FDI and ITS Impact in Bangladesh

RAB 8 Barisal

INTRODUCTION

Foreign direct investment occurs when a firm invests directly in facilities to produce and/or market a product in a foreign country.

FDI is defined as investment made to acquire lasting interest in enterprises operating outside of the economy of the investor.

Foreign direct investment (FDI) is seen as an instrument by which countries can gain access to the benefits of globalization (Azim and Uddin 2001). In recent years, FDI has received singular attention in many developing countries. The close integration of national economies, driven by worldwide competitive pressures, economic liberalization, and the opening up of new areas of investment, has helped many countries to attract FDI (IFC 1997). Policy makers and multilateral organizations have increasingly emphasized

the importance of a sound investment climate and flow of FDI in promoting economic growth in developing countries (Stern 2002). The climate for investment is determined by the interplay of many factors—economic, social, political, and technological—which have a bearing on the operations of a business. The business environment has three main

features: macroeconomic conditions, governance, and infrastructure. The more favorable these factors are to a firm’s operation, the more likely it is that the firm will invest in the economy and help create a bandwagon effect for others. Bangladesh has long been trying to attract FDI. In the 1990s, Bangladesh achieved a growth rate far superior to that of most low-income countries and positioned itself with a better macroeconomic policy regime to attract FDI. The Government introduced a generous program of incentives for investors. The country experienced an upward trend in FDI inflow in the early 1990s, but recently too little foreign capital has come in (Azim 1999, World Bank 2005). In gross FDI inflows as a share of gross development product (GDP) in the 1990s, Bangladesh was 137th out of 141 countries (World Bank 2005).

Despite a relatively liberal FDI regime, foreign investors are not interested in moving to Bangladesh. It is therefore crucial to understand the major impediments that distort the business environment. A conducive business environment—with well-functioning factor markets, efficiently run infrastructure services, easy market entry and exit, an enabling regulatory environment, access to information, and strong competitive pressures—allows

businesses to become productive, competitive, dynamic, and innovative (World Bank 2005). In view of these considerations, this paper investigates the business environment in Bangladesh and identifies critical factors, especially economic governance issues that affect the volume of FDI.

FDI in Developing Countries

The preconditions of FDI have been addressed by a number of theories. Among these theories are: the theory of market imperfection (Hymer 1960, Dunlop 1999); behavioral theory (Aharoni 1966, Dunlop 1999); product life cycle theory (Vernon 1977; Hossain, Islam, and Kibria 1999); internalization theory (Buckley and Casson 1976); transaction cost theory (Williamson 1975, 1985); location-specific advantage (Franco 1971, 1974; Porter 1990); and eclectic theory (Dunning 1988). Caves (1971) argues that through FDI multinational corporations (MNCs) attempt to exploit firm specific assets in a foreign market. But FDI is more than merely moving capital across borders; it offers certain advantages to both the host country and the investor. Dunning (1980, 1988) argues that a firm’s foreign investment decisions are influenced mainly by firm- and location-specific advantages.

Open-door economic policy (Singh and Jun 1995, Walder 1996), market size (Lardy 1995, Milner and Pentecost 1996, Fittock and Edwards 1998), political stability (Tesai 1994), and the host country’s macroeconomic policy, tax regime, and regulatory practices are considered major determinants of FDI. FDI inflows generate jobs through new establishments and expanded activities, and indirectly increase competition within domestic markets and facilitate the transfer of improved technology and management techniques (Crone and Roper 1999). For the investor, the potential benefits lie in penetrating a new market, gaining access to raw materials, diversifying business activity, rationalizing production processes, and overcoming some of the drawbacks of exporting, such as trade barriers and transport costs. FDI also enables companies to learn about the host market and how to compete in it. Transaction cost theory (Williamson 1975, 1985; Buckley and Casson 1976; Caves 1971; Caves, Christensen and Diewert 1982) explains how multinational enterprises (MNEs) own and control operations abroad to benefit from diverse production locations and globalization of markets (Benito and Gripsurd 1992, Buckley and Casson 1976, Teece 1986). Similarly, Vernon (1966) and Dunlop (1999) argue that MNEs undertake production in different countries to minimize production costs and expand globally. Firms therefore choose least-cost locations for their production activities (Buckley 1988).

 Dunning (1980, 1988) suggests that the propensity of a firm to get involved in international production depends on three conditions: ownership advantages, location advantages, and internalization advantages. Internal factors in host countries are also important determinants. Tatoglu and Glaister (1998) classify the host country location–related factors into two types. First are Ricardian-type endowments, which mainly comprise natural resources, most kinds of labor, and proximity to markets. Second are environmental variables, or the political, economic, legal, and infrastructural conditions in a host country.

 According to Dunning and Pearce (1988), FDI can be “resource seeking” (gaining access to local, natural, or human resources); “import substituting” (producing locally instead of exporting to the local market); an “export platform” (providing a basis for exporting to a regional market); or “rationalized or vertically disintegrated” (locating each stage of production where the local costs are most advantageous). A particular investment may, however, be motivated by several of these factors at the same time.

An economy that offers long-term business prospects can influence an FDI decision, but the prospects need to be directly relevant to the profitability of the venture (Petrochilos 1989). The inflow of FDI to a host country depends on the availability of location-specific factors and the opportunity to use those resources effectively. Overall, the factors that influence FDI decisions—Porter (1990) called these “factor endowments”—can include the size and growth of the host-country market, factor prices (labor, raw materials, etc.), economic policies (interest rates, exchange rates, taxes, etc.), profitability, and the protection afforded to investing firms by tariffs and other measures.

 Comments on the Proposed Investment by Tata Group in Bangladesh*

Wahiduddin Mahmud

University of Dhaka

Evaluating FDIs:  Some General Comments

 Foreign direct investment (FDI) brings in the much-needed foreign funds for current investment, but it also creates long-term debt obligation in the form of future repatriation of profits earned by the foreign investors. The non-repatriated a part of the future stream of value-added from the investment directly contributes to the growth of the country’s gross national income (GNI); and this mainly consists of the wage income of the domestic workers employed by the project and the tax revenues of the government.

 The desirability of FDI, however, depends on its “net social benefit” accruing to the host country, the estimation of which is much more complicated.  As in the case of social cost-benefit analysis of domestic investment projects, all inputs and outputs need to be estimated at their “economic” prices, which represent their “real” value to society (the so-called opportunity costs). This is important because domestic prices are often largely distorted. For example, any subsidies on input prices that make actual prices lower than their “economic” prices have to be deducted in estimating the benefit of FDIs. Likewise, when FDI produces for a domestic market that is highly protected by import tariffs, the value-added that it creates in terms of domestic currency is much higher than its true worth in terms of foreign exchange (that is, at international prices).

This is not to argue that FDI should not be given the benefit of any subsidized inputs or other incentives like tax breaks, but that these should be taken into account in assessing the benefit of FDI. There is a need to provide reasonable incentives to attract FDI. But, unless the benefit for the country is assessed in relation to “economic” prices, one cannot be sure that the proposed investment is genuinely profitable enough to result in a win-win situation.

 Fortunately, not all FDIs require such detailed evaluation to see that the country is getting a fair deal.  This would include FDIs that work within the market discipline, such as those in labour-intensive manufacturing industries catering to the export market or a highly competitive domestic market. The very fact that foreign investors are attracted to make such investments under market determined competitive prices is itself an indication of a win-win situation.

 On the other hand, the economic benefit from FDIs that operate in a non-competitive domestic market is not self evident. These include the FDIs involving “administered” prices, such as under purchase or sale contracts with the government. Some of these FDIs, such as in electricity generation, may be potentially highly desirable because of their being in strategically important sectors; but their benefit depends on the terms of agreement regarding prices and other incentives. International competitive bidding can be a mechanism to ensure that an “exploitative” arrangement is not imposed on the country; but this is easier said than done.

 Even a competitive bidding process does not do away with the need to determine whether the investment is at all genuinely profitable so as to be able to yield a win-win result. The problem is compounded by the fact that, for a country like Bangladesh having a poor international country-risk rating, the perceived risks of investment will be factored in while prospective foreign investors offer their bid. Also, in a perceived risky environment, foreign investors may have a too strong preference for getting their profits sooner than later, which may result in an overexploitation of exhaustible resources like minerals.

 Another problem may arise from the fact that FDIs in the “non-tradable” sectors, such as in electricity generation, telecommunications or other infrastructure provision, do not directly contribute to earning or saving foreign exchange. True that these investments provide funds for making strategically important investments that may greatly contribute to overall economic growth. But the fact that there is no immediate involvement of the country’s resources may lead to the neglect of the problem created by too large future obligations for profit repatriation. In going for such FDIs, the implications for the long-term viability of the balance of payments should be taken into account.

 In promoting the case for FDIs, some indirect benefits are often cited. While these benefits may be quite important, their nature needs to be properly understood in evaluating FDIs, particularly since these benefits are largely of an intangible nature. The following are three most commonly cited benefits in the context of Bangladesh:

 First, beyond the direct economic impact, the investments may yield indirect benefits by creating jobs and promoting economic activities in other related sectors through the so-called forward and backward linkages – that is, by purchasing inputs (or outsourcing) and/or producing goods that are inputs for other activities. Whether creating demand for other sectors is an additional benefit from FDI depends on the nature of production constraints in those sectors. In a capital-scarce and labour-surplus economy like Bangladesh, the expansion of most production activities is not constrained by demand deficiency, but by a lack of investment to create additional production capacity. However, there are many low-productivity labour-intensive activities, mostly services, which can easily respond to increased demand without much investment. The employment and incomes generated in this later way can be considered as a genuine spill-over benefit from the inflow of FDIs. As regards forward linkages, the benefit will depend on whether the FDI is for producing essential inputs for other activities that would not be otherwise produced because of lack of technical know-how or would be available only at a higher price, say, from imports.

 Second, FDIs may save foreign exchange by producing tradable items – exports or import-substitutes. This will be an additional benefit depending on whether there is an effective balance of payments problem that constrains economic growth. In such a case, a taka worth of output that can be internationally traded will carry a premium over a taka worth of non-traded output – hence the likely benefit arising from FDI’s contribution to the balance of payments. Recent development experience in Bangladesh suggests that the balance of payments can indeed be a problem at times of accelerating economic growth.

 Third, the claim that an initial FDI may promote investor confidence and reduce the perceived country risks by future prospective foreign investors – hence the case for providing it some extra incentives. While this may be correct, an “unfair” deal may create future resentments and other problems that will do damage rather than promote the investment environment. The best way to improve the country-risk factor is to address the underlying causes rather than offer too generous concessions to foreign investors.

How to Evaluate Tata’s Proposal?

 Tata’s investment proposal is a complex one with several components. Of these components, the proposed urea plant is an entirely separate project with no link with the rest of the investment proposal; as such, its merit is better judged separately. This aspect is mostly blurred in the way the overall impact of the project on the Bangladesh economy is discussed in the report of the Economic Intelligence Unit (EIU) as well as in much of the documentation produced by Tata. The other part of the investment project is an integrated one involving steel production, power generation and coal mining. Even for this integrated project, the possibility of generating power by gas and thus leaving out the coal mining component may be kept open as an alternative, given the many unresolved issues regarding coal mining.

 About the IEU report, it is mainly concerned with the likely economy-wide or macroeconomic impact of Tata’s investments; it has very little to say about the likely net social benefit of the project in terms of a cost-benefit analysis as discussed above. It does not deal with the key issues nor make any attempt to quantify the key variables that will directly determine the part of the project benefit accruing to Bangladesh – such as the pricing of gas and the future streams of wage incomes and tax yields generated from the project. Instead, the EIU report mainly dwells upon what may be called indirect project benefits, such as those arising from the impact on the balance of payments and from any backward and forward linkages. As noted above, these indirect benefits may be additional considerations in deciding on the desirability of the project, but these are not the basic ingredients for estimating the net benefit of the project. Even in estimating these indirect benefits, the IEU report does not often take into account some of the common caveats of such estimates, some of which have been mentioned earlier. We come back to these issues towards the end of this report, but for the time being, let us concentrate on the basics.

 Steel production is highly energy-intensive, while urea production is a non-energy use of gas. According to the data available from Tata, the urea plant will produce US$ 127 worth of value-added annually by using 0.04 tcf of gas (total of 0.8 tcf in 20 years). The value added from steel production will be US$ 495 million annually against the annual use of 0.028 tcf of gas (0.7 tcf in 25 years.). If captive power generation for the steel mill is to use gas instead of coal, the total annual use of gas for steel production will be 0.033 tcf (0.825 tcf in 25 years). Including power generation and coal production, Tata’s total project, when in full operation, is estimated to generate US$ 972 million value-added annually.

 The critical importance of the pricing of gas in determining Bangladesh’s benefit from Tata’s investment can be readily seen from some aggregate figures. If the price of gas were to be reduced by US$ 1 (which will be a subsidy if the real “economic” price of gas is taken as the benchmark), this will reduce Petrobangla’s sale proceeds from this project by US$ 68 million annually (by US$ 83 billion if captive power were to be generated from gas). Against this, the direct benefit will include the part of value-added accruing to Bangladesh in terms of wages and salaries of local employees and the tax revenue of the government. The salaries are estimated to be US$ 20 – US$ 30 annually (the true social benefit may be half of this if we assume that the “shadow” wage rates representing the opportunity cost of labour in Bangladesh is half the market wage rate). This is a very low proportion of the estimated total value-added – about 2 to 3 percent. This is an implication of the fact that although the production processes in the various components of the project are highly resource-intensive; their labour-intensity is extremely low.

 Tata estimates that the annual taxes payable after the tax holiday period will be approximately US$ 120 million per annum. This would include mainly corporate tax on profit at the prevailing rate of 40 percent, and also royalties for coal mining and other indirect taxes (presumably net of various tax exemptions sought by Tata as part of the incentive package). Applying a time discount rate of, say, 8 percent annually, the above tax revenue can be estimated as equivalent annual revenue for a 20-year project life. This works out to be US$ 38 million annually if we assume that the tax holiday is for the initial 10 years, but the amount rises to US$ 63.5 annually for a six-year tax holiday period.

 The above aggregate figures suggest some broad features of the benefit to be derived from Tata’s investments:

(a)          If we consider the net benefit from the direct investment impact, this will be quite sensitive to the pricing of gas. While some amount of subsidy in gas sales (compared to the “economic” price of gas, see later discussion) may be accommodated, a large subsidy may easily make the net direct benefit negative.

(b)         The period of tax holiday can make a large difference to the net benefit, since tax revenues seem to be the main direct benefit from the investments.

(c)                Tata’s projected profits from the investments seem to be large enough, particularly for the steel-power complex, so as to provide ample scope for bargaining in order to arrive at a fair win-win deal. There also thus does not seem to be any strong case for allowing tax-breaks or other incentives beyond what are allowed under the existing structure of incentives for such investments. Special incentives beyond the existing rules also create precedence for giving such incentives to other prospective investors.

 The last point is a bit problematic because the information that is available from Tata’s documentation and the EIU report is rather insufficient and, in some respects, also appear inconsistent. To make decisions regarding the separate components of the project (the urea project in particular), component-wise detailed information is necessary. There seems to be also very large discrepancies between the estimates of Tata’s annual profits as implied by the annual tax revenue to be paid after the tax holiday period and as can be directly estimated from the annual value-added net of taxes and salaries (the later seems to be much larger). To help evaluate the investment proposal component by component and, thereby, negotiate the terms of contract, Tata should be encouraged to share more detailed information for each component.

Economic Price of Gas

Gas is an exhaustible resource and it does not also have a global market like any other commodities that can be easily traded internationally. The determination of an “economic” price of gas therefore involves difficult conceptual problems (since market does not provide much guidance for it) and depends on country-specific circumstances.

 One plausible way of conceptualizing the economic pricing of gas is by considering that the cost of using an extra unit of it now is the cost that will be incurred for importing an equivalent amount of fuel (e.g. fuel oil, coal or gas) when domestic gas will be exhausted. However, because of society’s time preference of income (or money), the future cost needs to be discounted to convert it to its present cost equivalent. Three factors are thus crucially important for the determination of the present economic price of gas: (i) the predicted year of gas exhaustion, (ii) the projected import price of alternative fuels at that time, and (iii) the social rate of discount. For this report, we use a social discount rate of 8 percent per annum, which is admittedly arbitrary, but seems reasonable by the standard of social cost-benefit analysis.

 It should be noted that the idea of estimating an equivalent amount of fuel to replace, say, 1 mcf of gas is not a straightforward one. In the energy discourse in Bangladesh, the equivalence of energy from different sources is measured in terms of their heat generating capacity. This is not an ideal basis to determine the “economic price equivalents”, which are those prices that would make the production costs equal for producing, say, one unit of electricity by using alternative fuels. Such price equivalence usually differs from the one derived from the purely physical concept of energy equivalence, depending on the relative efficiency and costs of alternative technologies associated with the use of different fuels. The concept of “economic price equivalents” (sometimes called “replacement equivalents”) is a useful tool for energy planning, but not yet familiar in the energy discourse in Bangladesh.

To make some rough calculations, we estimate the equivalent price of imported fuels for replacing gas in the medium to long run to be US$ 6 per mcf of gas. For this we have taken into consideration several factors. The above price of  gas roughly corresponds to the medium to long run oil price projections of around US $35 – 40 per barrel of crude oil (notwithstanding the current price hike) converted by the conventional energy equivalent between gas and fuel oil. Another relevant factor is the existing prices of natural gas and fuel oil in countries such as Canada where both the energy sources are abundantly used for electricity generation; the assumption being that market forces would bring the relative prices close to “replacement equivalents”. For example, the 2004 plant-gate price of fuel oil in Canada was US$ 41 per barrel and that of natural gas US$ 5.42 per mcf.  A third consideration is the current negotiations regarding the possible price of gas imported through pipeline in this region (such as by China or India from Myanmar); this price is likely to be nearly US $5 per mcf.

According to some estimates, the country will run out of gas in ten year’s time (by 2016) given the domestic gas demand projections along with the estimated “proven and probable” discovered gas reserves. Applying the annual discount rate, the implied present economic price of gas works out to be US$ 2.78, which would rise by 8 percent annually during the ten year period (after which imported fuels will replace domestic gas). It should be noted that the estimated present economic price of gas is highly sensitive to the assumed gas exhaustion year. Thus, extending the exhaustion year by 5 years and 10 years (that is, year 2021 and 2026) would reduce the current economic price to US $ 1.86 and US$ 1.28 respectively. If, on the other hand, it is assumed that the country will need to start importing fuel to partially replace gas even before the exhaustion year (because, say, the oil fields are not developed in time to meet domestic supply), then that will be the year when the economic price of gas becomes equal to the equivalent price of imported fuel. The projected economic price will also need to be revised whenever new information will be available regarding the domestic gas supply-demand scenario.

 While the economic price is projected to escalate annually under any given scenario, it is interesting to see what would be the equivalent price in a sale contract in which the price in dollar terms were to remain unchanged from year to year. This is not the simple annual average of the projected price, since paying a higher amount in the initial years is not the same as doing so in the later years (again because of the social discount rate). The annual price of gas in the above three scenarios of gas exhaustion in 10, 15 and 20 years works out as US$ 4.14, $ 3.31 and $ 2.60 respectively. If we assume the replacement price of imported energy to be $ 5, instead of $ 6 as assumed above, these prices will proportionately change to US$ 3.45, $ 2.76 and $ 2.13 respectively.

 The above analysis shows the crucial importance of strengthening gas exploration efforts to determine the country’s gas reserves, since such knowledge is essential for making long run plans for gas utilization. In all probability, Bangladesh has gas reserves to last a much longer time than is indicated by the currently available estimates of proven reserves. As the estimate of proven gas reserves increases, and provided enough investments are made in developing the gas fields to meet domestic demand, the estimate of economic price of gas will have to be revised downward. But prudent economic planning should not rely too much on risky assumptions. This is a fundamental problem in making commitments regarding the ensured supply of gas at a pre-determined price as is sought in Tata’s proposal.

 A conceptually less appealing but practical way of finding an economic price of gas would be to estimate the average cost of producing an extra unit of gas and then add a premium on it, the premium being the rent earned for the ownership of gas. Additional gas production in Bangladesh will come largely from the fields operated by the IOCs. The average cost of this gas would depend on the share that Petrobangla gets and the price charged by the IOCs for the remaining share. This will vary depending on the stage of the project life cycle (involving the cost-recovery phase) and between different PSCs as well as between off-shore and inland gas. The transmission cost will have to be then added to get the end-user gas cost. Rough estimates suggest that the average wellhead cost may be US$ 2.00 to $2.20/mcf in the cost recovery phase and $ 1.24/mcf in the later phase. Averaging this and adding a transmission cost of $ 0.20/mcf and a minimum premium of $ 1.00 will work out to be around $ 2.90.

  The estimation of economic price of gas is important not only for negotiating the terms of contracts for prospective FDIs, it has much wider implications for determining the most economically beneficial use of gas. It is “wasteful” to use an extra unit of gas for uses from which society gets benefit less than the economic price of gas. When it is argued that exporting gas can jeopardize the country’s energy security, it must be recognized that using gas wastefully for domestic use can equally do so. In particular, when long-run commitment is being made for supplying gas, such as in setting up a fertilizer factory, the social benefit from the investment involved needs to be assessed on the basis of appropriate pricing of gas (along with the option of importing fertilizer instead of producing domestically). Whether gas and fertiliser prices should be subsidized for the benefit of farmers, and by how much, is an altogether different issue.

 Bangladesh has a history of subsidised gas supply. Almost 70 percent of the gas produced annually is sold to the state-owned fertiliser factories and power plants at a highly subsidised price of $ 1 per mcf. The private power producers also buy gas at a subsidised price of $ 2 per mcf. The joint-venture fertiliser factory, KAFCO, has been supplied gas at an average price of $ 1.22 for ten years; only recently the price has been raised to $ 2.34 which is also about the price now charge for industrial use of gas.

 Gas Contract with Tata

 What can we say about a gas supply contract with Tata on the basis of the above analysis? Overall, the present price of gas for industrial use ($2.35 per mcf) does not seem to be highly misaligned from its true economic price; but it will need to be continuously adjusted upward if the estimates of gas reserves and the projected demand-supply scenario for gas remain unchanged. If the government commits to a gas price policy in which the price of gas will be revised from time to time keeping in view the gas reserve position and the projected cost of importing alternative energy, Tata may be offered gas at the prevailing price for industrial use. Or, such a price policy may be formulated for FDIs only (since the benefit of subsidy to local producers stays home) or for industries in which the use of gas as a proportion of value-added is higher than a certain level. There will then be no need for making special price deals with Tata for gas sale.

 Tata wants some kind of guarantee for assured gas supply during the life of the project. This is problematic in many respects. What happens if the country runs out of gas?  For understandable reasons, Tata would like to ensure that it is not discriminated against at times of temporary gas shortages or supply disruptions. The rationale behind Tata’s proposal lies in the belief that new gas reserves will be discovered (or coal will be available as an alternative energy source) so that no genuine gas shortage will appear during the lifetime of its proposed projects. To the extent that there is a risk of that belief not proving correct, that risk should be fairly shared by both Tata and Bangladesh. One possible formula for that may be to estimate the proportion of the country’s total gas supply to be used by Tata at the beginning of its going into full production and ensure that Tata will continue to have a claim of that share at the minimum. In that way, as long as gas production does not decline, Tata will have nothing to worry. But there may be other workable formulas as well.

 To create investor confidence under gas pricing and sale arrangements as discussed above, the gas exploration efforts must be strengthened. There is a problem in depending on the IOCs entirely for gas exploration. There is a large gap between high and low projections of domestic gas demand. The IOCs will tend to plan their exploration and gas-field development activities keeping in view the low demand projection, since they would like to be sure about getting quick returns from their investments through full-capacity production from the discovered fields. For this reason, it is important to strengthen the domestic capacity for gas exploration.

  The Implication of Coal Mining

 There now seems to be a possibility that domestically mined coal may provide an alternative to gas as a source of energy. The availability of coal can lower the economic price of gas by deferring the projected date of gas exhaustion and also by providing an alternative to gas even before that date. Much will depend on coal production projections, the pattern of use of coal and the estimates of recoverable reserves. There will be a need for a comprehensive energy policy for making decisions regarding the use of gas and coal as competing sources of energy. A discussion on this would be premature for the time-being, given the many uncertainties regarding the economic feasibility of coal mining and the likely volume of production.

 Indirect Benefits (and Costs)

 As indicated earlier, the investments may generate indirect or economy-wide benefits by providing balance of payments support and by boosting production in other sectors through the mechanism of forward and backward linkages. Some likely caveats in estimating these benefits were also mentioned earlier. Unfortunately, by ignoring these caveats and lacking any credible analytical framework, the EIU report ends up making exaggerated and unsubstantial claims about these benefits. This diminishes the value of the report, since it is these indirect macroeconomic benefits that are mainly dealt with by the report. This is not to ignore some substantial indirect benefits (as well as some costs) that may genuinely arise as a result of these investments.

 The EIU report estimates that the additional electricity generating capacity of 500MW (in addition to captive power for the steel mill) will translate into 0.1-0.2 percentage point higher GDP growth. In addition, the direct contribution to GDP would be equivalent of 1.9 percent of nominal GDP annually, which in turn would lead to even higher GDP through an estimated “multiplier” of around 1.5. The multiplier of 1.5 is meant to imply that the expected annual gross sales of about US$ 1.8 billion from Tata’s operations will lead to additional production worth about US$ 800 per year through the purchase of inputs.

 Attributing the above benefits to Tata’s operations is based on rather naïve assumptions. The “multiplier” effect (that is the spill-over effects of the investments working through demand linkage) is estimated in the report by a simple-minded application of the so-called input-output analysis. As mentioned before, much of this multiplier effect cannot be attributed as additional contribution of Tata’s investments towards GDP growth, since the expansion of production activities in an economy like Bangladesh is generally constrained by lack of inadequate production capacity rather than by demand deficiency. As regards the direct impact on the economy, the report refers to GDP instead of GNP or GNI, and thus ignores the all important issue regarding how much of the value-added generated will be repatriated as profits. Curiously, this is also ignored while assessing the impact on the balance of payments.

 There will be of course some demand-driven expansion of activities in sectors where employment can be created with very little investment in fixed capital. Such employment will be mainly in service sectors – such as the employment created in and around the township that will grow around the steel mill. The quantification of employment and incomes generated in this way will require a much more discriminating application of the input-output analysis than is attempted in the EIU report.

 Tata’s operations will create demand for infrastructure provision than can in fact lead to costs to be incurred by the government instead of being a source of large indirect benefits as claimed by the EIU report.  In particular, there will be an increased demand on railway transportation for the import of iron ore and the export of steel and coal. This will need substantial investment in railway infrastructure, along with improvement in management efficiency to ensure that such transportation does not incur losses for the government. The viability of the investments will also depend on the tariffs charged, given the fact that the public transport systems, including railways, are heavily subsidised in Bangladesh.

 The benefit from steel production will in fact come more from forward than backward linkages. Tata’s project will produce about US$ 1 billion worth of steel annually, 75 percent of which will be exported after meeting the country’s entire domestic demand. Because of the shift from the current import regime to an export regime, the domestic price of steel will be lower; since it will be related to the export price rather than the import price. There are a whole range of industries and construction activities that will get a boost directly or indirectly from the cheaper supply of steel, and the benefit will increase with the growth of steel-based industries in the country. Although some existing facilities for steel production, mostly from scraps, may be adversely affected, this will be much more than compensated by the benefit.

 A major benefit from Tata’s operations will be the balance of payments support provided through net exports (estimated at US$ 628 million annually) and import substitution of (US$ 300 million annually).  The extent of net contribution to the balance of payments will of course be much lower because of the repatriation of profits; and it will also depend on whether the proposed investment package is fully implemented or some components are left out.

   Land Acquisition

The implementation of Tata’s proposed projects will need land acquisition and resettlement of residents and the construction of road links to the plants. Agreement will be needed about how Tata proposes to pay for the costs involved. While Tata has proposed to buy the land at market prices, an alternative would be for the government to incur the entire costs and to recover it through renting or leasing the infrastructure to Tata. Land being the scarcest resource in Bangladesh and as it becomes even scarcer with the growth of economic activities, land prices tend to increase quite rapidly in real terms. Thus, buying land and even keeping it idle may prove a profitable investment. The sale of land to foreign investors could thus lead to windfall gains to them at the time of winding up the investment project.

 Conclusion

 Detailed data on the project profile are required for a more rigorous evaluation of the project, component by component. On the face of it, the steel-power complex appears   promising, since it combines the advantage of the availability of iron ore and energy resources in India and Bangladesh respectively; however, many strategic issues need to be resolved, particularly regarding infrastructure provision, land acquisition and the feasibility of coal mining. The issue of gas pricing is the key to the determination of Bangladesh’s net economic benefit from the investments. In fact, the economic viability of the fertiliser project may depend largely on subsidised gas supply, particularly when the investment returns need to cover the country-risk factor as perceived by the foreign investor. In making a decision, any subsidy in gas pricing must be compared with the estimated benefits from the investments.

Foreign Direct investment: impact on sectoral growth in BanglaDesh

By Iftekhar Ahmed Robin, a researcher in the Policy Analysis Unit

(PAU), the research wing of the Central Bank

Until the1980s, most developing countries viewed Foreign Direct Investment (FDI)1 with great suspicion. In recent years, however, FDI restrictions have been significantly reduced. Most countries offer incentives to attract FDI, such as tax concessions, tax holidays, accelerated depreciation on plants and machinery, export subsidies, import entitlements, etc. Many theoretical and empirical studies have attempted to account for the reasons of FDI movement across the globe. As a developing country, Bangladesh needs FDI for its ongoing development process. Since independence, Bangladesh has been trying to be a suitable location for FDI. Special zones have been set up and lucrative incentive packages have been provided to attract FDI. Total FDI inflow has been increasing gradually over the years. In 1972, annual FDI inflow was 0.090 million USD (UNCTAD 2005), but after 33 years, in 2005 annual FDI rose to 845.30 million USD. The time has come, then, to investigate the benefit of FDI inflow in different sectors of the economy. Until recently, there has hardly been any empirical study undertaken to examine the impact of FDI on sectoral growth. What has been done so far mostly addresses the barriers and prospects of FDI (Rahman and Hossain 2001): one study investigated whether optimum utilization of natural gas was directly or inversely correlated to the FDI in that sector (Anu Muhammad 2004). The objective of this paper is to address the impact of FDI on sectoral (agriculture, industry and service) growth patterns. It analyses data from secondary sources and estimates the relationship between inflow of FDI and annual output growth achieved in different sectors between 1995-2005, by computing correlation co-efficient and corresponding p-values. The analyses reveal that FDI inflow in the industrial sector does not appear to correlate much with industrial growth; however, it relates better to service sector growth. FDI inflow in the service sector is fairly well correlated with the growth in that sector. FDI in agricultural sector does not have any close relationship with the sectoral growth pattern. The paper is organized as follows: Firstly, it shows the trend of FDI inflow at both sectoral and aggregate levels. Secondly, it explains the relationship between FDI inflow and sectoral output growth based on Pearson Correlation Co-efficient. Thirdly, it provides an account of country-wise FDI inflow. Fourthly, it reports componentwise FDI inflow. Fifthly, it reviews FDI related outward remittances. Sixthly, it discusses net effects of FDI and policy recommendations in guiding FDI decisions. Finally, it offers some concluding remarks. 1. Foreign Direct Investment (FDI) is capital provided by a foreign direct investor, either directly or through other related enterprises, where the foreign investor is directly involved in the management of the enterprise. 182 Foreign Direct Investment: Impact on Sectoral Growth in Bangladesh

 The magnitude of FDI

FDI played a minor role in the economy of Bangladesh until 1980, a crucial year of policy change. This is because the Government of Bangladesh (GOB) then enacted the ‘Foreign Investment Promotion and Protection Act, 1980’ in an attempt to attract FDI. Except five industries, which were reserved for the public sector, (defence equipment and machinery, nuclear energy, forestry in the reserved forest area, security printing and minting, and railways), FDI was allowed in every sector of the economy.

 Table 1 shows total FDI inflow (including that in Export Processing Zones or EPZs) over the last 11 years (1995-2005). Data reveals that in 1999, there was a sudden fall in FDI, and again in 2001, mainly because of continued political unrest, which discouraged foreign investment. Subsequently, it took several years to regain the confidence of foreign investors. FDI stabilized afterwards but remained below the heights reached during 1997-2000. In spite of Bangladesh’s comparative advantage in labour-intensive manufacturing, adoption of investment friendly policies and regulations, establishment of EPZ in different suitable locations and other privileges, FDI flows failed to accelerate in the next

few years. However, in 2005 substantial improvement was achieved once more.

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FDI in Flow: Sectoral composition

There have been several shifts globally in the concentration and composition of FDI. The first major compositional shift was within manufacturing, that is to say, from import-substitutes to export-oriented manufacturing. A more recent shift of FDI has been towards services. The presence of these global changes is also evident in the Bangladesh economy which has also been driven by the opening up of service industries to FDI. With the country’s accession to the World Trade Organization (WTO), service sectors like power and energy, banking, insurance and telecommunications are being liberalized and progressively opened up. Owing to comparative advantage and an accommodative policy regime, a large chunk of FDI has gone into the ready-made garment (RMG) sector for establishing backward linkage industries, telecommunication, and power and energy sectors.

Table 2 depicts the pattern of FDI inflow in different sectors and the growth rate during 1995-2005. In fact, there has been a substantial change in the pattern of FDI inflow in the new millennium. Foreign investors are now looking at sectors like telecom, banks and power and energy, where profit growth is likely to be high. This may alter the sectoral composition in the days to come.

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Foreign Direct Investment: Impact on Sectoral Growth in Bangladesh If we compute correlation and corresponding p-values (probability) between the FDI inflow and the sectoral growth pattern, using the data in Table 2, we obtain the following results (Table 3) for 11 observations (1995-2005).

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From the estimated Pearson correlation coefficients and corresponding p values (shown in parentheses), it is evident that FDI inflow in industrial sector does not appear to correlate much to industrial growth, However, it relates better to service-sector growth. On the other hand, FDI inflow in the service sector is fairly well correlated with the growth in that sector as well as in the industrial sector. FDI inflow in agricultural sector does not have any close relationship with the sectoral growth pattern. The above pattern is suggestive of mutual externalities between growth in industrial and service sectors, though curiously, FDI in the service sector co-varies with growth in both these sectors, while FDI in industry co-varies only with service sector growth. The paucity of data prevents further inference.

 FDI in flow by source country

The emergence of new sources of FDI may be of particular relevance to low income host countries like Bangladesh. Indeed, the role of developing and transition economies as sources of FDI has been increasing with the passage of time. Transnational Corporations (TNCs) from developing and transition economies have become important investors in many LDCs. Bangladesh also has to depend on 36 countries from across the globe for FDI. Among the sources, 21 countries belong to developing and transition economies. Table 4 illustrates total FDI inflow in Bangladesh over the last 11 years from 1995 to 2005 from different countries across the world. Nearly 70 percent of annual FDI was received from only 11 countries (Table-4).

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FDI in flow by components

FDI basically consists of three components: equity capital, reinvested earnings and intra-company loans. Equity capital is the foreign direct investor’s purchase of shares of an enterprise in a country other than its own. Reinvested earnings equal the direct investor’s share of earnings (in proportion to direct equity participation), not distributed as dividends by affiliates, or earnings not remitted to the direct investor. Such retained profits by affiliates are reinvested. Intra-company loans are intra-company debt transactions, and refer to short or long-term borrowing and lending of funds between direct investors (parent enterprise) and affiliated enterprises. Table-5 illustrates the distribution of FDI in Bangladesh by its main components.

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OBJECTIVE:

 The prime objective of this term paper is to find out:

  1. The Impacts of FDI in the economic development of Bangladesh

In terms of

    • Capital formation,
    • Output growth,
    • Technological progress,
    • Exports and
    • Employment.
    • In GDP,

Concerns remain about the possible negative effects of FDI, including the question of market power, technological dependence, capital flight and profit outflow.

METHODOLOGY

Firstly, we collected the necessary information to prepare the term paper from various sources like textbook on International business, journal, newspaper, articles etc. From these sources of information concepts and ideas are developed on FDI inflows particularly and the various parameters that we assessed.

 on the basis of information collected we assessed the impacts of FDI inflows on the economic development of Bangladesh in terms of  Capital formation, Output growth, Technological progress, Exports, Employment and GDP,

Finally based on the findings we recommended formulating a set of priorities to guide FDI decisions. One should weigh both the positive and negative implications of individual FDI proposals before taking any decision on them. It would appear that specific policy directives might be revalued so as to reduce dependence on foreign bank borrowing, instead foreign and domestic investors alike should be tapped to raise more capital from the domestic equity market.

  FINDINGS AND DISCUSSION

 FDI has become the engine of development and economic progress around the world-irrespective of political and social systems existing in the respective countries. China, Vietnam, India, among many, are prime instances.

 But for causes that are either quaint or outdated or perhaps because of misinformation every time there is talk of FDI in Bangladesh certain by now well-known persons begin a well-coordinated campaign against FDI in Bangladesh in spite of the positive impact it has been seen to have on the lives of the people of the countries which have benefited from such foreign investments.

Opponents of FDI claim that such investments will kill local industries even when the proposals clearly spell out that the industries to be set up will, in fact, substitute imports of products that are not produced in the country and will moreover assist local industries to access production materials that they now have to import. Surely, reduction of import dependence cannot be against the national interest!

Asking for security of feedstock is not an unknown phenomenon in business and industry; but in reality it in no way risks complete depletion of Bangladesh’s gas reserve and certainly does not create any ground for apprehending that we will have to “import” gas. It’s a preposterous notion given that, for example in Tata’s case; a mere six per cent of today’s proven gas reserve will be consumed in the lifetime of the project and evidently much less during the secured period asked for. Equally significantly, gas will not have to be supplied at a subsidized price ever.

Yet despite the facts to the contrary opposition on imagined and/or ill-informed ideas continues against much-needed FDI. Furthermore, opposition to the utilisation and enhancement of our energy resources also persists in some easily identifiable quarters even though power requirement of the nation, both for household use and industrial needs, is not merely urgent but demands immediate answers if we are to develop economically and societally.

Obviously, the sensible route to take at this point in our economic progress is to judge investment proposals, not on emotional or partisan responses, but on the basis of clearheaded economic criteria keeping the national interest above everything else. Otherwise, the consequence is self-evident: this country will continue to debate and argue but the faster development required will not and cannot come our way.

 More foreign investment can lead to more jobs in Bangladesh, reducing unemployment, decreasing the level of poverty in the country and increasing the per capita GDP of Bangladesh. It can also be used to increase competition in the economy and can serve as a vehicle through which global best practice and technology are transferred to domestic firms, leading to wider acceptance and practice of principles like Corporate Governance and Corporate Social Responsibility. Finally, increased foreign investment can help Bangladesh successfully meet the major challenge of post-MFA (Multi Fiber Agreement) era, how to diversify our export basket and move away from exporting mostly ready made garment (RMG). This is a necessary precondition to Bangladesh’s survival in today’s new globalizing world.

 Investment in Mobile phone Sector and Transfer of foreign Exchange

In 1995, the Government of Bangladesh took a bold decision to open up the mobile telecommunication for private sector operations. Since its inception Grameen Phone has invested more than US$ 750 million. In 2004, out of total $660.8 million foreign investment, $237 million was invested in the telecommunication sector, a share of 35.93% of the total FDI in Bangladesh. As for example, Telenor of Norway got license in Pakistan and the bid price is US$ 291 million. But the license fee is fixed here in Bangladesh & it’s only US$ 16.5 million. But the call rate in Pakistan is Tk 3.50/minute and Tk 7/min. With the scope of repatriation of profit, these companies remit huge amount of money, creating additional pressure on the shaky foreign exchange reserve. They are remitting huge amount of money, putting tremendous pressure on foreign exchange.’ These companies were supposed to bring in foreign currency. ‘Apart from giving dividends, they are buying machinery and paying interests with our foreign currency.

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An increasing flow of FDI was supposed to supplement domestic investment in the country, thereby inducing employment generation, income growth and enhancement of prosperity. FDI potentially generates both direct and indirect impacts, some of which are described below:

 Direct impact of FDI in Bangladesh will concentrate on three issues: balance of payments, employment consequences, and revenue impact.

 Balance of Payments Support

 Though FDI can increase capital formation in the country, it may also create pressure on the balance of payment through repatriation of profits. As overall foreign investment was comparatively insignificant in Bangladesh, the impact of repatriation remained manageable. To keep this pressure within tolerable limits, Bangladesh has tried to encourage foreign investment in export oriented industries. Total repatriation of profit, dividends and royalties on account of foreign investment in FY03 was $266.01million, which is around $70 million higher than the net inflow of FDI for the same year. Thus, a capital starved country turns out to be a net exporter of capital.

  Employment Situation

 Due to scarcity of data on non-EPZ employment, it is difficult to draw a complete picture relating to employment generation impact of FDI. A recent study by FICCI in 2004 had the goal of ascertaining the size of employment by foreign companies in the domestic tariff area. According to this survey, a total of 129,549 persons were employed in foreign firms, accounting for 0.68 percent of total manufacturing employment of Bangladesh, the highest share of workers in foreign companies was employed in the consumer-goods and apparels industries. In the EPZs, the number of workers increased from about 130,000 in FY03 to 140,050 in FY04, which is about 0.74 percent of country’s total manufacturing employment. In all, foreign companies (EPZs and domestic tariff area together) have generated about 2.7 million jobs, which accounts for less than 15 percent of total manufacturing employment. This indicates that FDI fails to play any prime role in employment generation in Bangladesh.

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Revenue Impact

 Foreign investors are a potentially important source of revenue for host countries, and these revenues can in turn support economic and social development through increased public investment. It has been estimated that foreign investors in Bangladesh are paying around $13.20 million annually to the government exchequer. However, much revenue-earning opportunity is often lost due to excessively generous incentive packages offered to FDIs.

 Technology Transfer

 The degree of technology transfer through FDI is an important measure of impact. While any cutting-edge technologies are not brought onto the market, developing countries have

increasingly come to consider investment as one of the most important means of acquiring knowledge and upgrading their domestic production base, as well as improving the environment.

 Market Intelligence

The consensus view on the linkages between FDI and foreign trade has changed somewhat over the past decade. Most importantly, imports, exports and allocation decisions by TNCs form integral parts of an increasingly international system of production of goods and services. The fact that sharply higher shares of industrial input

goods are imported by the foreign companies illustrates the point that TNCs increasingly rely on trade in raw materials and input goods within sister enterprises to maximize profit through transfer pricing. For example, South Korean investors who came to Bangladesh in late 1980s to utilize the textile quota under the Multi-Fiber Arrangement (MFA) instilled significant market intelligence.

 Competition

The relationship between FDI and corporate sector competition is complex. Clearly, the entry of foreign competitors in and of itself acts to spur competition, particularly in economies where competition policies are weakly enforced and market incumbents assert undue influence on pricing. Competition with foreign investment also enhances efficiency within the country, leading to improvement in product quality. These efficiency gains are generated through enhanced labor and capital productivity as well as increased efficiency. These gains ultimately underpin improvements in product quality and decreases in unit prices.

NET EFFECTS AND POLICY RECOMMENDATIONS

 While welcoming FDI, we should also formulate a set of priorities to guide FDI decisions. The general principle one can easily agree on, is to promote longterm sustainable economic growth through labour-intensive economic activities, which should be the primary goal of any investment. The issue of advanced technology and its diffusion, strengthening of the country’s comparative advantage that should be to help develop the domestic capital market are among the elements that should be the next level of focus. However, within these broad guidelines, it can be observed that foreign investors are often keen to private loans. As a result, they have to remit more outside the country for repayment purposes, which creates pressure on the country; foreign exchange reserves. Foreign companies are often reluctant to arrange funds domestically or float shares in the domestic capital market. These practices do not help the capital market overcome its weaknesses. One reason is perhaps the fear that if the stock prices of these foreign companies remain low in Dhaka that may ultimately hamper their business in other locations. Of course, as of now listing in the stock exchanges is not mandatory for foreign companies. Moreover, due to restrictions on sanctioning funds (e.g., single borrower exposure limit) by domestic banks and financial institutions, foreign companies have not been looking for domestic finance in most cases. In this connection, the syndication of domestic credit being negotiated by the Saudi owners of Rupali Bank is a positive move. Recently, Bangladesh Bank (BB) issued directives for foreign owned/controlled firms/ companies seeking domestic currency term loans regarding the composition of their investment. The directive (FE Circular no.07, August 14, 2006) stipulates that debt may not exceed 50 percent of total investment.2 In spite of the negative flows generated in some years, overall FDI has helped output growth, particularly in the service and industrial sectors of the economy. However, one should weigh both the positive and negative implications of individual FDI proposals before taking any decision on them. It would appear that specific policy directives might be revalued so as to reduce dependence on foreign bank borrowing, instead foreign and domestic investors alike should be tapped to raise more capital from the domestic equity market. If some industry segments, e.g., cellular phone companies find the local market too limited, funds may be raised by floating shares simultaneously in both domestic and regional markets (e.g., Dubai, Hong Kong, Malaysia, Singapore, etc.).

CONCLUSION

 FDI can undoubtedly play an important role in the economic development of Bangladesh in terms of capital formation, output growth, technological progress, exports and employment. The relatively small share of FDI in GDP, however, indicates that thus far the potentials are far from being exploited. Concerns remain about the possible negative effects of FDI, including the question of market power, technological dependence, capital flight and profit outflow. The limited evidence gathered above tends to give credence to some of these apprehensions. On a positive note, service sector growth appears well correlated to FDI flow in this sector. Further, this has a linkage effect to the rest of the economy. Still political tension and lack of investment friendly bureaucratic attitude are often pointed out by potential investors as major impediments to FDI in Bangladesh.

There is no doubt that globalization has resulted in large increase in FDI. Greater inflow of FDI has bolstered deeper integration of World economies. Though there are some serious potential drawbacks of FDI, developing countries are not in a position to turn back from FDI. But, what they can and should do is to try to minimize its negative effects. They should look at ways to make FDI more meaningful. One option might be to encourage investment in certain sectors only. Import substitution development strategy followed by many Latin American countries and other LDCs that emphasize import substitutionaccomplished through protectionism1-as the route to economic growth. It is high time that developing countries at least agree on some basic policy frameworks so that there is not much unfair competition among them. If the present trend of giving concessions continues without trying to set the ‘basics’ rights first, it’s obvious that developing countries will collectively lose in the long run.

 In developing countries, there are strong arguments against unlimited FDI and equal treatment with domestic producers, such as loss of control over quality and quantity of foreign investment, threat of a deepening BOP crisis, suspension of domestic support policy to the weak and priority sectors, reduced possibility of technology transfer etc. Compared to the present proposals and suggestions of industrialized countries and international organizations, the investment regime under GATS Mode 3 gave increased flexibility for developing countries to minimize the adverse impacts of a full opening of their investment regimes.

REFERENCE

 A report prepared at the request of the Board of Investment, Government of Bangladesh.

  1. Azim and Uddin 2001, Senior Lecturer, Department of Management, Monash University, Australia.
  2. Stern 2002, Deputy Director, BCS Administration Academy, Dhaka, Bangladesh.
  3. Report of World Bank 2005
  4. www.supro.org
  5. Comments on the Proposed Investment by Tata Group in Bangladesh by Wahiduddin Mahmud, Professor, Department of Economics University of Dhaka
  6. Foreign Direct investment: impact on sectoral growth in Bangladesh by Iftekhar Ahmed Robin, a researcher in the Policy Analysis Unit (PAU), the research wing of the Central Bank
  7. www.en.wikipedia.org
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