Policy choices in the FDI domain

by Syeed Ahamed

Published in the Daily Star on 24 February 2010.

This piece explores policy trade offs for attracting foreign direct investment.

Bangladesh is an atypical country where a very favourable foreign investment policy and reasonably attractive investment incentives remain untapped merely for its lack of infrastructure, primarily in the power sector. Over the last one and half decades, attracting foreign direct investment (FDI) in the power sector has been a priority to break the vicious circle of low FDI and energy shortage. Numerous writings and dialogues have already highlighted drawbacks in infrastructure, different forms of corruption and administrative complications being the major obstacles to FDI inflow.

Let me focus on some policy choices that the government needs to make to attract and balance the FDI flows in a post-recession global economy.

Recent trends
May be it’s the ‘Wall-Mart effect’ whereby our ready-made garments sector performed well from the western consumers turning to cheaper alternatives, or may be it’s just a very low benchmark, but Bangladesh’s performance in attracting FDI was not too bad during the recession. According to UNCTAD’s latest Global Investment Trend Monitor report, world’s FDI flow declined by 38.7 percent in 2009, with FDI flow towards developed and developing economies declining by 41.2 percent and 34.7 percent respectively. Developing economies of South, East and South-East Asia also witnessed a 31.8 percent decline in FDI flow.

As UNCTAD noted, the most severe decline was witnessed during the first quarter of 2009 (UNCTAD data in calendar year and Bangladesh data in fiscal year). In this context, the net FDI inflow of US$941 million in FY2009, a 44.8 percent growth over FY2008, looked promising. But, during the first four months of FY2010 we have only received US$207 million as FDI, registering a 48.5 percent fall over the corresponding period of FY2008. Perhaps this is a delayed response to the global recession, even though UNCTAD forecasts a moderate rebound in FDI for 2010 and a significant worldwide recovery in 2011.

Portfolio investment
In a steady capital market, foreign institutional investment (FII) that comes as portfolio investment can stimulate the local market. In a country where infrastructure and administrative bottlenecks complicate FDI, FII becomes an easy alternative for foreign investors. However, the flow and impact of FII in Bangladesh is as unpredictable as its capital market. Lack of regulation and improper management of the capital market fails to attract regular inflow of FII, but encourages opportunistic short-term investment that results in boom-and-bust of the secondary market and repatriation of the capital. As is evident in chart 1, a sudden boom in the capital market is usually followed by a net outflow of portfolio investment and a subsequent fall in the share market. This is one reason why transitional economies should remain sceptical about this volatile investment and prefer FDI over FII.

But there appears to have a significant change in the market behaviour over the past three years (coincidentally, this period is also marked with the restructuring of the capital market). Unlike 1996, when the outflow of portfolio investment (to the tune of Tk564.8 crore) witnessed a steep fall in DSE price index, the outflow of Tk 678.8 crore during FY2009 had little impact on the DSE index. However, unlike 1996 when very little inflow of FII was followed by a very high outflow, the outflow of FY2009 was on the heels of a steady inflow of foreign investment during the previous years and an availability of excess liquidity in the local market. As a result, we have seen another jump in DSE general index during the first half of FY2010, which stood at little over 5000 points as of January 29.

Nonetheless, if history is any lesson for us, this is the time when the market regulators should put their monitoring hat on.

Exports and FDI

Star File Photo

In addition to the essential administrative and infrastructural supports, the market potential also determines the flow of FDI. For investors who come to Bangladesh with a goal to export the products to a third market usually invest in manufacturing sector and are encouraged by the facilities provided by export processing zones (EPZs). On the other hand, investors who are encouraged by the potential size and growth of our domestic market are mainly attracted by the market potentials in our health, energy and telecommunication sectors.

As it stands, almost two-thirds of FDI comes in the service sector whereas less than a third comes in the manufacturing sector. In order to encourage FDI without compromising the competitiveness of the local industries, government is encouraging export oriented FDI in EPZ while inviting FDI in non-EPZ sectors on Build Operate and Transfer (BOT) basis (in few cases on Build Operate Own basis too).

During the first five months of FY2010, FDI flow in EPZ saw a positive growth despite the overall negative growth in the balance of payment. During this period, three-quarter of total EPZ-targeting FDI came in Adamjee and Chittagong EPZs which attracted US$44.67 million and US$22.84 million respectively. But the sheer lack of intra-ministerial cooperation seems to be a major problem is this regard. Last year’s BEPZA directive to 14 foreign investors at Karnaphuli EPZ to suspend the construction works of their factories was a pure display of lack of cooperation and coordination among various government agencies. At a time when the external sector was embracing the full impact of the global financial crisis, such moves were totally uncalled for.

FDI and balanced, broad-based growth
The correlation between FDI and income inequality is well evident in the literature, and if we are to minimise the regional disparity, the concept of our existing EPZs needs to be reviewed. While few city-centric EPZs contribute to regional inequality, establishment of EPZs and special economic zones (SEZs) across various regions were also unsuccessful. Stagnation of Mongla EPZ is one example where setting up an EPZ area was just not enough to attract FDI. The construction of Padma Bridge, revival of Mongla port, connection to Asian Highway, and promotion of regional connectivity should be marketed as different pieces of one single puzzle which can be used to attract East Asian investors for further investment.

The regional economic integration in East and Southeast Asia is evident by the high internal flow of FDI within the region. An operational ‘flying geese pattern of development’ is clearly visible in intra-Asian FDI flow where cheap farm labour of less developed economies are attracting FDI from more developed Asian neighbours. Moreover, FDI from developing countries to developing countries (South-South FDI) have grown faster than FDI from high-income countries to developing countries (North-South FDI) since the late 1990s.

In addition to low labour costs and market-access opportunities, geographic proximity seems to have played an important role in the Asian South-South FDI flows. Western countries such as the United Kingdom, the United States or Scandinavian countries are still the major source of FDI flow to Bangladesh. But Asian region is emerging as the key source of FDI flow into our manufacturing sector, owing to the investment from Hong Kong, Japan, Malaysia, Singapore, Korea and Taiwan. This makes it all the more important for Bangladesh to get connected with other Asian countries through infrastructure linkages.

The diaspora
Another untapped source of FDI has been the non-resident Bangladeshis (NRBs). At times of global political and economic doldrums, NRBs — who want to keep a parallel income source back home as a safety net — can become a good source of FDI flow. Trust is a major issue in attracting NRBs to invest in Bangladesh, and at the initial stage some lucrative joint-venture opportunities should be opened up for them to increase their confidence. Since the proposed International Gateway (IGW), Interconnection Exchange (ICX) and International Internet Gateway (IIG) forbid any form of offshore investment including that of from NRBs, alternative opportunities in the telecommunication sector should be launched.

The regulators of proposed public?private partnership (PPP) initiatives may keep this in mind while preparing the legal framework for the scheme.

Contrary to popular belief, corruption does not automatically reduce FDI. Rather, corruption affects the quality of the FDI. Corruption often lures multinational corporations (MNCs) to invest in the under developed countries where they can bribe to bargain favourable entry and exit conditions. Bangladesh’s past experience with some FDI in the energy sector is a prime example of this. While attracting some short?term FDI from MNCs, corruption however discourages small and medium investors who come here with long-term investment. This is where Bangladesh also needs to rethink corruption in relation to FDI.

Bangladesh has already begun an active campaign for fresh FDI flow into power and other infrastructure sectors. The government is initiating the process to float pre-qualification process to find investors for Bibiyana, Meghnaghat and Bhola power projects. Some successful FDI projects in power sector may channel new FDI in the balance of payments and pave the way for more investments. However, to become a middle-income economy by the next decade, Bangladesh needs to look for new avenues to keep the FDI inflow steady over a billion dollar benchmark.


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