Emerging FDI Trends

in Developing Asia

Dilek Aykut The World Bank

ICRIER WorkshopNew Delhi, India

April 2007

Motivation: FDI flows to developing countries surged during the last two decades

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1970 1975 1980 1985 1990 1995 2000 2005

All Developing Countries

Developing Asia

US billion

Note: United Nations’ developing country definition is used.

• Progress in technology in transport, communications, information and data processing

• Progress in liberalization of FDI and trade policies in developing countries

Motivation: There have been considerable changes in FDI flows

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1990 1995 2000 2005

All Developing Countries

Developing Asia

US billion

• The role of M&A as form of FDI increased

• There has been a shift towards services

• The rise of multinationals from developing countries as FDI investors, particularly in other developing countries (South-South FDI)

How do these trends apply for Asian developing countries ?

FDI in Services Sector has increased since the 1990s…

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80

DevelopedCountries

DevelopingCountries

LAC AFRICA ECA ASIA

PRIMARY MANUFACTURING SERVICE

Share in total FDI Stock in 2004

among developing countries

Source: Author’s calculation based on collected data from various resourcesNote: Some are approximation based on flows data. The years might be different depending on the region and country.

percent

…there is a significant variation among developing Asia

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NIEs China India Other Asia

PRIMARY MANUFACTURING SERVICE

Share in total FDI Stock in 2004

Source: Author’s calculation based on collected data from various resourcesNote: Some are approximation based on flows data. The years might be different depending on the region and country.

percent

As conventionally defined, services sector includes:

Infrastructure (Electricity, Gas, Water, Transport, Storage, and Communication)

Finance and insurance

Trade & Repairs

Business Services

Real Estate

Others

Source: United Nations Statistics Division ISIC

Factors behind the increase in services-FDI

Income growth

Technological progress

Changes in investment and trade policy

The sectoral composition of FDI mirrors that of GDP in most countries

Source: World Bank.

Services share in: FDI GDPAsia NIEs 69 65

China 31 41

India 55 52

Other Asian Countries 43 45

Europe and Central Asia 65 60

Latin America and the Caribbean 65 59

Africa 29 52

Memo item

 High-Income OECD 69 72

Factors behind the increase in services-FDI

Income growth

Technological progress- Global production networks - Increased tradability of services (outsourcing)

Changes in investment and trade policy

Factors behind the increase in services-FDI

Income growth

Technological progress

Changes in investment and trade policy- Unilateral liberalization- Bilateral and regional agreements- Commitments under the WTO and General

Agreement on Trade in Services (GATS)

Service sector has been liberalized much later than manufacturing

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Telecom. Banking Air transport Manufacturing

1981

1991

1998

FDI restrictions over time in selected sectors 1981-1998 (OECD Average)

Source: Golub (2003)

higherrestriction

FDI restrictions in services are higher in Asia compared to other developing countries

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West Asia SouthAsia

South-East Asia

East Asia NorthAfrica

OtherAfrica

LatinAmerican

EasternEurope

World

FDI restrictions in developing countries by region, 2004

Source: Unctad (2006)Note: The study uses two different weights for regional average GDP and FDI. The graph shows the GDP weighted indices, but the results from FDI weights are very similar.

higherrestriction

Some sectors are more restricted than others…

Indonesia India China Korea Developing Asia (GDP-Weighted)

Electricity 1.00 0.15 0.55 1.00 0.67

Communication 0.65 0.45 0.55 0.51 0.50

Finance 0.57 0.58 0.48 0.24 0.38

Transport 0.59 0.47 0.61 0.49 0.37

Distribution 0.35 0.60 0.55 0.18 0.28

Business 1.00 0.60 0.23 0.18 0.23

Health 0.65 0.35 0.55 0.23 0.23

Tourism 0.75 0.13 0.15 0.20 0.22

Education 0.65 0.15 0.25 0.78 0.21

Construction 0.68 0.35 0.15 0.33 0.19

Environment 0.35 0.15 0.25 0.28 0.16

All Services 0.61 0.45 0.44 0.30 0.31

Source: Unctad (2006)

As bulk of services FDI came as privatization and mega M&A transactions, the role of M&A as a form of FDI increased

Global M&A rose more than five-fold between 1995 and 2000 to a peak of $1.1 trillion in 2000, before dropping by some 45 percent in 2001 with the decline in stock markets and the global economic slowdown.

The bulk of the cross-border M&A transactions continue to be in service sectors (more than half in finance, transport, storage, and communications alone).

Extensive privatization of state-owned assets in developing countries during the late 1990s in Latin America and Eastern Europe.

Reflecting the recent favorable economic conditions, global cross-border M&As reached to yet another peak of $1.3 billion in 2006.

The ratio of cross-border M&A sales to FDI flows, 1990-2005

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DevelopingAsia

OtherDevelopingCountries

DevelopedCountries

1990-1994 1995-1999 2000-2005

percent

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NIEs China India Others

1990-1994 1995-1999 2000-2005

Services FDI is particularly sensitive to changes in investment climate

Relies mainly on domestic demand

Generates local-currency earnings

Subject to complex regulatory systems

Nontradable products (location-bound), unlike primary and manufacturing sectors that benefit from exporting to international markets

Improved investment climate is associated with higher FDI…

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FDI-GDP Ratio

Policy Performance

High Middle Low

percent

… and with higher FDI in Services

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Services FDIas a share of

total FDI

Policy Performance

High Middle Low

percent

Emerging multinationals from developing countries

The last two decades also witnessed the emergence of MNCs from developing countries (EMNCs) as a result of increased globalization:

– Developing country firms are faced with growing competition in sales and in access to resource and strategic assets

– Southern firms have amassed sufficient capital, knowledge and know-how to invest abroad.

– Many developing country governments have eased their policies towards capital outflows.

– Same drivers as the Northern multinationals: Access to new markets or defend the export markets Access to resources Access strategic assets

Internationalization of EMNCs

Partly explained by Dunning’s Investment Development Path (IDP)

– Major investors are mostly from FDI recipient middle-income economies– Some invest abroad in earlier stages due to increased competition

Comparative advantage range from a patent, brand, production capacity or access to certain markets or resources– In services, EMNCs may have certain comparative advantages vis-à-vis Northern

MNCs Ex: America Movil, Orascom – In primary sector, access to resources and scale of production. Ex: Petronas,Petrobras– In manufacturing sector, special production techniques can lead to comparative

advantages. Ex: Marcopolo, Hikma

Acquiring strategic assets through cross-border M&A– In 2006, three mega purchases by EMNCs: Cemex’s Australia’s Rinker, CVRD’s

Canadian Inco, and Tata’s purchase of Dutch Corus, each more than $10 billion.

Inward FDI recipient => develop comparative advantage => outward FDI

Region Development policies since the 1980s

Characteristics of major MNCs

Competitive advantages

Latin America and the Caribbean

Washington consensus Private firms, mostly focused on core business (Gerdau →

steel; Tenaris → tubes; Embraer → aircraft)

Know to play the post-privatization regulatory game and have become leaner and

meaner as suppliers to Western MNCs.

Russia and the CIS Big bang and transition economies

State-owned enterprises (Gazprom) and privatized firms still dependent on

Kremlin support (Severstal)

Russian regional players in telecoms and global ones in

metals and natural resources.

New Europe EU convergence Privatized firms, Turkish conglomerates (Koç, Sabanci)

Regional players in telecoms, electricity and gas, retail.

NIE Export-oriented with strong state

Conglomerates (chaebols, Temasek) and contract

manufacturers

Innovation capabilities

China FDI-driven with strong state Public-private firms, mostly focused on core business (Lenovo → PCs; Haier →

appliances; Huawei → telecom equipment)

Leverage of huge domestic market

ASEAN FDI-driven Conglomerates (CP Group) Management of mainland China’s insertion into global

value chains, Guanxi

South Asia Gradual opening backed by diaspora linkages

Private conglomerates (Tata) and ICT firms (Infosys, Wipro)

Low psychic distance with the US and Commonwealth,

engineering skills

Source: Aykut and Goldstein 2006

As a result, outward FDI stock from developing countries increased

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1980 1990 2005

Other Developing

Asia

Latin America and the Caribbean

Africa

$ billion

Outward FDI stock by region, 2005

Geography of investments by EMNCs

EMNCs tend to invest regionally and in other developing countries due to familiarity through trade, ethnic and cultural ties.

Supported by regional agreements and government incentives

Intra-regional South-South FDI is significant for Asian economies– Already part of regional production networks– Internationalization of ‘ethnic Chinese” business in Asia– India is major investor in neighboring countries but have begun to go the

West rather than the East. Major investor in United States, UK.

Venturing beyond their immediate region– Brazilian investments in Angola, Nigeria, China and Turkey– Chinese investments in Latin America and Africa– Malaysian investments in South Africa– Indian investments in Africa

Policy Implications

South-South FDI is significant in some low-income countries and represents an opportunity for the others – For example, investment from China and India in Nepal; recent Indian investments in Bangladesh

It has considerable development implications for both home and host countries– Increased competitiveness for EMNCs

Enlargement and diversification of the investor pool:– Investment promotion

Also poses some risks– Operational and financial challenges may lead to unsuccessful projects– Higher South-South integration may increase vulnerability for a possible contagious effect in case

of an economic crisis.

FDI outflow from EMNCs is expected to continue its positive trend– South-South is expected to increase as Southern MNCs are very active in the recent wave of

privatization in developing countries

As a result of technological progress and policy reforms both in developed and developing countries, FDI flows have evolved in terms of the sectors it goes to, its mode, and in terms of who is investing over the years.

Today, developed and many developing countries alike, services sector has become the major sector attracting investment from foreign MNCs.

And these MNCs are only from developed countries but also fromdeveloping countries.

Developing country MNCs are not necessarily inferior to their developed country competitors in terms of technology; managerial skills and access to capital, however. On the contrary in some of them are major global players in their fields.

Conclusion

Thank you

For more information:

Aykut, Dilek, and Dilip Ratha, “South–South FDI flows: how big are they?,” Transnational Corporations, Vol. 13, No.1, 2004.

Aykut, Dilek and Joseph Battat, "Southern Multinationals—A Growing Phenomenon” A note prepared for the IFC/FT Conference 2005.

Aykut, Dilek and Andrea Goldstein, “Developing Country Multinationals: South-South Investment comes of age” OECD Working Paper No.257. 2006