CHAPTER 1: FOREIGN DIRECT INVESTMENTMeaningThese three letters
stand for foreign direct investment. The simplest explanation of
FDI would be a direct investment by a corporation in a commercial
venture in another country. A key to separating this action from
involvement in other ventures in a foreign country is that the
business enterprise operates completely outside the economy of the
corporations home country. The investing corporation must control
10 percent or more of the voting power of the new venture.According
to history the United States was the leader in the FDI activity
dating back as far as the end of World War II. Businesses from
other nations have taken up the flag of FDI, including many who
were not in a financial position to do so just a few years ago.The
definition of FDI originally meant that the investing corporation
gained a significant number of shares (10 percent or more) of the
new venture. In recent years, however, companies have been able to
make a foreign direct investment that is actually long-term
management control as opposed to direct investment in buildings and
equipment.It usually involves participation
inmanagement,joint-venture,transfer of technologyandexpertise.
There are two types of FDI: inward foreign directinvestmentand
outward foreign direct investment, resulting in
anetFDIinflow(positive or negative) .Foreign direct investment
reflects the objective of obtaining a lasting interest by a
resident entity in one economy (direct investor) in an entity
resident in an economy other than that of the investor (direct
investment enterprise).The lasting interest implies the existence
of a long-term relationship between the direct investor and the
enterprise and a significant degree of influence on the management
of the enterprise. Direct investment involves both the initial
transaction between the two entities and all subsequent capital
transactions between them and among affiliated enterprises, both
incorporated and unincorporated. Foreign Direct Investment when a
firm invests directly in production or other facilities, over which
it has effective control, in a foreign country. Manufacturing FDI
requires the establishment of production facilities. Service FDI
requires building service facilities or an investment foothold via
capital contributions or building office facilities. Foreign
subsidiaries overseas units or entities. Host country the country
in which a foreign subsidiary operates. Flow of FDI the amount of
FDI undertaken over a given time. Stock of FDI total accumulated
value of foreign-owned assets. Outflows/Inflows of FDI the flow of
FDI out of or into a country. Foreign Portfolio Investment the
investment by individuals, firms, or public bodies in foreign
financial instruments. Stocks, bonds, other forms of debt. Differs
from FDI, which is the investment in physical assets.
Definition Foreigndirectinvestmentis that investment, which is
made to serve the business interests of theinvestorin a company,
which is in a different nation distinct from the investor's country
of origin.A parent business enterprise and its foreign affiliate
are the two sides of the FDI relationship. Together they comprise
an MNC. The parent enterprise through
itsforeigndirectinvestmenteffort seeks to exercise substantial
control over the foreign affiliate company. 'Control' as defined by
the UN, is ownership of greater than or equal to 10% of ordinary
shares or access to voting rights in an incorporated firm. For an
unincorporated firm one needs to consider an equivalent
criterion.Ownership share amounting to less than that stated above
is termed as portfolio investment and is not categorized as FDI.FDI
stands for Foreign Direct Investment, a component of a country's
national financial accounts. Foreign direct investment is
investment of foreign assets into domestic structures, equipment,
and organizations. It does not include foreign investment into the
stock markets. Foreign direct investment is thought to be more
useful to a country than investments in the equity of its companies
because equity investments are potentially "hot money" which can
leave at the first sign of trouble, whereas FDI is durable and
generally useful whether things go well or badly.FDI or Foreign
Direct Investment is any form of investment that earns interest in
enterprises which function outside of the domestic territory of
theinvestor. FDIsrequire a business relationship between a parent
company and its foreign subsidiary. Foreign direct business
relationships give rise to multinational corporations. For an
investment to be regarded as an FDI, the parent firm needs to have
at least 10% of the ordinary shares of its foreign affiliates. The
investing firm may also qualify for an FDI if it owns voting power
in a business enterprise operating in a foreign country.
Types of FDI
Types of Foreign Direct Investment
FDIs can be broadly classified into two types: Outward FDIs
Inward FDIsThis classification is based on the types of
restrictions imposed, and the various prerequisites required for
these investments.
Outward FDI: An outward-bound FDI is backed by the government
against all types of associated risks. This form of FDI is subject
to tax incentives as well as disincentives of various forms. Risk
coverage provided to the domestic industriesand subsidies granted
to the local firms stand in the way of outward FDIs, which are also
known as 'direct investments abroad.'
Inward FDIs: Different economic factors encourage inward FDIs.
These include interest loans,taxbreaks, grants, subsidies, and the
removal of restrictions and limitations. Factors detrimental to the
growth of FDIs include necessities of differential performance and
limitations related with ownership patterns.Other categorizations
of FDIOther categorizations of FDI exist as well. Vertical Foreign
Direct Investment takes place when a multinational corporation owns
some shares of a foreign enterprise, which supplies input for it or
uses the output produced by the MNC.Horizontal foreign direct
investments happen when a multinational company carries out a
similar business operation in different nations. Horizontal FDI the
MNE enters a foreign country to produce the same products product
at home. Conglomerate FDI the MNE produces products not
manufactured at home. Vertical FDI the MNE produces intermediate
goods either forward or backward in the supply stream. Liability of
foreignness the costs of doing business abroad resulting in a
competitive disadvantage.
CHAPTER 2: FOREIGN DIRECT INVESTMENT IN DEVELOPING COUNTRIES
Now-a-days Foreign Direct Investment (FDI) is the most important
issue in most of the countrys foreign economic policy. FDI is
defined as Any investment in another country which is carried out
by private companies or individuals as opposed to government
aid.The positive role of FDI in accelerating pace of development in
developing countries as is evidenced I Hong Kong, Singapore, Korea
and Taiwan these countries are known as newly industrialized
Economic, attracting FDI has become a priority agenda for the
developing counties foreign economic policy. At present there is
hardly any country in around the globe, big or small, financial
base or newly emerging which is not in the race of capturing
foreign investment.Over the recent past, most developing nations in
the, are adopting increasingly more open policy toward FDI.There
are various things working as barrier in the way of FDI in
developing countries. The major impediments in the way of the
sufficient inflow of FDI are the negative image of the country.
Moreover, political instability, particularly repeated strikes, red
tapism, bureaucratic hurdles and lengthy administrative procedure,
inadequate infrastructure, particularly energy and
telecommunication facilities, rigid and conservative banking system
and absence of service-oriented banks, lack of accurate information
for taking correct business decision etc. are now working as
barriers in the way of sufficient inflow of FDI. Even due to
non-fulfillment of commitment.In order to face the challenges of
the 21stCentury, the governments of the developing countries have
to take necessary measures to remove those constraints, e.g.
shortage of power inadequate infrastructures, low level of human
resources etc. And have to promote the image of the country as a
sage and profitable destination of FDI.FACTORS THAT AFFECT FDI IN
DEVELOPING COUNTRIES: Macroeconomic stability: This is the first
thing which firms will look at when deciding where to invest.
Stability is very important because it make investment easiersince
when inflation is stable, firms will be able to take into account
the anticipated inflation into their future costs where as if
inflation is out of control,firms will hold their investment or
won't even invest at all. So government need to foster a stable
environment for business investment
Lower Corporate Taxes: Level of taxation is very important. If
taxes are high in a country, firm will not invest because a large
proportion of their profits will beconfiscated by the state so this
is a very strong disincentive to invest. Also, to corporations,
corporate taxes are a cost so they will pass it on to
consumersthrough higher prices which lead to a general rise in
price levels so lower corporate taxes will make a country more
attractive for investment.
Skilled Workforce: Skilled workforce is very important to a firm
who is transferring its capital to a different place/country
because if a country's labour isunskilled, firms who want to invest
will have to spend a fortune on training and education of their
workforce which costs a lot and will outweighthe likely benefit
ofmoving their production plant/capital to a new country.Also,
their costs will also rise due to low productivity which at the end
affects their profitability.
Minimum Wage: Firms look at labour as a cost and a production
unit. When the government imposes a minimum wage, they simply
interfere in the labour market and massunemployment will be the
result. Not only minimum wage hurts workers because firms have to
lay workers off, but it also leads to a rise in costs which lowers
firmsprofitability and firms have to pay workers theminimum wage
regardless of their productivity which leads to lower productivity
in general because whatever the workerproduces in one hour, he will
get the minimum wage. Regulation: Some regulations are good and
need to be in place but most of the regulations are very costly and
often seen as unnecessary to firms. Small businesseswill get hit
the hardest and often due to these heavy regulations, businesses
wont start in the first place. In the case of big firms, they might
not be hit as hardbut this adds to their costs and these costs are
passed on to consumers since corporations wont lower their profit
margins so regulations wont in some cases help theconsumer but in
fact, it hurts them. Employment regulations will actually lead to
firms not employing workers in the first place because it costs a
lot for firms and the the fact that firms won't be able to get rid
of workers easily scares them away from the beginning so they just
won't hire from the beginning. Some employment regulations are good
such as anti discrimination act which stops employers from
discriminating on the basis of gender, race and disability.Another
good regulation is basic health and safety, not the one we
currently have.
Free Trade: Free trade allows firms to move capital around
freely and export their products to wherever they want and also
import whatever they want. For the sakeof this topic, free trade
allows firms to freely trade with no restrictions. Let me give you
an example: Imagine a firm in a protectionist country, they cant
tradefreely due to tariffs, quotas and embargoes. This affect their
costs when trying to trade and in some cases, not being able to
trade with the world markets means theywill have a substantially
smaller market to sell their products which minimises their profit
levels and they won't be abler to achieve economies of scale.
National Debt: If a country has high levels of national debt,
this means that the real interest rates are high and if the
government doesn't deal with its debts, theinvestor confidence will
fall.Also high levels of taxation will soon follow because the
debts will have to be paid of eventually. Now as i mentioned
earlier, hightaxes are a disincentive to investment and high
interest rates will mean lower borrowing which again puts
investment off because it costs a lot to borrow so firms willnot
invest.
CHAPTER 3: FDI IN INFRASTRUCTUREIn developing countries, an
essential requirement for economic growth and sustainable
development is the provision of efficient, reliable and affordable
infrastructure services, such as water and sanitation, power,
transport and telecommunications. The availability of efficient
infrastructure services is an important determinant of the pace of
market development and output growth, and, in addition, access to
affordable infrastructure services for consumption purposes serves
to improve household welfare, particularly among the poor. In most
countries, however, the potential contribution of infrastructure to
economic growth and poverty reduction has not been fully realized,
and existing infrastructure stock and services fall far short of
the requirements.Traditionally, infrastructure was the exclusive
province of the public sector, with large, state-owned enterprises
(SOEs) being responsible for investment and service delivery.
Typically, SOEs were costly and inefficient providers of
infrastructure services in most developing countries. Since the
mid-1980s, however, governments around the world have pursued
policies to involve the private sector in the delivery and
financing of infrastructure services. Encouraged by international
organizations such as the World Bank, privatization has been a
major component of the economic reform programmes pursued by many
developing countries over the past two decades (Parker and
Kirkpatrick, 2004). Privatization was thought to promote more
efficient operations, expand service delivery, reduce the financial
burden on government and increase the level of foreign and domestic
private investment (World Bank, 1995). Early privatization measures
were, on the whole, concentrated in the manufacturing sector but,
in recent years, the private sector has become increasingly
involved in the financing and delivery of infrastructure services.
A large number of developing countries have introduced private
participation into their infrastructure industries and, by the end
of 2001, developing countries had received over $755 billion in
private investment flows in nearly 2,500 infrastructure projects
(World Bank, 2003a).Utilities such as water supply, gas,
electricity and telecommunications and certain modes of transport,
e.g. rail, all have natural monopoly characteristics arising from
pervasive economies of scale and scope. These characteristics mean
that competition is unlikely to develop or, if it develops, it will
be uneconomic because of the duplication of assets. Although
technological advances, notably in telecommunications, have
whittled away some of the natural monopoly characteristics in
utilities, permitting economic competition in certain areas of
service delivery, each of the utilities retains some natural
monopoly features. As a consequence, privatization of these
industries, in whole or in part, risks the introduction of
private-sector monopolies that will exploit their economic power,
leading to supernormal profits (high producer surplus) and reduced
consumer welfare (a lower consumer surplus). Consumers may suffer
from no or a limited choice of goods and services and face monopoly
prices.To prevent such an outcome, governments need to develop
strong regulatory capabilities so that they can police the revenues
and costs of production of the privatized utility firms and protect
consumers from monopoly exploitation. At the same time, there needs
to be commitment on the part of government to the regulatory rules
so that they are perceived as credible by investors. Where
regulatory credibility is weak or absent, private investment
decisions will be adversely affected.
CHAPTER 4: FDI IN INFRASTRUCTURE IN DEVELOPING COUNTRIESFDI has
expanded steadily over the past three decades. The growth in FDI
accelerated in the 1990s, rising to $331 billion in 1995 and $1.3
trillion in 2000. As a result, developing countries experienced a
sharp increase in the average ratio of FDI to total investment
during the 1990s. A principal feature of the growth in FDI has been
its rise in the services sector, which is now the dominant sector
in global FDI. For developing countries, FDI in services increased
at an annual rate of 28% over the period 1988 to 1999, and by 1999,
accounted for 37% of total foreign investment inflows.A significant
part of the increase in FDI in the services sector has been the
growth in private capital flows for infrastructure in response to
the general trend towards privatization of infrastructure in
developing countries. In contrast, there was a sharp decline in
donor support for infrastructure projects during the 1990s, with
aggregate flows of official development assistance for the
infrastructure industries falling by half during the course of the
decade (Willoughby, 2002). Private sector participation in
infrastructure projects in developing countries has risen
dramatically since 1990 and the annual investment commitments
reached a peak of $128 billion in 1997. According to the World
Banks Private Participation in Infrastructure (PPI) database, 26
countries awarded 72 infrastructure projects with private
participation in 1984-89, attracting almost $19 billion in
investment commitments. In the 1990s, 132 low- and middle-income
countries pursued private participation in infrastructure 57 of
them in three or all four of the sectors covered in the database
(transport, energy, telecommunications, and water and sewerage). In
1990-2001, developing countries transferred to the private sector
the operational responsibility for almost 2,500 infrastructure
projects, attracting investment commitments of more than $750
billion.Private infrastructure projects have taken a number of
forms, involving varying degrees of investment risk. Management and
lease contracts involve a private entity taking over the management
of an SOE for a given period although the facility continues to be
owned by the public sector. The public sector retains the
responsibility of financing the investments in fixed assets. In the
case of management contracts, the public sector also finances
working capital. Under a concession agreement, a private entity
takes over the management of an SOE for a given period, during
which it assumes significant investment risk. The ownership of the
facility reverts back to the public sector at the end of the
concession period. With greenfield projects a private entity or a
public-private joint venture builds and operates a new facility for
the period specified in the project contract. The facility may
return to the public sector at the end of the contract period or
may remain under private ownership. The fourth form of private
participation in infrastructure is divestiture where a private
entity buys an equity stake in an SOE through an asset sale, public
offering or mass privatization programme. Over the period
1990-2001, divestitures accounted for 41% ($312 billion) of total
private participation infrastructure projects in developing
countries, greenfield projects accounted for 42% and concessions
for 16% (World Bank, 2003a).Among the developing regions, Latin
America and the Caribbean accounted for 48% of the cumulative
investment in infrastructure. In this region, private participation
in infrastructure was often part of a broader reform programme
aimed at enhancing performance through private operation and
competition, and generating the financial resources needed to
improve service coverage and quality through tariff adjustments
(World Bank, 2003a, pp. 2-3). Under this approach, divestitures and
concessions of existing assets predominated, accounting for 75% of
the cumulative investment in private infrastructure projects in
Latin America during the period. In more recent years, Latin
Americas share of investment in infrastructure has declined from
80% in 1990 to 40% in 2001, as other regions have opened their
infrastructure industries to private participation. The East Asia
and Pacific region has been the second largest recipient of private
investment in infrastructure. Over the period 1990-2001, it
accounted for 28% of cumulative private participation in
infrastructure in developing countries. In contrast to Latin
America, the Asia region has focused on the creation of new assets
through greenfield projects, which accounted for 61% of the
investment in East Asia in 1990-2001. The Asian financial crisis of
1997-1998 saw the regions share in annual investment in
infrastructure decline from 40% in 1996 to 11% in 1998, before
recovering to 28% in 2001.Private participation in infrastructure
in developing countries has been concentrated in the
telecommunications industry, which accounted for 44% of the
cumulative investment in 1990-2001. Energy, which includes
electricity and the transmission and distribution of natural gas,
attracted the second largest share of investment, accounting for
28% of the cumulative investment in private infrastructure projects
in 1990-2001. In contract, private participation in the water and
sewerage industry has been limited, accounting for 5% of cumulative
investments over the period 1990-2001. The limited amount of
private involvement in water utilities is likely to be a reflection
of the inherent difficulties that face privatization in this
industry, in terms of the technology of water provision and the
nature of the product, transaction costs and regulatory
weaknesses.
CHAPTER 5: GOVERNANCE AND FDIThere is long established and
extensive literature on the determinants of FDI flows to developing
countries. The focus of many of the early contributions to this
literature was on the economic determinants of FDI inflows and they
showed that TNCs were attracted to invest in locations that allow
the enterprise to exploit its ownership specific advantages.More
recent contributions have examined the influence of institutional
factors in explaining cross-country differences in foreign
investment flows. Building on the insights of the new institutional
economics, it is increasingly recognized that differences across
countries in economic conditions provide only a partial explanation
of the location choices of TNCs and that the quality of a countrys
institutional framework can have a significant impact on the
perceived investment environment.Institutions have been defined in
a variety of ways. According to Douglas Norths widely cited
definition, the term institution framework refers to the set of
informal and formal rules of the game that constrain political,
economic and social interactions. From this perspective, a good
institutional environment is one that establishes an incentive
structure that reduces uncertainty and promotes efficiency, thereby
contributing to stronger economic performance. Included in this
institutional structure are the laws and political and social norms
and conventions that are the basis for successful market production
and exchange. This broad concept of institutions has been
incorporated into empirical studies of FDI using a range of
indicators. It is now common, for example, to include a variable to
control for inter-country differences in the broad political
environment although, as noted by Dawson (1, the results have been
mixed. A measure of inter-country differences in corruption has
also been shown, in several studies, to have a significant impact
on private investment. The extent of legal protection of private
property and how well such laws are enforced is an additional
factor that has also been shown to have a significant effect on
foreign investors location decision.A parallel stream of research
has focused on perceptions and assessments of the quality of public
institutions especially on how well they function and what impact
they have on private sector behaviour (IMF, 2003). The term
governance has been adopted in the literature to cover different
dimensions of the quality of public institutions, including
government effectiveness and efficiency. Recent empirical evidence
has confirmed that cross-country differences in growth and
productivity are related to differences in the quality of
governance. This approach has been extended recently to consider
the impact of governance on cross-country differences in FDI flows.
Steven Globerman and Daniel Shapiro (2002) use the six governance
indicators estimated by Daniel Kaufmann et al. (1999) to assess the
impact of governance quality on both FDI inflows and outflows for a
broad sample of developed and developing countries over the
period1995-1997. The Kaufmann indices describe various aspects of
the governance structures, including measures of political
instability, rule of law, graft, regulatory burden, voice and
political freedom and government effectiveness, and therefore
encompass many of the individual institutional variables used in
earlier studies. The Kaufmann governance variables are combined
with measures of physical, human and environmental capital to
explain FDI flows. The results indicate that the quality of
governance infrastructure is an important determinant of both FDI
inflows and outflows (Globerman and Shapiro, 2002, pp. 1908-1914).
The study by Ernesto Stein and Christian Daude (2001) uses the
gravity model approach to test for the role played by institutional
quality on FDI location in Latin American countries during the
period 1997-1999. A group of four alternative measures of
institutional quality is combined with two other sets of variables
and tested as potential determinants of FDI flows. The first
consists of variables that are typically used in gravity models of
trade, such as GDP, per capita income and distance between the
source and host countries (Greenaway and Milner, 2002). The second
group consists of variables, other than the institutional ones,
which can affect the attractiveness of a country as a location for
FDI, such as the level of taxes on foreign investment activities,
human capital and infrastructure quality. The results show that the
governance variables are almost always statistically significant,
confirming that the quality of institutions has a positive impact
on FDI. The results are shown to be robust to the use of a wide
range of institutional variables, to different model specifications
and to different estimation techniques.
CHAPTER6:REGULATION AND FDI IN INFRASTRUCTURE IN DEVELOPING
COUNTRIES
The role of economic regulation in the development process has
generated considerable interest among researchers and practitioners
in recent years. Economic regulation by government is associated
with righting market failures, including ameliorating the adverse
effects of private enterprise activities. From the 1960s to the
1980s, the market failure argument was used to legitimize direct
government involvement in productive activities in developing
countries, such as promoting industrialization through import
substitution, investing directly in industry and agriculture, and
by extending public ownership of enterprises. Since the early
1980s, policy in developing countries has shifted from that of the
interventionist state to the current focus on the regulatory state.
The regulatory state model envisages leaving production to the
private sector where competitive markets work well while using
government regulation where significant market failure exists.The
widespread privatization of SOEs in developing countries has
focused attention on the need for an effective regulatory
framework. The available evidence on the effects of privatization
in less developed countries suggests that, in general,
privatization has improved the economic performance of former SOEs.
But the evidence also suggests that privatization, per se, may not
be the critical factor in raising productivity and reducing
production costs. More important is the introduction of effective
competition and organizational or political changes. In the case of
infrastructure industries, simply moving a monopoly from the public
to the private sphere will not result in competitive behaviour. A
key requirement for privatization success then becomes the
effectiveness of the regulatory regime in promoting competition or
in controlling the anti-competitive behaviour of dominant firms. As
a result, a growing number of developing countries have introduced
new, dedicated regulatory offices to supervise the activities of
their privatized utilities. Most of these regulatory offices are
expected to have some degree of independence from day-to-day
political control, although, in practice, political intervention
seems to occur in a number of countries. Evidence on the impact of
utilities regulation in developing countries is still limited, but
studies for telecommunications and electricity industries confirm
that privatization brings greater benefits when it is accompanied
by an effective regulatory regime.The aim of utility regulation is
to establish a policy environment that sustains market incentives
and investor confidence. For this to be achieved, the regulator
needs to be shielded from political interference, and the
government needs to support a regulatory environment that is
transparent, consistent and accountable. This implies that the
capacity of the state to provide strong regulatory institutions
will be an important determinant of how well markets perform. In
particular, this form of arms length, independent regulation is
expected to encourage private capital to invest in infrastructure
utilities in the face of a potential hold up problem. Privatization
requires investors to sink funds into fixed assets that are
specific to the venture, so that once a network is created the
balance of bargaining advantage shifts from the private-sector
investor to the regulator (on behalf of the government) with
implications for prices and investment. Where the investor fears
this outcome, referred to as hold up, investors may be deterred
from committing to investment, or may require front-end loading of
returns or sovereign guarantees from the state or international
agencies. In turn, such guarantees reduce the net economic benefits
of attracting private capital by reducing managerial incentives to
control costs. Some form of independent regulation can provide
reassurance to investors that prices, output and profits will not
be politically manipulatedThe challenge of providing infrastructure
regulation that establishes credibility with the private sector
and, at the same time, ensures efficient economic performance on
the part of the regulated enterprises is not easily achieved. There
is an extensive literature on the distorting effects of state
regulation even when conducted by dedicated regulatory bodies
(Armstrong et al. 1994; Guasch and Hahn, 1999). Regulation is
associated with information asymmetries. The regulator and the
regulated can be expected to have different levels of information
about such matters as costs, revenues and demand. The regulated
company holds the information that the regulator needs to regulate
optimally. Thus, the regulators need to establish rules and
incentive mechanisms to obtain this information from the company.
Given that it is highly unlikely that the regulator will receive
all of the information required to regulate optimally, the results
of regulation, in terms of outputs and prices, remain second best
to those of a competitive market. This leads on to credibility and
commitment considerations: credibility that the regulatory rules
will bring about the intended outcome; and commitment of government
to the current regulatory rules, so that post-privatization or
post-concession award, the regulator does not act opportunistically
to reduce the prices and profits of the private regulated
businesses.Regulatory regimes are also prone to regulatory capture,
by which the regulatory process becomes biased in favour of
particular interest groups, notably the regulated companies. The
regulatory capture literature concludes that in the extreme case
regulation always leads to socially sub-optimal outcomes because of
inefficient bargaining between interest groups over potential
utility rents . In the Chicago tradition of regulatory capture,
regulators are presumed to favour producer interests because of the
concentration of regulatory benefits and diffusion of regulatory
costs, which enhances the power of lobbying groups as rent-seekers.
What is clear is that the capability of firms to influence public
policy is an important source of competitive advantage. Balanced
against the risks of regulatory capture, however, is the
possibility that regulators might develop a culture of arrogant
independence, bordering on vexatious regulation. This creates some
uncertainty about the desirable degree of regulatory independence.
In principle, three broad forms of regulation can be identified:
(a) the regulatory authority is integrated into the normal
government machinery, notably where it is a section of the ministry
and controlled by the minister; (b) the semi-independent agency,
which has some independence from the ministry but where decisions
can still be over-ruled by a superior government authority; and (c)
the independent agency, where there is no right of appeal to a
superior government (political) authority, though there usually
will be a right of appeal to the courts to ensure fairness and
rationality in the decision-making process. The independent agency
is normally favoured by western advisors, who draw from the
experience of regulation in the United Kingdom and the United
States. However, regulatory independence and an impartial judicial
review of the due process may not be credible in some institutional
settings. An additional constraint on establishing credible and
effective infrastructure regulation in developing countries can be
related to the resource constraints that exist in lower income
countries. Many developing countries lack the necessary trained
personnel to sustain regulatory commitment and credibility.
Regulatory offices in developing countries tend to be small,
under-manned for the job they face, and possibly more expensive to
run in relation to GDP than in developed countries. Familiarity
with the regulatory models and methods of regulatory policy
analysis is often limited. The other main difficulties found in
many developing countries relate to broader governance problems or
the legal powers and responsibilities of regulators, including
their effective independence from regulatory (including political)
capture.
.
CHAPTER 7: FDI AND INFRASTRUCTURE A GLOBAL PRESPECTIVE.The
economic model followed by India after independence relied on
import substitution and selective foreign capital inflow, both
through portfolio investment and the Foreign Direct Investment
(FDI) route. This changed radically with the liberalization
measures post-1990. Both portfolio and Foreign Direct Investment
were not only allowed but also actively encouraged. The Foreign
Investment Promotion Board (FIPB) was created to approve FDI
proposals speedily and in most sectors, particularly
infrastructure. The Reserve Bank of India gives automatic approvals
for investments. During the decade of the nineties, the ceilings on
FDI in different sectors were progressively raised. From 2001, 100
per cent foreign investments were allowed in several industrial
sectors. Currently, 100 per cent Foreign Direct Investment is
allowed in almost all the infrastructure sectors.Cross border
investments and technology transfers that broadly constitute
Foreign Direct Investment have multiplied greatly over the past two
decades especially since the mid-1980s. Several global economic
changes have fuelled this growth. These include: Liberalization and
economic reforms across a large swathe of national economies. The
emergence of regional trading blocs particularly in Europe and
North America. Rapid technology absorption and industrialization in
East Asia.As a consequence, the annual magnitude of FDI flows
across the globe has risen from US$ 55 billion in the early
eighties to US$ 1393 billion in 2000 and then declined to US$ 560
billion by 2003.The Role of Foreign Direct Investment.The role of
Foreign Direct Investment in an economy goes beyond simply easing
financial constraints. FDI inflows are associated with multiple
benefits such as technology transfer, market access and
organizational skills. Consequently, there is an increasing and
intense competition between countries to maximize the quantity of
FDI inflows. Any successful policy for attracting FDI has to keep
this competitive scenario in mind.The Benefits of FDI Inflows can
be broadly identified as: Bridging the financial gap between the
quantum of funds needed to sustain a level of growth and the
domestic availability of funds. Technology transfer coupled with
knowledge diffusion that leads to improvement in productivity. It
can, thus, fasten the rate of technological progress through a
contagion effect that permeates domestic firms. The transfer of
better organisational and management practices through the linkages
between the investing foreign company and local suppliers and
customers.In the context of a developing country like India, the
role of FDI in easing financial constraints becomes critical.
According to the Planning Commission, at current levels of
efficiency in the economy, the increase in investment needed to
achieve a percentage point rise in the overall growth would be 6
percentage points. Since this addition to investment cannot come
entirely from domestic sources, a substantial portion will have to
be funded by FDI.
FDI in Infrastructure: Alternative Modes of InvestmentOf the
total quantum of FDI flows across the globe, a large fraction has
gone into infrastructure projects. Growing pressures on Government
budgets and a general concern about the quality of service
provision by incumbent entities saw an explosion of private sector
FDI into infrastructure, particularly in the developing countries.
Between 1990 and 1998, infrastructure projects in the developing
countries attracted about US$ 63 billion through the following
routes: Privatization sales Concessions Leases and other
contractual agreements New capacity creation through
Build-Operate-Transfer (BOT) Agreements1The bulk of infrastructure
FDI in terms of quantum of investment has flowed into the telecom
and power sectors. This is not surprising since projects in these
sectors tend to be large. In terms of the number of projects, the
distribution is more or less even across sectors.Infrastructure FDI
in Asia and Latin America: A ContrastInternationally, countries
have followed two routes to infrastructure development. Latin
American economies generated the vast majority of their
infrastructure FDI inflows through privatization. This constituted
about 88 per cent of total inflows during 1999-2000 with the rest
coming from green-field investments and concessions. In Asia, on
the other hand, Governments relied exclusively on green-field
investments through the BOT route. India has followed the Asian
route where the bulk of FDI in infrastructure has come in through
the green-field route rather than through privatization. The
Government, for instance, has allowed strategic investment in major
airports with a 74 per cent equity ceiling.Modes of Foreign Direct
Investment in IndiaFDI can enter India through two possible
channels: The automatic route under which companies receiving
Foreign Direct Investment need to inform the Reserve Bank of India
within 30 days of receipt of funds and issuance of shares to the
foreign investor. For sectors that are not covered under the
automatic route, prior approval is needed from the Foreign
Investment Promotion Board (FIPB)The Infrastructure Focus of Indias
FDI PolicyThe effort of attracting FDI should not be an end in
itself but a means of industrialization and development. Thus, FDI
is not an undifferentiated black box the specific nature of the FDI
determines its impact on development and growth. In the Indian
case, expanding infrastructure investments are viewed as critical
adjuncts to the policy of stepping up the growth rate of the
economy. This is coupled with the view that domestic sources alone
may not be adequate to provide commensurate resources.
The FDI Needs of the Telecom Sector in IndiaThe telecom services
sector in India has seen explosive growth over the last two years.
Revenue growth in the sector touched 16 per cent in 2003-04 and it
is likely that a similar growth rate will be sustained in 2004-05.
From 13 million in March 2003, the mobile phone subscriber base
grew to 33.7 million by March 2004. This rapid growth necessitates
a sharp rise in capital investment over the next few years. Total
FDI inflows into the telecom sector were US$ 2.6 billion between
August 1991 and July 2004. Industry estimates put the quantum of
investments required in the sector over the next four years at
about US$ 20 billion. A substantial portion of this investment is
to come from FDI. Thus throughout the phase of liberalisation, the
Indian Government has adopted a liberal approach towards allowing
FDI in the infrastructure sectors. This is reflected in the
sectoral mix of investment inflows where energy and
telecommunications account for 43 per cent of total FDI approvals
and 23 per cent of inflows.FDI Norms in Infrastructure
SectorsAutomatic clearance for foreign investment (not requiring
the approval of the FIPB) was first introduced for infrastructure
sectors like power and roads. Other determinants of FDI in
InfrastructureWhile a liberal entry policy can go a long way in
encouraging foreign investments in infrastructure, the willingness
to invest in infrastructure projects has been restrained by a
number of constraints across a number of economies. Thus, any
successful strategy of attracting Foreign Direct Investment into
these sectors will have to deal with these issues directly. These
are: Subsidised prices: In most developing countries,
infrastructure services are priced below the cost of supply.
Subsidies may be hidden as increasing arrears to the banking system
or outstanding payments to State agencies (like State Electricity
Boards). This undermines the financial viability of projects. Mixed
signals from different constituencies: Many diverse groups with
varying levels of influence on Government policy have a stake in
the policy that affects private infrastructure operations.
Consumers benefitting from subsidised prices may resent price
increases associated with privatisation. Managers and employees of
public utilities are understandably concerned about their jobs.
This often influences policy related to private infrastructure and
affects the investment environment. Loss of authority: Governments
are often reluctant to abdicate control over key sectors of the
economy particularly where foreign ownership is involved. Most
Governments do not have a strong record of regulating private
industries because the public sector has been so dominant. This
often results in rules prohibiting private entry into certain
sectors, imposing limits on foreign ownership.Misunderstanding
regarding what private involvement can offer and what investors
require: Although private sector involvement does offer extra
financing and the willingness to manage some risks (construction
and operation risks), they are unwilling to bear risks that they
cannot control (policy or regulatory risk).
CHAPTER 9: FOREIGN DIRECT INVESTMENT (FDI) AND THE REGULATORY
ENVIRONMENT
Major infrastructure development requires a substantial influx
of investment capital. The policies of the Indian Government seek
to encourage investments in domestic infrastructure from both local
and foreign private capital. The country is already a hot
destination for foreign investors. As per the World Investment
Report of the UNCTAD, India was rated the second most attractive
location (after China) for global FDI in 2007.FDI inflows,
particularly with a view to catalyzing investment and enhancing
infrastructure, the Indian Government had introduced significant
policy reforms. For example, it had permitted 100% FDI under the
automatic route for a broad range of the approval route process,
including setting up several agencies to expedite FDI approval.
Further liberalisation is expected as the Government continues to
emphasise infrastructure investment.From an exchange control
perspective, India is moving towards full current account
convertibility. Most revenue transactions are freely permitted,
except certain transactions like royalty, consultancy fees, etc.,
which are subject to certain limits. Capital account transactions
need prior approval, except where specifically permitted. In order
to promote the construction sector, the Indian Government has
relaxed some of the exchange control restrictions and is now
allowing foreign nationals/ citizens to acquire immovable property
in India, subject to certain conditions and procedures. Hurdles to
investment remain. Although India has a well-developed legal
system, the current legal and regulatory environment sometimes acts
as an obstacle to the necessary injections of foreign private
capital into Indias infrastructure. Major infrastructure projects
are governed by the concession agreements signed between public
authorities and private entities. Tariff determination and the
setting of performance standards vary somewhat by sector. In the
roads and highways sector, the ministry generally sets tolls while
in major ports projects, and many of those in electricity
generation, an independent regulator will decide relevant tariffs.
In the airport sector, a new independent regulator was planned for
2009 and is likely to play a major role in determining tariffs in
concession agreements for the segment. In some instances, ministry
or regulator control over potential proceeds can act as a
disincentive to the private infrastructure developer. As is the
case in many countries, there is no single regulator which
formulates the policy for all infrastructure projects. There is
also no standardization in the concession agreements across the
different infrastructure sectors. As a result, the development of
certain sectors in India may be hampered due to lack of adequate
and co-ordinated planning. Projects which were approved may face
difficulties if related projects are substantially delayed. One
example is Bangalores new international airport, one of the largest
PPP projects to date. The project is facing growing pains related
to insufficient road and rail connections to the new facility, in
part due to delays of expected high-speed rail and highway projects
under the auspices of other government bodies.
Opportunities for FDI in infrastructures in IndiaThe Planning
Commission of India has planned extensive expansion in the roads
and highways, ports, civil aviation and airports, and power
infrastructure segments all of which provide substantial
opportunities for FDI.
Roads and highways:Indias roads are already congested, and
getting more so. Annual growth was projected at over 12% for
passenger traffic and over 15% for cargo traffic. The Indian
Government estimated around US$90 billion plus investment was
required over FY07-FY12 to improve the countrys road
infrastructure. Plans were announced by the Government to increase
investments in road infrastructure would increase funds from around
US$15 billion per year to over US$23 billion in 2011-12. Such
programmes would be funded via a mix of public and private
initiatives.The Indian Government, via the National Highway
Development Program (NHDP), planned more than 200 projects in NHDP
Phase III and V to be bid out, representing around 13,000km of
roads. The average project size was expected to US$150
million-US$200 million. Larger projects reached upto the US$700
million-US$800 million range. About 53 projects with aggregate
length of 3000km and an estimated cost of around US$8 billion were
already at the pre-qualification stage. The procurement process
favors players with good experience and sound financial
strength.More than 10 states were also actively planning the
development of their highways. While the average size of these
projects was smaller than the NHDP projects, most will still be
substantial, in the US$100 million-US$125 million range. More than
4,500km of state highways were awarded by the end of 2010.
State Roads (Highways, Major DistrictRural
National HighwaysRoads, Other Roads)RoadsNorth EastTotal
NHDP1NHDPNon-NHDP
YearPublicPrivate(Public)TotalPublicPrivateTotal
2007-083,1733,7024637,3384,3471,3335,6801,87521215,104
2008-093,3053,9664867,7574,5281,4285,9562,02523815,976
2009-103,4644,4955108,4694,7451,6186,3642,15029117,273
2010-113,8345,68553610,0555,2532,0477,2992,30031719,971
2011-124,7076,47856311,7476,4882,3458,8342,46334423,387
Total18,48324,3262,55745,36525,3618,77134,13210,8131,40191,711
RailThe Indian Government had also recognised existing
infrastructure gaps and capacity constraints in the rail system,
and as a consequence planed large scale investment over the five
years from FY07-FY12. Projected investments total US$65 billion, of
which 40% was expected to be contributed by the private sector. One
major PPP programme was already in its initial phases. The
Dedicated Freight Corridor project was designed to alleviate
congestion on the rail routes between Delhi and Mumbai and Delhi
and Kolkota by building long-distance, cargo-only rail lines, at an
estimated cost of US$6 billion-7 billion.Other proposed initiatives
included the development of manufacturing plants for rolling stock
with long-term committed procurement for several years, and the
setting up of logistics parks. City metro systems were also in the
pipeline. The first corridor of the Mumbai Metro Project was
awarded to Reliance Infrastructure and the Government had asked the
final shortlisted companies to submit detailed financial bids for
the second phase of the Mumbai Metro.
Ports and airportsIncreasing connectivity with inland transport
networks is just one of many challenges currently facing Indias
ports, which have seen massive swells in the amount of goods
transported. Traffic was estimated to reach 877 million tonnes by
2011-12, and containerized cargo was expected to grow at 15.5%
(CAGR) over the next 7 years. Indias existing ports infrastructure
was not sufficient to handle the increased loads cargo unloading at
many ports was currently inadequate, even where ports have already
been modernised. An estimated investment of around US$22 billion
was targeted for port projects in the five year period from
FY07-FY12. The National Maritime Development Programme included 276
projects, with a required investment of about US$15 billion over
the next ten years, with private investment targeted at around US$8
billion. In addition to improving road and rail connections,
projects related to port development (construction of jetties,
berths, container terminals, deepening of channels to improve
draft, etc.), will provide major opportunities for FDI. Recent
deregulation of the sector now permits 100% FDI, and an independent
tariff regulatory authority has been set up to facilitate projects
at major ports.Air traffic had increased rapidly in recent years,
although this slowed in 2007. While a number of Indian airlines had
faced challenging market conditions in 2008, and the rate of growth
is likely to be significantly less than initially projected,
Indians are still flying in much greater numbers. Estimates made in
2007 by the Indian Governments Committee on Infrastructure suggest
that passenger traffic will grow at a CAGR of over 15% in the next
5 years. Indian manufacturers are also looking to the skies the
same source anticipates that cargo traffic will grow at over 20%
p.a. over the next five years.The Indian Government has projected
that an investment of around US$8 billion in the five year period
from FY07-12 will be needed to help cope with additional demand,
and private sector participation is expected to play a key role.
The private sector had already stepped up to the challenge of
airport infrastructure development in several cases, with private
participation in recent years at Delhi, Mumbai, Hyderabad, Cochin
and Bangalore supplementing the efforts of the Airports Authority
of India.
PowerIncreased manufacturing activities and a growing population
are also causing a surge in power usage. India has the fifth
largest electricity grid in the world with 135 GW capacity, and the
worlds third largest transmission and distribution (T&D)
network. Large investments were needed to meet growing demand and
provide universal access. An investment of US$167 billion was
projected for electricity projects in the five year period from
FY07-FY12. The massive number and scope of potential projects had
attracted a number of new investors, lenders and operators.
CHAPTER 9: CONCLUSIONSThe 1990s saw an unprecedented increase in
private foreign investment in infrastructure projects in developing
countries. Much of this investment was in the telecommunications
and electricity industries. For the private sector, infrastructure
investment is associated with a sizeable investor risk linked to
the long-term sunk cost characteristics of infrastructure projects.
For the government, the involvement of the private sector in
natural monopolies raises new challenges in designing regulatory
structures that can control anti-competitive or monopolistic
behaviour, while at the same time maintaining the attractiveness of
the domestic economy to potential foreign investors in the
infrastructure industries.The purpose of this article was to assess
the impact of regulatory governance on FDI in infrastructure
projects in middle and low income economies. Using a dataset on
private participation in infrastructure projects in developing
countries for the period 1990 to 2002 recently made available by
the World Bank, we constructed an econometric model that was used
to estimate the determinants of FDI in infrastructure. The
determinants were grouped into control variables for economic
policy and structural characteristics and infrastructure regulation
variables. The selection of control variables was motivated by
existing research on FDI, and our results are consistent with the
empirical evidence on the key determinants of FDI reported in the
literature. Three alternative measures of regulation quality were
used in our empirical analysis. All are positively signed and
statistically significant.We interpret these results as
confirmation of the basic hypothesis that FDI in infrastructure
responds positively to the existence of an effective regulatory
framework that provides regulatory creditability to the private
sector. By implication, where regulatory institutions are weak and
vulnerable to capture by the government (or the private sector),
foreign investors may be more reluctant to make a major commitment
to large scale infrastructure projects in developing countries. The
main policy implication of our findings is the need for supporting
capacity building and institutional strengthening for robust and
independent regulation in developing countries.
CHAPTER 10: BIBLIOGRAPHY
BOOK:
INTERNATIONAL BUSINESS P.K. BANDGAR
WEBSITES:
https://www.imf.org/external/pubs/ft/fandd/2001/06/loungani.htm
https://www.imf.org/external/pubs/ft/fandd/2001/06/loungani.htm
http://unlimitedeconomicszone.over-blog.org/article-how-can-foreign-direct-investment-help-developing-countries-108953176.html
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