FDI in South Asia: Trends and Prospects

Net private capital flows to developing countries reached a record high of $491 billion in 2005, driven by privatizations, mergers and acquisitions, external debt refinancing, and strong investor interest in local-currency bond markets in Asia and Latin America (Global Development Finance Report, 2006). The surging flows, including record bank lending and bond issuance, among others, coincided with 6.4 percent economic growth in the developing world last year, more than double the 2.8 percent growth in developed countries. The sharp rise in private capital flows to developing countries came despite uncertainties caused by high oil prices, rising global interest rates and growing global payments imbalances. The rise in private capital flows to developing countries was basically driven by abundant global liquidity, steady improvements in the credit quality of developing countries, lower yields in rich countries, and the expansion of investor interest in emerging market assets. These gains reflect the estimated GDP growth of 6.4 percent in low- and middle-income countries in 2005, buoyed by PRC and India, whose output grew by 9.9 and 8 percent, respectively.

Private capital flows to South Asia reached a record $23.6 billion in 2005, up from $9.7 billion in 2000. This growth was largely driven by India, which received the majority of capital flows to the region. Foreign Direct Investment (FDI) in South Asia rose to $8.4 billion in 2005, an increase of $1.2 billion from 2004.

Basic Indicators of South Asian Economies

It is not only the investment flows to South Asian countries which are increasing; overall macroeconomic growth is also promising, and a few macroeconomic and trade indicators are exhibiting robust growth as seen in Table 1 (in Appendix-B [ PDF 133.8KB | 23 pages ]). ²⁷ The global competitiveness index ranks countries on a broad range of indicators such as institutions, macroeconomics, infrastructure, business sophistication and innovations. In a set of 117 countries, it is evident from Table 2 [ PDF 133.8KB | 23 pages ] that the South Asian countries except India are way at the bottom in the overall index. Low-income developing countries such as Bangladesh and Pakistan are ranked 98 and 94 respectively whereas Sri Lanka is ranked 80. However, India and PRC are quite close to each other in the overall index, obtaining ranks of 48 and 45 respectively, India is in fact ranked higher than PRC on the overall index, with a score of 4.32 out of 7. Even in matters related to infrastructure, India and PRC are neck and neck, though the other South Asian countries such as Sri Lanka have a long way to go in terms of improving infrastructure. PRC is ranked 65 in infrastructure and India 69, with PRC scoring better than India. By contrast, Sri Lanka is ranked 81. But there is apparently a huge gap when one compares the macro economy, business sophistication and innovation in South Asian countries vis-à-vis PRC and other East Asian counterparts. India and its neighbours rank poorly, which may be a reason for their relatively poor FDI performance compared to other developing economies in the region.

Infrastructure Indicators in South, East and Southeast Asia

Infrastructure constitutes the backbone of economic development in most developing economies, and South Asia is no exception. The importance of infrastructure for overall economic development and the enhancement of trade and business activities in a country needs hardly be emphasized. Table 3 [ PDF 133.8KB | 23 pages ] shows the major infrastructure indictors of South Asian countries in comparison with East and Southeast Asia in 2004.

With the exception of Singapore, no country in the region is performing well in the overall infrastructure quality index. Singapore has a score of 6.7 out of 7, indicating a high level of infrastructure, followed by Republic of Korea with a score of 5.2. PRC has a score of 3.2, which is higher than most of its counterparts in the region but is not as high as Singapore or Republic of Korea. India has managed to receive a score of 2.9, and Pakistan fares slightly better at 3.0. Bangladesh has a score of 2.7.

Further, if one compares the countries in the South Asian region, particularly in terms of the number of days required to start a business, there appear to be huge differences. In India, it takes about 80 days to start a business whereas in smaller economies such as Bangladesh and Pakistan it takes much less time. Moreover, as seen in Section III, labor reforms and the ability of employers to hire and fire workers has been a much-debated issue in most of the developing countries of South Asia. It is very evident from the scores in Table 3 [ PDF 133.8KB | 23 pages ] that most countries have fairly rigid labor laws, which are greatly in need of reforms. Table 4 [ PDF 133.8KB | 23 pages ] reports transport, telecommunication, information and energy infrastructure indicators for South Asian countries vis-à-vis other developing countries. All the South Asian countries lag behind other developing countries in almost all indicators. Overall, South Asia has a long way to go in improving infrastructure in the region. Active participation of the private sector along with the government would help infrastructure development, a crucial determinant of FDI in the region.

FDI Performance and Potential Index

Table 5 [ PDF 133.8KB | 23 pages ] and Table 6 [ PDF 133.8KB | 23 pages ] present the Inward FDI Performance Index ²⁸ and FDI Potential Index for South Asia and a few other countries in the region. Most South Asian countries, along with PRC and Thailand, have managed to increase their Inward FDI Performance and FDI Potential Index consistently over the years. In fact, countries like Pakistan and Bangladesh have faired better than large economies such as India in FDI performance, though the potential of larger economies is higher. However, India's FDI Performance Index has remained more or less constant and has taken a slight dip in the last two to three years, which may be due to delays in FDI reform measures as a result of stiff opposition from leftist political parties. India has not been able to liberalise its FDI policy framework to the extent that some of its neighbours like Bangladesh and Sri Lanka have accomplished in recent years. The sectoral caps on insurance and retail are still in place, with little possibility of deregulation. For instance, Bangladesh ranks 103 among a set of 140 countries in the FDI performance index in 1990 and in the same year, its FDI Potential Index was ranked slightly higher, at 102. In the year 2003, Bangladesh's FDI Performance Index is ranked at 132 though it has the potential to be ranked 115. Thus, most countries in the region have the potential to improve their FDI performance rankings. Tables 6 and 7 show the FDI inflows into major economies in the region and their share in the total world and developing countries inflows from 1996-2004.

Global FDI Inflows and South Asia

FDI flows to developed countries have typically been much higher than flows to developing countries. As a result, until very recently, the global trend largely mirrored trends in the developed world. A major break from this pattern took place in 2004, when FDI flows to developed countries declined, whereas global flows increased, spurred by the surge in FDI to developing countries (see Table 7 [ PDF 133.8KB | 23 pages ]). It can be seen from Table 8 [ PDF 133.8KB | 23 pages ] that FDI flows to developed countries gradually declined from $547 billion in 2002 to $442 billion in 2003 and further to $380 billion in 2004. In fact, this is in line with the overall decline in FDI flows to the world. On the contrary, along with the shift in trade to developing economies, there has been a consistent increase in FDI inflows to the developing world, with most of the growth being concentrated in Asia and Latin and Central America. Figures 1 and 2 show the global trends in FDI to developing countries.

Figure 1 looks at trends in global FDI flows since the 1980s. FDI flows were fairly stable in the first half of that decade, but started to rise steadily in the second half. This trend continued through the early 1990s, with the growth rate rising sharply in 1997. The years from 1997–2000 witnessed dramatic increases in FDI flows, which peaked in 2000 and declined sharply in the following three years, reflecting the global recession sparked by the dotcom crash in 2000, and the economic effects of 9/11 in the US. They recovered marginally in 2004 (by 2.46 percent), settling at close to their 1998 level (see Figures 4 and 5).

FDI Flows to developing countries were fairly stable in the 1980s. The 1990s witnessed a gradual rise in FDI, largely brought about by the dramatic changes in the policy structures of the “Asian Tigers,� which had begun to embark on programmes of structural liberalisation and open-market reform, aimed at ushering in a phase of export-led growth. Another contributing factor may have been the recovery of the Latin American economies, which had begun to emerge from the Debt Crisis of the 1980s. Inflows stagnated in 1998, departing from the trend growth rate – a result of the East Asian Financial Crisis – but then bounced back by the following year. There was negative growth in FDI inflows in 2000 and 2001, partially because of a global recession. However, both the quantum of FDI to developing countries, and the rate of growth in FDI have been rising steadily since 2002, with FDI growing by 7 percent in 2003 and 40 percent in 2004. This trend, combined with falling inflows to the developed world, has resulted in a new trend in the distribution of FDI between the developed and developing world (see Figure 3)

FDI Inflows to South Asia

FDI inflows in absolute value to South Asia have continuously increased over the years and particularly since 2000 (see Table 7). They climbed for the fourth consecutive year in 2004. An improving economic situation and a more open FDI climate encouraged inflows to India, at record levels of $5 billion. Cross-border M&As in India rose in 2004 as the telecommunications, business process outsourcing and pharmaceutical industries saw an increase in large deals. The improved investment environment and the privatization of assets in Pakistan and Bangladesh contributed to increased FDI inflows to those countries. Overall, business confidence in South Asia improved.

It is evident from Table 8 that figures for South Asia are negligible. While the share of South Asia in the FDI inflows of developing countries is about 3 percent, its share in the global FDI inflows is almost negligible at 1.08 percent. One quarter of all FDI inflows are going to PRC, and the other countries in South Asia are getting less than one percent of the total FDI inflows to the developing countries. Even FDI inflows as a percentage of Gross Domestic Capital Formation in South Asian countries are quite low though they have increased gradually since 2000. The same trend is also seen in FDI stocks as a percentage of GDP (see Table 9 and 10 [ PDF 133.8KB | 23 pages ]).

Trends among the South Asian Countries

The South Asian countries have been making consistent efforts to attract more FDI by liberalizing their FDI policy frameworks to compete with other countries in the region (see Section III). However, given the wars and ethnic strife in most countries in South Asia, they are nowhere close to their counterparts in Southeast Asia. India has attracted the maximum FDI in South Asia. While India's share of FDI to developing countries has been, and still is, significantly lower than that of the major Latin American and East Asian economies, it receives the most FDI in South Asia. However, after controlling for the size of the economy (measured by gross domestic product), Pakistan and Sri Lanka both do better than India. Figures 6, 7, and 8 depict FDI inflows in South Asia, focusing on India, in comparison with those counterparts.

India's share of FDI inflows to developing countries rose to 1.9 percent in 1997, but declined sharply to 1 percent in 1999 and 2000. However, 2001 saw an increase in FDI inflows. This trend continued until 2003 when it reached a peak of 2.6 percent. In 2004, there was a slight fall to 2.3 percent. The sum of FDI inflows into India in 2003 and 2004 was $4.2 billion and $5.3 billion. Thus, in absolute amounts, 2004 also saw a rise in FDI inflows to India (see Table 7).

In 2002, PRC held the highest share of developing country FDI (33.9 percent) followed by Brazil (10.7 percent). The gap between the shares of these two countries narrowed during the nineties, with Brazil gradually catching up. However it has widened again in the last few years. Though the shares of FDI to Argentina, Republic of Korea, Singapore, Malaysia and Taipei,China were much lower than those to PRC and Brazil, until 2000 they were still two to five times that of India's measured inflow. ³ Subsequent years saw a sharp drop in FDI inflows into these countries. As a result, in 2004, (of these countries) only Singapore and Republic of Korea had a higher share (6.9 percent and 3.3 percent respectively) of developing country FDI than India (2.3 percent). The increase in India's share from 1.6 percent in 2001 to 2.3 percent in 2004 was largely a result of the decline in FDI inflows to developing countries as a whole. Republic of Korea liberalized its FDI policy in the late 1990s and the economy saw a stock adjustment and sharp temporary increase in FDI inflows in 1998-2000. Since 2001, the inflows have fallen to nearer their trend level, standing at US$2 billion in 2002, though it received $7.7 billion in 2004. Because of the Asian Financial Crisis in 1997-98 and the effect of sanctions on investor sentiments, India's share of developing country FDI fell at the end of the nineties. There has, however, been a significant improvement since 2001.

Sources of FDI and Sectors Attracting Maximum FDI in South Asian Countries

Though the South Asian countries have lagged behind in attracting FDI compared to their counterparts in East and Southeast Asia, in recent years they have managed to consistently step up their FDI inflows mostly from the developed countries. The following section briefly presents the sources of FDI and sectors attracting the maximum FDI in a few of the South Asian countries.

FDI trends in India: Sector-wise Inflows: The sectors that received the highest cumulative inflows of FDI over the period August 1991 to September 2005 (see Table 11 [ PDF 133.8KB | 23 pages ]) are electrical equipment (13.71 percent), transport (8.59 percent), services (8.01 percent), telecommunication (7.96 percent) and fuels (6.99 percent). Similarly, in 2005 the sectors that received the most FDI were electrical equipment (23.8 percent), services (16.3 percent), cement and gypsum products (10.21 percent), miscellaneous industries (9.1 percent) and transport (5.01 percent). Investment rose in industries such as cement, sugar, plastics and rubber, and hotels.

The Sectors in which FDI grew most dramatically between 2003 and 2005 were cement and gypsum products, metallurgical industry, ceramics, textiles and paper and paper products. The sectors in which FDI fell during the same period were glass, fuel, power and oil, food processing, transport (which includes the auto industry) and consultancy services. Table 12 [ PDF 133.8KB | 23 pages ] shows the details of sector-wise FDI and the top five sectors receiving the maximum FDI, respectively. However, the only striking feature about the sectors receiving the most FDI in India is that most FDI is coming into transport, electrical equipment, infrastructure, etc., but very little is flowing into India's export sectors. Therefore, there appear to be problems with the synchronization of policies. India should make an effort to attract FDI in its export sectors such as gems and jewelry, pharmaceuticals, textiles, marine products and light engineering goods and this would be one way of stepping up FDI overall. Though further empirical investigation is required to arrive at any concrete inference, it can be inferred that FDI inflows to India are domestic market oriented.

Engineering, services, electronics and electrical equipment and computers are the main sectors receiving FDI in recent years (Table 12). Domestic appliances, finance, food and dairy products which were important sectors attracting FDI in the early nineties have now seen a downtrend. Services and computers have seen an increasing trend in the latter half of the nineties. On the whole, there have been significant changes in the pattern and composition of FDI inflows during the last decade.

The state-wise trends in FDI in the table show that the advanced states such as Delhi, Maharashtra, Karnataka, Tamil Nadu and Pondicherry have been the largest recipients of FDI during the last five years. This may be attributed to their better resources, infrastructure such as roads and power, and investor-friendly policies like single window clearances and investment promotion schemes including special economic zones, etc. However, competition among the states in attracting FDI has led to increasing trends in states like Gujarat, Punjab and also Andhra Pradesh (See Table 13 [ PDF 133.8KB | 23 pages ]).

Country-wise FDI inflows to India: Among the countries with high FDI inflows into India is Mauritius. This may be attributed to the double taxation treaty that India has signed with Mauritius and also to the fact that most investment into India from the United States is being routed through that country. However, the U.S. is the second largest investor in India, followed by Japan and the other developed countries such as the Netherlands, United Kingdom, Germany, Singapore, France, etc., which are India's major trading partners. Nearly one quarter of India's exports go the EU and the other quarter to North America; these two regions also happen to be the largest investors in India. Table 14 [ PDF 133.8KB | 23 pages ] shows the share of top investing countries in India's FDI.

Sources of FDI and sectors attracting the greatest FDI in Pakistan: Foreign investment flows into Pakistan have increased continuously since 1997-98, and the rate has increased since 2002-03. This can be primarily attributed to closer U.S.-Pakistan ties and the liberalised foreign investment environment since 2000. The FDI inflows reached a record US$1524 million in 2004-05 (see Table 15 [ PDF 133.8KB | 23 pages ]). In Pakistan, privatization and resource-related FDI led to a doubling of foreign investment from $1.1 billion in 2004 to $2.2 billion in 2005.

The major source of FDI in Pakistan in the year 2004 was the United Arab Emirates, which accounted for nearly 42.5 percent of the total FDI inflows to Pakistan. The United States occupied the second position with a share of 13.9%, and other countries include Saudi Arabia, Switzerland, U.K, the Netherlands, etc. However, an examination of sources of FDI into Pakistan from 1997-98 to 2004-05 clearly shows that the U.S. has dominated investment, followed by the U.K. and UAE in third position. See Tables 16 [ PDF 133.8KB | 23 pages ] and 17 [ PDF 133.8KB | 23 pages ] for details. For instance, Table 17 shows that in 2004-05, nearly 42.5 percent of the total FDI inflows into Pakistan came from UAE, followed by the U.S., whose share of inflows stood at 13.9 percent. Similarly, Table 18 [ PDF 133.8KB | 23 pages ] gives the list of the top 11 sectors attracting FDI from 1997-98 to 2004-05. Power, chemicals and pharmaceuticals, and mining and quarrying top the list. This can be attributed to the increasing needs and demand for energy in Pakistan and natural resource advantages in the case of pharmaceuticals and mining. Table 19 [ PDF 133.8KB | 23 pages ] shows the list of sectors that attracted the maximum investment in 2004-05. Communications (IT&T) tops the list of sectors receiving FDI with a percentage of 46.5 percent of total FDI inflows, followed by power (10.3) and financial business, etc.

Sources of FDI and sectors attracting maximum investment in Bangladesh: Bangladesh has the most systematic investment regime in South Asia, with a Board of Investment that promotes and facilitates investment effectively. Table 20 [ PDF 133.8KB | 23 pages ] shows FDI inflows into Bangladesh from 1991-92 to 2004-05. It is evident that the period from 1996-97 to 2001- 02 constituted the golden years of the history of foreign investment in Bangladesh. However, since then FDI flows have declined due to political strife and natural calamities. Table 21 [ PDF 133.8KB | 23 pages ] shows sector-wise FDI inflows into Bangladesh. The services sector has attracted the greatest investment, followed by IT and engineering and manufactured goods. It is also evident from the table that agro-based industries have attracted a fair bit of investment, as Bangladesh is a predominantly agrarian economy, and the second most important industry in the country is textiles. In fact, textiles form the backbone and are the greatest source of employment to the Bangladesh economy.

Table 22 [ PDF 133.8KB | 23 pages ] shows FDI inflows into Bangladesh by source country. The U.K. is the top investor in Bangladesh, with investment to the tune of $2 billion, followed by Canada, Malaysia, and the U.S. The second tiers of investors are Singapore, India, Thailand, Hong Kong, China, PRC, Germany, and Republic of Korea. Prior to 1995, the stock of U.S. investment in Bangladesh was estimated to be approximately $25 million in book value, including five manufacturers in the Chittagong EPZ, one life insurance company, banking operations of two U.S. commercial banks, and about ten other U.S. service and marketing firms. Since 1995, 16 U.S. companies have invested in Bangladesh in the following sectors (in production & under implementation). In 2004-05, the engineering and manufacturing sector got the maximum investment (26.57 percent) of total FDI inflows. Textiles has been one of the leading sectors of Bangladesh for many years and nearly 10 percent of the total FDI inflows went into that sector, followed by agro-based industries which have attracted large amounts of investment in recent times due to Bangladesh being an agricultural economy.

Sources of FDI And sectors attracting maximum investment In Sri Lanka: The investment scenario is Sri Lanka is no different from those of its neighbours. It is the developed countries, again, which have made the largest investments, with Singapore having the maximum share of FDI inflows followed by the U.K. and Japan. Similarities in cultures and close ethnic ties may be one of the reasons for high Singaporean investment. Table 23 [ PDF 133.8KB | 23 pages ] shows FDI as a percentage of GDP in Sri Lanka (1990-2005) and surprisingly compared to most of its South Asian countries, it is quite high at 26.5 percent in 2004-05.

As is the case in most other South Asian countries, the major sources of FDI in Sri Lanka are Singapore, the U.K, and Japan as mentioned above due to ethnic similarities. In addition, countries like Australia and the British Virgin Islands have invested in Sri Lanka due to geographical proximity. See Table 24 [ PDF 133.8KB | 23 pages ] for details. Similarly, Tables Table 25 [ PDF 133.8KB | 23 pages ] and Table 26 [ PDF 133.8KB | 23 pages ] show that the maximum number of FDI projects has been in the area of manufacturing, followed by services and lastly agriculture.

Sources of FDI And sectors attracting maximum investment In Nepal: Nepal, being a least-developed country in the South Asian region, has attracted the least amount of foreign investment in the entire region. A close study of the economy indicates that it is largely dependent on its big brother neighbor, India. In fact, the major chunk of FDI in Nepal is from India. Moreover, the Maoist struggle and other ethnic conflicts have made investors weary of investing in Nepal. Table 27 [ PDF 133.8KB | 23 pages ] shows FDI inflows into Nepal. In the initial years of its liberalisation, Nepal hardly attracted any investment. In fact, even to this day, its investment stands at only US$15 million, a negligible amount.

Table 28 [ PDF 133.8KB | 23 pages ] shows FDI investments in different economic sectors. Tertiary sectors, hotels and restaurants and transport, etc., have attracted the maximum investment. It is basically the U.S., PRC, Japan and India that are the major investors in Nepal, as is evident from Table 29 [ PDF 133.8KB | 23 pages ].

Conclusion

FDI is certainly the key to economic prosperity in the region, and trends clearly reflect the increasing potential of South Asia to play an important role in the greater Asian dream of an Asian Economic Union.

FDI in services has focused in communications. A detailed look at the investment scenario of South Asian countries also reveals that they are making rapid strides in the service sectors, with services contributing more that 50 percent to the GDP of each economy. The investment policy reviews and the board of investment websites of most of these economies also reveal that they have signed a large number of bilateral investment treaties and double taxation treaties in recent years to step up investment. Therefore, considering their highly liberalized macroeconomic and investment environments, the trends of FDI in South Asia are likely to improve in the coming years.

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