My last column was published at the end of a large conference in Dhaka, a business summit intended to attract foreign investment. I argued that such events, although useful, may not achieve the desired results if certain processes are not put in place and some major irritants are not removed.
In this column, I dig a bit deeper into the foreign direct investment (FDI) scene. The government has been talking for a long time about attracting FDI. Let us look at some statistics to assess what all this talking has achieved in terms of actual FDI inflows.
The data are from the Bangladesh Bank, and it is useful to understand the meaning behind this data.
The Bangladesh Bank distinguishes between three types of FDI: Equity capital, reinvested earnings, and intra-company loans. Equity capital can come from both new foreign investors, ie, those investing for the first time in Bangladesh, and from foreign investors already in the country who bring in fresh equity to their invested ventures. But reinvested earnings and intra-company loans relate only to existing foreign investors.
A foreign investor may reinvest all or part of its profits earned from the investment in Bangladesh. It may do so for a variety of reasons, such as expanding the business, replacing depreciated machinery, introducing new technology or for some other reason. This would appear in the Bangladesh Bank data as reinvested earnings. The parent company may also provide loans to its invested company in Bangladesh. This falls in the category of intra-company loans.
These distinctions are important. We want to know how much of the net FDI flows each year is due to our ability to attract new investors vs our ability to create conditions that encourage existing investors to invest more.
We shall come to that question in a moment, but let us start by looking at overall FDI flows. The first chart shows net inflows of FDI to Bangladesh for the past twenty-five years. The solid line shows actual inflows while the dotted line depicts the long-term trend. It is important to look at the overall trend since actual flows may fluctuate a lot from year to year. In the chart, I have drawn a non-linear trend line because that represents the trend better than a linear one.
In 1996/97, at the mid-point of Bangladesh's journey as an independent country, FDI inflows were very modest, about $387 million annually. It remained so till 2010-11 after which we observed a faster rise in FDI inflows.
In most years, FDI inflows have been close to the trend line. But the pattern has been more erratic in recent years. FDI inflows shot up to $3.89 billion in 2018-19, a 50% jump over the previous year. This is largely due to an unusually high FDI inflow that year in two sectors, power and food.
The advent of Covid led to a drop in FDI inflows, which fell substantially below trend in 2019/20 and 2020/21. The 37% jump in the last fiscal year (2021/22) is thus more a recovery from these low levels, rather than a real acceleration of FDI inflows. Indeed, as we can see from the chart, FDI inflows in 2021/22 were exactly on trend.
The shift from a modest level of FDI inflows (below $1 billion annually) to moderately higher flows in the past decade, reflects the attraction of a growing domestic market in Bangladesh, and increased political stability. The government may like to claim that this increase is due to its investment promotion activities. One can't be sanguine about such a claim.
This is evident from Chart 2. It was mentioned earlier that two categories of FDI flows, ie, reinvested earnings, and intra-company loans, represent investments by foreign investors already in the country. Chart 2 shows that these two categories, important to begin with, have become even more so in recent years.
If we look beyond year-to-year fluctuations, we notice a declining trend in this share during the period 1996/97-2007/08. But after that, the share increased, rising from 30% in 2007/08 to more than 84% in 2013-14.
Even after a slight decline in recent years, the share of FDI coming from existing investors remains quite high -- it was 60% in 2021-22. Actually, the share is even higher because a part of what is shown as equity capital also comes from existing investors. Unfortunately, the published data from the Bangladesh Bank does not provide a breakdown of this category of FDI.
Nonetheless, the bottom line is clear. The bulk of our FDI inflows are coming from investors already in the country and not from new investors. This suggests that investors who are already here have succeeded in navigating the challenging investment climate in the country and are making sufficient profits that motivate them to invest more.
This is good news. However, it is possible that such investors had planned to reinvest even more but had been discouraged by adverse policy or regulatory actions by the government. We don't if this is the case.
This is where an investor grievance mechanism, something I discussed in my previous column, becomes handy. Such a mechanism not only helps address problems that lead investors to abandon or cut down their investment plans, but also helps us understand if we are missing out on some reinvestment potential.
But the more important point is this. We don't seem to be doing well in attracting new investors. Here, the rhetoric is not matched by success on the ground. This brings me to a point I made in my last column. We need to have good tracking systems to assess the status of potential investors, such as the ones who show up at business summits or investor roadshows.
How far have they progressed? If they have got stuck somewhere, where is it and why? If they have lost interest in Bangladesh, why is that so? If policy and regulatory uncertainty is deterring them, what can we do to give them more comfort?
The final point I made in my last column was about the composition of the FDI flows. I argued that it is very important for Bangladesh to attract investment in export-oriented activities, especially those that will open new markets for us and give us a foothold in sophisticated global value chains.
The Bangladesh Bank data provides a sectoral breakdown of the FDI flows. I wish the data were granular enough for me to identify the specific products or services that the investments will produce. That would make my analysis more rigorous. However, even the available data allows us to reach an important conclusion, which would not change much even if more disaggregated data were available.
Let me explain what I did with the data. I defined a few categories of FDI according to the sectors where these went. Thus, FDI in the gas and petroleum sectors are classified as ‘natural-resource seeking' FDI. Here, the foreign investor is primarily interested in exploiting the natural resources of the country.
FDI going to the trading, cement, food, chemicals, pharmaceutical, insurance, non-bank financial institutions, banking, construction, power, and telecommunications sectors, and a few less important ones, are termed as ‘market-seeking' FDI. Here, the investor is primarily targeting the Bangladesh market, hence the term market-seeking.
Some of the investments in these sectors may lead to exports (such as pharmaceuticals) but, as mentioned above, the available data are not granular enough for me to make that distinction. This is not a big problem though because the numbers involved are not that large.
Finally, I have classified FDI going to agriculture and fishing, leather and leather products, textile and apparels, computer software and IT as ‘efficiency-seeking' FDI. Such FDI is seeking to exploit the export market using Bangladesh as an efficient production base from which to export.
As with the other categories, the assignment of the sectoral values to this category may not be perfect since some of the FDI in these sectors may be targeting the domestic market instead of exports. But this slight imperfection in my analysis will not change the picture much.
So, what do we find about the sectoral distribution of FDI flows into Bangladesh? Chart 3 provides the answer. It shows the composition of the stock of FDI at the end of three fiscal years: 2011-22, 2018-19, and 2021-22. The findings reveal something that we should be concerned about, ie, much of the FDI coming to Bangladesh is of the market-seeking type.
The scenario has not changed much over the years. Ten years ago, a little more than half (53%) of the FDI stock was of the market-seeking type. At the end of June 2022, the share had increased slightly to about 58%.
In other words, most of the foreign investors are coming to exploit the domestic market, not to help Bangladesh make a breakthrough in global value chains. Efficiency-seeking FDI, ie, the kind of foreign investment that uses Bangladesh as an efficient base to export abroad, constituted only 27.5% of the stock of FDI ten years ago. At the end of June 2022, this share had fallen to 23%.
Diversifying exports is a major development priority of the Bangladesh government. This is where FDI can be very useful for us since foreign investors have the technology, knowledge, brand recognition and market links to help us make a breakthrough in global markets, especially in technologically sophisticated products. The data presented in Chart 3 shows that, so far, we have failed to leverage FDI to help achieve this objective.
In this note, I have gone beyond the feel-good headlines and rhetorical pronouncements of government leaders to project a somber picture of our success (or lack of it) in attracting FDI, especially that of the right kind. The results on the ground, at least till the end of the last fiscal year, do not seem to match the rhetoric.
It is possible that the FDI proposals that are currently being discussed may change the above picture substantially, both in terms of volume and composition.
The flagship agenda of the government, ie, the Economic Zones agenda, may be giving a boost to foreign investor interest. I could not say anything about FDI in the pipeline since such data are not publicly available. It will be useful if the government shares detailed data on planned foreign investments.
A prominent Indian journalist once remarked on the progress of reforms in his country, “After all is said and done, it appears that more has been said than done!” We surely don't want to be in such a situation.
Syed Akhtar Mahmood is an economist, previously with an international development agency.