Enhancing FDI Flow in South Asia: Framework for Regional Cooperation

    The opinion piece on FDI by Dr Khondaker Golam Moazzem, Additional Research Director, CPD was originally published on the SARCist website in March 2015.

    Enhancing FDI Flow in South Asia: Exploring a Framework for Regional Cooperation

    I. Introduction

    Foreign direct investment (FDI) in South Asia did not get momentum over the last decades. Changes in national policies related to trade and investment and undertakingregional integration initiatives under the SAARC made little changes in inward flow of FDI in South Asia.The region remains one of the least FDI-recipient regions in the world (ranks 24th out of 44 different regions). Its share in global FDI flow remains at a low level (only 2.2 per cent in 2013) despite the fact that absolute volume of FDI has increased over the years (from US$4.6 billion in 2000 to US$32.5 billion). In contrast, neighbouring regions of South Asia such as South East Asia have received overwhelming amount of FDI during the same period (from US$22.6 billion in 2000 to US$117.5 billion in 2013). South Asia as a region has yet to develop an enabling environment necessary for attracting FDI. This note highlights on current state of FDI flow in South Asian countries and suggests possible framework for regional cooperation for enhancing FDI flow in South Asia.

    II. State of FDI Flow in South Asia

    It is observed that limited level of FDI flow in South Asia mainly targets few destinations with having various location-specific advantages (Table 1). India because of huge domestic market, infrastructural facilities and availability of educated and skilled labour force, is considered to be one of the most potentialinvestment destination in the world (UNCTAD, 2012). At present, India alone receives over 85 per cent of total FDI flow inSouth Asia and its share has been increasing over the years. Other South Asian countries are far behind India– Bangladesh and Pakistan receives FDI over US$1billion while Sri Lanka receives close to US$1 billion and other three countries including Afghanistan, Bhutan, Nepal and Maldives receives miniscule amount of FDI. Unlike neighboring regions, South Asia has yet to emerge as a contiguous region to attract large volume of FDI by overcoming their structural and other differences in terms of level of development, size of economy, nature of geographical proximity and connectedness and various kinds of trade relatedbarriers. Eventually, FDI stock has been concentrated to few locations(Table 1).

    Table 1: Inward Flow of FDI and Stock of FDI in South Asia

    Note: Figures in the parentheses indicate share of total FDI flow/stock in South AsiaSource: UNCTAD

    Most of the FDI in South Asia has been originated from outside the region; however the share of extra-regional sources is rather high compared to other neighboringregions. Developed countries of Europe and North America are the major sources of FDI particularly for India, Pakistan, Bangladesh and Sri Lanka. Developing countries particularly African countries are one of the important sources for India. Unlike other regions, intra-regional investment makes limited contribution to South Asia. India is the major source of investment for Bhutan, Nepal and partly for Sri Lanka. Due to limited investment potentials within the region, India’s outward FDI mainlytarget different industries of Europe and North America. Most of the FDI in South Asia is market-seeking in nature- mainly target different service related industries including telecommunication, finance and energy (53 per cent). The investment in the manufacturing sector (43 per cent of the total) is mainly market-seeking and partly efficiency-seeking in nature.

    South Asian countries by and large follow a liberalized investment regime. Despite that there are lots ofpre-requisites at pre-establishment stage including sectoral prohibition, investment cap, screening requirement, minimum capital requirement and locational issues (Moazzem et al., 2014). Regional investment has been blocked by special provisions on country-specific investments in few cases. Some countries maintain general and sectoral provisions regarding minimum investment requirement, screening requirement and access to foreign skilled workers etc. From the perspective of promotion of FDI, harmonization of various provisions both at pre- and post-establishment stages are highly important.

    Lack of necessary infrastructure and logistics are major constraints for higher FDI flow in South Asia. As a result South Asia stands far behind other neighbouring regions such as East Asia and Pacific in most of the business related indicators (Table 2). Performance of individual South Asian countries in those indicators varies widely. For example, time for starting a business varies between countries by 7 to 28 days, time for getting electricity varies between 70-429 days and time for exporting across borders varies between 16-86 days etc. Such huge differences portrays lack of harmonized standard with regard toinfrastructural facilities, logistics and connectivity with ports in South Asian countries which increase trade cost with the region. Absence of cross-border movement of vehicles also increase the trade cost. Under such weak state of infrastructure and logistics, regional supply chain operates with limited level of efficiency.

    Table 2: State of Enabling Business Environment in South Asia

    Source: World Bank, 2014

    South Asian countries could not take the benefit of regional trade integration both under SAPTA and SAFTA. Rise in trade-openness of South Asian countries over the years is not reflected in the share of intraregional trade of South Asian countries (intra-regional trade comprises less than 5 per cent of total share of regional trade). In other words, regional trade regime is not conducive for trade-led investment within the region.Regional trade of South Asian countries have been constrained by long sensitive lists, high MFN tariff rates, non-tariff barriers, poor cross-border logistic facilities and weak regional connectivity (http://econpapers.repec.org/paper/wbkwbrwps/6696.htm). All of which contribute to high trade cost.

    III. Framework for Regional Investment Cooperation in South Asia

    Bilateral initiatives of South Asian countries are found to have limited impact in overall flow of FDI in South Asia. South Asian countries have signed bilateral investment treaties (BITs) with potential investor countries including few in the region. But its impact on enhancing FDI flow is rather mixed (http://icrier.org/pdf/Working_Paper_218.pdf). Strengthening initiatives forregional investment cooperation is therefore increasingly becoming important for South Asia.

    Unfortunately regional initiatives for enhancing FDI flow are very scant. The issue of investment did not get adequate attention in earlier SAARC Summit (http://www.keepeek.com/Digital-Asset-Management/oecd/commonwealth/trade/regional-integration-in-south-asia/regional-investment-co-operation-in-south-asia_9781848599147-10-en#page1). SAARC Agreement on promotion and protection of regional investment has been drafted in 2006 but has not yet been approved at the SAARC Summit. In this context, SAARC Agreement on Trade in Services (SATIS) signed in 16thSAARC Summit could be considered as a major development towards deepening cooperation in services through market access, progressive liberalization of domestic regulations, recognition, dispute settlement, safeguard measures and subsidies etc.

    SAARC could take lessons from other successful regions such as ASEANin order to promote FDI. Intra-regional investment in ASEAN region has been promoted through a number of specific regional initiatives which include ASEAN Comprehensive Investment Agreement (ACIA), ASEAN Industrial Joint Venture (AIJV). These initiatives put emphasis ondevelopment of regional value chain (RVC) through undertaking sectorial measures. In the context of South Asia, a number of fiscal and monetary issues including tariff and non-tariff measures, rules of origin, openness of capital account and sectoralmeasures in FDI regulations need to be harmonized.

    Given the importance of countries outside the region as sources of FDI,SAARC could follow the precedence of ASEAN by putting equal importance on bothmember and non-member countries (Moazzem et al., 2014).An‘open regionalism’ policy could facilitate inward flow of FDI in South Asia. Moreover, South Asian countries need to undertake a number of measures towards development of a regional value chain which include harmonization of MFN tariff rates, significant reduction of number of sensitive products, reduction of NTBs, improvement of regional connectivity, development of physical infrastructure and removing political barriers (http://www.ips.lk/index.php/541-regional-economic-integration-challenges-for-south-asia-during-turbulent-times).