The Way Forward

Taking the regional route

Dr. Khondaker Golam Moazzem

There is no denying the fact that South Asian countries urgently need huge investment in order achieve a sustained level of growth. But the region has been entrapped in a low domestic saving -- low investment situation, which hampered it's efforts for attaining the desired level of growth. In this scenario, investment from abroad, especially foreign direct investment (FDI), has been regarded as one of the major sources for boosting region's poor investment situation. To this end, South Asian countries started taking private sector-led and market-oriented policies since 1980s and in recent years, the flow FDI has been on rise in the region. But the share of South Asia is still very low compared to that received by other neighbouring regions such as South East Asia and East Asia.

So far, intra-regional investment in South Asia has been highly disappointing because of many reasons, including poor economic standing of most of the countries and poor condition of regional integration. Since South Asian countries are now actively pursuing a regional integration process under South Asian Free Trade Agreement (SAFTA) and other regional and sub-regional trade agreements, there is a strong prediction by researchers and business bodies that intra-regional investment will grow in the coming years. The examples of European Union, ASEAN, and NAFTA can be cited where member countries have received sizable amounts of investment from within the region. Thus regional cooperation for investment in South Asia is urgently needed to realise the potentialities in different sectors of the constituent economies. However, there is lack of knowledge and understanding about the appropriate mechanism to develop regional investment cooperation in South Asia.

FDI flow in South Asia
There was almost no FDI flow in South Asia before 1990 (less than US$1 billion) and after taking structural adjustment policies and liberalising major sectors in early 1990s, FDI flow has increased to a considerable amount, it went up to US$1,736 million in 1991-96, and in 2004 it has reached the highest amount of US$7 billion. Major FDI recipients are India, Pakistan, Sri Lanka and Bangladesh, but their shares vary widely; India alone received more than 2/3 of total FDI inflow into South Asia. Besides, the amount of FDI received by South Asian countries is less than 3 percent of total FDI flow in Asia during 1991-96 periods, and it has exceeded 5 percentage points only in 2003. On the other hand, South East

Dhaka summit gave a boost to free trade

Asian countries received more than 17 percent of total FDI flow in Asia. FDI flow into South Asia in terms of global figures has recently crossed 1 percentage point (1.14%).

Majority of South Asian countries are still looking for FDIs from a limited number of developed countries such is USA, UK, Japan and some developing countries like Korea, Hong Kong, Malaysia. India, the only country in South Asia is the major investor in Nepal. All this indicates that most of the South Asian countries are targeting the same sources for FDIs and competing with each other to attain maximum possible share of FDI. Transnational companies (TNCs) are not so much interested to invest in South Asia and their only mentionable presence is found in India and Pakistan, where number of foreign affiliates is 1,416 and 583 respectively. On the other hand, foreign affiliates of TNCs have substantially invested in South East Asian countries. South Asian countries, therefore, need to find out the loopholes that hinder large scale investment in the region.

In terms of sectoral distribution, investment is largely concentrated in the service sector (power and energy, telecommunication etc.), which is followed by manufacturing sector (textiles, chemicals and petrochemicals). This indicates that FDI in South Asia is particularly targeting large domestic markets.

South Asia's intra-regional FDI in most countries is less than 5% of the total FDI flow, while intra-regional flow of FDI in South East Asia is much higher. Among South Asian countries, India is the major investor within the region but at a very small amount, especially compared to its outsourcing in other regions. India's FDI outflow in 1996-97 was on average US$ 96 million, which in 2003 in creased up to US$913 million (World Investment Report, 2003). In 2003, India's investment in Sri Lanka, Nepal and Bangladesh was only 0.7%, 0.5% and 0.1% respectively of its total outward investment. Interestingly, during 1996-2003, India's average investment in USA was 19%, and in Russia 18%, and it is becoming an important investor for the UK and France. However, outward flow of FDI from other South Asian countries is either low or not directed to the region. It is perceived from the recent development of trade and investment agreements that South Asia's importance as a strategic location for investment will gradually increase, especially when SAFTA will start to operate.

Different agreements and scope for investment in South Asia
In order to ensure guarantee and protection to foreign investment, South Asian countries are signing investment treaties with developed and developing countries. Bangladesh has so far signed bilateral Investment Treaties (BITs) with 20 countries, India has signed with 57 countries, Pakistan with 23 countries, Sri Lanka with 39 countries and Nepal with 3 countries. Most of these treaties have been signed with OECD countries, and some Asian countries. South Asian countries at the same time have signed treaties for avoidance of double taxation (DTTs) with these countries. Interestingly, there is lack of interest of South Asian countries for signing BITs and DTTs within the region, although intra-regional trade and investment are becoming more important especially when SAFTA will be operational in the near future.

All the South Asian countries have signed different trade agreements both within and outside the region. The most promising trade agreements as already mentioned is SAFTA, which has become operational from January 2006. It proposes a tariff reduction of 20% by developed country members and of 30% by least developed country members by 2008 and a further reduction of tariff to 0-5% by developing country members by 2013 and that of least developed country members by 2016. A complete elimination of tariffs as projected will increase the intra-regional trade by 1.6 times of the existing level of intra-regional trade. This will attract a lot of intra-regional and extra-regional investment in South Asian countries, and presumably investment of TNCs as well. Under the agreement Bay of Bengal Initiative for Multisectoral Trade and Economic Cooperation (BIMSTEC) member countries such as, Bangladesh, India, Myanmar, Sri Lanka, and Thailand have identified different areas for cooperation, such as textiles and clothing, drugs and pharmaceuticals, gems and jewelry, horticulture and floriculture, processed food, automotives and parts, rubber, tea and coffee, coconut and spices. Numerous opportunities have been identified under sub-regional cooperation initiative, for example, the Bangladesh, Bhutan, India, Nepal Growth Quadrangle (BBINGQ) envisages multi-modal cooperation, especially in transportation and communication, energy, natural resources, trade and investment facilitation and promotion, tourism and environment. Moreover Bangkok Agreement would provide extended opportunities for intra-regional and extra-regional investment; in this context, opening of the markets of China and Korea and availability of low cost resources of Bangladesh and Cambodia are worth mentioning.

However, a slow progress in implementing regional trade agreements has led member countries to sign more bilateral trade agreements with regional member countries. Under India-Nepal FTA, Nepalese manufactured goods get duty free access to Indian markets, which already influence Indian investors to invest in Nepal. India and Sri Lanka signed FTA in 1998, which has a positive impact on bilateral investment situation in Sri Lanka. Several others bilateral FTAs are currently on the table, such as between Bangladesh and India, Bangladesh and Pakistan and Bangladesh and Sri Lanka. Outside the region, India has signed a draft framework bilateral free trade agreement with ASEAN countries and South American countries. South Asian countries, therefore, can develop vertical and horizontal linkages within and outside the region, which can be an effective mechanism to attract more FDIs.

South Asian LDCs (Bangladesh, Bhutan, Nepal and Maldives) have duty free market access to EU, Canada and some other countries under GSP facility. Under TRIPs of WTO, LDCs get extension of time for not signing TRIPs agreement for pharmaceutical products until 2016. All these facilities would make LDCs of South Asia attractive to prospective investors.

In search of an effective mechanism for investment cooperation
So far, South Asia's attractiveness to foreign investors is judged in terms of its comparative advantages on low cost labour, natural resources, market access to developed countries etc. Technological structure has gradually improved from resource-based to low and medium tech. structures facilitating technologically intensive investments as well. It is argued that FDI in South Asia has been concentrated in a limited number of sectors, especially in service related activities, although South Asia has immense potentiality in various other sectors, which needs to be explored. However, exploring those potentials of different sectors of different countries and creating an appropriate mechanism to make the regional cooperation process operational, is not an easy task. This is because most of the countries have similarities in terms of resource structure, production process and potentials in different sectors, which would make the cooperation process difficult.

According to information collected from various sources, India's potential sectors are transportation, electrical equipment, ICT, trading activities, services, pharmaceuticals, food processing and telecommunications. Pakistan has potentiality in infrastructure, tourism, housing and construction and ICT. Sri Lanka seeks FDI for agricultural products, mining, timber, fishing, mass communication, education, shipping, air transport, coastal development etc. Bangladesh has potentiality in textile, ceramic, light engineering, natural gas-based industries, leather, agro-processing, ICT etc. Maldives has potentiality in fisheries, financial sector, transport, and infrastructure. Nepal looks for FDI for energy-based industries, tourism, mineral resources, agro-based industries, and services. Bhutan demands FDI in fisheries, finance, transport, infrastructure, aqua culture, and management. The sectors in which countries have unique potentiality could be easily explored by foreign investors, especially by South Asian investors without competing for FDIs of all sectors providing equal weight. For example, Bangladesh has unique potential in textile, ceramic, natural gas-based manufacturing industries, leather and frozen foods, India has uniqueness in drugs and pharmaceuticals, and Sri Lanka's in mining and processing of non-renewable, timber, mass communication, education and freight etc. It appears that developing countries have uniqueness in relatively capital-intensive sectors, while LDCs have it in relatively labour intensive ones.

However, there are sectors where two or more countries have their potentialities, and would like to attract FDI by competing with each other. Since countries of the region are at different stages of development, they have differentials in quality of human resources, technological readiness, infrastructural development etc. There is a huge possibility for interlinking complementary sectors between different countries. For example, India and Pakistan have FDI demand on ICT, where lower-end component of investment in manufacturing and services of ICT could targeted by Pakistan and higher-end components could be opened for investment in India. Countries that are relatively technologically developed would be better off setting their target at high-tech component of potential industries, and could leave the low tech. part for investment by least developed countries, which have comparative advantages there.

Such a mechanism has started functioning between India, Sri Lanka and Nepal. India-Sri Lanka FTA has stimulated new and more Indian FDI in Sri Lanka, mainly in rubber-based products, ceramics, electrical goods and electronics, wood-based products and consumer goods, which are worth an investment of $145 million (RIS, 2005). During the past three years, leading Indian companies such as Gujarat Ambuja, Asian Paints and Larsen and Toubro have committed substantial investments in Sri Lanka, while CEAT and Taj Hotels, for example have expanded their operations.

Where does Bangladesh stand?
Bangladesh has recently taken a target-oriented approach to enhancing FDI in the country. Board of Investment (BOI) has targeted FDI to grow from US$ 400 million in 2003 to US$ 1 billion by 2006. In view of this target, BOI has invited prospective TNCs to invest in Bangladesh, especially from India and UAE etc. After taking the approach, BOI reached nearer to the targeted level in 2003, but fell behind in 2004. In the current state of FDI inflow, it will be a challenge to achieve the targeted US$800 million in 2005. However, there are a number of good investment proposals that are now under negotiation.

In 2004, India, Pakistan and Sri Lanka have invested about US$ 4.67 million, which was only 1.6 percent of the total. In July-June 2003-04, India has formally submitted investment proposal worth of US$10.14 million for agro based (copara oil), service (cargo service, computer software), engineering (railway track fitting), chemical (ball point pen), and food and allied (bakery) sectors. Pakistan has formally submitted proposal worth of US$ 0.36 million for services (test tube baby, kits and cylinder fixation in vehicles, telecom, computer software), while Sri Lanka has proposed to investment an amount of US$ 0.14 million in engineering products (steel products). It is evident that South Asian investment in Bangladesh has mainly targeted the country's growing market, while there is not much of investment noticeable in the export-oriented sectors. It is expected that Tata's investment in Bangladesh would induce other big investors of the region to invest and there are some signals in that direction as evidenced in registering new investment proposals with Bangladesh.

Challenges ahead
It is evident that an appropriate mechanism needs to be set upto exploit the potentialities of investment cooperation in South Asia. Under the proposed mechanism countries can effectively benefit from increasing inter-regional flows of FDI which would not distort each other's interest. But there are a number of issues that need to be resolved in order to get results from such a cooperation mechanism. South Asian countries immediately need to improve business environment in their respective countries. Firstly, South Asian countries should immediately sign BITs and DTTs with other member countries. Secondly, South Asian countries need to improve their infrastructure, such as power, transport, port, which would substantially improve the region's competitiveness.

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The author is Research Fellow at the CPD