Foreign Direct Investment: Brief Introduction and Bangladesh

Case Scenario Observation

Submitted to:
Dr. Mohammad Farashuddin
Course Instructor
Public Economics

Submitted by:
Mokaddim Jashim Bhuiyan
ID no. 2014-3-88-004

Department of Economics
East West University

December 15, 2014

Foreign Direct Investment: The Concept

Foreign Direct Investment (FDI) is a type of controlling ownership in a business enterprise in one
country by an entity based in another country. It is the acquisition of managerial control by a citizen
or corporation of a home nation over a corporation of some other host nation.1 Corporations that
widely engage in FDI are called Multinational Companies, multinational enterprises, or
transnational corporations. However, all types of indirect overseas investments are not Foreign
Direct Investment. Foreign direct investment is distinguished from portfolio foreign investment,
which refers to a passive investment in the securities of another country such as public stocks and
bonds, by the element of "control".2 The accepted threshold for a foreign direct investment
relationship, as defined by the Organization for Economic Co-operation and Development (OECD),
is 10%. That is, the foreign investor must own at least 10% or more of the voting stock or ordinary
shares of the investee company.1
Broadly defined, foreign direct investment includes mergers and acquisitions, building new
facilities, reinvesting profits earned from overseas operations and intra company loans. In a narrow
sense, foreign direct investment refers to just building new facilities. FDI is the sum of equity
capital, other long-term capital, and short-term capital as shown the balance of payments. FDI
usually involves participation in management, joint-venture, transfer of technology and expertise.
In technical terms, Foreign Direct Investment is one example of International Factor Movements.
While the procedure to invest determine the nature of investment (i.e. FDI as compared to portfolio
foreign investment and the likes), the origin of the investment does not impact the definition as an
FDI, i.e., the investment may be made either "inorganically" by buying a company in the target
country or "organically" by expanding operations of an existing business in that country. 1 An
example of foreign direct investment would be an American company taking a majority stake in a
company in China. Another example would be a Canadian company setting up a joint venture to
develop a mineral deposit in Chile.

Types of FDI:1
Foreign Direct Investments can occur in three types:
1. Horizontal FDI: This type of investment takes place when a firm duplicates its home
country-based activities at the same value-chain stage in a host country through FDI
2. Platform FDI: This is the type of Foreign Direct Investment from a source country to a
destination country for the purpose of exporting to a third country.
3. Vertical FDI: It occurs when a firm through FDI moves upstream or downstream in different
value chains i.e. when firms perform value-adding activities stage by stage in vertical
fashion in a host country.

Factors that Affect Foreign Direct Investment:3

There are quite a few that affect the nature and quantity, thereby the expansion, of foreign direct
investments in a home country.
a. Inflation: If a countrys inflation rate increases relative to the countries with which it
invests, its capital account would be expected to decrease, other things being equal.
1

Wikipedia: Foreign Direct Investment

Investopedia: Foreign Direct Investment
3
(Nasir, 2012) (Development, 2014)
2

Consumer and corporations in that country will most likely purchase more goods or invest
more in overseas (due to high local inflation), while the countrys exports to other countries
& flow of investment from foreign will decline.
b. National Income: If a countrys income level (national income) increases by a higher
percentage than those of other countries, its capital account is expected to decrease, other
things being equal. As the real income level (adjusted for inflation) raises does consumption
of goods. A percentage of that increase in consumption will most likely reflect an increased
demand for foreign investment.
c. Government Restrictions: A countrys Government can prevent or discourage investment
from other countries. By imposing such restrictions, the Government disrupts investment
flows. Among the most commonly used investment restriction are bureaucratic tangles,
projection of intellectual property right and f\fiscal policy changes. In addition to these, a
Government can reduce its countrys investment by enforcing laws, or a maximum limit that
can be invested.
d. Exchange Rates: Each countrys currency is valued in terms of other currencies through the
use of exchanges rates, so that currencies can be exchanged to facilitate international
transaction. The values of most currencies can fluctuate over time because of market and
government forces. If a countrys currency begins to rise in value against other currencies,
its capital account balance should decrease, other things being equal. As the currency
strengthens, Investment by that country will become more expensive than the receiving
countries.

Why FDI is Necessary:3

The world has seen a spectacular wave of global corporate activity particularly during the second
half of the last decade. This has been facilitated by advances made in the information technology.
This trend, strengthened with the direction toward border less- Economies, is drawing more and
more TNCs (Trans-national Corporation) into the global operation. FDI is no longer only a strategic
option of corporations; it also plays a key role in the national economic development strategies.
Various countries are attempting to attract foreign investors through a variety of measures, i.e.
liberalization of investment environment, fiscal reforms and a package of incentive offers. FDI can
transform a countrys economic scenario within shortest possible time. It is not merely access to
fund, but also provide transfer of technical know-how and management expertise. It is also a
stabilizing factor in any economy, because once TNCs have made an asset-based direct investment,
they cannot simply pull out overnight like in the case of portfolio investment. Normally the benefits
accruable from FDI are inclusive of:
Transfer of technology to individual firms and technological spill-over to the wider
economy
Increased productive efficiency due to competition from multinational subsidiaries
Improvement in the quality of the factors of production including management in other
firms, not just the host firm
Benefits to the balance of payments through inflow of investment funds
Increase in exports
Increase in savings and investment
Faster growth and employment
Thus, foreign direct investment is viewed as a major stimulus to economic growth in developing
countries. Its ability to deal with two major obstacles, namely, shortages of financial resources and

technology and skills, has made it the center of attention for policy-makers in low-income countries
in particular.

Motives for Foreign Direct Investment:3

Multinational corporations or enterprises generally look for two types of motives while making
foreign direct investments:

Revenue-related
Cost related

Revenue-related motives:

Attract new sources of demand after saturation in home market

Enter profitable markets across boundary
Exploit monopolistic advantage in an unexplored market
React to trade restrictions
Diversify internationally

Cost-related motives:
Fully benefit from economies of scale
Use foreign factors of production (Labor, Raw materials, technology)
React to exchange rate fluctuations

FDI in Bangladesh:
The technological and cultural interaction done through foreign direct investment is extremely
crucial for the home country, especially if its a least developed country (LDC). No country has
developed without investment of foreign capital. It is quite impossible on the part of a nation to
develop a vibrant economy only with local investment. Bangladesh, being a member of the LDC
group, is no exception to this rule. In fact, many of our industrial sectors thrive in FDIs and these
sectors are performing formidably in the global platform thanks to FDIs from developed world.
Since we are a nation reaping benefits of the FDIs made in our country, when we refer to FDI
increase, we often imply it as the FDI inflow, not the outflow of FDI.

Latest trend in FDI Pattern:

Inflows of foreign direct investment into Bangladesh rose 24 percent year-on-year to $1.6 billion in
2013 although the country witnessed serious political unrest and an anti-business climate during
the period. FDI inflows increased 13.75 percent to $1.29 billion in 2012, compared to the previous
year, according to United Nations Conference on Trade and Development (UNCTAD).45
The report also revealed that Bangladesh is currently placed as a distant second favored investment
destination in South Asia after India, which got $28 billion or 78 percent of the total FDI inflows
into the region in 2013. Pakistan stood third in South Asia with $1.3 billion.5
Following is the breakdown of the sector wise inflows of FDI in Bangladesh in 2013:

4
5

Unctad.org/en/PublicationsLibrary/wir2014_en.pdf
(Star, 2014)

Name of Sectors
Textile and weaving
Banking
Telecom
Power, Gas and Petroleum
Food
Agriculture and Fishing
Others
Total

Amount (US$ million) (% of FDI)

422 (26%)
327(21%)
324(20%)
99(6%)
40(3%)
31(2%)
356(22%)
US$ 1.599 Billion

FDI by Sectors
Others
22%

Textile and Weaving

26%

Agriculture and
Fishing
2%
Food
3%
Power, Gas
andPetroleum
6%
Banking
21%
Telecom
20%
Textile and Weaving

Banking

Telecom

Power, Gas andPetroleum

Food

Agriculture and Fishing

Others
Figure 1: FDI by different sectors, Bangladesh, 2013

Of the $1.6 billion FDI +that Bangladesh received last year, $541 million came as equity (direct
investment in Bangladesh), $361 million as intra-company loans (debt transactions between parent
enterprises and affiliates) and $697 million were reinvested earnings (investors' share of profits
not distributed as profits).
It is worth mentioning that Global FDI grew 9 percent to $1.45 trillion in 2013 and could rise to $1.6
trillion this year, the report said. FDI inflows into developing economies reached a new high at $778
billion or 54 percent of the total FDI last year. Transition economies got $108 billion. Of the US$1.45
Trillion, about $188 Billion was drawn by the United States, while China stood next, drawing $124
Billion.
Lets now look at the January-to-January figures of FDI inflows in Bangladesh:

FDI Inflows in Bangladesh (Million US$)

1400

1300
1191

1200
961

1000
800
800

743

793

913
775

748

600
400

276

200
0
Jan '05

Jan '06

Jan '07

Jan '08

Jan '09

Jan '10

Jan '11

Jan '12

Jan '13

Jan '14

FDI Inflows (Million US$)

Figure 2: FDI inflows in Bangladesh (Jan-Jan basis)6

As we can clearly see, the amount of FDI inflows in Bangladesh has experienced a huge expansion
over the last years, with a few hiccups in between i.e. shrink in FDI inflows. Here, January 14 data
shows us a total FDI inflow of 1.3 Billion US$, and from the previous chart, we found the FDI inflow
to be 1.6 Billion US$ as of June 14. So, in that regard, we are heading towards the right direction.
Such expansion, at least while we still remain in the LDC bracket, is extremely crucial for us.

Top investing Countries in Bangladesh:

In the following bar chart, we demonstrate, in terms of total investment made during 1996-2010,
the highest investment making countries in Bangladesh:

Country-wise FDI inflows in Bangladesh from top 10

investing countries (1996-2010) (US$ million)
2000
1500
1000

1530.66
1139.08
697.91

674.89

563.8

540.73

500
0

FDI (US$ million)

Figure 3: Top 10 investing countries in Bangladesh (1996-2010)
6

(foreign direct investment, 2013)

493.61

453

421.77

420.26

As we can see, UK and USA holds the lead in this regard, followed by countries such as Egypt, South
Korea, Netherlands, and Singapore.
As mentioned earlier, FDI has three components:

Equity Capital
Intra-company Loans

FDI by components in Bangladesh 2014 (US $ Million)

[CATEGORY
NAME],$[VALUE],
[PERCENTAGE]

[CATEGORY NAME],
$[VALUE],
[PERCENTAGE]

[CATEGORY NAME],
$[VALUE],
[PERCENTAGE]
Equity Capital

Intra-company borrowings

Reinvested Earning

Figure 4: Allocation of components in FDI, Bangladesh, 2014

Reinvested earnings

Here, we compare their relative share with the latest available data:

FDI, as a portion of GDP:

When we look at FDI inflows as a percentage of Gross Domestic Product (GDP), it gives an idea as to
how and to what extent GDP is affected with the movement i.e. reduction or expansion of FDI. Here,

FDI, as percentage of GDP

6
5
4
3
2
1
0
2005

2006

2007

2008

Bangladesh

2009
India

2010

2011

China

USA

2012

2013

Figure 5: FDI, as percentage of GDP

we can see FDI, as a percentage of GDP, for Bangladesh, India, China and the United States7:

Why Foreign Direct Investment is lucrative in Bangladesh:

Projection of Foreign investment from nationalization and expropriation

Abolition of ceiling on investment and equity and share-holding by foreigners
Tax holiday between 5-10 years for power generating companies
Accelerated depreciation in lieu of tax holiday on certain simple conditions
Concessionary duty and VAT on capital machinery and spares
Rationalization of import duties and taxes
Six month multiple visa for prospective investors
Citizenship by investing US$ 500,000 or transferring US$ 1,000,000
Permanent relationship by investing US$ 75,000
Tax exemption on capital gains under certain simple conditions
Bonded warehouse and back to back L/C for exporting industries
Avoidance of double taxation with certain countries
Facilities for repatriation of capital, profit, royalty, technical fee
Tax exemption on royalty, technical know-how and expatriates salary
Protection of intellectual property rights
Taka convertibility in current account
Treating reinvestment of repatriable dividend as new investment

Conclusion:
To conclude, in this essay, I have tried to briefly introduce the concept of Foreign Direct Investment
and some of its simple implications on the local and foreign economy. It is, however, very important
7

(bank, 2014)

that the government of the home country remains open to new horizon and patterns of
investments, thereby enabling the potential to cultural, social and technological interaction. FDI
becomes almost impossible if the home country doesnt react in accordance with the global
movement of the market. Again, the policy regarding the foreign direct investment should be clear
and flexible and should contain some lucrative options for the foreign investors. This will certainly
boost the growth of FDI in our country. From a developing countrys perspective, FDI is very
essential for overall growth of the economy. We dont have sufficient resources to meet up the
growing demand of the increasing population at different aspect. As a result, we must create a
conducive environment to make way for suitable foreign direct investment.

References
bank, w. (2014). FDI inflows,percentage of GDP. Retrieved from worldbank.org:
Data.worldbank.org/indicator/BX.KLT.DINV.WD.GD.ZS?page=1
Development, U. N. (2014). World Investment Report 2014. unctad.
Foreign Direct Investment. (n.d.). Retrieved from Wikipedia:
en.wikipedia.org/wiki/Foreign_Direct_investment
foreign direct investment. (2013). Retrieved from trading economics:
www.tradingeconomics.com/bangladesh/foreign-direct-investment
Nasir, T. (2012). Current Scenario of Foreign Direct Investment in Bangladesh. Retrieved from
academia.edu:
www.academia.edu/6046865/Current_Scenario_of_Foreign_Direct_Investment_in_Bangladesh
_EXECUTIVE_SUMMARY
Rahman, A. (2012). Foreign DIrect Investment in Bangladesh, Prospects and Challenges, and Its Impact
on Economy. School of Management, AIT, Thailand.
Star, T. D. (2014, June 25). The Daily Star/Business. Retrieved from The Daily Star:
www.thedailystar.net/business/fdi-rises-24pc-despite-political-shocks-30228