January 2015 Issue
Over the last 60 years or so, globalisation has played a significant role in developing international trade and finance, shaping their place in a new global economic system. Furthermore, it has facilitated the acceptance and integration of a number of the world’s developing and emerging nations into the global economy.
One of the cornerstones upon which globalisation has grown is foreign direct investment (FDI). Flowing predominantly from high income western nations, over the last 20 years or so FDI has evolved into a major source of development finance, contributing handsomely to the economic growth of many countries.
Asia in particular has benefited enormously from FDI flows into the region. According to a recent UN conference on trade and development, Asia is the world’s top recipient of FDI. The report, ‘World Investment Report 2014’ notes that total inflows to developing Asia, excluding West Asia, amounted to $382bn in 2013, 4 percent higher than in 2012. Large, western multinational corporations have long been attracted to Asia as an investment destination, though this interest has intensified recently thanks to the growth of local and regional markets, the region’s abundance of natural resources and its strategic position as a base for export oriented production.
However, openness to FDI has historically been far from uniform across Asia. While China and the Association of Southeast Asian Nations (ASEAN) have embraced FDI, other economies have been comparatively unreceptive. Regional powerhouses such as India, South Korea and Japan have been hesitant to open themselves fully to FDI, despite knowing that a greater willingness to embrace inflows could potentially drive further economic growth and efficiency.
However, as the global economy begins to slow again, a number of the region’s largest economies are starting to change course, becoming more receptive to the possibilities of FDI.
Reform
Following sustained economic success in the early part of the century, the outlook for Asia’s development is no longer as optimistic as it once was. In the coming years, the region will likely face a number of challenges to its productivity and growth, making targets increasingly harder to achieve.
The Federal Reserve’s decision in late 2014 to end its program of quantitative easing (QE) is likely to have a significant impact on Asia. In Japan, however, the announcement from the Bank of Japan (BoJ) that its own program of QE would continue, and would ultimately be expanded, will offset some of the impact. The BoJ said it was increasing purchases of Japanese government bonds to an annual rate of ¥80 trillion, around $700bn – an increase of around ¥30 trillion.
The winding up of the Fed’s QE scheme is likely to pose serious questions for much of Asia. For Asian societies averse to the idea of FDI, the paradigm is beginning to shift. Opacity is no longer an option for many countries as they search for the investment needed to kick-start their economies. Accordingly, many of the region’s governments have begun to discuss the implementation of a number of transformative schemes. Plenty of reforms have been mooted but a region-wide reduction of FDI barriers has the potential to be one of the most transformative.
In India, the Modi government has implemented a number of reforms aimed at raising the limits for FDI across a variety of sectors, as well as attempting to shore up investor confidence worldwide. To date, however, India’s increased receptiveness to FDI has resulted in something of a mixed bag. New FDI into the region has fluctuated. According to data from the Department of Industrial Policy and Promotion, in the April to August period of the 2014-15 fiscal year, foreign capital investment demonstrated growth of 42 percent to $12.01bn. However, the level of investment in August fell dramatically, dropping by around 10 percent to as little as $1.27bn – the lowest level of FDI into India for over eight months.
“Openness to FDI has historically been far from uniform across Asia.”
If the Indian economy is to get back on track, it will need to attract significant foreign investment across a number of sectors. Among the most targeted, the telecoms, services, pharmaceuticals and construction sectors will all require substantial investment. Infrastructure development is another area in need of major investment; it is estimated that India requires investment of approximately $1 trillion over the next five years to overhaul its infrastructure sector. Newly relaxed rules in the railway sector will hopefully increase foreign investor confidence, opening the door to transformation and modernisation. Previously, foreign investors were only permitted to invest in the country’s Mass Rapid Transit railway system. The decision taken by the government will allow foreign investors to pour additional capital into a number of new areas. The construction, operation and maintenance of suburban corridor projects, high-speed trains, dedicated freight lines, rolling stock and coach manufacturing facilities will all be permitted.
Many other nations in Asia would do well to follow India’s lead as the country embarks on a journey to attract as much foreign capital as possible. Recently, India has been able to attract FDI from a wide variety of nations, including Mauritius, Singapore and the Netherlands. The Indian government has also coveted investment from a number of the world’s largest developed and emerging economies. US investors in particular have been championed by Indian industries and politicians alike. Though US FDI into India has been on the decline in recent years – falling to around $800m in the year ended 31 March 2014, from a peak of $1.9bn in 2010 – hopes are high that the visit by Prime Minister Narendra Modi to the US in late September 2014 will bear fruit. To this end, the US-India Business Council has announced plans to invest around $41bn in India over the next three years.
Intra-regional FDI
Intra-regional investment has also been highlighted by the Indian government as an important source of development capital. Over the next five years, Japanese industries have pledged to invest a further $33bn into Indian infrastructure development projects. A similar arrangement has been struck with fellow BRIC nation China, comprising a five-year trade and economic cooperation pact designed to improve India’s trade balance. Under the terms of the agreement, around $20bn worth of Chinese capital will be invested in India over the next five years.
Intra-regional FDI is not simply a matter of attracting capital into India, however; it is one of the key areas of focus for the wider Asian region. The Indian IT sector, which itself has witnessed significant growth in recent years, has identified investments in Southeast Asia as key targets. According to the Asian Development Bank, business process outsourcing, knowledge process outsourcing, call centres and other IT related sub-contracting positions are likely to shift to Southeast Asia as companies look to offset the increased cost of operating in India.
Japan, too, has begun to increase its FDI contributions to neighbouring countries. As it diversifies away from China, Japan is now investing heavily in ASEAN states. Vietnam in particular represents an attractive option for Japanese companies. Benefitting from a young and increasingly well-educated workforce, Vietnam is well-positioned to succeed in the coming years, with predicted 2015 GDP growth of 6.2 percent. The country’s burgeoning domestic market and strong geographic location between local powerhouses India, China and Australia, means that Vietnam is ideally positioned to foster even greater economic development and investment. The level of Japanese FDI into Vietnam has exploded over the last five or six years. Since the Japan-Vietnam Economic Partnership Agreement came into effect in 2009, Japanese investors have poured huge sums of money into the country.
One of the main beneficiaries of Japanese FDI in 2014 was Thailand. Japanese FDI into Thailand increased 41 percent in the first half of 2014, reaching $2.6bn. According to data from the Bank for International Settlements, Thailand is now also the second-biggest destination for Japanese bank lending in all of Asia, behind China. Furthermore, Japanese loans to Thailand also grew by 75 percent in Q2 2014, reaching $77.5bn.
A number of Japanese companies have also been busy establishing manufacturing bases in Thailand, as well as completing M&A deals in the country. The automobile and electronics industries have been particularly active in this area in recent years. In addition, the Japanese banking sector has fuelled a spate of acquisitions in Southeast Asia over the last two years or so, helping to fund a record $10.3bn worth of Japanese deals. Mitsubishi UFJ Financial Group has led the way, spending around $5.6bn to acquire a majority stake in Thailand’s Bank of Ayudhya.
Intra-Asian deals have become increasingly common. Firms from Japan, South Korea and China are likely to continue investing, particularly in the emerging markets, as they look to boost growth. Opportunities in Myanmar, India, Indonesia and Thailand should prove popular for Asian investors. The TMT, energy, pharmaceuticals and consumer products sectors will be among the most targeted.
Conclusion
With the winding up of the Fed’s QE program, it is inevitable that many of the world’s emerging economies will need to adapt to a new financial climate in the coming months. Emerging markets will continue to court US investment. For the ASEAN countries in particular, the US remains a key market for exports as well as an important source of FDI. Following the establishment of US manufacturing facilities in the region in the 1960s, ASEAN nations remain attractive locations for US investment. Developing economic ties and attracting new FDI from the US will be a priority for ASEAN countries aiming to maintain a steady flow of investment.
Intra-Asian cooperation, M&A activity and FDI are set to increase. In November 2014, at the Asia-Pacific Economic Cooperation (APEC) annual meeting in Beijing, there was an agreement to launch a two year ‘strategic study’ of the Free Trade Area of the Asia-Pacific trade pact, which has been designed to promote and increase financial and economic cooperation within the region. Agreements of this nature are likely to be the shape of things to come.
© Financier Worldwide
BY
Richard Summerfield