Outside-in would help to attract more FDI

India’s Union Minister of Commerce and Industry Anand Sharma addressing the ICC Asia Pacific CEO Forum in Delhi recently observed that “in South Asia, India is an integral part to the development of the region. There is a need to build regional strategic cooperative partnerships. A paradigm shift is taking place and Asia-Pacific will play a critical role in contributing to the economic and financial growth of the world.”

He further said: “India’s National Manufacturing Policy is one of the initiatives of the Government to raise the GDP share of manufacturing from 16% to 25% in a decade, which would result in creating 100 million skilled jobs,” and added that the Government was working on other policy reforms to encourage more and more FDI and infrastructure development of the country.

Foreign Direct Investment

Foreign Direct Investment (FDI) generally refers to long-term participation by one country in another country. It usually involves participation in a JV, inflow of key talent, capital transfer, transfer of technology and management expertise. There are two types of FDI: inward foreign direct investment and outward foreign direct investment, resulting in a net FDI inflow (positive or negative) and stock of Foreign Direct Investment.

There is substantial evidence that such investments benefit host countries. In Sri Lanka, during periods of relative economic and political stability, Foreign Direct Investment inflows have responded positively. Sri Lanka expects Foreign Direct Investment to more than quadruple. FDI generally benefits the host country; however its potential impact should be carefully and practically accessed.

FDI is viewed as the “good cholesterol” HDL, where as international debt flow of short term varieties are considered “bad cholesterol” LDL. FDI is thought to be “bolted down and cannot leave so easily at the first sign of trouble”. Unlike short-term debt, direct investments in a country are straight away reprised in the event of a crisis.

Foreign Direct Investment has been proven to many to be resilient during a financial crisis. A good example would be the Mexican crisis that took place during 1994-1995 and the Latino crisis in the 1980’s. The resilient of foreign direct investment during a financial crisis can lead to many developing countries to monitor it as private capital inflow of choice, rather than investing in other forms of private capital such as portfolio equities, debt flows, and in particular, short term flows which were all subjected to large reversals during the same period.

Generally, private capital flows across borders, because it allows capital to seek out the highest rate of return. Countries often choose to exempt some of its revenue when they cut corporate tax rates in an attempt to attract FDI from other countries. FDI also allows the transfer of expertise and technology, particularly in the form of varieties of capital inputs, which cannot be got via financial investments or trade in goods and services.

However, there are many findings that show FDI is a relatively bigger portion of total inward investment in some countries, where the risks are very high. This is often because FDI tends to take advantage of the countries where the market is inefficient. It happens because of foreign investors prefer to operate directly instead of relying on local financial markets, supplies, or legal arrangements.

In high-risk countries, the share of total inflows is higher and the risk is measured by the countries credit ratings. Also, FDI may not be beneficial to developing countries when foreign investors increase vital inside information about the productivity of the firms under their control. That fact gives them an information advantage over “uniformed” domestic savers, whose buying of shares in domestic firms does not involve control. Taking advantage of this superior information, foreign direct investors will tend to retain high productivity firms under their ownership and control, and sell low productivity firms to the uniformed small time retail players.

Outside-in

Most strategies to attract FDI adopted by developing countries have been inside-out. A country would look at it from the areas of what its core competencies are and where they can be applied. The opportunities and threats are looked at from the inside lens.

Outside-in means you look at the external landscape from different multiple lenses and then position the country to exploit potential opportunities. Therefore from an outside-in approach the best solution for developing countries to increase their overall amount of inward investment of all kind, is to focus on concentrating on improving the environment for investment, the functioning of capital markets and private companies need to improve governance within their enterprises, skills level, internationalise and work towards becoming multinational enterprises. By doing so, they are likely to be rewarded with increased investment as well as with more capital inflows.

The global debt crisis is speeding up the shift of focus to frontier and emerging markets since they remain the only source of growth in the world economy. Sri Lanka could very well attract more foreign investment, and develop faster, if we improve our infrastructure, workforce skills, have efficient capital markets, provide sustainable legal guarantees to protect investment and further strengthen governance in both the public and private sectors. However this would require a 180 degree change in the mindset.

 

(The writer is a senior company director.)