Policy Research Institute - PRI Bangladesh

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Providing the much-needed impetus to FDI


Published: Thursday, Feb 25, 2016

Published : 25 Feb 2016, 00:11:32

Providing the much-needed impetus to FDI

writes Tahsin Farah Chowdhury

Bangladesh's economy is at an inflection point, ready to move to a higher growth trajectory. But it is falling short of a critical ingredient -- foreign direct investment (FDI). FDI is recognized as a catalyst for economic progress of developing countries like Bangladesh. This is because FDI is a stable and lasting form of capital inflow, unlike portfolio investment (hot capital) that ebbs and flows in and out of our equity market. FDI enables a developing country to attain higher rates of economic growth by increasing its capacity to acquire more financial resources in the form of capital infusion, thus bridging its savings-investment gap. FDI also facilitates the transfer of modern management approaches, advanced technologies and production techniques from developed countries.

 Most importantly for Bangladesh, FDI instills skill development of the labour force, and creates significant employment opportunities by linking domestic manufacturing with vast global markets, infusing knowledge and skills about product standards, patterns of consumer demand, and international rules of trade.  If the quantum of FDI is significant, it can make a substantial contribution to the nation's output or its gross domestic product (GDP) through job creation, exports, and income generation. Since Bangladesh is aiming to reach the 8.0% GDP growth trajectory in the medium term, one of its main policy focuses should be to create a favourable investment climate that is conducive to attract and welcome the inflow of FDI within the country.

Providing the much-needed impetus to FDI

In fiscal year (FY)15, the total FDI inflow into Bangladesh was recorded at US$ 1.83 billion, up from $ 1.48 billion in FY14, an increase of 23.8%.However, due to the challenging business environment and persistent tepid investment climate in Bangladesh, the share of FDI as a percentage of GDP has only hovered around 1.0% in the last couple of years. Figure 1 shows that FDI's contribution to GDP fell from 1.15% in FY13 to 0.86% in FY14, rising slightly to 0.94% in FY15. These values are considerably lower than that of India, Sri Lanka and Vietnam. Whereas the economy faces the challenge of raising investment-GDP ratio to 34% in order to attain a growth rate of 8.0% per annum, private investment in Bangladesh has been stagnant at around 22% in FY14-15, leaving the public sector to bear the major brunt of investment deepening. As such, it becomes all the more critical to augment the quantum and share of foreign investment in order to reach the target GDP growth rate. In the FY16 budget, the Bangladesh government set an ambitious target of 7.0% GDP growth rate. This rate of economic growth can only be sustained if the average share of FDI as a percentage of GDP is increased. The Seventh Five Year plan has set an investment target amounting to Tk 31.9 trillion in constant FY16 prices. While domestic private investment will play an important role in the Plan financing strategy, FDI in Bangladesh needs to be raised to 3.0% of GDP in order to reach this target. The flow of FDI is very competitive across countries and highly sensitive to the investment climate of a country. According to the World Bank Doing Business (DB) 2016 report, Bangladesh ranks quite low in its 'Ease of Doing Business' ranking, where out of 189 countries it stands at the 174thposition. Its neighbouring countries, such as Sri Lanka, Pakistan, India, Nepal etc., have all ranked higher, indicating why foreign investors eschew investing in Bangladesh.  According to the 2015 Global Competitiveness Index (GCI), Bangladesh ranked at 107 out of 140 countries, lagging far behind other South and South East Asian countries like Sri Lanka (68), Vietnam (56), and Indonesia (37) in terms of overall competitiveness. The widening gap in competitiveness between Bangladesh and other South and South East Asian countries indicates the country's inadequacies in its financial sector, infrastructure, institutions, technological readiness etc. Both the measures (DB and GCI) imply that Bangladesh suffers from a weak investment climate. What are the constraints that weaken Bangladesh's investment climate, thereby deterring foreign investors? There are mainly two types of constraints: institutional and infrastructural. In the Doing Business 2016 report, Bangladesh ranks the lowest in providing electricity. Investors get very poor infrastructural support in the form of access to serviced land (i.e. installed with gas, water and electricity lines), access to port facilities, transportation facilities, etc. The institutional capacity of Bangladesh is also unsatisfactory as the country ranks among the lowest in registering property, enforcing contracts, dealing with construction permits etc. These licensing and registration processes take an inordinately long time due to red tape or bureaucratic interferences, and in some cases also add to investors' growing expenses in the form of bribes. In addition, investors have noted that non-transparent and frequent changes in policies on import duties for raw materials, machinery and equipment create uncertainty in making business decisions. The financial market is not accessible enough for businesses, as they have also ranked quite low in providing credit facilities. As a result of these infrastructural and institutional barriers, potential investors tend to find Bangladesh less appealing as an investment destination than some of its competitors like Vietnam, thus hindering the country from achieving a faster FDI growth rate. For higher FDI flows, concerted efforts will have to be made to make Bangladesh's investment climate more conducive for foreign investors to feel confident that their investment will yield high returns and that the associated risks are low. Bangladesh has so far failed to attract any major multinational companies or MNCs (such as Toyota, Intel, Foxconn, Samsung) in terms of relocation of their operations or establishment of their subsidiaries here, despite the attraction of a cheap labour force, all due to lack of investors' confidence. This is where Special Economic Zones (SEZs) could become the game changer. The government could potentially utilize the concept of SEZs to greatly boost FDI.  In contrast with the rest of the economy that is constrained by infrastructure and institutional weaknesses, SEZs could provide fully serviced industrial zones with special economic regulations within the country that are conducive to foreign investment. In this regard, the Bangladesh Economic Zones Authority (BEZA) has been officially instituted by the government to set up the economic zones in feasible areas, as mandated by the Bangladesh Economic Zones Act 2010. According to the BEZA authorities, the construction of 46 SEZs is currently underway. However, it will take at least a year before any of the zones are operational. As stated in the FY16 budget, Bangladesh plans to develop 100 economic zones within the next 15 years. SEZs are important for both domestic and foreign investments (FDI) because Bangladesh's investment climate and business environment are weak. SEZs provide an opportunity to potential investors, domestic or foreign, to set up their business in a secure, enclosed zone, where they will receive incentives such as tax holidays, duty free import of raw materials, construction materials, capital machineries, finished goods, full repatriation of capital and dividend, no ceiling on FDI, and duty exemption on exports. When operating in an SEZ, businesses can avail facilities in the form of industrial infrastructure, logistics support (including goods handling, warehousing, transportation etc.), easy access to port facilities, and access to serviced land. Most importantly, SEZs allow businesses to overcome regulatory challenges like customs, environmental clearance and enforcement, building code enforcement, import export permits, implementation of other labour and compliance related laws and rules, to name a few. Since SEZ is a bonded area, businesses will not have to face fluctuating customs and duties, thus removing a significant source of uncertainty for investors. Businesses can easily access credit facilities since economic zones also lead to emergence of proper financial institutions around the area. Such zones may also lead to the growth of backward linkage industries nearby, which can aid the industries within SEZs by cutting down their input costs. There is improved overall governance within the area, as well as the institutional capacity for proper implementation and enforcement of laws to protect the businesses, which significantly lessens investors' risks of doing business in Bangladesh. Hence, through the establishment of SEZs and their effective operation, Bangladesh will be able to provide the stable business climate required to gain investors' confidence from both home and abroad, thereby helping to boost private investment and FDI. The country can, thus, attract high profile MNCs in sectors such as automobile or electronics, and therefore facilitate transfer of advanced technology and technical know-how to Bangladesh. In addition, this can generate positive spillover effects on the economy in terms of influx of capital, improved management, enhanced skill of workforce and growth of outward looking export-oriented industries. [Tahsin Farah Chowdhury is a Research Associate at Policy Research Institute (PRI). She can be reached at tas091@hotmail.com]