Harnessing potential gains from outward FDI

Corporate Bangladesh is increasingly demanding the easing of draconian restrictions on outward foreign direct investment (OFDI) as they seek to diversify earnings. Indeed, OFDI can yield financial, intangible capability, and tangible capacity returns, thus complementing the development benefits realised through trade, migration and inward FDI.

Businesses in developing countries are using OFDI as a catch-up strategy by expanding overseas operations. Samsung has been the frontier firm in the production of dynamic random-access memories, and Mittal Steel has become the globe's leading-edge manufacturer of steel.

THE CHANGING FDI LANDSCAPE

Mainstream economic theory predicted capital to flow from capital-rich developed countries to capital-poor developing countries. Indeed, in 1995, OFDI from developing countries constituted just 4 per cent of global FDI flows. However, in 2017, the share of OFDI from capital-poor countries reached 27 per cent, according to the World Bank Global Investment Competitiveness Report 2017-2018.

There were 21,000 multinational enterprises from developing countries --3,500 from China, 1,000 from Russia, 815 from India, and 220 from Brazil. Many developing countries are now engaged in OFDI regardless of their level of development. Between 2008 and 2018, developing countries in the Asia Pacific region (excluding China) provided on average $150 billion in OFDI annually. The region has been the largest source of OFDI globally since 2018. Asia was the only region recording (7 per cent) expansion in OFDIs in 2020, a pandemic year in which FDI flows plunged globally by 35 per cent, says the UNCTAD World Investment Report 2021.

Domestic policy choices in developing countries and global economic conditions shaped these changes. FDI is a natural extension of the globalisation process that often begins with exports. In the late 1990s, firms in high-growth economies embraced OFDI seeking efficiency in resource allocation and diversifying risks from economic shocks in any region. Rapid and sustained growth in much of the developing world and commodity price booms in the subsequent decades propelled firms to internationalise.

Market, strategic asset, and efficiency-seeking are important motivations for OFDI from developing countries. They are a particularly crucial source of FDI for countries in Sub-Saharan Africa, Europe, Central Asia, and South Asia.

BENEFITS, ENTRY MODES AND EVIDENCE

Financial returns result from profits generated by the overseas processing and sales outlets of merchandise produced in the host economy. Chinese firms, for example, invested heavily in sales offices and assembly operations in Europe to strengthen exports of low-cost products made in China.

Some OFDI, such as Taiwanese offshoring to mainland China enhance the sale of intermediate goods to production locations in other countries, thus creating opportunities for locally embedded suppliers in the home economy. Overseas investments in joint ventures and wholly-owned subsidiaries have been essential channels for promoting global business by the developing country entrepreneurs.

Mergers and acquisitions (M&As) and other forms of alliances with companies in host countries are particularly valuable for the generation of intangible capability returns such as additional knowledge, skills, technological upgrading, managerial expertise, and a brand's goodwill. As much as 56 per cent of global cross-border M&As were undertaken by multinationals from developing and transition economies in 2013.

Mergers and acquisitions have helped Indian companies get direct access to newer, more extensive markets and better technologies, thus widening their customer base and global reach.

The extent to which OFDI enhances development outcomes in home countries is a nascent area of study in developing countries. The Southeast Asian experience from 1981 to 2013 shows a 1 per cent increase in OFDI led to a $750 million rise in exports for the Philippines, $72 million for Singapore, $41 million for Thailand, and $31 million for Malaysia.

Analysis of the effects of OFDI on regional innovation performance in China finds that OFDI has a very significant impact on domestic innovation. The management expertise, exports, quality, and costs of Indonesian firms that invested abroad improved dramatically after their investment relative to other firms and their own past performance. Generally, the evidence suggests that the productivity benefits of OFDI occur primarily through efficiency gains from specialisation and scale advantages of firms competing in international markets and the indirect import of knowledge and technology.

THE GAINS ARE BY NO MEANS CERTAIN

Bangladesh's experience so far is mixed.

A Bangladeshi apparel exporter invested in Jordan in 2007 by forming a joint venture with one of the leading Indian garment manufacturers. They established the factory to produce high-value garments for the US market in the Jordan export processing zone. Their pandemic-affected factory in Jordan is now recovering.

Another leading global outsourcing Bangladeshi partner to many of the world's largest advertising, media, and technology companies is doing well after recovering from the adverse pandemic shock. In 2017, a tobacco conglomerate was allowed to invest in Malaysia to part-finance an acquisition that is fetching a good return.

There are cases of failures as well.

The first Bangladeshi OFDI in 2013 in a joint venture in Myanmar turned sour. After making a good profit initially, the company faced massive losses owing to increasing political unrest and frequent policy changes. Eventually, the company closed its business in Myanmar in 2020.

Another OFDI in a garment factory in Ethiopia's Tigray region to cash in on the country's duty-free access to the US market, low prices of land, and cheap labour failed because of conflict in the region in 2020.

Enough firms from Bangladesh have not yet been involved in OFDI to generate any significant impact at a macro-level. When OFDI are limited, the returns and risks will be limited as well. Scaling it up may divert domestic resources to overseas projects and crowd out other domestic economic activity such as investment, production, exports, employment, income, and tax revenue (the offshoring effect). Between 1980 and 2018, OFDI from Indonesia had a significant adverse effect on domestic investment.

The benefits could outweigh the costs and risks. Most Bangladeshi products are sold abroad under international brands who appropriate the largest share of the revenue. Bangladeshi investors must start production in countries into which they are venturing to jump non-tariff barriers and exploit preferential market access in third countries to overcome the challenges of the post-LDC graduation period. The East Asian export dynamism is associated both with inward and outward FDI.

TIME TO REVISIT POLICY

Bangladeshi companies were all but forbidden from making investments overseas. The government has been relatively more circumspect on undertaking liberalisation of outward investment.

The foreign exchange regulations were amended in 2015 to allow limited investment on a case-to-case basis. Apart from crowding out onshore investment, unfettered OFDI could have significant implications for the sustainability of the current account deficit, external debt profile and exchange rate stability.

Bangladesh needs a transparent policy framework to manage investment abroad. In September 2020, the Bangladesh Bank allowed export-oriented businesses to make overseas equity investments up to 25 per cent of their net annual export receipts. The businesses must comply with the 'Capital Account Transactions (Overseas Equity Investment) Guidelines 2020'. 

The guideline requires a 30 per cent workforce of a company set up aboard to be Bangladeshi nationals. Reinvestment of funds derived from overseas operations requires prior BB approval. The companies need to send profits, dividends, and other incomes back home in 90 days. The entrepreneur must be financially sound and have a clean track record of export proceeds repatriation, payment of import obligations, loan repayment and tax payment.

Selective policy and incentive frameworks are indeed needed. Different types of OFDI promote home economy development in different ways. The policy should encourage OFDI where significant financial and tangible or intangible capability returns might be expected in short- to medium-term.

Priority should be given to companies with technical knowledge and foreign currency income. The policy must blueprint the priorities for OFDI, acceptable financing arrangements, and the procedures for the decision on specific OFDI proposals.

The government should review existing restrictions on OFDI, weigh their costs and benefits and adopt measures that strengthen economy-wide policy coherence and absorptive capacity. Risk management capabilities are critical for dealing with the use of multi-layered structures that create opacity not justifiable on business grounds and non-value-adding 'round‐tripping' of capital to mine preferential treatment.

The finance and commerce ministries, the BB, the corporates, and professional bodies must put together their collective wisdom to constantly review the policies facilitating outward FDI.

Just as with trade, OFDI will create winners and losers. Resistance from the latter may be dealt with by attracting more inward FDI given the current small levels relative to other Asian countries.

Simplifying investment processes to ensure clarity of rules regarding foreign investment and establishing a conducive investment climate will help mobilise investments for sustainable development. Focus on OFDI must not be at the expense of creating a competitive business environment, enhancing firm capabilities at home, sustaining domestic economic stability and accelerating inclusive growth.

The author is an economist.