Jahangir Alam A.F.M. Aowrangazab Regional FDI.pdf · 1 Extracted from Alam, Jahangir (2005). 2...
Transcript of Jahangir Alam A.F.M. Aowrangazab Regional FDI.pdf · 1 Extracted from Alam, Jahangir (2005). 2...
Intra-Regional Foreign Direct Investment- The South Asian Perspective
Jahangir Alam Associate Professor
Department of Finance and Banking University of Chittagong
Bangladesh. Email: [email protected] / [email protected]
Phone: ++88-031-684543
&
A.F.M. Aowrangazab Associate Professor
Department of Management University of Chittagong
Bangladesh. Email: [email protected] / [email protected]
Phone: ++88- 031-657496
2
INTRA-REGIONAL FOREIGN DIRECT INVESTMENT – THE SOUTH ASIAN PERSPECTIVES
Abstract
Global economic events of the past decade or so, particularly those driven by
technological advances, regional integration and the realignment of economic systems
and policies, have altered fundamentally the perception of the governments of the host
countries of how Foreign Direct Investment (FDI) can contribute towards their economic
and social goals (Dunning, 1994). This is, indeed, a subject matter of developing
countries like Bangladesh for accumulating capital to fuel the gap between saving and
investment with an ultimate goal of economic development by creating employment, by
transferring technology, and to achieve sustained economic growth. Moreover, different
countries have also been taking different legal and institutional measures to cope with the
globalizing economy and to reform the national economic policies to accommodate the
pressures from different supranational organizations like the IMF, the World Bank, WTO,
IFC, etc.
This article attempts to examine some critical points of FDI within South Asian countries.
These points include present scenario of FDI in the region, the existing and potential
benefits from intra-regional flows of FDI, the attitudes of nationals towards FDI, the
present and potential threats to FDI and some remedial suggestions in achieving the
targets set by the respective nation. The article also tries to find out the economic
interdependences among the countries of South Asian Association for Regional
Cooperation (SAARC) in terms of FDI.
It has been found that South Asian countries’ performance of attracting FDI is not up to
the mark. The reasons of such situation have been analyzed and critical points and factors
affecting low performance in attracting the same have also been identified. It has been
suggested that these countries can use FDI as an important tool of reducing or eliminating
poverty that can also act in building an effective SAARC by reducing regional
imbalances in trade and FDI.
3
Intra-Regional Foreign Direct Investment- The South Asian Perspective 1. Introduction
Foreign Direct Investment (FDI) is the acquisitions of foreign assets for the purpose of
control them. FDI occurs when a firm invests directly in facilitating to produce and / or
market a product in a foreign country. The U.S. Government Statisticians define FDI as
“Ownership or control of 10 percent or more of an enterprise voting securities.... or the
equivalent interests in an unincorporated U.S. business’ (Quijana, 1990). FDI is net
inflows of investment to acquire a lasting management interest (10 percent or more of
stock) in an enterprise operating in an economy other than that of the investor. It is the
sum of equity capital, investment of earnings, other long term capital, and short-term
capital as shown in the balance of payments. Gross capital formation is the sum of gross
fixed capital formation, changes in inventories, and acquisitions less disposals of
valuables (World Development Indicators 2003). FDI may take many forms such as;
purchase of existing assets in a foreign country, new investment in property, plant and
equipment, and participation in Joint Venture with a local partner.
Global economic events of the past decade or so, particularly those driven by
technological advances, regional integration and the realignment of economic systems
and policies, have altered fundamentally the perception of the governments of the host
countries of how Foreign Direct Investment (FDI) can contribute towards their economic
and social goals (Dunning, 1994). This is indeed, a subject matter of developing countries
like Bangladesh for accumulation capital to fuel the gap between saving and investment
with an ultimate goal of economic development by creating employment, by transferring
technology, and to achieve sustained economic growth. Moreover, different countries
have also been taking different legal and institutional measures to cope with the
globalizing economy and to reform the national economic policies to accommodate the
pressures from different supranational; organizations like IMF, the World bank, WTO,
IFC, etc.
4
South Asia consists of seven countries namely, India, Bangladesh, Sri Lanka, Nepal,
Bhutan and the Maldives. The dollar-a-day poverty incidence in South Asia is currently
around 37 percent. Over the years, income poverty has shown considerable decline in the
region. However, the rate of decline in South Asia is much lower than that of East Asia
and the Pacific. Also, South Asia remains as the region with the largest number of people
living in poverty. Though it accounts for 20 percent of the global population, it is homes
for 40 percent of the world’s poor. In absolute numbers, it accounts to 400 million people,
more than all the poor people of sub-Saharan Africa, the Arab states, Latin America and
the Caribbean put together. Similarly, in terms of poverty indicators, such as child
mortality, maternal mortality, youth literacy, primary school enrolment, etc., the general
trend is one of improvement, but these are still at very undesirable levels. Despite
measurement problems, inequality in terms of both Gini Coefficient and ratio of
income/consumption share of the richest 20 percent to the poorest 20 percent appears to
be on the increase in the region (Sobhan, 2004). The economic indicators of the countries
under SAARC are shown in Appendix-1.
This paper attempts to examine some critical points of FDI within South Asian countries.
These points includes present scenario of FDI in the region, the existing and potential
benefits from intra-regional flows of FDI, the attitudes of national towards FDI, the
present and potential threats to FDI and some remedial suggestions in achieving the
targets set by the respective nation. The article also tries to find out the economic
interdependence among the countries of South Asian Association for regional
Cooperation (SAARC) in terms of FDI.
It has been found that South Asian countries’ performance of attracting FDI is not up to
the mark. The reasons for such situations have been analyzed and critical points and
factors affecting low performance in attracting the sale have also been identified. It has
been suggested that these countries can use FDI as an important tool of reducing for
eliminating poverty that can also act in building an effective SAARC by reducing
regional imbalances in trade and FDI.
5
2. Review of Literature1
One of the sensitive areas in international economics is FDI as it is now defined not only
merely a simple transfer of money but a mixture of financial and intangible assets like
technologies, managerial capabilities, and marketing skills and other assets. The present
form of FDI that gained momentum after World War-II mainly originated in the United
States, when it was regarded as a means to increase their political hegemony on a world
level (Bulcke, 1987). Dunning (1958) published a comprehensive book on the
consequences on inbound FDI for host countries where he took United Kingdom as a
subject of study. Later on, there have been more publications on the substantive studies
for Canada (Safarian, 1966), Australia (Brash, 1966), Norway (Stonchill, 1965), New
Zealand (Deane, 1970), the Netherlands (Stubenitsky, 1970), Kenya (Longdon, 1981),
Singapore (Mirza, 1986), the United States (Graham and Krugman, 1989), India (Kumar,
1990), Mexico (Peres-Nunez, 1990), and Central and Eastern Europe (Aristien, Rojec and
Svetlicic, 1993), which carry weights in the field of FDI. It has been observed these days
that hundreds of books, theses and Government reports, and thousands of papers in
academic and professional journals have been written on FDI (Dunning, 1994). There are
different dimensions covered by different books and articles. For example, after thirty-six
years of publication by Dunning (1958), his emphasis has been shifted to cost-benefits of
FDI in 1994. Bulcke (1987) has been found interested in evaluating policy framework in
the context of developing countries. Michalet (1994) shows that Transnational
Corporations (TNCs2) are the main driving forces of new international economic system.
The impacts of FDI to economic growth have been debated quite extensively in the
literature. The ‘traditional’ argument is that an inflow of FDI improves economic growth
by increasing the capital stock, whereas recent literature points to the role of FDI as a
channel of international technology transfer (Lensink and Morrissey, 2001). There is
growing evidence that FDI enhances technological change through technological
diffusion, for example, because transnational / multinational firms are concentrated in
1 Extracted from Alam, Jahangir (2005). 2 Although there are subtle differences in TNCs and MNEs, we shall use these words interchangeably to mean the same type of organizations.
6
industries with a high ratio of R&D relative to sales and a large share of technical and
professional workers (Markusen, 1995). TNCs are probably among the most
technologically advanced firms in the world. Moreover, FDI not only contributes to
imports of more efficient foreign technologies, but also generate technological spillovers
for local firms. Kinoshita (1998) and Sjoholm (1999), on the other hand, argue that FDI
works as a tool of knowledge spillovers that may take place via imitation, competition,
linkages and / or training. A comprehensive study by Bosworth and Collins (1999)
provides evidence on the effect of capital inflows on domestic investment for 58
developing countries during 1978-95. The sample covers nearly all of Latin America and
Asia, as well as many countries in Africa. The authors distinguish among three types of
inflows: FDI, portfolio investment, and other financial flows (primarily bank loans). They
find that an increase of a dollar in capital inflows is associated with an increase in
domestic investment of about 50 cents.
A comprehensive study has been done by Agrawal (2000) to evaluate the economic
impact of FDI in South Asia where he took Bangladesh as one of the sample-countries of
his study. He found that the impact of FDI inflows on GDP growth rate was negative
prior to 1980, mildly positive for early eighties and strongly positive over the late eighties
and early nineties, supporting the view that FDI is more likely to be beneficial in more
open economies. He also found that since 1980, FDI inflows contributed more to GDP
growth in South Asia than did an equal amount of foreign borrowing. This suggests that
FDI is preferable to foreign borrowing.
3. Scenario of foreign Direct Investment in South Asia
Apart from Sri Lanka, countries of South Asia only began to offer the incentives needed
to attract foreign direct investment (FDI) in the 1990s. India relaxed restriction on FDI
and portfolio investment in 1993, and a substantial inflow commenced in 1994 reaching
an estimated $3.5 billion in 1997. Early inflows were dominated by short-term capital
from non-resident Indians (NRIs) and from foreign institutional investors (FIIs). FDI only
caught up with FII flows in 1996.
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Net foreign investment in Pakistan was negligible in 1980s. It has attracted limited FDI in
the 1990s, i.e. a range from $200 million in 1991 to $400 million in 1995, averaging
around $310 million annually. There was a sharp increase in 1996 associated with a
single investment in a power plant, but it fell in $684 million in 1997 (SBP 1997). Inflow
of portfolio in vestment in the 1990s was initially low at $84 million in 1992. It was rose
around $270 million in 1992 and 1993 and more steeply to $1.3 billion in 1995 associated
with the privatization of the Pakistan Telecommunication Corporation but fell to $378
million in 1997.
Bangladesh has recently been attracting small and variable volumes of FDI in the 1990s
ranging from $41.5 million in 1992 to $407.5 million in 1994, falling to $104 million in
1995. The variations were due to investments in a large fertilizer plant. FDI was
negligible in 1996 and 1997 owing to political disturbance in 1996.
In Nepal, new incentives have been succeeded in attracting small inflows in recent years.
From 1992 to 1995. authorized FDI in joint ventures and collaborations totaled $784
million of which actuals were $624 million.
In Sri Lanka, there was a surge of FDI from 1989, accompanied by a substantial but
variable inflow of portfolio investment in the 1990s. The second wave of reforms set the
stage of the surge, aided by new internationalization moves by manufacturers in Japan
and the newly industrialized economies (NIEs) in East Asia (especially Korea) in
response to their massive exchange rate appreciation and domestic wage increase. Annual
inflows increased from around $50 million in 1990 to $187 million in 1993. The inflow
fell away following the change in government in 1994. The total number of projects
attracted by the Board of Investment (BOI) declined from 327 in 1993 to 270 in 1994,
and only 139 projects in 1995. The foreign component of total investment in contracted
projects has declined dramatically over 77 percent during 1989-92 to less than 45 percent
during 1993-95. A comparison of the Sri Lankan experience with that of other countries
in Asia, such as Malaysia, Indonesia, Vietnam, and even India, suggests that the
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significant decliner in FDI in Sri Lanka was predominantly an isolated ‘home-made’
phenomenon and not part of a regional pattern (Athukorala and Shand 1997)
Most of the South Asian countries have undertaken far-reaching economic reforms: they
have adopted industrial policies that encourage foreign direct investment (FDI) resulting
in an increase in FDI flows. However, the amount of inflows attracted by the regions
remains relative to East Asia and South East Asia quite insignificant. In 1998, it was
US$ 3.43 billion, a mere 0.5 percent of global flows. In contrast, China received more
than 10 percent of global inflows. By 2002 although total FDI flows to South Asia had
increased to Us$ 4.58 billion, this was still well below 1 percent of global FDI inflows.
FDI to the region is predominantly from outside the region. The sectors that have
attracted most foreign investment vary between countries. In the case of Bangladesh, and
Sri Lanka, the textile and garment sectors account for 28 percent and 16 percent
respectively of FDI, whereas 56 percent of FDI has gone into infrastructure projects in
India. In the case of Pakistan, 40 percent of all FDI has gone into the power sector. While
FDI from outside the regions has been far greater than intra-regional investments, there
are signs that intra-regional investments are increasing. The major inward FDI flows are
from Indian firms, which have started to expand FDI both within South Asia and beyond.
Firms from other South Asian countries are also increasingly undertaking FDI within the
region and investing in a wide range of sectors and activities.
There are two SAARC countries, Nepal and Bhutan, where FDI from India is the
predominant source of FDI. On the other hand, none of the SAARC countries are
significant investors in Pakistan though there is a very limited FDI flow from other
countries in the region. India is the largest investors among the SAARC countries in the
Sri Lanka, while Pakistan and Maldives are respectively second and third to India as
investors. In the case of Bangladesh, firms from India, Pakistan and Sri Lanka have in
recent years invested US$ 418 million in 133 ventures covering a wide range of sectors.
In spite of India’s huge internal market, investment from other SAARC countries have
been quite insignificant, both in relative and absolute terms, accounting for less than one
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per percent of total foreign investment in India. Bangladesh is the largest investors in
India from the region, followed by Sri Lanka, Nepal and Maldives.
The Lafarge Surma Cement in Bangladesh is the single largest cross border investment in
the region involving a major multinational firm, Lafarge, a French multinational, is one
of the largest cement manufacturers in the world. The plant is expected to go into
production very shortly. The raw materials, mainly limestone and shale, for this 210
million dollar joint venture cement plant in the district of Sylhet, located Northeastern
Bangladesh close to the Indian border will be supplied from a quarry in the bordering
state of Megalaya. The plant, one of the largest in the region, and the quarry are
connected by a 17 kilometer (11 mile) cross-border conveyor belt to transport the lime
stone. The plant will have an initial capacity of 1.2 million tons of cement per annum
although this capacity is expected to be doubled in due course.
Another example of a successful joint venture is the rubber sector in Sri Lanka. The
vertical joint venture was initially between an Indian motor vehicles company,
Associated Motorways Private Ltd. and the Sri Lankan subsidiary of CET for the
manufacture of tyres. Sri Lanka, which did not have a developed rubber-based industry,
gained greater access to the protected and growing Indian market, while India obtained
easy access to the supply of good quality natural rubber. At the end of the day both
countries benefited through this joint ventures.
This is evident from the above-mentioned facts that the intra-regional flows of FDI
among the member states of SAARC are negligible.
4. Potential Benefits of Intra-Regional Flows of FDI
Various statistics show that there exists an acute poverty in the Member States of the
SAARC (different poverty indicators have been provided in Appendix-2). There are
different ways and means of eradicating poverty and almost all the Member States of the
SAARC keep poverty alleviation as the top policy agenda in formulating their fiscal
measures in the short run and development plans in the long run. Researchers have
10
identified various causes behind the poverty of the region. Low level of economic
dynamism is considered as one of the key factors of economic backwardness of the States
of the SAARC. The South Asian Center for Policy Studies (SACEPS) 3 and Asian
Development Bank4 have identified two causes of economic backwardness. These are
lack of investment capital accumulation and regional cooperation. Investment capital can
be accumulated through FDI that can be ensured by effective regional cooperation.
Unlike East and South East Asia where regional cooperation initiatives have contributed
significantly to the economic growth of the countries in these regions through an increase
in inter-regional trade and investment, regional cooperation in South Asia remains weak.
An opportunity for accelerated growth and further energizing the economies of South
Asia does exist by increasing investment through regional cooperation. Therefore,
enhancing investment cooperation and facilitating investment among countries in the
region will be crucial for the development of the economies in the region (Sobhan, 2004).
There are different sectors for investment within the region. Three sectors have already
been identified (Sobhan, 2004) that can be treated as some of the potential sectors of
intra-regional investment. A short description of each of these three sectors is given
below;
1. The Energy Sector: Bangladesh, Bhutan, India and Nepal can develop join
cooperation for investment for the utilization of thermal and hydropower
efficiently. In this regard it can be stated that Indian reserve of coal and
Bangladesh reserve of coal and gas can be utilized effectively whereas locations
of Nepal and Bhutan can be chosen for their large untapped hydro-power potential.
Indian giant Tata group has already understood this potential and has started to
negotiate a two billion dollars investment in Bangladesh.
2. Transport and Communication: This sector is also considered an important and
profit earning sector of investment in this region. Because transport and
communication systems of all the Member States are not well developed that
3 SACEPS Task Force Report on Common Investment Strategy for South Asia (2003). 4 Asian Development Bank (1996). Background Paper on Regional Cooperation in South Asia.
11
hampers the flow of goods and services within the region. Investors may take this
sector to invest for the long-term generation of income.
3. Information Technology: information technology (IT) plays an important role
by increasing connectivity, communication and transparency in the business
process. In this case India can take a lead to develop this sector in the region so
that India can also gain by utilizing IT specialists of different Member States.
However, we are going to identify some more sectors for investment in the region that are
yet to be identified:
1. Agriculture: The economies of all the countries in the region are highly
dependent on agriculture. South Asia, one of the major growers of agricultural
commodity, and a major growth region in the present world, has bright prospect
in exporting agricultural products. The trade prospect in south Asia is to be
influenced by the region’s attempts in stabilization, and reforming the economic
policies as well as by changes in the external environment and internal policy
adjustments to those changes (Hossain, 1999). Although agriculture is one of the
most important sectors contributing to the GDPs of the respective countries in the
region, there has been lagging behind in the industries for the food processing
plants that hampers the preservation of agricultural products. This affects the
farmers in getting reasonable prices of their products and countries are also
deprived in export earnings of those products. Intra-regional investment can be
encouraged in agricultural product processing, preservation, packaging and
transport industries.
2. Tourism: As an industry, its position is second in the world only by petroleum
industry. The main reasons of growth of tourism industry in the world are
growing prosperity especially in the areas or regions from where the bulk of
international tourists originate, continuous reduction in the work time leading to
more leisure time, lessening of travel costs and time due to rapid development in a
aviation technology, increasing flow of information about the place, and men /
women’s natural desire to see new places and experience himself / herself what
12
they have been told and to escape from monotonous and hectic life of industrial
societies. Development of tourism industry in SAARC is not up to the mark. It
was concluded by Jyoti (1996) in the first seminar that inspite of having one-fifth
share of the humanity and having all the attributes for becoming a very popular
tourist destination, SAARC region’s performance in this sector was rather poor.
At the moment, SAARC Member States are emphasizing attracting tourists from
other regions, especially from developed countries. But development of intra-
regional tourism could relatively be more prospective as compared to present
move. Tourism can help establish people to people contact that eventually will
help in building trust among the citizens of the region. The outcomes will be that
the investors in the region will find the prospective sectors such as infrastructure,
hotels, motels, transport, theme parks, etc. Not only that through the mobility of
people, many other potential sectors such as agriculture, industry, etc, could be
identified for investment.
3. Textile and Garments: This sector is also considered as an important sector in
terms of earning foreign currencies and job creation in the region. For example,
garments sector is the top ranking export sector for Bangladesh. If there could
have intra-regional FDI in this sector, some backward (forward) linkages are
possible. For instance, Pakistan is good in textile and Bangladesh is good in
garments. If there could have joint ventures between these two countries, these
would add value, enhance productivity, save foreign currencies, and also reduce
the cost of production that will in competing in the world market.
5. The Attitudes of Nationals towards FDI
The present attitudes towards FDI are due to massive changes in global economy, politics,
information technologies, and most importantly the mentality of all – the host countries,
the home countries and the MNEs (as MNEs are treated as the main driving force of
globalization). Dunning (1994) provides the changing world of FDI as follows:
13
Figure –1. The changing world of FDI
• From a country’s perspective
Renaissance of the market system.
Globalization of economic activity.
Enhanced mobility of wealth-creating assets.
Increasing number of countries approaching the “take-off” stage in
development.
Convergence of economic structures among developed countries
and some newly industrialized economies.
Changing criteria by which Governments evaluate FDI.
Better appreciation by Governments of the costs and benefits of
FDI.
• From a firm’s perspective
Increasing need to exploit global markets (e.g. to cover escalating
research and development costs).
Competitive pressures to procure inputs (raw materials,
components etc.) form the cheapest possible sources.
Regional integration has prompted more efficiency-seeking
investment.
Growing ease of trans-broader communications and reduced
transport costs.
Heightened oligopolistic competition among leading firms.
Opening up new territorial opportunities for FDI.
Need to tap into foreign sources of technology and organizational
capabilities and exploit economies of agglomeration.
Changes in significance of particular locational costs and benefits.
Need to better balances the advantages of globalization with those
of localization.
Source: Dunning, 1994.
14
Historically, FDI flows were dominated by USA to its European allies dating roughly
from the Korean War (1950-1953) to the first oil shock (1973-1974). The Americans
have shown a greater preference for FDI and direct control than have other investing
countries, particularly Britain, France and the oil-rich nations, all of whom have
channeled a greater proportion of their foreign investments into portfolio lending.
Initially, in 1960s US firms introduced new and sophisticated products into the European
markets with FDI that became a matter of concern for Europe. It is documented from
Vernon (1971) where he showed in “Sovereignty at Bay” that the problems posed by the
so-called “American Challenge” were not strictly US oriented rather the US MNEs’
penetration to France with FDI. At the same time it was thought that such penetration
would influence the setting of national objectives by lowering the freedom in setting
national policies by those MNEs for their own interests. Whereas in 1970s and 1980s FDI
moved away from the Third World, where it had met resistance and expropriations
climaxing in the 1970s. Smeets (1998) states that FDI flows remained mainly
concentrated in the industrialized world, which could partly be explained by the existence
of large consumer markets and partly by the liberalization of capital markets, mainly
within OECD. Indeed, about three quarters of FDI inward stock and 60 percent of FDI
inflows were taking place in developed countries that were also the principal home
countries and invested 85 percent of world FDI. The triad (the EC, Japan, and US)
accounted for 70 percent of world inflows. The five major home countries (France,
Germany, Japan, United States and United Kingdom) accounted for two thirds of FDI
outward in 1980s.
This trend reversed itself beginning in 1992 as FDI flows into developing countries
increased dramatically as Dunning (1994) termed it as “good news” for FDI.
Qualitatively, developing countries (LDCs) enjoyed a wide variety of location-specific
advantages over and above natural resources (World Investment Report, 1997). At the
initial stage of development of FDI, developing countries were also less interested in
inviting FDI though TNCs due to their previous experience about TNCs where they
entered for trading and eventually intervened politics and captured political power (e.g.
15
East India Company in India). On the other hand, TNCs also complained against LDCs in
terms of different barriers put by the LDCs for the TNCs. The following figure shows the
complaints of both – LDCs and TNCs – against each other.
Figure – 2: Shows the complaints of LDCs and TNCs / MNEs
Complaints of LDCs against multinational
• TNCs extract excessive profits because of their oligopolistic or monopolistic market
position
• TNCs allocate markets to specific subsidiaries, thus not allowing individual
manufacturing subsidiaries to develop export markets.
• TNCs do not engage in research and development in all of the countries in which they
operate, thus causing technological progress in those nations to stagnate or even
regress in relative terms.
• TNCs set transfer prices for intermediate inputs at rates other than arms-length in
order to minimize tax consequences or discourage to entry of competitive firms that
would buy intermediate inputs.
• TNCs do not transfer ‘appropriate technology’ when establishing manufacturing
facilities, thereby minimizing the benefits of foreign capital and technology.
Complaints of TNCs against LDCs
• Setting high tax rates on the profits of multinational firms.
• Requiring the local production of many products, there by stimulating the local
economy by shifting employment into the host country.
• Encouraging the dissemination of technology by requiring that host country national
be employed at specific position within the foreign corporations.
• Restricting the ability of MNCs to protect proprietary technology through patent and
trademark law .
Source: Miller and Crespy (1993)
However, there are some intra-regional adverse attitudes among the people of the region
towards FDI. Although almost all the countries of the region are trying to attract FDI
16
from other regions, efforts are not so worthy for the same from each other. The main
reasons include lack of people-to-people contact, lack of mutual trust and confidence,
lack of political cooperation, religious hostility among nations, big brother type attitude
of India, lack of organized campaign about the benefits of intra-regional investments
among the people, etc.
6. Present and Potential Threats to FDI
It has already been established through earlier discussion that there are various
potentialities of intra-regional foreign direct investment. In spite of this prospect,
investment from the countries is not yet satisfactory. Because some hindrances prevailing
in the region that are acting as bottlenecks to the smooth flow of investment. Some of the
constraints for intra-regional FDI in South Asia are highlighted below:
a. Different Sizes of Economies: The enormous differences in size among the
economies in the region, above all, the overwhelming size of the Indian economy in
comparison to other countries in the region has proved to be psychological barrier for
other countries. As a big economy, India is in better position than other. Here India is
reluctant to open its economy for its neighbors, and the same attitudes are also prevailing
in other states.
b. Varying Economic Policies: The intra-regional investment flow is further hampered
because of differences in economic policies of the states. Various economic reform
programs have been adopted by the states without considering the regional cooperation
and coordination on economic policies among themselves. The safeguard measures
designed and adopted by some of these countries particularly to protect their respective
domestic industries indicate their conservativeness to welcome regional investment.
c. Trade Barriers: South Asian intraregional investment are also affected by the
presence of many trade barriers including tariff and non-tariff barriers, such as different
standardization and certification processes, subsidies on agricultural products and
different custom rules and regulations formulated in different states. The differences in
17
tax laws and regulations, exchange rates, interest rates, duty structure as well as
macroeconomic policies in general have proved to be a major factor inhibiting intra-
regional investment flows.
d. Poor Physical and Non-Physical Infrastructure Facilities: One of the important
preconditions for attracting FDI in a country is the presence of developed infrastructure.
Excepting India, other countries of the region still could not develop their infrastructural
facilities up to the mark. A study conducted by the Bangladesh Enterprise Institute in
2002, which was supported by the World bank, found that poor infrastructure, electricity
problems, corruption, excessive regulations and poor access to finance for Small and
Medium Enterprises (SMEs) were important factors that impede economic growth and
development of Bangladesh; that the investment climate was also a major factor in
influencing FDI flows into the country. The very same problem, in varying degrees, was
adversely impacting on the investment climate of all the other countries in South Asia
(Sobhan, 2004). The relatively poor regulatory, fiscal, and legal systems have held back
investment in South Asia by raising direct cost and by corruption; bureaucratic delays;
property disputes also create a sense of uncertainty.
e. Absence of Effective Banking Network: Presence of develop banking network
among the countries is another essential factor in any international business. The banking
network in the region is poorly developed; the level of cooperation between the central
banks of the states is all but absent.
f. Lack of Cross-Border Facilities: Another impediment has been identified for
insignificant intra-regional investment is the lack of sufficient cross border facilities like
transportation, and communication, etc. For smoothening production and marketing of
goods and services in the region, intercountry roads, rail, waterways, and airways modes
of transportation must be available at the required level. But still it is yet to have an
integrated transport network for helping the easy movements people and products.
18
g. Political Factors and Acute Mistrust among the Nations: Majority of the countries
in the region were under British rule for about 250 years. After getting independence in
1947, India, and Pakistan became separate states. But these two countries could not build
trust on each other from the very inception. Subsequently Bangladesh got independence
in 1971 from Pakistan through a tragic war. Political hostility between Pakistan and India
has long been continued as they have many unsettled political issues like Kashmir.
Bangladesh also cannot trust Pakistan still for its earlier bitter experience. According to
the authors, this factor can be treated as the main impediment for poor level of intra-
regional investment. Thus political factors, acute mistrust and lack of confidence,
governance issues, lack of knowledge about each other’s financial system and capital
markets and the reluctance to share information are important factors regarding the
progress and pace of regional cooperation in South Asia.
With the above-mentioned constraints, we can cite about other impediments to South
Asian regional investment identified in SAARC Summit (Sobhan, 2004).
i. Low growth rates of the countries;
ii. Shallow credit market;
iii. Financial market imperfections and weak creditor’s rights that weaken the efficiency
of the credit market and restrict financing for investment;
iv. Low levels of private savings and financial development and high investment;
v. Identical comparative advantages;
vi. Low levels of FDI that reduce investment by limiting access to an important source of
finance and by forgoing the complementarity between foreign and domestic investment.
7. Some Remedial Suggestions
It is said that if there would have effective SAARC, this could be the largest trade block
in the World in terms of population. In order to create conducive conditions for
promoting intra-regional trade and investment the following measures should be
considered:
a. Building Mutual Trust and Confidence among Nations: This should be
considered as the main measure for effectiveness of SAARC. An
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organized political campaign should be taken to convey the message to the
people about the benefits of regional cooperation. In this regard,
politicians must be active in building trust and confidence among the
people of the respective nations. Increase in cultural exchanges,
development in tourism sector, reduction of bureaucracy in the mobility of
citizens, not letting territories for using by the terrorists, etc. can be some
measures for boostinf up the trust and confidence.
b. Harmonization: This includes fiscal policies, investment policies;
exchange rates, tax laws, custom laws and procedures, national standards
and certification process, common investment strategy towards FDI,
uniform liberalized rules and regulations for FDI should be formulated.
This can be materialized through South Asian Preferential Trade Area
(SAPTA)
c. Creating an Investment Area: A SAARC investment area, similar to
ASEAN investment area, can be established in generating intra-regional
investment flows as well as attracting FDI from outside the region.
d. Building Networks Among Financial Institutions: An integrated
network can be set up among the banks (including central banks) and other
financial institutions to ensure free flow of information and funds. A
SAARC Investment Authority can be built up to facilitate investment,
improving bank links, intensify cooperation among the stock exchanges in
the region.
e. Physical Infrastructure Development: An effective initiative should be
taken by the states to develop intra and inter country infrastructural
facilities that include rail, ports, roads, air transports, electricity,
telecommunication, etc. These will enhance flow of goods and services
within the region.
f. Establishment of Free Trade Area: At present there is a regional
agreement among the states known as SAPTA that concentrates only on
trade and commerce, a move should be taken to form a South Asian Free
Trade Area (SAFTA) for speeding up investment cooperation in the region.
20
g. Encouraging Sub-Regional Cooperation: Intra-regional investment can
be increased if countries of the region can exploit opportunities for sub-
regional cooperation that are based on geographic proximities and
common economic interests.
h. Cooperation in Government Level: Governments of the region should
be more proactive by taking measures relating to regional cooperation in
general and SAARC in particular. Institutional supports should be strong
for close interaction and cooperation among governments, ministries,
government agencies, public and private sectors, etc.
i. Cooperation in Non-Government Level: South Asian cooperation can
be enriched through establishing interaction among the non-government
organizations like Chamber of Commerce, Trade Associations,
Educational and Cultural Institutions, Religious Groups, Social
Institutions, Professional Groups, etc.
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Appendix-1: Size of Economies in SAARC Member Countries Gross nationalIncome
Gross national income per capita
PPP gross national income Gross domestic product Country Population2001
Surface area Thousand of sq.km 2001
Population Density People per sq.km2001
$ billions 2001
Rank 2001
$ 2001
Rank 2001
$ billions 2001
per capita $
Rank 2001
% growth2000-01
Per capita % growth 2000-01
Bangladesh 133 144 1,024 48.6 51 360 172 213 1,600 173 5.3 3.5India 1,032 3,287 347 477.4 12 460 162 2,913 2,820 143 5.4 3.7Nepal 24 147 165 5.8 108 250 190 32 1,360 180 4.8 2.4Pakistan 141 796 183 60.0 44 420 164 263 1,860 167 2.7 0.3Sri Lanka 19 66 290 16.4 73 880 140 61 3,260 134 -1.4 -2.8
Source: World Development Indicators, 2003, The World Bank, Washington DC, USA.
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