one spot to become the 3rd most attractive FDI location, losing ground mainly in the light manufacturing and financial services sectors. However, the United States ranks among the top 5 most attractive FDI locations among investors in the primary sector, telecom and utilities, and heavy manufacturing (specifically in high-technology and computer equipment firms). Canada has not benefited from the growth in global cross-border M&As. Foreign investment in Canada has declined significantly since the peak of the global M&A boom in 2000, when FDI hit a record high of $67 billion. In 2004, Canadian FDI was $6.3 billion—an ebb not seen since 1993. However, companies from Canada’s next leading sources of FDI—the United Kingdom, France and the netherlands—are more eager to commit to the market. In fact, after the United States, the european Union is Canada’s most important trade and investment partner, with one in four Canadian FDI dollars coming from european companies. Investors express more confidence in Latin America as it enjoys continued economic recovery. FDI inflows to Latin America increased after four years of declines—reaching $68.9 billion in 2004 up from $48 billion in 2003. The FDI recovery was driven mainly by activities in the manufacturing and the primary sectors. Still, with the winding down of privatizations and M&A deals, FDI has yet to return to the peak levels of 1999 when the region received $107.4 billion. United States. Last year, the United States was the largest FDI recipient in the world, cap-turing $96 billion—a strong rebound from the

3 The Sarbanes-Oxley Act, Pub. L. No. 107-204, 116 Stat. 745 (July 30, 2002), is a United States federal law also known as the Public Company Accounting Reform and Investor Protection Act of 2002. Basel II Accord is the second Basel Accord and represents recommendations by bank supervisors and central bankers from 13 countries to revise the international standards for measuring the adequacy of a bank’s capital.

A.T. Kearney | FDI ConFIDenCe InDex 1�

$56.8 billion received in 2003. Several major cross-border deals in the financial services sector drove this performance. For example, Canada-based Manulife Financial Group acquired John Hancock Financial for $11.1 billion, which was the second largest deal in 2004. Although FDI in the U.S. financial sector has been high in recent years, investors appear to have cooled on the U.S. financial market. This year, financial services investors rank the United States 6th, down from 2nd place in 2004. More than one-third of global insurance carriers are more negative on the U.S. market, which is likely due to the country’s destructive hurricane season. Investors from the highly competitive light manufacturing segments, such as electronics, food and textiles, are less likely to commit FDI to the United States than to lower-cost, faster-growing emerging markets. China, India, Brazil, Russia, Poland, Mexico and Hungary take the first 7 spots in the light manufacturing rankings, with the United States coming in 8th—down from 3rd place last year. The U.S. economy remains a behemoth, producing $12.5 trillion in GDP, three times that of Japan, which is the next largest market. Having weathered unprecedented current-account deficits, massive natural disasters and interest rate hikes, U.S. economic growth remains robust. Underlying the strength of the U.S. economy are U.S. companies that poured more investments overseas than ever before in 2005—approximately $229 billion—reinforcing the country’s role as a primary source of FDI. The Homeland Investment Act (HIA) could affect the final tally of global FDI recorded in 2005. When the HIA expired in 2005, so did the tax break for U.S. companies on repatriated foreign affiliate earnings. The U.S.-europe inter-est rate differential and the HIA have helped strengthen the dollar in the face of massive U.S.

deficits. With U.S. companies taking advantage of the one-time tax break, U.S. FDI outflows are estimated to be nearly $60 billion for the first half of 2005 down from $108 billion over the same period in 2004. Canada. Canada dropped from 16th to 21st place in the Index this year—its lowest recorded ranking. In particular, U.S. investors, who account for 65 percent of the country’s FDI inflows, put Canada 8th among their most attractive FDI locations, compared to 4th place in 2004. If the diminished outlook among U.S. companies con-tinues, it could mean future declines in overall FDI for Canada. Globally, manufacturing and financial services investors were less interested in the Canadian market in 2005. Food and kindred products companies are more attracted to the Canadian market and con-sider it their 4th most preferred FDI location. one-third of executives in these sectors view Canada more positively than they did a year ago. The Canadian food market is shifting toward packaged and convenience food—driven by a rise in the number of single people, longer work hours, and dual-income households. Beer accounts for half of all beverage consumption, with quality-conscious Canadians demanding premium alcohol products. Brazil’s Ambev acquired Canada’s John Labatt Ltd. for $7.8 billion, making it the fifth largest cross-border deal in 2004. The surge in prices and global demand for commodities (particularly oil and gas) has helped move Canada up a notch (from 14th to 13th place) in the primary sector. Canada ranks 9th among mining companies—up from 11th in 2004. Since the 1990s, the leading sources of Canadian job growth have gradually shifted from cars and computers to mining and construction. Investments in the resource-rich Western prov-inces of Alberta and British Columbia are on the rise, as is investment in rail systems and ports,


which help fuel the construction sector. Brazil. Brazil shot up 10 spots to 7th place from its all-time lowest ranking in 2004. FDI in Brazil increased 79 percent, reaching $18.2 billion in 2004. Much of the optimism is due to the country’s healthy macroeconomic perfor-mance, resulting from increased exports to China, higher commodity prices, rising incomes and increasing demand. Wholesale and retail, telecom, financial and non-financial services, primary and manufacturing sector investors all expressed increased confidence levels in Brazil. Brazil’s natural resource markets are heat-ing up. The mining sector posted some of the strongest improvements in the country’s rank-ings, moving Brazil to 7th place from 22nd. Investments in the raw materials sector were also positive, moving Brazil to 4th place from 14th. Investors are encouraged by continuing strong global demand for a wide range of commodi-ties—from iron ore to soybeans. In the chemicals sector, Brazil ranks 5th, up from 9th in 2004. The Brazilian pharmaceuti-cal sector has posted positive sales performance since 2003. Many foreign companies are apply-ing for licenses to produce generic drugs in Brazil. In 2004, a wholly-owned Brazilian subsidiary of India’s Glenmark Pharmaceuticals Ltd. acquired Laboratories Klinger, a local pharmaceutical firm, and obtained approved product registrations, most of which were generics, in the process. Global investors rank Brazil 9th most attractive R&D investment location. The Brazilian consumer is returning and helping to fuel the country’s economic perfor-mance. The wholesale and retail sectors are invest-ing in Brazil again—eager to tap into a domestic market with rising incomes, increasing purchasing power, and growing interest in premium brands. In 2004, Wal-Mart (U.S.) acquired Royal Ahold’s

(netherlands) local subsidiary, Bompreço, and quickly expanded into Brazil’s northeast region where growth in real income has been the highest. Meanwhile, Interbrew SA’s (Belgium) acquisition of Braco SA for $4 billion was the largest cross-border M&A in Latin America. Automotive and transportation equipment investors rank Brazil slightly lower this year (moving Brazil from 6th to 5th place in the Index). But both sectors remain optimistic as vehi-cle sales increase due to lower interest rates, higher incomes and government-sponsored tax conces-sions. Global automotive companies, including Fiat (Italy), General Motors (U.S.), Mitsubishi Motors (Japan) and Hyundai (South Korea), plan future investments in Brazil. However, the strengthening of the real is hurting export compet-itiveness and encouraging manufacturing investors to pursue domestic market opportunities. Since 2000, many companies, particularly in the telecom, electricity and financial sectors, divested across South America due to economic stagnation, regulatory uncertainty and macroeconomic instability. Looking ahead, however, financial services and telecom investors are rethinking the Brazilian market. With debt and inflation under moderate control in 2005, finan-cial services investors rank Brazil 14th, while telecommunications and utilities investors rank the country 16th. Indeed, Citigroup Brazil plans to add 62 new branch banks, and Goldman Sachs (U.S.) is in talks to create a joint venture with Banco Pactual SA. Despite renewed investor enthusiasm and the government’s economic pragmatism, Brazil still has considerable obstacles. For example, Brazil suffers from one of the most rigid labor markets in the world, high business costs, heavy bureau-cracy, and slow implementation of public-private partnerships needed to address infrastructure bottlenecks.


Mexico. Mexico climbs up the Index from 22nd in 2004 to 16th in 2005 among global investors. Mexico’s turnaround is led by increased FDI interest spurred by recent bilateral economic agreements and increased confidence among manufacturing investors. Japanese investors rank Mexico their 5th most attractive market, up from below the top 25 last year. The Japan-Mexico economic Prosperity Agreement (ePA), effective in April 2005, offers Japanese companies new opportunities in Mexico. The Mexican government’s strategy to reduce dependence on the United States by pursuing a constellation of free-trade agreements in europe and Asia could be paying off. The maquila sector is helping Mexico’s FDI inflows rebound. Mexican FDI inflows jumped from $12.8 billion to $17.9 billion. The economic recovery in the maquiladora sector, supported by U.S. demand for imports, helped spur a return of manufacturing investors. Mexico suffered a steep drop in maquila FDI between 2001 and 2003. BBVA (Spain) purchased its local affiliate for $3.8 billion and Holcim Ltd (Switzerland) acquired its local affiliate for $591million. Combined, these deals accounted for more than one-quarter of overall FDI inflows to Mexico in 2004. Manufacturing investors see brighter pros-pects in Mexico. In 2005, heavy and light man-ufacturers rank Mexico 8th and 6th respectively, up from 15th and 21st a year earlier. Since January 2004, Volkswagen (Germany) and Ford (U.S.) have announced more than $3 billion

in multiyear investments. electronics investors are similarly optimistic about Mexico, ranking the country 4th, up from 21st a year earlier. Throughout 2005, leading electronics manufac-turers, such as Motorola, acquired facilities and land along the U.S. border, suggesting a continu-ing FDI improvement in the maquiladora sector. Despite rising energy prices and demand, oil and gas investors lost confidence in Mexico, ranking the country 16th this year, down from 7th a year earlier. As the country prepares for the July 2006 presidential elections and as con-tinued high oil prices help fill the state’s coffers via state-run PeMex, the much-needed energy sector reforms are less likely in the short term. Mexico’s business climate will continue to face higher costs and it may soon become a net oil importer if infrastructure and technology invest-ments to upgrade oil, gas and electricity sectors are delayed further. Transport services investors are optimistic about the Mexican market. Investor confidence in transportation services increased in 2005 as air-line holding company Cintra SA announced plans to sell off Mexico’s two main airlines, Mexicana and Aeroméxico. With several aviation investors eyeing the Mexican market, and as the airline sector opens up to competition, the aviation market could undergo a transformation over the next few years. A gap in human capital may limit Mexico’s R&D potential. Mexico ranks as the 15th most attractive R&D location globally. Compared to

Investors express more confidence in Latin America as it

enjoys continued economic recovery. FDI inflows to Latin

America increased in 2005 after four years of declines.


China, for example, Mexico is hardly a competi-tor. Between 1996 and 2002, total R&D spend-ing in China reached $15.6 billion compared to $2.7 billion in Mexico. Another reason Mexico lags as an attractive R&D location is the lack of a growing, highly skilled work force. even though Mexico’s population has more than doubled in three decades, the public education system has not kept up. Mexico is making efforts to improve, with an increase in private universities and private equity funds investing in for-profit universities, but it is yet to be seen if these private universities can fill the country’s technical skills gap. Chile. Despite Chile’s small market, its favor-able business climate and political and economic stability continue to attract investors. Foreign direct investment into Chile jumped to $7.6 billion in FDI inflows in 2004, driven mainly by investors in telecom and primary sectors. Investments in the telecommunications are bol-stered by the country’s sound regulatory system, increased competition and advanced telecom market. Indeed, 41 percent of the total $3.2 billion increase in Chile’s FDI inflows from 2003 to 2004 was due to Telefónica Móviles (Spain) $1.3 billion acquisition of Telefónica Móvil (Chile). The primary sector accounted for 82 percent of Chile’s total inward FDI, driven by higher mineral prices and reinvesting earnings by foreign affiliates. Argentina. FDI inflows to Argentina grew by 125 percent in 2004, albeit from a low base. FDI flows to Argentina reached $4.3 billion in 2004, still below the 1990 FDI levels. The primary sector and export-oriented automotive sector con-tinue to attract FDI in the aftermath of the 2002 devaluation. Toyota (Japan) recently announced plans to further expand its Argentine operations, focusing on export markets. The end of privatiza-tion programs, lingering political and economic uncertainty, and numerous pending international

investment disputes are all hindering Argentina’s ability to regain the level of investor interest expe-rienced in the late 1990s when the country ranked among the top 10 most attractive FDI locations. Andean Region. The primary sector remains the focus of investor interest in the Andean region. Continued high prices and robust demand for minerals and oil sustained investor interest in nat-ural resource opportunities. However, declining levels of overall FDI flows to Venezuela, Bolivia and ecuador may be due to political instability. U.S. companies are the leading source of FDI in the region, and with the Andean Trade Promotion and Drugs eradication Act due to expire in December 2006, current negotiations are under-way between the United States and Peru for a bilateral free trade agreement. This may further bolster U.S. interest in the region, if politics do not get in the way.

Europeeurope’s performance has been mixed with Western europe losing investor confidence and eastern europe gaining confidence. Most major Western european investment destinations dropped in rankings this year. While the United Kingdom held its 4th place position, Germany, France, Italy and Spain all declined. The old eU-15 countries experienced declines in FDI inflows in 2004—hitting $231.4 billion—the result of sluggish growth rates, dis-investments, and substantial repayments of intra-firm credits by foreign affiliates to their parent firms overseas. Germany, the netherlands and Sweden accounted for 95 percent of the total decline among the eU-15. These countries exhibit little room for fiscal stimulus. They have large pension lia- bilities, aging populations and high levels of debt. Moreover, high savings rates in France, Germany and Italy are not likely to decline and


help boost consumption because people are concerned over the future of publicly funded pensions and health-care costs. The rejection of the eU constitution by the French and Dutch electorates (two founding members of the eU) and the shifting political scene in Germany have increased the uncertainty. Although many european firms have improved their balance sheets and reduced debt, business confidence remains sluggish and continues to be a drag on growth. With the bulk of european investment derived from other european markets, this will likely mean diminished FDI prospects in Western europe. Investment outflows from the european Union declined from $372 billion in 2003 to $280 billion in 2004. However, eastern european markets are ben-efiting from a sharp increase in FDI confidence levels—with Poland, Russia, Hungary, the Czech Republic, Turkey and Romania all experiencing more FDI confidence. Countries with the most positive outlook—Poland, Russia, Turkey, the Baltic States and the Czech Republic—all rank in the top 10. FDI flows to the 10 new eU markets increased from $12 billion in 2003 to $20 billion in 2004. As a result, FDI inflows as a share of gross capi-tal formation rose from 11 percent to 16 percent in these countries—surpassing the average level of the eU-15. Industry consolidation and cor-porate restructuring across europe are benefiting eastern european markets. eU membership has removed obstacles for small- and medium-size eU firms that were previously deterred from investing due to border controls and just-in-time delivery requirements. Despite rising costs and more regulations, new eU members are relatively more attractive to global companies. This is due to higher levels

of productivity and better tax rates. The average corporate tax rate among the new eU members is 20 percent, but reaches 31 percent for the eU-15. Poland, the Czech Republic and Hungary benefited from double-digit growth in the first half of 2005. These countries are experiencing strong export demand from Russia, Ukraine and the Balkan States, which compensates for less export demand from Western europe. Higher oil prices, which are eroding growth in Western europe, are actually fostering stronger demand in oil-producing countries such as Russia and the Commonwealth of Independent States (CIS). The shifting trade patterns between West and east are acting as a shock absorber for eastern european markets. Russia, Turkey and Romania also made significant gains in FDI attractiveness this year, further reflecting higher FDI prospects in eastern and Southern europe. United Kingdom. The United Kingdom held steady in 4th place in 2005, behind China, India and the United States.4 French, Canadian and U.S. investors maintained the highest levels of FDI confidence in the U.K. market in 2005—ranking the country their 4th, 7th and 4th most attractive FDI destination, respectively. In 2004, FDI inflows to the United Kingdom hit $77.6 billion, up from $27.4 billion in 2003. This was the third largest FDI inflow to the United Kingdom and was driven largely by a few major cross-border M&A deals, including Santander Central Hispano SA’s (Spain) acquisition of Abbey national for $15.8 billion, and Ge’s (United States) purchase of Amersham plc for $9.6 billion. The United Kingdom, among the world’s leading financial markets, continues to attract investors from banking, insurance and other financial services sectors. Global bankers say the United Kingdom is their 3rd most attractive

4 UNCTAD preliminary figures for 2005 puts the United Kingdom in the number one position, having attracted more than $200 billion in FDI, an increase of 182 percent.


FDI location, while insurance companies rank the United Kingdom 4th. London is the world’s largest market for cross-border bank lending—responsible for nearly one in five dollars lent overseas—as well as over-the-counter derivatives, foreign exchange trading, and marine and avia-tion insurance. Business services—mostly software, engi-neering, accounting, research and management companies—rank the United Kingdom their 3rd most attractive FDI location globally. Silicon Glen (Central Belt of Scotland), Silicon Fen (Cambridgeshire), Thames Valley/M4 Corridor, Greater Manchester and the Midlands represent highly advanced software clusters supporting the United Kingdom’s rapidly growing software industry, which is estimated to be worth $40.5 billion as of 2004. In part, the United Kingdom’s strong perfor-mance in business services is related to the coun-try’s attractive R&D capabilities. Global investors rank the United Kingdom their 4th most attractive R&D location globally, behind India, China and the United States. The country boasts advanced technical and engineering skills, strong ties between industry and academia, and operates on the cutting-edge of new product research, design and development in many fields. The largest share of U.S. and Japanese R&D operations located in europe are based in the United Kingdom. Telecom and utilities investors rank the United Kingdom, their 6th most attrac-tive market. Although the U.K. mobile market quadrupled between 1998 and 2003, growth rates will slow in the coming years as penetration rates exceed 90 percent. But content innovation through third-generation networks (3G) allow-ing internet access, video and data transmission will provide further room for growth on a per user

basis. The United Kingdom is the current global leader in 3G technology. Telecom regulator, ofcom, is forcing domi-nant BT to provide greater market access to rivals and encouraging new entrants to help improve service, reduce prices and expand consumer inter-net access. In a clear sign of increasing competi-tion, Carphone Warehouse’s Talktalk and onetel are wooing customers away from BT. Poland. Poland jumped from 12th to 5th place in the Index—its highest ranking since 2000—driven by increased interest from U.S. and european investors. U.S. investors rank Poland their 7th most attractive FDI location (up from 12th a year ago), while european investors rank Poland 3rd, up from 6th in 2004. Most enthusiasm in europe comes from U.K. and Dutch investors. Both countries rank Poland their 3rd most preferred investment location worldwide. Italian and Swiss investors rank Poland 5th and 6th, respectively. notable european investments are Germany’s MAn AG, which invested $123 million in a new factory to start producing trucks in 2007, and France’s Michelin, which is expanding its existing plant in the northeast in a $306 million deal. About one in four global investors is more optimistic about the Polish market—only India, China and Brazil achieved higher levels of investor enthusiasm worldwide. one in 10 global investors indicated they will make first-time investments in Poland. Poland’s full membership in the eU has meant the adoption of eU laws, greater regulatory stability and reduced risk pre-miums. Similarly, eU Structural Funds are aimed at improving infrastructure, human resources, competitiveness and enterprise development. In 2004, Poland received $12.6 billion FDI inflows—up from $4.6 billion in 2003.5

5 UNCTAD preliminary figures for 2005 reveal that FDI inflows to Poland decreased by 31 percent to $8.7 billion.


nearly 60 percent of these flows were attributed to greenfield investments (new investments by entrepreneurs, as well as profits posted to pre-vious greenfield investments). nearly 1 in 10 greenfield investments in the european Union went to Poland in 2004. From a sector perspec- tive, manufacturing accounted for most FDI, with automotive, chemical and metal invest-ments leading the way. Looking ahead, global communications inves-tors are the most bullish on Poland—ranking it their number one market worldwide. Poland repre-sents the largest communication market in central europe. With a large population and lower mobile phone penetration rates than the Czech Republic and Hungary, Poland offers solid market oppor-tunities. Vodafone (U.K.), TDC (Denmark), and T-Mobil (Germany) are increasing their invest-ment stakes in two Polish mobile operators. Poland’s fixed-line operator, TPSA (the former state-owned monopoly), faces little competition and the market remains fragmented. However, consolidation among other fixed-line competi-tors is expected to boost growth and improve service. Further improvements to the telecom infrastructure would reduce consumer costs and foster greater broadband internet access. Already, Poland has more internet users than Bulgaria, the Czech Republic, Hungary, Romania and Slovakia combined. electric and gas investors rank Poland their 2nd most preferred investment location. Although privatization in the electricity sector has been slow, eU entry will require liberalization. As the country moves away from energy-intensive indus-tries and pursues environment-friendly policies, coal production has declined in favor of mostly imported natural gas. Polska Gornictwa naftowa i Gazownictwa (PGniG), the state-owned gas storage, distribution and trade company, is being restructured and opened to foreign investors.

After joining the european Union, food restrictions on the eU-15 markets were elimi-nated, thus making Poland a major european agricultural player. Food, tobacco, textiles and apparel investors rank Poland their 5th most attractive market, while investors in agriculture, forestry and fishing place Poland 3rd. The food-processing market is growing fast and the industry is moving up the value chain. Poland ranks 5th among fabricated metal, industrial machinery and computer equipment investors. The world’s largest PC maker, U.S.-based Dell, plans to build a PC assembly factory in Lodz—a move expected to generate 12,000 new jobs and further increase the supplier market. Poland’s offshoring potential is also rising. Investors are attracted by the special economic zone in Lodz, with Philips (netherlands) trans-ferring its european financial and accounting operations there. The zone has become a hub for on-shore call centers of domestic firms. For exam-ple, telecom incumbent TPSA, mobile Polkomtel and Bank Pekao all operate customer service centers from Lodz. europeans rank Poland their 4th most attrac-tive R&D investment destination globally. German-based Siemens expanded its Wroclaw research and development center and increased staff by 40 per-cent. In 2002, Poland’s gross domestic expenditure on R&D was $1.1 billion—more than any other new eU member and about one-third of the com-bined spend of the 10 new eU countries. Russia. After tumbling from 8th place in 2003 to 11th place in 2004, Russia places 6th in the Index. French, German and Swiss inves-tors express the most confidence in the Russian market, ranking it 3rd, 4th and 7th respectively. Russia is the 4th most preferred location for first-time investors. Russia received $12.5 billion in 2004, up from the $8 billion received in 2003, marking an

FDI ConFIDenCe InDex | A.T. Kearney�0

all-time high.6 The bulk of investment flows went into the petroleum and natural gas extraction sec-tors. The Sakhalin region—where Royal Dutch Shell, Mitsui and Mitsubishi have built Russia’s largest oil and gas facility—benefited significantly from this FDI. Investors from the energy sectors may be cooling on Russia, as it ranks 9th among primary sector investors, down from 6th in 2004. electric and gas investors rank Russia 14th, down from 2nd place last year. The increasing role of the government in the energy sector (through state-controlled companies Rosneft and Gasprom) may be adding to foreign investor uncertainty and apprehension. State intervention has also moved beyond the energy sector: earlier this year, the government blocked Siemens (Germany) from acquiring Power Machines, one of Russia’s major engineering firms, in favor of UeS, the domestic electricity monopoly. Investors are receiving mixed messages from the Kremlin. The government’s gradual transition toward flat and lower taxes is an encouraging sign, but the political and seemingly capricious use of tax enforcement mechanisms, such as audits, may undermine investor confidence. The BP-TnK deal represents a significant step in opening the energy sector to foreign investment. However, new restrictions on foreign participation in oil and metal deposit tenders may hinder future FDI. Manufacturing investors are bullish on Russia,

which ranks 3rd (up from 8th) among heavy manufacturing investors, and 4th (up from 13th) among light manufacturing investors. Automotive investors are buoyed by rapid car sales and oil exports. Toyota is the first Japanese automaker to build a manufacturing plant in Russia, with Mercedes, Volkswagen and Mitsubishi consid-ering manufacturing there. Ford is expected to double its output of Focus sedans built near St. Petersburg. one in four transportation equipment investors globally is more upbeat on the Russian market, and investors in chemicals and allied products rank Russia 7th (up from 14th), appar-ently despite concerns over state interference. Russia’s retail market also retains investor interest. Russia ranks 2nd among paper and allied products companies, perhaps the effect of the current retail boom. Russia maintains its posi-tion as the most attractive market among food, tobacco, textiles and apparel investors. Currently, Russia is the 12th largest retail market worldwide, and is expected to jump to 9th largest market in a few years—overtaking Spain, Brazil and Mexico. Already, investors are increasing their presence there. Altadis (Spain) acquired Russia’s Balkan Star earlier this year, and in 2005, Coca-Cola (U.S.) acquired Multon, Russia’s second-largest juice company. Similarly, 35 new shopping centers are under development in Russia, although logistics prob-lems and the lack of highly skilled professionals

Europe’s performance on the Index has been mixed,

with Western europe losing investor confidence and

Eastern Europe gaining it.

6 UNCTAD preliminary figures for 2005 reveal that FDI inflows to Russia increased by 109 percent to $26.1 billion.

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make it difficult to expand beyond the major cities of Moscow and St. Petersburg. While Russia boasts notable investors such as IKeA (Sweden), the absence of major U.S. companies is a striking characteristic of the country’s retail boom. Russia ranks 11th among telecom and util-ities. This is a significant jump from below the top 25 in 2004. Mobile penetration rates have nearly doubled annually for the past four years, making Russia one of europe’s fastest-growing mobile markets. energy, finance and commer-cial sectors are demanding both IT services and an improved infrastructure. Some of the largest cross-border deals in Russia last year were in the telecom sector. For example, Alfa Telecom Ltd. bought Vimpelcom oJSC for $1.4 billion and Access Industries, Inc. (U.S.) acquired Svyazinvest JSC for $625 million. Rising wages, however, are stifling growth in sectors outside energy. Without an overall strat-egy to diversify beyond the energy sectors, Russia could continue to suffer from “Dutch Disease” and deindustrialization. Germany. Germany fell from 5th to 9th place—its lowest ranking since 1999. French, Swiss, U.S., Italian and Dutch investors expressed less interest in the German market. FDI inflows dropped from $27.2 billion in 2003 to negative $38.6 billion in 2004, the result of lower equity capital and substantial repatriations of intra- company loans. equity capital declined from $40.5 billion in 2003 to $21.6 billion in 2004, while intra-company loans soared—from nega-tive $8 billion to negative $46.2 billion—over the same period. In part, the steep decline was due to revisions to the German tax code intended to encourage foreign companies to transfer their corporate loans into equity capital. The tax change made it less attractive for foreign companies to retain liquid reserves at their German affiliates. Moreover,

the large negative intra-company loan flow was influenced by one major $24.5 billion transaction in the telecom sector. Manufacturing investors soured on Germany this year. Heavy manufacturing investors rank Germany 10th, down from 4th place, while light manufacturing investors rank it 15th, down from 4th place a year earlier. The desire to move closer to export markets combined with Germany’s high payroll and compliance costs is driving manufac-turing firms to emerging markets, including China and eastern european countries. Domestically, Germany’s automotive market, which is europe’s largest, suffered from sluggish growth between 2001 and 2003 and expanded only modestly last year. Transportation equipment investors are sig-nificantly less interested in the German market. Germany ranks 11th among financial ser-vices investors. Italy’s Unicredit created head-lines by acquiring Germany’s third-largest bank, HVB Group, for $18.5 billion in June 2005. The consumer finance market is becoming more sophisticated, evident in a rise in non-mortgage consumer loans and credit-card activity. We expect to see a rise in corporate bonds and equities. The elimination of state guarantees in July 2005, has led to an increase in bank bor-rowing costs, causing banks to lend less money and encouraging corporations to shift to cap-ital markets. The future, however should be brighter. Legislation cutting future pension liabil-ities and creating incentives to encourage private savings will likely spur growth of retirement savings products and services. The life insurance business is also expected to grow due to concerns over the public pension system. Germany ranks 3rd among chemicals and allied products companies. In June 2005, novartis (Switzerland) acquired Hexal, the generic drug maker, while Torrent (India) purchased Heumann Pharma. In 2004, Roche (Switzerland) poured

FDI ConFIDenCe InDex | A.T. Kearney��

money into two biotech plants in Bavaria, while GlaxoSmithKline (U.K.) invested in a second vaccine plant in Dresden. other notable chemical deals in 2004 include: Air Liquide SA’s (France) acquisition of Messer Griesheim-Ind Gas ops for $3.4 billion, Rockwood Specialties Group’s (U.S.) purchase of Dynamit nobel AG by for $2.7 billion, and The Blackstone Group’s (U.S.) purchase of Celanese AG for $2.2 billion. Hungary. Hungary climbed to 11th from 19th place in the Index. Investment in Hungary is buoyed by increased confidence among Western european investors. German, Swiss, Dutch and U.K. investors express the most enthusiasm for the Hungarian market. Despite heightened macroeconomic risk and one of the world’s strongest currencies last year, Hungarian FDI rose from $2.1 billion to $4.6 billion in 2004. Wages rose sharply and unit labor costs in U.S. dollar terms nearly doubled from 2000 to 2003, but slowed in 2004. Still, Hungary offers some of the lowest wages in eastern europe (31 cents on the U.S. dollar compared to the eU-15 average). Hungary’s recent eU-entry, rising pro-ductivity, and a multilingual, skilled and motivated workforce act as magnets for foreign investors. Hungary ranks 2nd among communications investors and 7th among electronic and electrical equipment investors. Investments by nokia and elcoteq (Finland) and Flextronics (Singapore) are helping to position the country as a major european hub for manufacturing mobile handsets. However, in the price sensitive and highly competitive elec-tronics industry, Hungary’s rising wage costs and currency appreciation have negatively affected the market. Already, Flextronics and IBM have moved some production from Hungary to China. Hungary ranks 10th—up from 17th last

year—among chemicals and allied products investors. The country inherited a solid pharma-ceutical industry from the Communist era that has evolved into a european platform for low-cost production of patented compounds and branded generic substitutes. Local pharmaceutical compa-nies are also engaged in R&D activities. Czech Republic. The Czech Republic is the 12th most attractive FDI location—an all-time high in the Index. U.S. investors rank the Czech Republic 14th (up from 20th), displaying the largest improvement in FDI confidence this year. european investors express the strongest levels of FDI confidence in the Czech market, with Germany ranking it 7th, the United Kingdom 9th and France 11th. FDI inflows more than doubled in 2004, reaching $4.5 billion.7

Insurance, real estate and holding compa-nies rank the Czech Republic 7th up from 13th place in 2004. A series of central bank interest rate hikes may dampen strong growth in the tra-ditional banking sector, but new opportunities are emerging in insurance and asset management. Société Générale (France) and Allianz (Germany) are jointly expanding insurance operations in the country, while Aegon (netherlands) is enter-ing the market. Concerns from the 1990s about minority shareholder rights, asset stripping and insider trading could be fading as wealth man-agers launch new products to benefit from rising Czech incomes. The Czech Republic ranks 9th among trans-portation equipment firms. Automakers are keen on the market and are expected to make additional investments over the next few years. Car exports, mainly destined for other european countries, comprise 23 percent of all Czech exports. And although car ownership in the country is higher than anywhere else in Central europe, it is still

7 UNCTAD preliminary figures for 2005 reveal that FDI inflows to the Czech Republic increased 181 percent to $12.5 billion.

A.T. Kearney | FDI ConFIDenCe InDex ��

low compared to developed countries. Hyundai (South Korea) is leaning toward the country’s ostrava region for a planned $1.2 bil-lion production plant, after building a Kia Motors subsidiary in Slovakia. Toyota Peugeot Citroen Automobile (an auto consortium) is expected to ramp up production at its plant near Prague. Telecom and utilities investors rank the Czech Republic 7th. The country has one of the most advanced information and communications technology (ICT) sectors in Central and eastern europe. When Telefónica (Spain) acquired Cesky Telecom in 2005, it crowned a decade of efforts by Czech authorities to privatize the sector. earlier, Vodafone (U.K.) acquired major mobile operator oskar. With Germany’s T-Mobil and France’s orange, the country’s entire mobile net-work is now foreign-owned. Another promising area of growth is in broadband services, driven by internet use and internet shopping. In fact, one in six Czechs shops online. There is rising demand for professional inter-net, e-commerce, web design and systems inte-grator services, particularly within the banking and government sectors. U.S. firms dominate the software market: Microsoft, novell, Corel, Lotus Symantec, Sybase, oracle and Sun Systems are all active in the country’s IT and software sector. Turkey. Turkey jumps to 13th place from below the top 25. The potential for eU acces-sion—albeit uncertain—and reforms under the International Monetary Fund stabilization pro-gram have helped push Turkey up the Index. The interest is buoyed by the central bank’s adoption of inflation targeting strategies early in 2006, part of the last phase in a four-year process of reforming the country’s monetary policy. Turkey ranks 7th among countries consid-ering first-time investments over the next three

years. In 2004, the country had $2.7 billion in FDI inflows, a 56 percent increase over the previous year.8 european investors are the most optimistic about Turkey, ranking it 7th (up from 21st), with Italian investors ranking Turkey their number one FDI location, ahead of China and India. Turkey jumps to 11th place (from 20th) in the banking sector. After the 2001 financial crisis, the Turkish government poured capital into the failing banking system and is now seeking FDI through privatization. Recently, Turk Dis Ticaret Bankasi was acquired by Fortis Bank (Dutch-Belgium) for $1.3 billion. Turkey ranks 12th among telecom and util-ities investors. A consortium of Telecom Italia (Italy) and oger Telecom (Saudia Arabia) plans to purchase a 55 percent stake in Turk Telekom for $6.55 billion, while TeliaSonera (Sweden) and Alfa Group (Russia) are expected to invest in Turkey’s wireless market. Also, Turkey ranks 12th among heavy manu-facturers and 9th among light manufacturers (a jump from below 20th place). In the automobile sector, companies consider the country a viable export platform for europe. General Motors (U.S.) plans to restart its production facilities in Turkey, and Hyundai is expanding its already-significant investment there to meet growing demand in europe. France. France drops from 6th to 14th place in the Index. Last year, FDI inflows into France declined 43 percent. Looking ahead, France may see fewer FDI commitments: German, U.S., Dutch, Swiss and Italian investors all express less interest in the French market, with manufactur-ing investors the most pessimistic. France’s brewing “economic patriotism” has surprised investors. For example, PepsiCo’s (U.S.)

8 UNCTAD preliminary figures for 2005 reveal that FDI inflows to Turkey increased 77 percent to $4.8 billion.


bid for Groupe Danone, the French food and beverage firm, and HP’s decision to shed work-ers from its French subsidiary produced strong responses from the government. They also inten-sified the country’s ongoing debate over main-taining its social model amid globalization. The government expanded its list of “strategic sectors” that are off limits to foreign investors, and passed legislation that restricts shareholder rights and helps French firms defend against hostile take- overs. In 2004, the government helped thwart novartis (Switzerland) from acquiring Aventis and government intervention blocking an Italian takeover bid for Suez SA further fanned investor concerns. French FDI inflows declined last year due to lower equity and intra-company debt transactions. However, the actual number of FDI projects in the country increased, according to Invest in France, the economic development arm of the government. This reveals a decline in the number of large M&A deals, possibly due to rising political and public sentiment opposing such transactions. France ranks 7th among wholesale and retail investors, up from 10th place. FDI confidence in France is strongest among food and apparel retail-ers. And despite a rise in oil prices, consumer confidence has not waned. BC Partners Ltd (U.K.) spent $1.7 billion to acquire Picard Surgeles SA, France’s top frozen food retailer. The French cloth-ing market is expected to be worth $46 billion by 2009. An increase in the working-age population combined with more women in the workforce is expected to spur growth in this segment. electric and gas investors rank France 11th in the Index, down from 10th place. Weak public finances and sluggish growth have pressured the government to sell key companies. In 2005, the government sold stakes in France Telecom and Gaz de France and expects to move forward with

the partial-privatization of electricité de France. However, investors’ initial enthusiasm for owning shares in the nation’s utilities has waned, with the government reducing the original sale price and now planning to retain 85 percent ownership. Spain. FDI continues to play a major role in the Spanish economy. Market liberalization and eU accession, which began in the late 1980s, have led to macroeconomic stability, growth and restructuring of the industrial base. Despite the global FDI recession since 2000, FDI inflows to Spain have held strong in recent years—hitting an all-time high of $44 billion in 2002. Increasing competition, however, undermines the country’s future FDI potential. Facing stiffer competition from eastern europe and Asia, Spain’s ranking dropped for a third year in a row—falling from 7th place in 2002 to 17th in 2005. FDI inflows to Spain declined from $29 billion in 2003 to $18 billion in 2004, with many foreign companies liquidating previous invest-ments. Labor costs are part of the problem. Wages in Spain are more than three times higher than in Poland, the Czech Republic and Hungary—and the country is not achieving higher productivity rates to justify its higher wages. In fact, Spain is the only oeCD country to record negative pro-ductivity growth rates over the past decade. Heavy manufacturing investors downgraded Spain from 9th to 14th place. Wholesale and retail investors rank Spain their 10th most attractive market globally— up from 12th in 2004. Retailers are attracted to Spain’s rising incomes per capita and retail growth rates that surpassed the eU average for most of the 1990s. The recent housing boom is supporting growth as well. Decathlon (France), IKeA (Sweden), Ahold (netherlands), Carrefour (France), Auchan (France) and Toys “R” Us (U.S.) have helped transform the retail business landscape in Spain. Although the market remains


fragmented, Spain will likely see further consol-idation and more large-scale malls, supermarkets and retail outlets. Telecom and utilities investors rank Spain their 10th most attractive investment location—down from 9th in 2004. The entrance of Vodafone and France’s orange stirred-up the Spanish tele-com market and gained the attention of foreign corporate investors and private equity firms. In november 2005, private equity investors financed local operator ono’s acquisition of Auna to form a new company to challenge incumbent Telefónica. France Telecom purchased Amena, Spain’s third-largest mobile operator, which was spun-off from Auna. Spain’s R&D spending as a share of GDP is the lowest in Western europe—even the Czech Republic invests more in R&D than Spain. Global investors prefer India, China, Poland, Brazil and Russia over Spain as an R&D location. Limited access to seed capital and a high regulatory burden have stifled new enterprises and entrepreneurial activities. In addition, Spain is slow to innovate. While Spain has highly trained scientists and engi- neers, they have limited links to industry and ICT investments. To help address this prob-lem, the Catalan government is sponsoring the Barcelona Biomedical Research Park to recruit both Spanish and foreign scientists and link them with biotech venture capitalists in the

United States and europe. Italy. Foreign investment in Italy has risen slightly from $16.4 billion in 2003 to $16.8 bil-lion in 2004.9 However, this is relatively low by Western european standards: on a GDP basis, FDI is three times higher across the eU-15 than in Italy. Global investors rank Italy the 19th most attractive FDI location compared to 9th place in 2004. Although north American and european investors express less interest in the Italian market, German investors put Italy in 10th place. The government has implemented reforms for labor and pension, but not for professional services. Italy ranks 16th among financial services investors. The Central Bank’s intervention in the bidding war between Banca Popolare Italiana and ABn AMRo (netherlands), which are both seeking to acquire Banca Antonveneta, could be undermining foreign investor sentiment. electric and gas investors consider Italy the 3rd most attractive FDI destination globally. Italy is among europe’s largest importers of electric-ity, but increasing demand is putting a strain on the power grid links to France and Switzerland, leading to blackouts and shortages. Since 2002, when the Italian government liberalized its electric and gas market, foreign investors have been entering the market, led by electricité de France (France) and electrabel (Belgium). The government is expediting liberalization and investment approval for more thermoelectric

Traditional operational risks such as government regulation,

and financial, political and social instability, appear to be

less threatening in 2005 compared to previous years.

9 UNCTAD preliminary figures for 2005 reveal that FDI inflows to Italy decreased to $13 billion.


generation plants, and is expected to sell an addi-tional 10 percent of its stake in enel, the state electricity firm. Transport services investors—air, sea and land carriers and logistics services firms—view Italy as their 8th most attractive FDI location again this year. Italy’s robust tourism industry continues to draw in these investors. The expected privatization of the country’s freight and intercity travel markets, and continued liber-alization of roadways, will improve efficiency and likely increase investments. The creation of independent authorities to oversee the country’s 19 ports and privatization of port services have helped position Italy as a more competitive hub in the Mediterranean region. Romania. Romania enters the top 25 most attractive FDI locations for the first time, rank-ing 25th. Italian and Spanish investors are the most bullish on Romania, ranking it their 4th and 6th most preferred FDI location, respectively. Romania ranks 5th among electric and gas inves-tors, as liberalization continues to offer acquisi-tion opportunities. e.on energie (Germany), enel (Italy) and CeZ (Czech Republic) are moving into the distribution market. Investors are attracted to Romania’s substantial oil and gas reserves and large-scale, well-developed refining industry. Petrom was acquired by the regional oil player oMV (Austria), the country’s largest post-communist privatization. Gaz de France recently won the tender for the country’s major gas distribution and supplier Distrigaz Sud. The anticipated privatization of electricity generators, Termoelectrica and Hydroelectrica, may also be spurring investor interest. Romania ranks 10th among light manufacturing investors, up from below the top 25. The electronics, paper and furniture segments are keen on Romania and want to benefit from its low-costs and skilled labor force.

AsiaAsia’s FDI inflows reached $155.5 billion, an unprecedented $48.6 billion increase over the year before. Asia is attracting nearly one in four global FDI dollars compared to only one in 10 in 2000. The top five host economies—China, Hong Kong, Singapore, South Korea and India—account for 80 percent of the flows to the region. Although greenfield investments continue to be the dominant form of FDI to the region, merg-ers and acquisitions are playing a more important role. In 2004, cross-border M&A deals amounted to $25 billion—up from $22 billion in 2003—and were primarily concentrated in China, South Korea and Hong Kong. China and India are considered the world’s 1st and 2nd most attractive FDI locations globally. China held the top spot for the forth year in a row and India rose from 3rd to 2nd place, surpassing the United States. Hong Kong and South Korea dipped slightly from 8th to 10th and 21st to 23rd, respectively. Singapore and Thailand maintained their positions at 18th and 20th place. Despite an additional 1.5 billion people in the developing world (from 1981 to 2001), the number of extremely poor people in these coun-tries declined by more than 375 million—a feat unimaginable two decades ago and largely the result of progress in China and, to an extent, India. China and India are attractive to Ceos worldwide due to their strong growth rates, grow-ing consumer populations, and low-cost but highly educated labor pools. Pro-FDI reforms and accelerated integration into the worldwide IT network have made both countries more attractive to investors. China. China maintains its lead in the Index for the fourth consecutive year. China attracted $60.6 billion in FDI in 2004, the highest among all developing economies. Although total inflows


to China are much lower than to the United States, China has a much higher number of green-field FDI projects. The United States had 578 such projects in 2004, while China had 1,529. The Chinese economy continues its robust development, growing by 9.5 percent in the second quarter of 2005. Total growth in 2005 exceeded expectations at nearly 10 percent, with robust growth expected into 2006. once again, China is the top FDI location for first time-investors, with more than half (55 percent) of investors expected to make first-time investments there over the next three years. This is significantly higher than the 43 percent of investors that expected to invest in China for the first time in 2004. one in five FDI dollars for first-time investments will be committed to the Chinese market. China has successfully over-come the perceived risk associated with first-time market entry, which is typically the biggest barrier to generating new FDI. Implementation of World Trade organization (WTo) requirements is fueling investor interest, as is continued liberalization and deregulation in banking, insurance, telecommunications, and wholesale and retail segments. Policy changes to increase foreign ownership and reduce or elimi-nate geographic restrictions are also galvanizing FDI confidence. Investor interest in the Chinese financial sector is especially high. Despite concerns over non-performing loans and poor transparency, China ranks 1st among banking, insurance, real estate and holding companies. The Chinese government is seeking foreign investments to help restructure and modernize the country’s financial system. Under the WTo guidelines, China has to liberalize its financial services sector by the end of 2006.

Despite strong interest from financial services investors, most Chinese banks suffer from large amounts of non-performing loans, which is an estimated 30 percent of total loans, and still do not have risk-evaluation practices. Some banks are technically insolvent, but are kept afloat by government bailouts and individuals who view them as safe havens for their savings. The largest cross-border mergers and acqui-sitions were in the financial services sector as China focused on restructuring and publicly list-ing the four main state banks. In 2005, the China Construction Bank received a $3 billion commit-ment from Bank of America (U.S.) and its initial public offering in Hong Kong generated $8 billion—the world’s largest IPo in four years. Investors in the food, tobacco, textile and apparel industries are optimistic about China. More than 61 percent of investors express a more positive outlook on China.10 Investments by private equity and venture capital funds have become important sources of investment in China. The Texas Pacific Group (U.S.), General Atlantic LLC (U.S.), and newbridge Capital LLC (U.S.) together invested $350 million in Lenovo’s acquisition of IBM’s PC business. Also, the Carlyle Group (U.S.) invested $400 million in China Pacific Life Insurance. China maintains its position as the number one destination for manufacturing and assembly, but the profit cycle could be winding down. China’s manufacturing base has developed over the years in large part by foreign multinational companies; two-thirds of China’s manufacturing exports are from foreign companies. However, after three years of strong growth, U.S. foreign affiliates in China saw their earnings decline in the first half of 2005 with a 9 percent year-on-year decline.

10 Because the survey was performed following the expiration of the Multi-fiber Agreement and the liberalization of textiles trade, but before the United States imposed restrictions on Chinese imports in November 2005, the results may not reflect these restrictions.


Labor skills and enforcement of intellectual property rights remain weak. China has nearly the highest software piracy rate in the world (92 percent according to Business Software Alliance), while Zimbabwe and Indonesia offer more soft-ware protection. China continues to be hampered by poor english skills and a lack of managerial talent. With more companies moving into the market, competition will make it even more diffi-cult to recruit high-quality staff. India. India replaces the United States as the 2nd most attractive FDI location, up from 3rd place in 2004 and reaching its highest ranking ever. While India’s IT and software industry has made it the darling in the global business commu-nity over the past few years, global investor inter-est in other areas is just now catching up. FDI flows to India surpassed the $5 billion mark for the first time in 2004, reaching $5.3 billion. India’s FDI flows continue to be skill intensive, and concentrated in information and technology areas. Foreign corporate participation in the Indian economy typically occurs in the form of licensing and service contracts because of FDI restrictions and the increased capabilities of local subcontractors. This means companies can offshore their back-office IT operations to India without committing FDI. China and India use different FDI devel-opment paths. China attracts capital-intensive industries via an export-manufacturing frame-work that uses special economic zones. India favors an import-substitution system to attract more technology-oriented FDI. India’s previously restrictive FDI regime limits foreign participation to mostly licensing and other contractual agree-ments—not FDI. This may explain why foreign companies that outsource to India prefer to pur-chase the services of a third-party provider. The Indian government is reforming the Foreign Investment Promotion Board, and has

established the Indian Investment Commission to act as a one-stop shop between the investor and the bureaucracy. Also, India has raised FDI caps in the telecom, aviation, banking, petroleum and media sectors. Yet opposition from coalition partners may limit government reforms. The 2004 elections gave no party a clear majority, leading to the formation of a coalition government that has complicated India’s reform process. India requires $150 billion worth of investments to upgrade the country’s weak infrastructure over the next 10 years. The government is considering sweeping liberalization to expedite the FDI project review process and eliminate FDI restrictions across a broad range of sectors, including airports, oil, gas and natural resources. Although more investors view India as an attractive destination, bureaucracy, perceived corruption and a poor infrastructure may cloud efforts to attract FDI. Among the most recent troubles: Telecom Malaysia and Singapore Tech-nologies’ bid to buy Idea Cellular was abandoned when it ran into regulatory problems. Singapore’s Changi airport withdrew its bid for the Delhi and Mumbai airports because of constraints on foreign investors. India has signed an increased economic coop-eration agreement with Singapore. This is the first Indian bilateral agreement that includes services and measures to avoid double taxation—and it will likely lead to increased FDI inflows from Singapore. Specifically, the agreement allows Temasek Corporation and Government of Singapore Investment Corporation to buy 10 percent more equity in Indian companies than other investors. Also, several Singapore banks will be granted licenses to set up branches in India over the next four years. Financial services investors upgrade India from 4th to 2nd most attractive FDI location.


The emergence of local players, ICICI Bank and HDFC Bank, along with foreign investors, has helped restructure India’s underdeveloped finan-cial sector and spur competition. Deutsche Bank (Germany) is launching a range of savings, invest-ment and loan products as well as investment and financial planning services in seven major Indian cities. Telecom and utilities investors rank India their 3rd most attractive destination. one reason for the interest is the relaxation of ownership restrictions. In october 2005, the Indian gov-ernment raised foreign ownership levels to 74 percent (from 49 percent), a move that will add fuel to India’s booming IT and software industry. According to nASSCoM, the Indian IT software and services exports have grown from $5.3 billion in 2000 to $16.5 billion in 2005. Also, estimates suggest that India has the world’s fastest-growing mobile phone market, growing at 35 percent per year until 2006. Immediately following the relaxation of restric-tions, Vodafone Group (U.K.) acquired a 10 per-cent stake in Bharti Tele-Ventures, India’s largest mobile phone operator. Investors in the heavy and light manufactur-ing sectors are optimistic about India. The coun-try’s largest FDI commitment was won when Pohang Iron & Steel (South Korea) confirmed a $12 billion deal to build a steel plant and develop iron ore in orissa. The success of this deal will be a test case for future large-scale, long-term foreign investment in India. The government has estab-lished special economic zones to encourage a com-petitive, export-oriented manufacturing sector. In 2004, India had the fastest growing large- passenger-car market in the world, which will likely continue to expand given the country’s low loan rates, rising incomes and flourishing middle class. FDI in the retail sector continues to be the

subject of heated political debates. Almost half of investors have a positive outlook on India’s wholesale and retail sector, despite strict regula-tions. For example, while franchise operations are allowed, foreign direct ownership is banned. Australia. Australia drops one spot to 8th place, but remains the 3rd most attractive Asian FDI location worldwide for a second consecutive year. Asian investors are most bullish on Australia, ranking it their 4th most attractive location (up from 10th in 2004). U.S. investors are also more likely to invest in Australia; it is their 5th most attractive market, up from 8th in 2004. FDI inflows hit a record high of $42.6 billion in 2004, six times more than in 2003. Australia’s FDI performance was driven by a massive rise in equity investments—from $2.3 billion to $35.5 billion in 2004 and global demand for the country’s natural resources. In 2005, mining investors consider Australia their 4th most attrac-tive market and oil and gas investors rank it 5th. IToCHU (Japan) and Mitsui (Japan) plan to invest $3 billion in an iron ore venture with Australia’s BHP Billiton. Cross-border M&A flows rose from $9.7 bil-lion to $15 billion. This substantial rise is partly attributed to a U.K. investor group’s acquisition of edison Mission energy for $3.9 billion, and Singapore Pte Ltd’s purchase of TxU Australia Ltd for $3.7 billion. These are two of the coun-try’s largest M&A deals in 2004. Australia moves to 3rd place (from 13th) among transportation equipment manufacturers. This is primarily due to an auto boom. In 2003 and 2004, vehicle sales in Australia reached record highs and sales for 2005 were on track to break a new high. The country’s automotive market is opening up under the Australia-U.S. Free-Trade Agreement (AUSFTA) wherein all tariffs will be gradually lifted on vehicle and automo-tive components exported to the United States.

FDI ConFIDenCe InDex | A.T. Kearney�0

The government is also offering assistance to vehi-cle producers registered under the Automotive Competitiveness and Investment Scheme. Australia’s service sector is attracting more investors, with five business segments—engi-neering, accounting, research, health care and consulting services—citing Australia as the 5th most attractive FDI location, up from 16th a year earlier. Hong Kong. Hong Kong dropped two spots to 10th place in the overall Index, but remains a favorite of Asian investors who rank it their 3rd most attractive FDI location. The strongest improvements in FDI confidence come from Swiss, U.K. and U.S. investors. Swiss investors put Hong Kong in 4th place (up from 14th in 2004), U.K. investors rank it 5th (up from 7th) and U.S. investors put Hong Kong in 11th place (up from 19th). FDI flows to Hong Kong more than doubled—rising from $13.6 billion in 2003 to $34 billion in 2004, the highest level since 2000. After China, Hong Kong remains the 2nd largest FDI recipient in Asia. The FDI spike in Hong Kong is likely influ-enced by two circumstances: “round-tripping,” in which Chinese companies channel funds through Hong Kong to get tax benefits, and “hot money,” which comes from neighboring countries and is mainly invested in real estate in mainland China. Hong Kong’s FDI outflows reveal a similar spike, rising from $5.5 billion in 2003 to a mas-sive $39.8 billion in 2004. Most of the FDI comes from Hong Kong-based companies channeling funds through their offshore entities for tax pur-poses. offshore financial tax havens are among the leading sources of Hong Kong FDI. For example, in 2003, the British Virgin Islands accounted for 31.6 percent of total stock of inward direct invest-ment, and Bermuda accounted for 8.6 percent. Light manufacturers are shying away from the Hong Kong market, ranking it their 16th

most attractive location (down from 6th in 2004). High rents and expensive labor are encouraging manufacturers to migrate to lower-cost locations in other Asian countries. In 2005, appreciation in property values caused Hong Kong rents to soar, making them the second highest in Asia after Tokyo. Hong Kong ranks 4th among financial services investors, up from 5th in 2004. Hong Kong is a prime location for Chinese compa-nies to tap into international capital markets, and Hong Kong banks are gradually being granted the right to provide renminbi offshore services. The Revenue Bill, expected to pass in 2006, will provide tax benefits to non-residents who derive profits from securities transactions, and may signal a rise in securities activity in the city. Investors in consulting, engineering, account-ing and software consider Hong Kong 9th among most attractive markets (up from 24th). They are enticed by the highly skilled workforce and the service-oriented economy. Japan. Japan comes in 15th on the Index, down 5 spots from last year. Despite the drop in ranking, one in five global investors is more upbeat about the Japanese market compared to a year ago. Japan attracted $7.8 billion in FDI in 2004, almost a 25 percent increase over 2003, but still well below its 2002 peak of $9.2 billion. Inward FDI in Japan is dominated by the non-manufactured goods sector, with finance, trade and insurance representing more than 50 percent of investment. After a growth rate of 2.6 percent in 2004, growth in Japanese GDP picked up in 2005, ending the year up 5.4 percent, as defla-tionary measures continued to moderate. The country’s private sector no longer faces a debt overhang and unit labor costs have been declining in line with rising productivity. Among all broad sectors, financial services investors express the most confidence in Japan—

A.T. Kearney | FDI ConFIDenCe InDex �1

ranking it 10th (down from 9th place in 2004). one in three financial services investors have a more positive view of the Japanese market. Japan ranks 5th among insurance, real estate and hold-ing company investors, up from 12th in 2004. Japan’s attributes include a wealthy popula-tion, and unique asset management and finan-cial planning opportunities. Its financial services markets have room to grow, and given the finan-cial needs of the country’s rapidly aging popula-tion, demand for financial services will expand. The International Monetary Fund estimates that the public financial system is 20 to 25 percent under-funded, so foreign investors are becoming more interested in the troubled domestic finan-cial companies. electronic and electric equipment manufac-turers rank Japan as their 9th most attractive FDI location, up from 15th in 2004. Heavy losses in the consumer electronics industry are forcing Sony, Sanyo and Pioneer to restructure, while others struggle to survive. Japan is a ripe market for cross-border investments and acquisitions. There are few formal restrictions on FDI in Japan, but several obstacles impede market entry. one concern is the closed business structure of the keiretsu system. Rather than deal with the keiretsu, investors choose to make equity investments in strategic partnerships. Moreover, given the relative size of the Japanese economy, FDI plays a smaller role. For example, total FDI stock as a percent-age of GDP is 7.9 percent in Japan compared to 12.6 percent in the United States, 26.5 percent in

France and 36.3 percent in the United Kingdom. Thailand. Thailand holds steady at 20th place for the second consecutive year. U.S. inves-tors express less interest in the Thai market, while Australian investors are more interested, ranking it their 7th most attractive market (up from 11th in 2004). The Thailand-Australia Free Trade Agreement, which went into effect in 2005, cre-ates more market opportunities for Australian companies in Thailand. French, U.K. and Swiss investors also show increased FDI confidence in Thailand. After reaching $1.9 billion in 2003—more than double the amount in 2002—FDI fell to $1.4 billion in 2004.11

Financial services investors are more eager to commit FDI in Thailand as they gear up for the liberalization of Thailand’s financial services market, which is expected to follow the current period of consolidation. Corporations’ continued migration toward bond and equity finance, and away from banks, is expected to help increase stock market capitalization. After ceasing to issue new banking licenses for two years, the Bank of Thailand, plans to permit the resumption of foreign competition. In 2005, UoB (Singapore) acquired Bank of Asia from ABn AMRo, thus confirming Singapore’s strong outlook on Thailand. Transportation equipment investors rank Thailand 5th in the Index (up from 20th in 2004), confirming Thailand’s place as a hub for automotive production. The automotive indus-try accounts for roughly 16 percent of Thailand’s

Today, Asia is attracting nearly one in four global

FDI dollars compared to only one in 10 in 2000.

11 UNCTAD preliminary figures for 2005 reveal that FDI inflows to Thailand increased 159 percent to $3.7 billion.


GDP and employs about 8 percent of the coun-try’s workforce. The government’s effort to create an integrated automotive hub for the ASeAn region has spurred clusters of production and a network of auto-parts suppliers. Thailand’s auto-motive industry is also benefiting from foreign carmakers’ desire to diversify within the region, serving as a hedge against China. Japanese investors continue to view Thailand favorably, ranking it their 12th most attractive FDI location for a second consecutive year. Toyota plans to expand its vehicle production capacity in Thailand over the next few years, making Thailand its third largest production base after Japan and the United States. Isuzu also plans to invest, and Honda is building a second R&D center in Thailand to better serve its Asian market. The telecom and utilities sectors express significantly less confidence in the Thai market in 2005. Despite Thailand’s commitment to lib-eralize the telecom market by 2006, investors are disappointed by the slow pace of reform, lack of a sound regulatory climate, and continued limitations on foreign ownership. For example, orange (France) is reducing its Thai holdings. However, primary sector investors rank Thailand their 12th most attractive market, up from 20th in 2004. Also, one in five oil and gas investors is more upbeat about the Thai market. South Korea. South Korea’s gradual decline in FDI attractiveness continues, as it drops to 23rd on the Index from 21st in 2004 and 18th in 2003. This is despite the fact that South Korea offers foreign investors an attractive investment location. It is the world’s 10th largest economy, and it boasts a sophisticated local market and is recognized for leadership in technology. The chaebol and bank balance sheets are in better shape, and since 1998, the

government has less hand in the economy. South Korean FDI doubled to $7.7 billion in 2004.12 However, much of the gains in FDI resulted from M&A deals. After China, South Korea gained the largest volume of M&A flows in the region, roughly $5.6 billion. Despite the recent rise in FDI, the FDI reg-ulatory environment remains difficult because rules on shareholdings and market share limits can change suddenly. The massive tax-free prof-its earned by private-equity funds has generated a public backlash against foreign investors, with venture capital now considered “vulture capital.” Interference in management decisions, such as the proposed requirement that half of a bank’s directors must be South Korean nationals, and more stringent disclosure rules are feeding inves-tor reservations. Reforms aimed at limiting the influence of the chaebol conglomerates have not progressed. And although FDI helped save many companies that would otherwise have collapsed after the Asian financial crisis, there is still a great deal of ambivalence toward foreign investors. Japanese investors move South Korea to 11th on the Index (up from 19th in 2004). This upgrade is possibly the result of ongoing negotia-tions between Japan and South Korea on a free-trade agreement. one in four Japanese investors is more optimistic about the South Korean market compared to 2004. Japan is the third-largest source of South Korean FDI inflows behind the United States and the european Union. According to Jetro, the Japanese trade and investment promo-tion agency, South Korea is the most profitable location for Japanese businesses globally. Bankers rank South Korea 10th most attrac-tive FDI location, up one spot from 2004. Financial investors are following in the foot-steps of Citigroup’s (U.S.) acquisition of KorAm

12 UNCTAD preliminary figures for 2005 reveal that FDI inflows to South Korea decreased by 42 percent to $4.5 billion.


in 2004, marking the first foreign entry into the South Korean banking sector. In 2005, Standard Chartered Plc (U.K.) acquired Korea First Bank for $3.3 billion. electronic and electrical equipment inves-tors are buoyed by the South Korean market. They rank the country 11th on the Index, up from 19th in 2004. South Korea is an estab-lished export-oriented electronics producer and knowledge powerhouse, boasting global compa-nies such as LG electronics and Samsung. South Korea has a higher percentage share of population with first-year science and engineering degrees than regional competitors, the european Union and the United States. South Korea rose 5 places to 20th among transport service investors, particularly air trans-portation and ground logistics providers. The country is a key logistics hub in the region and hopes to benefit from declining Chinese tariffs. Central Asia. For the first time, Central Asia is among the top 25 most attractive FDI locations, placing 24th on the Index. High energy prices, fast growth and abundant natural resources are enticing foreign investors to the region. Primary sector investors—led by oil and gas investors—cite central Asia as their 2nd most attractive FDI location, up from 12th in 2004. FDI rose in every CIS country in 2004 (except Belarus), with oil-rich Kazakhstan and Azerbaijan leading the way. Compared to Russia, Azerbaijan, Kazakhstan and Turkmenistan have fewer limits on foreign own-ership, and lower royalties and tax levies in the energy sectors. In Kazakhstan, oil extraction and oil-related construction, transportation and processing accounted for more than 16 percent of GDP in 2004, and fuel and oil products comprised 63 percent of exports. For the first half of 2005, the country’s overall GDP hit a roaring 9.1 per-cent, largely the result of FDI increases. nearly

every major oil and gas player is in the market through a variety of consortium relationships, including ChevronTexaco (U.S.), exxonMobil (U.S.), Lukoil (Russia), BG Group (U.K.), enI (Italy), Gazprom (Russia), Phillips Petroleum (U.S.), Shell (U.K.) and TotalFinaelf (France). Political and social tensions over the contested parliamentary elections have not had a significant impact on foreign investor interest in Azerbaijan. The Baku-Ceyhan pipeline, expected to open soon, is the first alternative route for Caspian oil to Western europe outside Russian control. In addition, current extraction projects will create significant commercial opportunities, since the domestic oil and gas extraction infrastructure dates back to the Soviet period and requires new investment.

AfricaThe FDI drought in Africa could be ending. Global investors are more positive about the con-tinent, even though it continues to struggle with some of the world’s highest business costs, weak governance and poor growth. About 17 percent of senior executives are more upbeat about Africa’s investment prospects, while 11 percent are more negative compared to a year ago. As the international donor community focuses on debt relief and more effective develop-ment assistance, global companies are exploring new business models in Africa, in which eco-nomic and social development issues intersect with profitable growth strategies. If reform efforts are sustained and Africa continues to build stron-ger ties with the global business community, the continent may see investor interest translate into more FDI flows. Most African FDI is concentrated in resource-based industries. Looking forward, FDI flows and corporate investor interests will be concen-trated in a few key countries, including South


Africa, nigeria, egypt, Morocco and Kenya (see figure 9).13

The average FDI inflows to Africa rose to $18.7 billion between 2001 to 2004, compared with $10 billion during the preceding four years. However, the continent barely captures 3 percent of total global FDI compared to developing Asia, which receives nearly one in every four FDI dol-lars. FDI is more a lagging than a leading indicator in growth and development in Africa. For FDI to assist in a virtuous cycle of economic growth, job creation and rising incomes, Africa must develop targeted public- and private-sector initiatives that link industry, education, human capital and insti-tutional capacity.

The Middle EastIn its debut in the Index, Dubai/United Arab emirates (UAe) ranks as the 22nd most attrac-tive location worldwide. Asian investors con-

sider Dubai their 9th most attractive foreign direct investment location, while european inves-tors place it at 20th. Among Japanese and Indian investors, Dubai comes in 6th; Swiss investors rank it 3rd. FDI inflow to Dubai rose substan-tially in 2004, reaching $840 million, up from $30 million in 2003. Financial services investors see bright pros-pects in Dubai, ranking it 13th, as the emirate evolves into the region’s premier financial hub. After crises in the 1980s and 1990s, Dubai is set to attract international financial institutions eager to benefit from the region’s rosier outlook. Despite geopolitical instability and the war in Iraq, regional banking opportunities abound due to the flood of petro-dollars, rising equity markets and economic growth. Cash-laden companies in Saudi Arabia and across the region are seeking to diver-sify, and investment bankers are keen on capturing advisory fees from increased M&A activity. equity

Figure 9Investment in Africa is concentrated in a few countries


SouthAfrica

Nigeria

EgyptMoroccoKenya

Rest ofAfrica

0%

20%

40%

60%

80%

100%

Globalinvestors

Asianinvestors

Europeaninvestors

North Americaninvestors

22%

6%7%

8%

13%

44% 44%

14%

11%

6%

25% 24%

5%

11%

6%

13%

41%51%

11%

9%4%9%

16%

Perc

enta

ge o

f tot

al re

spon

dent

s

13 UNCTAD preliminary figures for 2005 reveal that FDI inflows to African countries have increased, albeit from a low base. FDI inflows to Egypt rose 226 percent, Morocco rose 38 percent, and South Africa rose 803 percent.


and bond issuances are rising and governments are leaning toward more privatization of state assets. Dubai is set to benefit from all these factors. In 2005, Dubai Holding and the new York Mercantile exchange announced the formation of the Dubai Mercantile exchange, a joint venture to develop the Middle east’s first energy futures exchange. Meanwhile, Morgan Stanley, HSBC and Credit Suisse have announced plans to invest in the Dubai International Financial Center, a free zone designed to promote financial services. Chemicals and electronics investors express the most confidence in manufacturing in region. Free zones in Dubai—such as the Jebel Ali Free Zone (JAFZ)—offer investors tax and tariff exemptions. The 2005 opening of the Dubai Industrial City, which offers similar investment incentives for heavy manufacturers, is further bolstering confidence among chemical investors. The UAe’s downstream hydrocarbon activity con-tinues to benefit from the roaring oil markets.

ConclusionIn 2005, China, India and eastern european countries reached new heights of attractiveness as destinations for FDI as they competed for higher value-added investments, including R&D. The United States dropped to 3rd place, but this is more a function of the accelerated confidence in China and India than the loss of the country’s role as an FDI magnet. (Although, recent con-troversies over the openness of the United States and europe to foreign investment, may well put a damper on these destinations for newly emerg-ing sources of FDI.) Western europe—the United Kingdom aside—is likely to remain a lower priority for executives who see more attrac-tive emerging market destinations. Despite rising costs, eastern europe enjoys better FDI pros-pects, while Brazil and Mexico have recovered

from last year’s lower confidence levels. Although FDI appears to be on the rise again, the corporate savings overhang and investor pes-simism about the global economy could dull the recovery of cross-border corporate invest-ment. Concerns over corporate financial health, an unexpected economic downturn, shareholder activism, and the risks associated with engaging in FDI have caused investors to hoard cash over the past four years. As investors face more intense competition and the lure of higher returns over-seas, they are cautiously unloading their accumu-lated war chests, albeit in a more conservative and selective manner than in previous years. Developing countries in Asia and eastern europe will attract more R&D investment relative to other regions of the world. The combination of lower cost and increasingly higher quality labor, more reliable property right regimes, and educa-tional and IT infrastructures is helping to galva-nize investor interest in these markets. However, the globalization of R&D will not be a zero-sum event. Rather, it will be a balancing act as compa-nies leverage opportunities in knowledge centers in the developing world in conjunction with tra-ditional R&D hubs in the industrialized world. The urge to offshore among global investors has intensified over the past three years. All major functions and business processes will see more off-shore activity over the next three years. However, business models used to send corporate functions offshore will vary. Companies will either use cap-tive or joint-venture business models (which result in FDI) or third-party outsourcing and other non-FDI business models. R&D and knowledge-related activities will most likely occur through FDI to mitigate intellectual property risks and ensure quality. However, information technology, call centers and distribution and logistics will tend to occur via third-party outsourcing contracts and other non-FDI operating models.


Methodology

The FDI Confidence Index® was constructed using primary data from a proprietary survey administered to senior executives of the world’s 1,000 largest corporations. The companies were selected from the Global 1,000 as determined by 2004 revenues and represent 47 countries and 24 different industries (as categorized by SIC codes). Participating companies are responsible for about 70 percent of global FDI flows and generate $27 trillion in annual sales. These companies closely resemble the country and sector coverage of the Global 1,000 population, generate $6.2 trillion in annual sales, and hold $30.5 trillion total global assets. Participating executives include Ceos, CFos, board members, and senior-level corporate strategists from 42 countries and 22 industries.

The Index was calculated as a weighted average of the number of high, medium, low and “no interest” responses to a question about the likelihood of direct investment in a market over the next one to three years. Index values are based on non-source country responses about various markets. For example, the Index ranking for the United States reflects all non-U.S. company responses about the U.S. market. All Index values have been calculated on a scale of zero to three, with three representing highly attractive and zero not attractive.

Since the inception of the FDI Confidence Index in 1998, the top 10 most attractive FDI destinations have consistently received 40 percent or more of global FDI inflows roughly one year after the survey. over the same period, on average, the top five countries captured 35 percent of global FDI inflows, while the top 25 countries cap-tured 71 percent of global FDI inflows one year after the release of survey results.

There is a strong positive correlation between the FDI Confidence Index country rankings and relative performance of countries according to FDI inflows one year later. There is an even stronger relationship between the Index rankings and future bricks-and-mortar FDI once anomolies, such as those driven by tax havens, are accounted for.

The secondary sources of information used in this analysis include the United nations Conference on Trade and Development (UnCTAD), the World Bank, the International Monetary Fund, organization for economic Cooperation and Development (oeCD), european Bank for Reconstruction and Development (eBRD), United nations economic Commission for Latin America and the Caribbean (Un-eCLAC) and the economist Intelligence Unit. Additional sources of information include country investment promotion agencies, country central banks, country ministries of finance and trade, and major newspapers and magazines.

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