Monday, December 12, 2005
The Promotion of FDI and the Role of Policies in Attracting FDI
Still related to my previous post below - understanding the gap between China's and India's success in attracting FDI.
A related argument is that China does better in attracting FDI than India because of its attitudes, policies and procedures.
The World Bank Group carried out a survey of a sample of firms in China and India and found that, on average it takes 10 permits compared to 6 in India and 90 days in India compared to 30 in China to start up a new business. China is also thought to have more flexible labour laws, a better labour climate and better entry and exit procedures for business.
Wei mentions a survey by the Economist Intelligence Unit that indicates that China is more attractive than India in the macroeconomic environment, market opportunities and policy towards FDI. India scored better on the political environment, taxes and financing.
The A.T. Kearney survey revealed that in 2002, China came first as FDI destination in terms of investment plans of the MNEs surveyed, displacing the US for the very first time. India came 15th.
The Federation of Indian Chambers of Commerce (FICCI) 2003 survey suggested that China had a better FDI policy framework, market growth, consumer purchasing power, rate of return, labour laws and tax regime than India.
The contrast in the performance of China and India can also be related to the timing, progress and content of FDI liberalisation in the two countries and the development strategies pursued by them.
The Role of Policies
China opened its doors to FDI in 1979 and has been progressively liberalising its investment regime. India allowed FDI long before that but did not take comprehensive steps towards liberalisation until 1991 (Nagaraj 2003). Two distinct phases can be identified in India’s foreign trade and FDI regimes: the pre-1991 reforms phase, and the post-1991 phase. These are looked into in detail by Balasubramanyam et al., among others. Prior to 1991, the Indian government exercised a high degree of control over industrial activity by regulating and promoting much of economic activity. Licensing, import controls and reservations were three forms of protection that resulted in monopolies, leading to inefficiencies. FDI policy put severe restrictions on foreign direct investment. The policy framework specified industries in which both foreign financial and technical participation were allowed, those in which only technical collaboration was permitted, and those in which neither technical nor financial participation was allowed. India’s reputation for hostility towards FDI though is mostly due to the restrictions on equity participation and export obligations imposed during the 1970s. These restrictive policies resulted in a dramatic decrease in the number of collaboration agreements over the period 1967-79, and the proportion of agreements with foreign equity participation fell from 36% during the years 1959-1966 to 16% over the period 1967-1979 (Kumar, 1994).
The policy regime that pre-dates 1991 has had an impact on the distribution of FDI across economic sectors, away from plantations and minerals and into manufacturing industries which accounted for 85% of the total FDI stock. A substantial proportion of FDI in India has been located in the higher-end spectrum of industries and services, while most FDI in China has taken place in the lower-end of the spectrum, mostly in electronics, which relates to assembly operations. Some view India as being unique among developing countries in the sense that it has a very large share of its GDP in the mostly informal part of the services sector. In 1980, around 25% of its GDP originated from the services industry, against 49% in China-. The services industry contributed to 21% of the Chinese GDP, against 37% in India. In the following two decades, India saw the decline in the share of agriculture to be absorbed by services, not manufacturing industries as in China.
Therefore, the two countries attracted very different types of FDI and pursued different strategies for industrial development. As summarised by the United Nations (2004) India long followed an import-substitution policy and relied on domestic resource mobilization and domestic firms, encouraging FDI only in higher-technology activities. This contrasts with China’s strategy which, despite the imposition of joint venture requirements and restrictions on FDI in certain sectors, has favoured FDI, especially export-oriented FDI, rather than domestic firms (Buckley 2004). It is that policy that contributed to round-tripping through funds channelled by domestic Chinese firms into Hong Kong (China), reinvested in China to avoid regulatory restrictions or obtain privileges given to foreign investors. Buckley (2004) suggested that, because of domestic market imperfections associated with problems of outsourcing, regulations and local inputs, some FDI has been undertaken as a second best response by manufacturing MNCs to the Chinese environment.
In India, MNC participation in production has often taken externalized forms (such as licensing and other contractual arrangements) as a result of the restrictive trade and FDI policies implemented until the early 1990s. Even since, internalisation is not necessarily dominant as firms have been successful in outsourcing to private Indian firms.
The relaxation of controls over FDI constituted a significant element of the wide-ranging economic reforms introduced in 1991. The three main elements of the reform were the abolition of the licensing requirements governing domestic investments, a reduction in tariffs on imports and the relaxation of controls over FDI. Possibly as a result of the change in policy regime, FDI approvals increased from around Rs 10 billion (around $384 million) during the late 1980s to around Rs2.5 trillion ($3 billion) during the late 1990s. However, the volume of FDI relative to the size of the economy is still low, accounting for only 5% of gross domestic capital formation. The volume of FDI India has attracted shades into insignificance compared with the sizeable volume China has attracted in recent years. The United Nations (2003), in their latest World Investment report ranked India 120th (out of 140 countries) in terms of inward FDI performance index. China is ranked 59th.
Tuesday, December 06, 2005
Round-tripping in China and India
This follows my earlier post on the extent to which China has been more successful in attracting FDI than India. Such a contrast in performance can be explained by a number of factors, some of which would include the role of the diasporas –far more business-oriented in China- and the timing and extent of liberalisation policies that were implemented in both countries.
Before touching upon these important issues, we first need to look at what makes official FDI statistics in both countries. And it is very much a case of comparing apples with pears!
Particular attention has been drawn to the double counting of investments coming out of China, through Hong Kong, and back into China, in search of tax breaks – money that is double-counted in FDI terms, in both Hong Kong and China, when in reality it is not strictly speaking ‘foreign’ at all. This phenomenon, known as “round tripping”, is explored in Wei’s paper. Round tripping can take many forms such as under-invoicing exports, over-invoicing imports, and overseas affiliates of Chinese companies borrowing funds or raising capital in the stock market and reinvesting them in China. Evidence of round tripping can be found in the destination of China’s FDI outflows. Chinese outflows to Hong Kong rose sharply in 1992 as did Hong Kong’s outflows into China! Hong Kong’s share of China’s FDI inflows has been declining since 1992. The decline continued after 1997 when Hong Kong was handed over to China. Meanwhile, inflows from overseas tax heavens such as the British Virgin Islands, Bermuda and Cayman Islands have been on the rise and make up for the declining contribution of Hong Kong. The 10 largest sources of FDI into China include Hong Kong, Virgin islands, Samoan and Cayman islands.
Wei mentions a number of studies, and it appears their magnitude varied considerably from 7% of total FDI inflows to 37%. The most recent estimate is from the World Bank, and they estimate that between 20 and 30% of FDI in China was due to round-tripping.
However, even after adjusting for round-tripping, China is still far ahead of India in FDI. In 2003, China’s FDI (inflows) were $40 billion. If 25% of that amount was down to round-tripping, China’s inflows still amounted to 10 times those for India.
Another element that distorts the figures is that round-tripping takes place in India too! Wei says that in terms of shares, FDI from Mauritius into India is like FDI from Hong Kong into China. Mauritius has been the dominant source of FDI inflows into India since 1995., In 2001-2002, Mauritius accounted for 60% of total FDI inflows into India.
It appears that most investments from Mauritius to India are affected through Mauritius Offshore Companies (MOCs) which are special purpose vehicles best suited to foreign investors wishing to utilize Mauritius as an investment platform benefiting from its network of double taxation treaties.
The Reserve Bank of India was reported to have found that the percentage of round tripping in total FDI inflows was “almost insignificant”. Wei suggests a percentage as low as 2 to 3% of FDI inflows.
What makes an FDI?
There are also more technical issues concerning what are and are not included in the FDI figures in India and China. The Economist says ‘many economists argue that its [China’s] growth figures overstate the truth by one or two percentage points’. The Economist also cites Srivastava, writing in the Economic and Political Weekly, offering a radical reinterpretation of the FDI figures. Technically, both Chinese and Indian FDI statistics are not comparable. This is because India’s definition of FDI does not include any of the 12 elements that make up for the IMF’s definition of FDI –with the exception of equity capital reported on the basis of issue/transfer of equity/preference shares to foreign direct investors.
The IMF definition of FDI includes equity capital, reinvested earnings of foreign companies, inter-company debt transactions, short-term and long-term loans, financial leasing, trade credits, grants, bonds, non-cash acquisition of equity, investment made by foreign venture capital investors, etc. India’s definition of FDI only comprises equity capital. China’s definition includes all 12 elements! UNCTAD’s statistics show that in 2000-2001, foreign affiliates’ reinvested earnings accounted for one third of all China’s inflows. China also classifies imported equipment as FDI while India captures these as imports in the trade data.
Efforts are taking place to align India’s definition of FDI with the IMF’s. Under the previous definition, India’s reported inflows amounted $2.57 billion in 2002-3, compared with $3.91 billion the year before. Under the revised norms, these figures are boosted to $4.66 billion in 2002-3, and $6.13 billion in 2001-2. These -more comparable- figures are still about one tenth of those reported in China. Whatever you do with the figures, important differences seem to remain. So we need to look elsewhere for proper explanations.
A third response is to try to explain the disparity in objective terms. Why is China growing faster than India? Why is China more attractive to foreign investors than India? Our earlier paper focused on these very questions. Forget the numbers, as the disparities remain whatever the way you look at the India v. China comparison. These questions provide fruitful grounds for discussion, and have been extensively discussed by Balasubramanyam and Mahambare (2003). These will be discussed next.