E2 The World Bank Foreign Direct 20005 Inves)/ w o tmen1W 11 t October 1999 in Bangladesh Issues of Long-run Sustainability 1999 I m AfK f'rtwa .'_et ,- . | 8s E -t-=- A |~~~~~~~ O The World Bank Foreign Direct Investment in Bangladesh Issues of Long-run Sustainability October 1999 This report was prepared by a team led by Zaidi Sattar and comprising Zahid Hussain and Bhaskar Naidu. The work was carried out under the general direction of Roberto Zagha. Throughout the preparation of this report John Williamson and Shekhar Shah provided valuable advice and contributions. Comments, suggestions and valuable inputs from the following are gratefully acknowledged: Kapil Kapoor, Hafeezuddin Ahmad, Bashirul Huq, Joslin Landell-Mills, Marc Heitner, M. Iqbal, Chrisantha Ratnayake, Sunil Mathrani, and Lucio Monari. Wajid Shah, Raihan Elahi, and Ziaul Ahsan provided competent research assistance. The report was processed by Mehar Akhter Khan. The findings, interpretations, and conclusions expressed in this report are entirely those of the authors and do not necessarily represent the views of the World Bank, its Executive Directors, or the countries they represent. (TForeword Foreign Direct Investment (FDI) is an emerging phenomenon in Bangladesh. A surge in FDI was experienced particularly during the second half of this decade. This report addresses some of the implications of this changing landscape in Bangladesh's development. First, it sets the record straight as far as the quantum of FDI flows is concerned. This was necessary in view of the recognizably gross under-estimates of FDI appearing in international publications. We believe this is the first credible estimate of FDI in Bangladesh. Second, the study assesses the potential future foreign exchange liabilities concomitant with FDI inflows. While pointing to the benefits -- in terms of physical capital formation, technology transfer and higher competitive efficiency - that Bangladesh could reap from FDI, the report warns of the downside risks associated with rising debt service payments, with the prospect of negative net transfers looming in the horizon unless new ways to earn additional foreign exchange are developed. Long-term foreign investment brings important benefits to the Bangladesh economy. Bangladesh's projected needs for investment in infrastructure for expanding cities and a growing population cannot and need not be met from its government and domestic savers alone. With improved economic management, much-needed reforms in key areas and a liberalized investment regime, Bangladesh can attract a significant part of the private capital now flowing into developing countries. This can play an important role in financing much needed infrastructure services as well as outward-looking industries which generate the employment necessary to reduce poverty in Bangladesh. Frederick T. Temple Country Director The World Bank Bangladesh C ontents Page No. EXECUTIVE SUMMARY i Introduction t Current Investment Regimes in South Asia 2 Sectoral Distribution of Private Capital Flows 3 Capital Inflows and Outflows 7 Macroeconomic Implications of FDI 8 a. Impact on Foreign Exchange Reserves and Balance of Payments 9 b. Options for Generating Incremental Foreign Exchange 10 Policy Concerns 12 a. Improving Financial/Performance of Energy SOEs 12 b. Issues of Exchange Rate Management 13 c. Issues of Capital Control 14 Monitoring FDI Flows 1 5 a. Problems in Mobilizing FDI Information 15 b. A Proposalfor an Improved Reporting System 17 Conclusion 1 8 Appendix 20 A bbreviations BB Bangladesh Bank BCF Billion cubic feet BGMEA Bangladesh Garment Manufacturing Exporters' Association BOI Board of Investment BOP Balance of Payments BOT Balance of Trade BMPP Barge-mounted Power Plant BPDB Bangladesh Power Development Board BTTB Bangladesh Telecom and Telegraph Board CCIE Chief Controller of Exports and Imports CDC Commonwealth Development Company DEG German Development Fund EXIM Export-import EPC Engineering, procurement and construction EPZ Export Processing Zone FDI Foreign Direct Investment FCA Foreign Currency Account FDI Foreign Direct Investment FICCI Foreign Investors Chamber of Commerce and Industries FIPB Foreign Investment Promotion Board GDP Gross Domestic Product IDC Interest during construction IOC International Oil Companies IFC International Finance Corporation IPPs Independent Power Producers KPC Khulna Power Company KWH Kilowatt Hour LNG Liquefied Natural Gas LOC Letter of Credit LOI Letter of Intent MOEMR Ministry of Energy and Mineral Resources MOPT Ministry of Posts and Telecommunications NBR National Board of Revenue PDB Power Development Board PPAs Power Purchase Agreements PSC Production Sharing Contracts RBI Reserve Bank of India RER Real Exchange Rate SIA Secretariat for Industrial Assistance SOE State-owned Enterprises TCF Trillion cubic feet WRIP Western Region Integrated Project Foreign Direct Investment in Bangladesh Issues of long-term sustainability Executive Summary 1. From a trickle in the 1980s, inflow of private foreign direct investment in Bangladesh have risen to nearly $400 million in fiscal 1997-98 and are expected to average about $780 million a year for the next five years. Trade and exchange liberalization, current account convertibility, and liberalization of the investment regime, have all helped to bring this about. 2. Bangladesh stands to gain from these inflows provided it is able to allocate and manage these resources efficiently, keeping in view foreign exchange liabilities arising from profit repatriation, interest, and debt payments. A legitimate concern under the circumstances is whether the economy can generate sufficient foreign exchange to finance the future stream of payments. 3. Data on the exact magnitude of FDI in Bangladesh is inadequate. This policy note, therefore, first seeks to make an assessment of the order of magnitude of inflows and outflows involved and then project the implications for balance of payments and foreign exchange reserves. 4. Foreign private capital flows into Bangladesh have taken three forms: foreign direct investment (FDI), portfolio investment, and foreign currency loans (supplier's credit or loan). But liberalization of the investment regime, while making foreign investmzent procedures simpler, has also nmade it difficult for Bangladesh Bank to mobilize information on capital flows. Reporting difficulties are being experienced by the central bank as private capital flows emerge as a significant component in the balance of payments under a liberalized investment regime. Even the Board of Investment (BOI) has had difficulty tracking actual FDI flows. Until FY98, FDI figures in the balance of payments reflected only cash flows recorded through the banking channels. Since much of FDI in energy, telecom and manufacturing finance imports of machinery and equipment, cash inflows are a small proportion of actual inflows, although outflows draw on the country's foreign exchange reserves. 5. Our projections show that FDI inflows will average $620 million annually during 1992-00, and about $900 million annually till 2010. Outflows in that case will rise, on an annual basis, from a mere $129 million during 1996-00, to almost $600 million during 2001-05, and 1.2 billion during 2006-10. The principal recipient of inflows in the early years is the energy sector, but, if current trends continue, foreign investment in telecom, manufacturing and services could overtake energy by 2006. Private corporate debt is a rising component of FDI with an average maturity of 6.6 years and average interest rate of libor +3.6 percent. Short-term debts of under one year's maturity is still a small fraction of this debt. 6. The main question being addressed in this policy note is: under what circumstances can the economy sustain foreign exchange payments that will be needed to cover profit repatriation, interest payments and amortization of private debts, while enjoying the benefits of substantial FDI? Clearly, there will be a need to augment the country's debt-servicing capacity through sustained growth in exports. 7. The immediate impact of the FDI flows is to increase the current account deficit due to the high import intensity of inflows and, as the stream of payments become due, the net draw-down of reserves. Projections indicate that there is little prospect of reserve accumulation on account of FDI inflows over the entire period (2000-10). Foreign Direct Investment in Bangladesh Executive Summary ii 8. The overall macroeconomic outcome of energy investments has been examined through a macroeconomic consistency model which helped track the evolution of output, internal and external balances, and the profile of debt and foreign exchange reserves for the period 1999 through 2010. The solvency of the public sector and creditworthiness of the economy was ascertained by examining the present value profile of debt. The simulated outcomes reveal that the base case (with current state of FDI) supports modest growth with sustainable fiscal and external balances while the high case (with increasing FDI volume over time) is associated with a higher growth performance. A comparison of the two scenarios indicates that higher intake of FDI (as in the high case) requires a much stronger export performance to meet payment liabilities. 9. The report examined the scope of gas exports as a means of augmenting foreign exchange earnings capacity. With current reserves-to-production ratio standing at 35 years, the Bank's assessment is that the country could easily earmark 2 TCF for exports which could fetch at least $200 million a year from 200:5. 10. Four major conclusions can be drawn from this brief study: L Bangladesh has experienced a more stable (less vulnerable) form of capital inflow, with FDI making up about 85-90 percent of total inflows so far. > Both FDI and private debt inflows in Bangladesh have largely financed imports of machinery and equipment - a sign that Bangladesh is only in the preliminary phase of FDI flows. t The FDI and debt inflows have not helped in augmenting foreign exchange reserves so far and are not expected to do so over the next ten years. In fact, as inflows grow, so do outflows in the medium- to long-term. > The benefits of FDI are many and worth harnessing. But the downside risks must not be lost sight of. Growing repayment obligations present prospects of net negative transfers in the future and pose major challenges requiring the country to search for new avenues of earning (or saving) additional foreign exchange. I H. Four major policy concerns will arise from the emergence of significant FDI flows over the next decade: > As recipients of the largest flows of FDI, energy SOEs will require deep-rooted reforms to improve their financial and operational performance. > In view of FDI-induced energy sector reforms entailing upward adjustment of energy tariffs, exchange rate management will become crucial for maintaining export competitiveness. > Will there be a role for capital controls in managing Bangladesh's FDI? > What mechanism should be in place to ensure better monitoring of the flows to keep the country's debt-servicing capacity in proper perspective? 12. Without deep-rooted reforms and financial restructuring, energy SOEs are unlikely to improve their financial and operational performance. One ingredient of these reforms include upward adjustment of energy tariffs (price of nontradables) - resulting in an appreciation of RER - and requiring offsetting depreciation of the nominal exchange rate to maintain export competitiveness. The benefits of FDI in terms of physical capital formation, transfer of technology and know-how are sufficient to justify sustaining these flows. Capital controls are not the answer to a rising flow of FDI. To ensure that resulting payments liabilities remain within the country's debt-servicing capacity, it is imperative to develop an effective non-intrusive reporting system - the main ingredients of which are presented in the study. Foreign Direct Investment in Bangladesh Issues of Long-term Sustainability Introduction From a trickle in the 1980s, inflows of private foreign direct investment in Bangladesh have risen to nearly $400 million in fiscal 1997-98 and are expected to average about $780 million a year for the next five years. Though trailing behind India -- South Asia's largest recipient of private capital flows - throughout the first half of this decade, it now matches India's per capita FDI inflow of $3.2. Trade and exchange liberalization, current account convertibility, and liberalization of the investment regime have all helped to bring this about. Most importantly, it is the opening up of infrastructure and services to the private sector -- both domestic and foreign -- that has provided the biggest impetus to foreign direct investment in Bangladesh. But for the participation of leading international oil companies in Bangladesh's gas exploration and development - involving both financial capital and technical know- how - its vast reserves of natural gas would have remained unexploited, thereby seriously restricting the country's power generation capacityl. Foreign direct investment generates economic benefits to the recipient country through positive impacts on the real economy resulting from physical capital formation, transfer of technology, and increased domestic competition. Bangladesh can gain from these inflows, provided it is able to allocate and manage resources efficiently, keeping in view concomitant liabilities of profit and income payments. In the Bangladesh context, the recent surge in FDI in the energy and telecom sectors appear to have heavy import content and little impact on foreign exchange reserve accumulation. The concern that logically emerges is whether the real economy will be able to generate sufficient foreign exchange to finance remittance of profits and income originating from foreign investment. Furthermore, the private sector has been incurring foreign debt obligations of short-, medium- and long-term maturity to the tune of $60-70 million a year. These give rise to interest and principal payments in foreign exchange over and above official debt obligations to bilateral and multilateral agencies. The principal focus of this policy note is therefore threefold: A. to determine the order of magnitude of private capital flows, i.e. FDI and private debt, their character and sectoral distribution B. to make an assessment of the outflow of foreign exchange payments in terms of profits, income repatriation, interest and principal repayments; and C. to develop a balance of payments profile and to study the impact on foreign exchange reserves for the next 5-10 years in order to evaluate whether such payments are sustainable out of the economy's current and future export earnings. Current Investment Regimes in South Asia In step with most developing countries of East Asia and Latin America, South Asian countries, including Bangladesh, have opened up their trade and investment regimes during the early 1990s. Current account convertibility now exists in India, Pakistan, Bangladesh, Nepal and Sri Lanka, though the capital I Gas-fired power plants are the principal consumers of gas and use about 45% of the gas supplied. Foreign Direct Investment in Bangladesh 2 account remains non-convertible. Nevertheless, many capital account transactions have been liberalized in varying degrees in each of these countries with the express objective of attracting foreign investment. Although India attracted the maximum amount of FDI in Soulrh Asia at $6.6 billion between 1991-96, on a per capita basis Pakistan led the pack both in terms of FDI per capita or as percentage of GDP ($5.3 and 1.1% respectively), followed by Sri Lanka ($3.1 and 0.9%). After a slow start, in fiscal 1997-98, Bangladesh was able to attract an estimated $386 million ($3.1 per capita and 0.9% of GDP) -- mostly in the energy and telecom sectors. A comparison of investment regimes in South Asia is revealing in many ways. In India, foreign direct investment is encouraged, but primarily as a means of supporting domestic investment. Limits are placed on foreign equity participation - up to a maximum of 74% for some class of industries. Some activities are eligible for automatic approval of RBI while others require government approval through the Foreign Investment Promotion Board (FIPB) or the Secretariat for Industrial Assistance (SIA). All foreign investments and returns on them are -fully repatriable with some provisos. Sri Lanka has also adopted fast-track approval procedures but places limits on foreign equity participation - up to 40% in certain sectors like garments, tea, rubber, telecommunications. Foreign equity participation beyond 40% requires approval of the Board of Investment. The law permits repatriation of profits, income and capital gains. Pakistan had by far the most open capital account prior to the nuclear explosions and consequent econiomic sanctions. Foreign investment continues to be encouraged but capital controls have now become more stringent and the country has reverted to a multiple exchange rate system. The quantum of FDI inflows is only partly a function of the degree of liberalization of the investment regime. Studies2 have shown that the package of incentives for foreign investors is a necessary but not sufficient condition for robust growth of FDI. Relative risks and opportunities for high returns generally guide investor interest. In manufacturing, it is clear that satisfactory initial performance often leads to greater equity participation by foreign investcrs. In South Asia, the size of the Indian domestic market has been an attractive element for investor consideration resulting in substantial foreign investment in manufacturing and services catering to the Indian domestic market. On the other hand, export orientation has been the principal guiding force for the rest of South Asia, until recently. All countries have their currencies convertible for current account transactions but not for the capital account. In comparison, the investment regime in Bangladesh would appear to be the most liberal in view of the absence of any prior approval requirement or limits on foreign equity participation. There are no limits either on repatriation of profits and income. However, as in other South Asian countries, licensing regulations apply to private activities in energy and telecom sectors. 2 For instance, the Bank's forthcoming report, Czech Republic. Enterprise Sector Report, 1999. Foreign Direct Investment in Bangladesh 3 FDI inflows in Bangladesh could be regarded as small compared to what has been flowing into some of the emerging markets in Asia. As Table I shows, even Cambodia and Vietnam seem to have outperformed Bangladesh by a wide margin in this category, not to mention Philippines and Thailand. China, of course, remains the leading recipient of FDI amongst developing countries. Sectoral Distribution of Private Capital Flows Tables 2 and 3 (based on Appendices 1 and I a) present a summary view of FDI and debt inflows until 2010 (actual and projected) and the corresponding outflows of profit and income remittances as well as debt repayments3. The next section gives a brief outline of the sectoral distribution of FDI and the corresponding profit and income remittances arising from it. Sectoral Distribution of Inflows and Outflows. Gas: With nearly 13 TCF of proven and recoverable gas reserves4, the gas sector has already drawn in excess of $400 million of FDI on gas exploration and development. There is heightened interest from intemational oil companies in contracts for further exploration ensuring similar inflows over the next five years. Thus, in FY98, more than half of the $386 million of FDI came in the gas sector alone. T his trend is likely to be sustained for the next five years, with average inflows anywhere from $200 to $300 million5. "itk 2'YOMUC1NIDIIU?2T. IIVS T IN IIAGLADES FeTo1~~~s" FY1~996O 4 2O POS FY200.&* 44 3~~~4 151 ' r T h L .. '_'_ __'_'_"_"_'_'_ _ __'_'_' ' .................... Foreign exchange payments to IOCs and IPPs are computations based on PSCs and PPAs. For telecom and other FDI, profit remittances are calculated on the basis of ROR of 25% with a reasonable moratorium. Outflows on private debt are based on schedules of repayment computed on the basis of contractual interest rates and repayment period. 4 Probable gas reserves of Bangladesh are estimated at 20-25 TCF (US Geological Survey, Geologic Assessment of the Fossil Energy Potential of Bangladesh (1981)). Moreover, the success ratio of 33% (30 discoveries out of 60 wells drilled) is high and the average field size is large by world standards. 5 The projections beyond 2000, conservative as they are, have been made on the assumption that the second round bids for gas exploration will be completed and awarded even at the current slow pace. This pace could accelerate in the event gas exports via pipeline are deemed commercially viable and are seen to provide the wherewithal for foreign exchange payments on eDI inflows. The recent joint proposal by Shell-Cairts-Unocal for exploration in blocks 5, 7 and 10 and implementation of WRIP could alone rake in a billion dollars FDI over the next five years or so. Foreign Direct Investment in Bangladesh 4 Foreign exchange payments arising from foreign investment in this sector are payments for cost- recovery and profit gas as specified in PSCs. On the basis of existing PSCs, and with Shell-Cairns and O)ccidental pumping gas from new fields, the stream of paymenits is expected to be $1 11 million per year until 2005. This is likely to go up around 2005 as some of the new PSCs take effect in the next 2-3 years. Power: There is considerable foreign investor interest in the power sector which was opened up receirntly for private investment -- both domestic and foreign. The Power Development Board's Power S3ystewm Master Plan stipulates raising present generation capacity from 2900 MW to 10,000 MW by 201 5. As part of the Plan, about 2000 MW of power generation capacity is expected to be added by 2005 at a cost of $1.2 billion through foreign investment in IPPs. Contracts for four BMPPs with a total capacity of 470 MW have already been signed and several other contracts are in the pipeline6. A total of $750 million of FD17 in this sector is expected in the next three years - this reflects principally external finarncing of imported power plants and auxiliary equipment. Some of these IPPs are relatively costly endeavors, -- the pre-fabricated BMPPs, in particular. The payments for power purchases will rise from $30 million- in FY2000 to $241 million in FY2005 amounting to a total of about $800 million for the period. Indeed, payments for power purchases are expected to make up almost half the outflows of profits and income remittances for the next five years. Telecommunications: Deregulation of the telecommunications sector has created scope for private operators to run mobile cellular phone systems, ope,rate rural telephone exchanges, provide paging and trunking facilities, and become internet service providers. Telephone companies like Norway's Telenor and Malaysia's Telecom Malaysia International have major stakes in local cellular phone companies. Those companies are gradually expandinpi their operations network through joint ventuires with established international operators. Their foreignr counterparts have provided equipment, technical know-how, and even management in exchange for equity. FDI inflows (including debt) in this 6 Due to financing difficulties encountered by the signatory companies, no more than three of the BMPPs can be counted as certain to be imnplemented. 7 Projections of private power plants up to 2005 are based on idientified IPPs only. However, if a clear-cut lpolicy is adopted for securing IPPs for all future power generation, there could be many more projects than what is listed here. Foreign Direct Investment in Bangladesh 5 sector have risen to $50 million in FY97. This trend is likely to be sustained8, considering the fact that Bangladesh has one of the lowest telephone penetrations in the region. There is no way that Bangladesh Telegraph and Telephone Board -- the public sector operator -- can meet the growing demand for telephones9 without significant participation of private operators. Profit and income remittances on account of investment in this sector are expected to be in the range of $9-15 million by 2001-2002, and could be around $30 million or more by 2005 at current and projected rates of investment. These are modest sums when compared to the foreign exchange receipts this sector operators will generate through revenue-sharing arrangements with international operatorslO. Other FDI: There is also a rising trend of FDI Figure 1: Profile of FDI Inflows inflows in manufacturing and services outside EPZ. A Million $S private container handling terminal at Chittagong port ""' should draw $200 million over the next two years. A FM similar amount could be forthcoming with the link-up Gas of Bangladesh's national airlines -- Biman -- with a Power leading international carrierlI which is expected to .0 Telecom take over its management in the next two years. If the 400 FDI in EPZ private container terminal and Biman divestment 2(K) Otier FDI materialize, estimated outflows on account of Private debt investment outside EPZ are projected to rise to as . much as $200 million by 2005. .S+ 1s', ww1@1_`, Years The accompanying graph (Figure 1) shows the trend in capital inflows in the recent past and projections until 2010. Based on current commitments in the gas sector and proposed IPPs in the power sector, the chart indicates a rising trend in FDI inflows until the year 2000 and a tapering off thereafter. This profile is mainly due to two reasons: (a) inflows in the power sector will rise until 2000 to eliminate power shortages, and (b) investment in gas exploration and development will decline once all blocks are contracted out12. It should be noted that, in the absence of sufficient information about possible developments in telecom, other services and manufacturing, projections beyond 2000 are bound to be conservative estimates. Private Sector Debt: Some relaxation of capital controls since 1994 have allowed private firms to borrow from abroad without permnission of Bangladesh Bank or BOI, if interest rates are within libor plus 4% and repayment period is no less than 7 years. As a result of this policy, foreign currency loans of the private sector have risen from $25 million in FY95 to $74 million in FY97. Much of this debt has financed equipment/machinery purchases by local manufacturing enterprises in sectors such as textiles, leasing, cement, leather goods and telecommunications. The average period of repayment is 6.6 years and the average interest rate of libor +3.6%. In the next two years, IFC is expected to disburse over $100 million of credit (with some equity participation) to viable projects in the private sector. 8 Considering the huge unmet demand for telephone lines, there is enormous prospects for expansion. However, expansion is subject to BTTB's providing the necessary inter-connectivity. 9 Estimated at 1.4 million telephone lines by 2000 against the current figure of 500,000. '0 Typically, incoming calls from abroad outnumber outgoing calls by a ratio of 3 to 1. Proposal for transferring the management of Biman to an experienced international carrier is moving fast and a deal could be struck fairly early. 12 These projections do not anticipate significant investments in pipelines that might take place before 2005 if gas exports become a viable option in the near future. Foreign Direct Investment in Bangladesh 6 For tlie next few years, it is expected that IFC will further intenisify its lending program in Bangladesh. Other institutional lenders like CDC, DEG, and ADB are already in tlle picture and are likely to step up their Elending to the private sector in Bangladesh. Most other non-institutional loans so far have been in the form of supplier's credit from vendors. There has hardly Ibeen any lending by major international comrrmercial banks. The stock of outstanding private debt as of'end FY98 is estimated at $124 mllion (7.6/ Of reserves) and is expected to rise to $336 million by 2000. Assuming that current trends persist, private debt inflowvs are expected to rise to at least $145 milliorn a year by 2005, and to $170 million by 201013. Our estimates show that these private debt obligationis have given rise to foreign exchange payments of about $90 million during FY97-FY98. Such paynents could rise to about $165 million a year biy 2005, and about $280 million by 201014. At 3 percent of' year-end reserves (Table 4) or less than one percent o-f foreign exchange earnings, amortization of these debts still does not pose a major risk, ,given current profile of foreign exchange reserves and earnings, particularly when the bulk of these debts is used to finance capital importsl5. FigFure 2: Profile of FDI Outflows A sometwhat different picture emerges v illion US$ when payments on both FDI and private debts are annl cosdlered. Figure 2 gives a profile of the foreign al a exc hange payments involved in the next few years ot nifa Power on account of profit and income remittances as well sM h as de bt repayments of the private sector. What is des Telecom evide(%t from a comparison of Figures I and 2 is that 2000 A Other FDI while capital inflows are likely to taper off once the 2005, a heavy commitments in the gas and power sectors ay Private debt decline, there will to be a secular upward trend in percent of year-end ee 4) or less than 3 Assuming that present policy with respect to private non-guaranteed foreign debt continues, the upward trend is likely to proie oarticularly with IFC entering the picture abd expecting, conservatively, to disburse a tinimum of $50 million a year until 2005. 14 Repayment obligations are computed on the basis of contracted interest rates and periods of repayment. 15 Our assessment is that information on private debts mobilizea during the period of this study is still incomplete. Despite our best efforts, the RMG industry, some of whose members are reported to have bought machinery and equipment on deferred payment has remained out of our data coverage till the writing of this policy note. Neither BOI nor BB pave any information on such loans to the RMG sector. Inquiries from the tvid o major suppliers of garment machinery, arudan and Tazima, revealed that they have been selling machinery worth $2-3 million annually on 360 days' deferred paydent at libor + 2%. Foreign Direct Investment in Bangladesh 7 the future stream of repayments, indicating rising demand on the country's foreign exchange reserves. Capital Inflows and Outflows Juxtaposition of capital inflows and outflows (figure 3) reveals that inflows will continue to exceed outflows until FY2004. Thereafter, outflows will tend to exceed inflows. This scenario remains largely unaffected whether or not we include private sector debt as a component of inflows. The main question that is being addressed in this policy note is this: can the Figure 3: Profle of Inflows and Outflows economy sustain the foreign exchange payments Million $US (FDI+Private Debt) 1500 that will be needed to cover profit repatriation, v interest payments and amortization of private 1250 Capitallnflows debt? Clearly, in the Bangladesh context, the l000 nature of private capital inflows has implied 7s5 0 little augmentation of foreign exchange 500 reserves. The bulk of FDI in the power sector so 250 Profit, income and debt payments far is made up of imports]6 (e.g. pre-fabricated 0 . . . . . . barge-mounted power plants); so are capital a?" b .9 ? 42'94' &,@ 9 s.40 \ % o costs17 (about 85% of PSCs) of IOCs engaged Years in the gas sector, and much of the foreign investment and lending in the telecom sector finance imports of telecommunications equipment. So is the case with foreign investment in manufacturing within and outside EPZ. Three critical issues thus emerge from the nature of these capital inflows: t First, the high import intensity of FDI inflows and subsequent profit repatriation and interest payments imply a worsening current account deficit associated with FDI. L Second, there is no discernible accumulation of foreign exchange reserves in the absence of gas exports. > Third, FDI, together with private sector borrowing in foreign currency, which has risen to an estimated $75 million in FY98, could give rise to a future stream of payments in foreign exchange averaging nearly $600 million a year between FY01 and FY05, and over a billion dollars a year for the next five years. The challenge, therefore, is to be able to raise the economy's debt-servicing capacity by some half a billion dollars a year by 2001-02 in order for private capital flows to be sustainable. Notably, payments on account of foreign investments in gas and power sectors are expected to rise from about $200 million in 2000-01 to nearly $600 million by 2010, mainly due to rising payments to IPPs - increasing from $75 million in 2000-01 to nearly $400 million by 2010, if future power demand is met through IPP investment. Cost recovery and profit repatriation of IOCs are expected to rise from $111 million in 2000-01 to nearly $200 million by 2010. 16 The EPC component of IPPs consists entirely of imports of equipment and machinery while only part of the "soft costs" (project development, financing costs and IDC) give rise to cash inflows. 17 Cost-recovery expenditure under the PSC contracts cover capital costs (imports of equipment and machinery) and personnel and overhead costs (which generate inflow of foreign exchange). Foreign Direct Investment in Bangladesh 8 Macroeconomic Implications of FDI To assess the overall macroeconomic outcome of energy investments, the Bank's Revised Minimum Standard Model could be used to track the evolution of outpul:s, internal and external balances, and the profile of debt and foreign exchange reserves for the period 1999 through 2010. Two alternative scenarios help describe the implications of significant FDI inflows and corresponding outflows. First, the base case presumes existing levels of FDI in FY99 with only first round bids in gas, some four IPPs which are in an advanced stage of implementation, and modest investments in telecom, other services, Box 1: Financial Sustainability of Macroeconomic Projections A. External Sustainability To ensure creditworthiness (and solvency) of an economy over the long run, the ratio of external debts to GDP must not increase continuously. To keep the external debt to GDP ratio from rising, the current account deficit must satisfy the following sustainability condition: Primcad < - (r* - g) * b* where Primcad = non-interest (primary) current account deficit r* = real foreign interest rate g = rate of growth of real GDP b* = external debt to GDP ratio B. Internal Sustainability The solvency of the public sector in the long-term requires the ratio of public debt to GDP to be stable or declining over time. To ensure sustainability, the following relationship must hold: Primdef< g*h+g*b*+(7c+ h-r*b-(r*+d)*b* where Primdef primary deficit to GDP ratio g real GDP growth b = domestic public debt to GDP ratio b* external debt to GDP ratio 7t = domestic inflation rate h = monetary base to GDP ratio r = domestic real interest rate r* = foreign real interest rate d = rate of real exchange rate (lepreciation Sources: The above approach to sustainability is credited to S. van Wijnbergen and W. Buiter and is drawn from the following publications: van Wijnbergen, S., "External Debt, Inflation and the Public Sector: Towards Fiscal Policy for Sustainable Growth", World Bank Economic Review, 3 (3:1989), 297-320; Buiter, Willem H., "A Guide to Public Sector Debt and Deficits", Economic Policy (November 1985), 13-79. and manufacturing. The alternative scenario assumes an optimistic level of FDI flows, particularly in the energy sector, where investments result from second round bids in gas and some 10-12 additional IPPs in power. Simulation results are presented in Appendix 3a-b. Given the growth projections for the alternative scenarios, the resulting profile of internal and external balances (fiscal and current account balances) are then examined against a profile of sustainable primary (non-interest) fiscal and current account deficits. The solvency of the public sector and creditworthiness of the economy could be judged Foreign Direct Investment in Bangladesh 9 by examining the profile of fiscal and external balances against two major criteria of solvency (see Box 1): * that the domestic debt to GDP ratio remain stable or decline over time; that the ratio of external debt to GDP must not increase over a long period. The net present value profile of the country's total debt serves as an additional guide for the above solvency tests. Comparison of Outcomes: Growth performance in the base case is inhibited by energy shortages which are only temporarily mitigated by current investments. GDP growth will therefore be limited to 5-5.5 percent until 2010. High FDI inflows in the alternative scenario will raise GDP growth levels to an average of 6.8 percent during 2006-10. Current account deficits are higher in the latter case due to higher FDI-induced imports as well as profit repatriation and amortization payments. Yet they converge to sustainable levels by 2010 due to strong export performance of 12-13 percent growth in the outer years. Such export performance would have to be the result of spillover effects of FDI into exports. Current account deficits are sustainable for the base case with a 10 percent export growth for the 2001-10 period. Sustainability of the fiscal deficit in either case will require some fiscal adjustments. In the base case, modest improvements in revenue effort (e.g. VAT extension) and some expenditure restraint (e.g. holding the proportion of expenditure to GDP constant) will stabilize the debt-GDP ratio, resulting in a declining present value profile of debt (chart 3a). On the other hand, a much stronger revenue effort and caps on expenditure would be required for achieving sustainability of fiscal balances in the high FDI scenario. The crux of the problem lies in the state-run energy sector which is expected to absorb a large portion of the FDI. Unless the sector undergoes reforms to improve its financial and operational performance it could fail to meet its contractual payment obligations to foreign investors without recourse to government subsidies. Past debts to GOB (on account of onlending by WB, ADB, bilaterals, etc.) are poorly recorded both in SOE accounts and government books with the result that SOE seldom meet their debt service obligations to the government. Typically, these are converted into Government "equity" in these organizations. The same is likely to happen in regard to IPP and PSC payments unless major sector reforms are implemented as quickly as possible. The budgeting process is also flawed and needs a major overhaul. a. Impact oni Foreign Eexchanzge Reserves and Balance of Paynments Will FDI inflows result in substantial accumulation of reserves or put pressure on the exchange rate (Dutch disease effectl8)? A careful examination of the nature and component of these inflows (both FDI and private debt) in fact suggests the opposite scenario. The import intensity of these flows has already been recognized. The implications of these flows, if properly reflected in the BOP, would be to Two symptomatic "Dutch disease" effects are noted in the literature: "resource movement effect", to indicate shift of resources away from tradable sectors to the booming sector (energy); and "expenditure effect", which result from increased spending on nontradable goods, bidding up their prices, with consequent appreciation of the exchange rate. Foreign Direct Investment in Bangladesh 10 increase the current account deficit with FDI entry in the capital account showitng the financing item19. The net effect on reserves, tlherefore, are expected to be limited. If anything, once these infloxvs are posted against associated imports, repatriation of profits, income, interest, and amortization payments that follow, thiere is likely to be a net draw-down of reserves over time unless this is offset bv increase in foreign exchlange earnings from exports or workers' remittances. The net impact of private capital flows could be exprossed througlh the following identity: net impact of FDI on foreign exchange reserves = FDI inflow - induced increase in imports of machinery - debt service payments + induced increase in exports. Table 5 summarizes the commodity and financial flows; involved. W~~~~~~~~~~~~~~~~~~~~~~~~~ The results indicate little prospect of reserve accum-ulalion on account of FDI iniflows over tlle e ntire period2i). The projections underscore tiie need for FDI to have a significant direct or indirect impact on incremental exports in order to offset rising payment liabiliities over time. Even witli an optim-istic export growth projection of 12-13 percent per annum during 200]-10, it would need a 50 percen0 t cotrlution to incremental exports - direct or indirect - in order to offset a seculardrawvdown of reserves [Table 5, row 6d]. Any slippage in t3e export performance coLld result in a draw-down1 of reserves since nuchi of tle payiments in the gas and power sectors are locked in by agree19e8ts backed by gove16 et guaranitee. b. O1;>tions for Generating Incremental Foreign Exchange The foregoing analysis has shown thlat a continuing strong export performaince would be essential to rmeet forecrig excliange payments liabilities arising out of FDI itnflows. Two possibilities thieii emerge: 19 Official BOP statistics have so far not reflected FDI transactions satisfactorily. Both FDI-financed imports in the current account and FDI entries in the capital account seem. to have been under-recorded. Errors and omnissions, which have been 1rowing, end up absorbin a lot of these discrepancies. 20 The balance equation micht be described as follows: Chan2es in Reserves = Current Account Deficit - Capital Inflows. In the Bangladesh case, capital inflows have essentially financed CAD leaving reserves unaffected. The exceptions are IFC/CDC/DEG loans wp ich fir ance projects whose co uponents oight include imports of plant and equipment as welr as other capital costs. Foreign Direct Investment in Bangladesh 11 > Assuming energy to be a binding constraint, the infusion of FDI in the gas and power sectors (the latter using new gas supplies), resulting in extra power generation, will boost domestic production and exports, which in turn will bring in the extra foreign exchange required to finance payments on FDI and debt inflows. w Bangladesh's plentiful gas reserves could offer scope for generating foreign exchange, particularly beyond 2002, when adequate surplus gas could become available above and beyond the needs of the power sector, and commercial, industrial and household demand. These points require some elaboration. Energy Constraints. The per capita consumption of electricity in Bangladesh is among the lowest in the world (about 90 kwh per capita/year). This is by default rather than design. There is enough cvidencc to suggest a considerable amount of "unserved" electricity which must be restraining output in all sectors: agriculture, industry and services. In Bangladesh today, a considerable amount of output is lost each year due to power sliortages wlhich keep investment away from many activities. Our preliminary exercise based on a limited survey of manufacturing and service establishments suggests that elimination of power shortage could add upto 0.5 percent to GDP growth. The output response of removing the "power constraint" could impact on foreign exchange reserves in two ways: 'i To the extent that domestic production competes with imports, a strong output response, particularly in manufacturing, would substitute for imports, thus saving foreign exchange. X If output response spills over into exports, this will generate additional foreign exchange. If either effect or some combination of the two holds, the outflow of profits and income remittance could be offset by new sources of foreign exchange earnings or savings. It is just as crucial not to lose sight of the issue of "internal" fiscal sustainability of FDI undertakings in gas and power sectors. The government has assumed market risks by providing sovereign guarantees for PPAs and PSCs. Ensuring payment by Petrobangla and BPDB to foreign contractors will require immediate rationalization of gas prices and power tariffs and improvement of billing and collection. Failure to raise sufficient revenues owing to non-viable pricing or system losses would mean that GOB will have to step in and make payments at the risk of creating an open-ended fiscal deficit to accommodate the consequences of ineptitude in energy sector management. Gas Exports. Given current prospects of economic growth and projected demand in the power sector, gas demand is likely to experience a steep rise to 400 bcf by 2002 and grow moderately thereafter. Gas supply, based on current production and estimates of future developments, is expected to rise by some 45% to 445 bcf by 2002. As a result, the surplus of gas, appearing in the early years of the next century, is likely to disappear by 2004, unless new PSCs arising out of the second round bidding start pumping gas around that time. The production of much of this gas, however, would have to be export- oriented - given current projections of gas demand by the power sector and prospects for economic growth. Gas exports could be particularly important in order to (a) generate adequate foreign exchange to sustain a comfortable level of reserves, and (b) ensure a market for private gas companies beyond the saturated domestic market. Foreign Direct Investment in Bangladesh 12 At present, proven and probable recoverable reserves o.f natural gas are unofficially estimated at 20-25 TCF although the officially promulgated reserve base is much smaller, at around 13 TCF. In deciding to go for gas exports, a question policy makers would face is what should be the optimal depletion rate consistent with a long-term conservation strategy for this important but exhaustible natural resource. Typically, the reserves/production ratio is used to define a benchmark for self-sufficiency or adequate reserves. The R/P of Bangladesh at present stands at 35 years, but is likely to increase if exploration efforts intensify. The Bank's assessment is that the country could easily earmark 2 TCF for exports2l. But global experience suggests that thie linkage between gas exports and reserves is tenuous. Some countries, like the Netherlands, monitor the ratio closely. Bolivia, on the other hand, has entered into a long-term export agreement with Brazil, committing itself to supply of a given quantity of gas, 20% of which is yet to be established. T his is because it is confident that the existence of a long-term contract with Brazil will promote exploration and that adequate discoveries will be made. In the Bangladesh case, much of the PSCs to be concluded under the second round bidding would have to be export-oriented as the anticipated production from Cairn and Oxy, together with existing production by Petrobangla, will be enough to meet all domestic demancl up to 2004-2005. The more complicated question is this: in what form should gas be exported? At present, the PSCs allow gas to be exported in LNG form only. Other possibilities of exports are in the form of fertilizer, electricity (with gas-fired IPPs) or the gas itself. In each case it is important to examine the commercial and political risks involved. Preliminary analysis indicates that, among the three options, the commercial risks of fertilizer exports are high; electricity exports are fraught with political risks, not to mention the incompatibility of Indian and Bangladeshi power grids. Surmounting these difficulties would allow Bangladesh to derive economic benefits from capturing the value addition associated with conversion of natural gas into electricity. Gas exports via pipeline to India - which would require the laying of a dedicated pipeline -- offer greater flexibility due tc the diversity of usage by commercial, industrial, residential and other users. Policy Concerns Four major policy issues emerge from this study which has presented an initial assessment of the magnitude of current and future FDI inflows into Bangladesh along with an estimate and projection of corresponding repayment liabilities. These policy concerns are: > In order to absorb mounting FDI inflows into the energy sector, major reforms need to be undertaken in the energy SOEs to improve their financial and operational performance. > Although an occurrence of the "Dutch disease" is unlikely, price adjustments stipulated in energy sector reforms warrant timely exchange rate management to maintain competitiveness. > In view of the given profile of private capital flows, there might be a need to change present policies on capital controls. > The need for ensuring better monitoring of inflows and outflows assumes greater importance. a. Improving Financial Performance of Energy SOEs Elements of macroeconomic vulnerability are evident in the poor state of finances of energy SOEs -- namely, Petrobangla, BPDB and DESA - and the nature of inter-relationships between the state 21 The target of 2 TCF is modest (it would still leave the reserves base equivalent to more than 30 years). Foreign Direct Investment in Bangladesh 13 and these SOEs in the area of financial management. The financial operations of these state utilities are hampered by (a) large system losses, (b) non-viable pricing of services, and (c) non-payment of dues by numerous state agencies. The incentive for improving operational performance through improved management practices has been lacking in view of the virtually guaranteed budgetary support of the state in meeting all debt obligations. Petrobangla. In coming years, the financial performance of Petrobangla will be heavily affected by the onset of production from IOCs and pricing policies for gas. Petrobangla now buys gas from lOCs at a price linked to the international price of fuel oil. Financial projections indicate that Petrobangla will incur increasing deficits, leading to a negative cash flow of more than $120 million in both 2001 and 2002. To rectify this, a tariff increase of another 25 percent (beyond the 15 percent already implemented) over two years is required. BPDB. BPDB's financial system is rudimentary and its financial performance in recent years has been inadequate because of low tariffs, low plant use, and a high (albeit declining) level of unaccounted for electricity. In addition to the benefits derived from a preferential tariff for natural gas, BPDB has been heavily supported by the government in the form of equity injections (through debt forgiveness). To become financially viable, BPDB needs to earn a net retLrn of 8 percent on its assets. In view of oncoming IPP payments, this wvould not be possible without increasing tariffs by 10-12 percent a year, along with an effective loss reduction program and better collection. DESA. DESA's financial performance in recent years has been catastrophic as evident in negative liquidity and negative capital. This situation can be attributed to large system losses and poor recovery of bills. Given that DESA controls 42 percent of the market (high density, high per capita consumption per connection), there is no question that the power sector will not recover unless DESA's financial performance improves significantly. This will require tariff adjustments of at leastl2.5 percent over 2000-02, better payments recovery, and privatization22. b. Issues of Exchange Rate Management The heavy concentration of FDI in a largely nontradable sector (energy) and the kind of price adjustments proposed above raise complex issues of exchange competitiveness and the need for exchange rate management, although prospects for a "Dutch disease" phenomena were essentially ruled out earlier. It has been argued that restoring financial viability of the energy sector SOEs will require sector reforms that include upward adjustment of gas and electricity tariffs (price of nontradables). A concept of real exchange rate (RER) that is widely used in analyzing external adjustments in developing countries is the domestic relative price of traded to nontraded goods23: RER= e= EPT*/PN Although for a small country like Bangladesh, the price of traded goods, PT* , is exogenous, the domestic price of nontraded goods is endogenous except over short periods of wage/price rigidity. The RER is therefore endogenous even under a pre-determined nominal exchange rate, if the price of nontraded goods, PN , is subject to variations due to policy changes. Under the given formulation, a rise in PN results in an appreciation of RER which would then require a depreciation of the nominal exchange rate to restore the previous level of competitiveness in the exchange rate. Thus FDI-induced energy sector reforms, which involve upward adjustments of energy tariffs, will indeed result in an 22 "Energy Strategy Note" (Draft), World Bank, 1998 23 For example, R. Dorbusch, Open Economy Macroeconomics, Basic Books, New York, 1984. Foreign Direct Investment in Bangladesh 14 appreciation of RER, and require offsetting devaluation of the nominal exchange rate to maintain competitiveness of exports. On the contrary, removal of the "energy constraint" would reduce costs of nontraded in production by eliminating the need for high-cost captive power generationi equipment. Which of the two effects is dominant will ultimately determine the need for and magnitude of exchange rate adjustment. c. Issues of Capital Controls Bangladesh has started the process of integration into global capital markets only in this decade. Portfolio capital, which is most vulnerable to abrupt reversals, is not this country's problem since much of what flowed into our nascent capital market left the scene followinig the stock market debacle of 1996. The concern is therefore with FDI (which makes up 85-90% of private capital flows) and private foreign debt. Two forces have played a key role in the surge of FDI flows into Bangladesh: liberalization of the economy, particularly lifting restrictions on FDI, and multinational corporations' shift toward more integrated global investment and production strategies. A legitimate policy concern is that these large FDI (and private debt) inflows will lead to large negative net transfers as those investment and lending mature and yield profits, interest, and principal repayments. The pertinent question then is this: will these inflows generate sufficient production , exports, and foreign exchange to provide the wherewithal for those payments? This policy note has revealed not only the magnitude but also the nature and composition of FDI flows in Bangladeslh. The stylized view that has emerged on Fl)I flows and net cash transfers to the host economy suggests that Bangladesh lhas entered preliminary stage. In this stage high import content offsets cash inflows. The bulk of FDI, whichi is in the energy sector, has involved direct financing of machinery and capital equipment imports. It is characterized by a long-term commitment of the parties concerned. There being no pressure on the exclhange rate, the question of putting restrictions on inflows does not arise. Even private debt inflows have financed import of machinery and equipment. Thus cash inflows, as the stylized facts suggest, have been minimal. The overall impact has been to raise productivity. Nonetheless, it would be prudent to keep a tab on foreign borrowings of the corporate sector without being overly restrictive. Evidence from other developing countries suggests that the cash-flow impact of FDI on BOP (net transifers) is hard to measure because profit remittances are poorly reported in BOP data. It is our juidgment that this need noi be so in Bangladesh. The bulk of FDI here is not in manufacturing but in infrastructure services. Profit and income repatriation - the major outflow - from gas development and power generation should be quite easy to monitor since they are based on contracted PSCs and PPAs. Our sense is that given the current investment and foreign exchange regime, BB has not been able to assess fully the magnitude of foreign exchange liabilities arising from FDI and private debt but, witlh due diligence, this can be resolved. The concerni over net negative transfers in the future should not be the basis for putting fresh curbs on outflows24. The preferred route would be to develop a system of monitoring the level and composition of payments involved. As noted earlier, the magnitude of payments will riot cause a serious dent on reserves until FY00, but could pose some problems in the years FY01 through FY05. 24 Continuity and predictability of FDI-related policies are critical for retaining foreign investor interest in the Bangladesh economy for the long term. Foreign Direct Investment in Bangladesh 15 Benefits of FDI for recipient economies range from its contribution to physical capital formation, human capital development, transfer of technology and know-how (managerial skills), to expansion of markets and foreign trade. The Bangladesh economy, being only at the preliminary stage of FDI flows, is only beginning to reap some of these gains. In part because of these gains, and in part because fast- growing economies attract a lot of foreign investment, Bank studies have shown evidence of a positive correlation between FDI and economic growth25. Herein lies the justification of sustaining these flows. However, it would be inept to ignore the importance of following sound macroeconomic policies, maintaining stable exchange rates, low inflation, and an open capital account that permits conversion of foreign exchange and repatriation of invested funds. Only then can the country reasonably expect to attract growing foreign investment. Monitoring FDI Flows It has been demonstrated in this study that once proper accounting has been made of the sharp increase in FDI flows recently into energy, telecom, industry and service sectors, the total quantum of FDI in Bangladesh is sizable, and, in per capita terms. comparable to those in the leading FDI recipients in Soutlh Asia, namely, India. Pakistan and Sri Lanka. Managing these investments within a liberal investment regime and yet ensuring sustainable macroeconomic balances hias assumed the utmost importance. The first step in this endeavor is the assimilation of regular and complete information on1 inflows and outflows. Herein lies a major challenge. a. Pr-oblenms in Mobilizing FDI Information Private capital flows are now recognized by the Bangladesh Bank as a problematic component in the balance of payments accounts. It is quite likely that many unrecorded transactions are subsumed under errors and omissions in the BOP accounts of the past few years. This realization has led the Bangladesh Bank to initiate a survey to retrieve as much information on FDI as is possible. Consequently, BOP statements of FY98 and beyond are likely to reflect more FDI transactions than in previous years. For the South Asia region, the World Bank publication, Global Development Finance 1998, records merely $47 million of FDI in Bangladesh for 1991-96 in comparison to Sri Lanka's $700 million. In reality, Bangladesh received FDI which was several times more than the reported figure26 The .Ba . 10.4 17.6 .... 17.- - .......... .6 . -> t i4 0t;--.~' k~ India 74.0 Q1 550.4z . 9I 2143.6 257 Nepl 2.0 41) 6.0 b 8.0 19~2 - - . ? j 257.2 .~ 3i0 : -6 - I 34 1 `N-41901-- 7:19.0 69- -- 0 -ri L. - - . . 48 .0 123.;0. . 195.0- . ;56.0 119.I 25 Reported in World Bank's Global Development Finiance, Vol. 1, 1997 (p.3 1). 26 Just one Japanese project, Karnafuli Fertilizer Company (KAFCO), brought investment worth $531 million between 1993-96. Foreign Direct Investlnient in Bangladesh 16 problem stems from current relaxed approval procedures and thie absence of any reporting requirement by individual investors. This problem could be addressed tlhroughi tlle development of an appropriate statistical approach. Foreign private capital flows into Bangladesh have taken three forms: foreign direct investment (FDI), portfolio investment, and foreign currency loans (supplier's credit or loan). The balance of payments accounts of Bangladesh have failed to give a complete picture of the flows involved. This is largely due to difficulties involved in accounting for transactions that do not require any government approval. Thits liberalizationi ojf the investtment regimle, while m7aking foreign investnment procedures sim2pler has also nmade it difficult for Bangladesh Bank to mobilize information on capital flows. Reporting difficulties are being experienced by thle central bank as private capital flows emerge as a significant component in the balance of payments under a liberalized investment regime. These difficulties stem from the fact that private firns are typically reluctant to volunteer information that is not required by existing regulations. The Board of Investment has tlhus far seen itself as a facilitator of investment rather than a record-keeper. Foreign investors register with BOI only if they need its assistance in fast-track delivery of infrastructure services (e.g. telephone, power, gas, etc.) or credit facilities. There is no follow-up to assess the extent of implementation of registered projects or any framework for retrieving information on the magnitude of FDI inflows specific to a project. Similarly, most foreign currency loans by private enterprises are not subject to any prior approval requirement27from the BOI or Bangladesh Bank except that they must register withl BOI after the transaction128. Yet the naturc and composition of FDI flows in Bangladesh present some advantages. Apart from portfolio investment -- which involve cash flows but where the quantum remains negligible -- the bulk of FDI and private debt appear to hiave financed imports of capital equipment and machinery. This is largely true for inflows in thie energy sector as well as manufacturing. These transactions enter as debits in the current account but the corresponding entries in the capital account would remain deficient as long as the amount of FDI and debt-financed imports are not identified as distinict from other LC-based imports29. Since licensing regulations cover all activities in the energy and telecom sectors, with some effort on the part of the regulating agencies it should be possible to obtain the required information from applicant firms. Full information is available on FDI inflows in export processing zones (EPZ) altlhough outflows on this account are difficult to record. To capture investment in other services and manuLfacturing outside EPZ would requlire regular surveys by the statistical agency or BOI. 27 As long as the interest rate is below libor plus 4% and the repayment period is over 7 years. 28 This practice is being reviewed by GOB and, in the backdrop of the East Asian crisis, a return to pre-approval requirements is almost a certainty. That will no doubt make it easier to track private foreign debt in the future. 29 This problem is acute when imports are financed from offshore funds. This is clearly an area where Bangladesh Bank needs to get regular feedback from Customs,'NBR on capital imports of identified firms for making proper entries in the capital accounts of the BOP. To the extent that the financing of these imports are not reflected in the capital account, the errors and omissions entry will be growing in proportion to the discrepancy. This would provide one explanation for the phenomenal increase of errors and omissions entry in the last two-three years during which FDI and debt-financed imports have grown substantially. The problem does not seem to exist in India since where all FDI and private debt have to seek approval of a government agency. Foreign Direct Investment in Bangladesh 17 A possible way out would be to develop a non-intrusive30 system of retrieving private capital flow informration on a regular basis from commercial banks, the Board of Investment, Foreign Investors Chamber, BGMEA, and other agency channels, namely, Petrobangla for the independent oil companies (IOCs) engaged in gas exploration and development, Power Development Board (PDB) for private power plants (IPPs), Ministry of Telecommunications for telecom sector investment and IFC, Dhaka Office. Short of regular surveys of firms with foreign equity or debt participation outside the EPZ, there seems to be no automatic or foolproof way of mopping up complete information at present. Fortunately, the number of private firms with foreign debt or equity will not be larger than 100 at the present time - not an unmanageable problem as yet. b. A Proposalfor an Improved Reporting System Foreign direct investment now occupies a significant place in Bangladesh's economic landscape. Therefore, recording comprehensive, internationally comparable, and up-to-date statistics on FDI is a prerequisite for economic analysis and policy making. It has been pointed out that there has been incomplete reporting of FDI levels in Bangladesh in international publications, including those of the World Bank. This could be due to the fact that FDI information is extracted from BOP statements which in the past had under-recorded these flows31. This situation could be mitigated by pursuing a retrieval approach that closely follows the categorization of capital flows depicted in Appendix I and Ia. Gas. PSCs between Petrobangla and IOCs clearly define the magnitude of inflows and outflows. BB could easily retrieve this information from Petrobangla with the concurrence (or intervention, if required) of MOEMR. Since much of the FDI inflows in this sector comprise machinery/equipment imports through special permits issued by CCIE (and not through opening of LOCs), periodic reports from CCIE and NBR might be sought by BB. Without this information, merchandise imports recorded in BOT is likely to remain incomplete. Power. In this sector, BPDB becomes the main source of information on FDI inflows and outflows under agreed PPAs. As in the case of the gas sector and for the same reasons noted above, FDI inflow information needs to be supplemented by data from NBR and CCIE for proper recording in BOT. Telecommunications. At the moment, five telecom operators have been receiving both FDI and foreign currency loans (mostly suppliers' credit with some equity participation). All operators are subject to licensing regulations under MOPT. Periodic submission of information on inflows of FDI or debts to BOI or the controlling ministry would be desirable and BB could then retrieve the information on a need- to-know basis. EPZ. There is proper and fairly complete recording of FDI inflows in EPZ. Exports from and imports into EPZ are also closely monitored and reported. Information on profit repatriation, however, is 30 The reason for this suggestion stems from the extreme reluctance of firms to divulge financial flow information. The British Office of National Statistics offers explicit guarantee of confidentiality of information so obtained. But similar guarantees are unlikely to work in Bangladesh. 31 Unfortunately, Board of Investment in Bangladesh, as in many developing countries, has not been a major source of FDI information. BOI compiles information on the basis of registrations. But evidence suggests that nearly two-thirds of registered/proposed investment do not materialize. As such, BOI registrations are not a sound basis for assessing the quantum of FDI. However, under existing rules with regard to foreign currency loans (borrowers being required to register with BOI), BOI does become an important source of information on private foreign debt. Foreign Direct Investment in Bangladesh 18 not required under the present foreign exchange regime, the concern being that such requirements would discourage investors. Consequently, BOP statements record E1'Z exports but not the outflows on account of profit repatriation. In the event that this information is not forthcoming, it would be appropriate to treat the entire exports shipment as profits/income repatriation to ofifset the positive entry in the BOT. Other Sectors. It is our assessment that at present no more than 150 companies outside the above categories (Gas, Power, Telecom, EPZ) are recipients of FDI or foreign currency loans32. So the numbers are still manageable and the total quantum of inflows are small relative to what flows into and out of the energy sector. But both the volume of FDI and number of firms are growing. Unfortunately, not all are registered with the BOI. So retrieval of information would require establishing direct contact and' eliciting response with the help of structured yet non-intrusive survey questionnaires. A recommendation here would be to require compulsory registration with BOI regardless of whether any approval is required by the investment agency. The cooperation of FICCI could be sought and should be forthcoming. NBR, which provides tax holiday privileges on application, is actually the best source of information for actual investment33. This would at least help keep track of private companies involved in foreign investment activity. In this respect, the rule for foreign currency loans requiring registration with BOI could yield a good deal of information on the magnitude, interest cost, and maturity of such private debt so that foreign exchange liabilities could be computed fairly accurately. In sum, tracking private capital flows does not appear to be an insurmountable task. Less time and effort would be required to retrieve information on the major portion of these flows in the gas, power, and telecom sectors. Exercising due diligence and doing periodic surveys34 with the help of simple and non-intrusive questionnaires can mop up the balance information on FDI in such sectors as cement, textiles, garments, container terminals, and miscellaneous manufacturing and services. Given that Bangladesh is still in the preliminary phase of FDI flows, it is important to recognize that sustaining increasing inflows of FDI require striking a balance between the need for maintaining an open investment regirne and the imperative of collecting sufficient information on capital flows to ensure that repayment liabilities are well within the economy's capacity to generate the- additional foreign exchange. Conclusion This policy note has revealed that FDI and private foreign debt are increasingly becoming significant sources of financing domestic investment in Bangladesh - particularly in non-tradables such as energy and infrastructure services. Together, these capital flows should account for over 2 percent of GDP in FY99 and nearly 10 percent of gross fixed investment. Between FY99 and FY02, average annual inflows are expected to be around $0.9 billion. Such a rapid rise in inflows is the direct consequence of Bangladesh having one of the most open investment regimes in South Asia today. Unlike in Sri Lanka, where the bulk of FDI is export-oriented, FDI in Bangladesh (with the exception of those in EPZ) is characterized by its inward-orientation, with heavy concentration in the energy sector. As a result, its direct impact on exports and in generating incremental foreign exchange is 32 Given the tirne constraint, we were able to record information from 111 companies using BOI, FICCI, IFC sources and direct contact with the firms. 3 [n applying for tax holiday privileges - which all new investors do - the investing firm has to provide information on the amount of investment actually made. 34 See Appendix 4 for a description of developed country practices and the type of questionnaire design that might be suitable in Bangladesh. Foreign Direct Investment in Bangladesh 19 difficult to gauge. Since the manufacturing sector of Bangladesh, including the export-oriented garments sector, cites power shortage as the major constraint to higher production35, it is only befitting to assume that removal of energy constraints through FDI in gas development and power generation will ultimately lead to higher exports and increased foreign exchange earnings. This is inherently productivity- enhancing. Thus, unlike investment in real estate development, these FDI expenditures on non-tradables are unlikely to contribute to a real exchange rate appreciation through an increase in the relative price of non-tradables over tradables. But capital inflows such as these do impose costs on the domestic economy in terms of financial liabilities to foreign suppliers of capital, quite apart from the complexities and challenges they present for macroeconomic management. This note was an attempt to take stock of some of these implications. Four major conclusions may be drawn from this brief study: > Bangladesh has experienced a more stable (less vulnerable) formn of capital inflow, with FDI making up about 85-90 percent of the total inflows so far. > Both FDI and private debt inflows in Bangladesh have largely financed imports of machinery and - equipment - a sign that Bangladesh is only in the preliminary phase of FDI flows. > FDI and debt inflows have not helped in augmenting foreign exchange reserves so far and are not expected to do so over the next ten years. In fact, as inflows grow, so do outflows in the medium- to long-term. > The benefits of FDI are many and worth hamessing. But the downside risks must not be lost sight of. Foreign exchange payments will average $500 million a year between 2000 and 2005, and $1 billion a year for the next five years. This growing repayment obligation presents prospects of net negative transfers in the future and poses major challenges requiring the country to search for new avenues of earning (or saving) additional foreign exchange. 35 Findings of the survey under the Bank's Study on Trade Liberalization: Its pace and impacts, now under way. Also regularly cited by local Chambers of Commerce and Industries. Foreign Direct Investment in Bangladesh Appendix la 20 Profile of Private Capital Inflows (million US$) SECTORS 1994 1995- 1996- 1997- 1998- 1999- 2000- 2001- 2002- 2003- 2004- 2005- 2006- 2007- 2008- 2009- -95 96 97 98 99 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1. GAS (lOCs) Production Sharing Contracts First Round Bids 14 40 170 217 194 41 90 95 65 42 40 33 3TO 27 25 23 Second Round Bids 0 0 0 0 0 10 44 346 112 204 52 86 80 80 80 110 Sub-total: GAS 14 40 170 217 194 51 134 441 177 246 92 113 110 107 105 133 2. POW]ER (IPPs) Barge plants Wartsila/Khulta Power Co. 108MW 60 43 Baghabari/Westmont (SC/CC) 130MW 102 -_ Haripur/NEPC 110 MW 102 New peaking plants Baghabari/Midlands 115MW 14 21 Central Zone GT 200MW 24 36 North Zone GT 200MW 24 36 West Zone CT 15OMW 18 27 SouthZoneCT 15OMW 18 27 Central-Zone CT 15OMW _18 27 West Zone CT 150MW 18 27 New base load plants Haripur (CC) 360MW 60 60 60 Central Zone/Meghnaghat (CC) 450MW 80 80 65 North Zone/Sirajganj (CC) 300MW 45 45 60 West Zone/Khulna 450MW 68 68 90 West Zone/Khulna II 450MW = - 68 68 90 - - = = South Zone (Chittagong) 300MW - - 45 45 60 Central Zone 450MW 68 68 90 North Zone 300MW =45 45 60 South Zone 450MW 1 68 68 90 Sub-total: POWER 0 0 0 60 321 185 245 214 146 203 158 248 200 203 128 90 3. TELECOM* 0 4 31 26 13 10 23 15 15 16 18 20 25 20 15 5 4. FDI in EPZ 31 26 46 59 73 88 101 III 122 135 148 163 179 197 217 238 5a. Ports (Container Terminal) 0 0 0 0 100 100 0 0 0 0 0 100 100 0 0 0 Sb. Biman (foreign partnership) 0 0 0 0 0 50 50 100 0 0 0 0 0 0 0 0 5c. Cemenit |15 35 0 0 89 135 75 50 50 50 50 50 0 0 0 0 5d. Textiles (incl RMG) 4 9 16 0 0 0 10 12 15 17 20 20 20 20 20 20 5e. Other (non-EPZ mfg & services) 19 127 34 25 17 1 1 50 55 134 140 147 154 162 170 179 188 Other FDI 15(a+b+c+d+e)l 38 171 50 25 206 296 185 217 199 207 217 324 282 190 199 208 Total FDI inflows 83 241 296 387 807 629 687 998 659 807 633 868 796 717 664 674 8. Private debt inflows 30 44 59 76 107 118 129 133 137 141 146 151 156 161 166 171 Total inflows: FDI + debt | 1131 2861 3551 4631 9141 7481 816 1131 796 948 779 1019 952 878 830 845 Note: (*) FDI in Telecom includes debt and equity financing; the former are included in item 8. Foreign Direct Investment in Bangladesh Appendix lb 21 PROFILE OF CAPITAL OUTFLOWS (million US$) FMW;;Jt4C 1994 1995 1996- 1997- 1998- 1999- 2000- 2001- 2002- 2003- 2004. 2005- 2006- 2007- 2008 2009- -95 -96 97 98 99 2000 2001 2002 2D03 2004 2005 2006 2007 2008 2009 2010 1. AAS Paymnats- Under PSCS - - -- ERoM BoundBids- 0 00 02 2 55 i 111 11 111 I102 91 82 75 69 Soond RoundBidS I O0 0 0 0 o ( 0 0 0 0 56 56 56 56 113 PhaSe1I -.:XL I -< i!X : 0 0 0 0 35 30 28 52 85 85 85 85 85 85 85 85 P1 II ei 0 0 0 0 0 0 48 62 75 103 156 166 219 258 301 329 SU-TotRi - ! -ergy 0 0 0 2 90 141 187 225 271 299 352 409 451 481 517 596 TELEOM 0 0 0 0 0 1 9 15 20 25 32 36 40 44 44 45 4.Other M(nonEPZniffgX 1 1 5 41 61 71 75 125 209 241 299 333 369 408 449 488 Twaot glou,wsen0FD1,, I 1 5 43 151 212 270 365 499 564 683 778 860 933 1010 1129 5 OutfkOwVs ompriva .debt 13 31 36 53 56 54 35 101 135 149 165 182 201 223 256 283 tOaou onleWSOn FD1 +debt 14 32 41 96 207 267 305 466 634 713 84 960 1061 1156 1266 1412 Foreign Direct Investment in Bangladesh Appendix Ic 22 Equipment Imports and Budget of Gas & Power Companies (Figures in million US $) Company 94-95 95-96 96-97 97-98 98-99 Total Cairn Capital cost in Budget $9.96 $21.63 $124.49 $133.23 $22.20 $311.52 Capital cost as % of Budget (87.85%) (86.77%) (74.91%) (75.89%) (88.17%) (77.26%) Imports of machinery/Equipment $29.85 $25.36 $153.50 $208.71 Occidental Capital cost in Budget $1.40 $11.89 $32.29 $70.58 $48.77 $164.93 Capital cost as % of Budget (31.79%) (57.90%) (78.65%) (90.02%) (91.22%) (83.36%) Imports of machinery/Equipment $0.03 $29.74 $109.21 $138.98 Rexwood- Capital cost in Budget $0.00 $0. DO $1.81 $3.98 $2.17 $7.96 Oakland Capital cost as % of Budget (81.20%) (80.54%) (80.00%) (80.54%) Imports of machinery/Equipment UMC Capital cost in Budget $0.00 $0.(0 $2.20 S5.43 $3.23 $10.86 Capital cost as % of Budget (83.95%) (83.29%) (82.85%) (83.29%) Imports of machinery/Equipment $1.92 $1.92 Khulna Power Co. Project Cost = $60.00 $43.00 $103.00 Capital cost as % of Budget - - Imports of machinery/equipment/fuel $35.16 $38.81 $73.97 Rural Power Co. Project Cost $23.00 $23.00 (Mymensingh Capital cost as % of Budget _ G.T.P Station) Imports of machinery/Equipment 7.18 $7.18 Note: Imports of machinery/equipment upto June '98 for IOCs and upto July '98 for IPPs Foreign Direct Investment in Bangladesh Appendix 2a 23 199_ _996 Energy Sector IPP Investments (million US$) 1994- 1995 1996 1997- 1998 1999- 2000- 2001- 2002- 2003- 2004- 2005- 2006- 2007- 2008- 2009- 95 -96 97 98 -99 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Phase I [ Wartsila/Khulna Power Co 108MW 60 43 Haripur (CC) 360MW =60 60 60 Central Zone/Meghnaghat (CC) 450MW 80 80 65 _ Phase 11 - - - HaripurtWestmont (SC/CC) 130MW 60 42 Haripur/NEPCI1OMW 60 42 Baghabari/Midlands 115MW - - _ 14 21 Central Zone GT 200MW 24 36 North Zone GT 200MW 24 36 West Zone CT 15OMW _ 18 27 South Zone CT 15OMW 1 8 27_ Central Zone CT 15OMW 1 8 27 West Zone CT I5OMW 18 27_ North Zone/Sirajganj (CC) 300MW 45 45 60 West Zone/Khulna 450MW - 68 68 90 West Zone/Khulna H 450MW 68 68 90 South Zone (Chittagong) 300MW r 45 45 60 Central Zone 450MW 68 68 90 North Zone 300MW 45 45 60 South Zone 450MW 68 68 90 TOTAL INVESTMENTS = = = 60 237 269 245 214 146 203 158 2481 200 203 128 90 Foreign Direct Investment in Bangladesh Appendix 2b 24 Projected Energy sector Payments to IPPs (million US$) 1994- 1995- 1996- 1997 1998- 1999- 2000- 2001- 2002- 2003- 2004- 2005- 2006- 2007- 2008- 2009- 95 96 97 -98 99 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Phase I _ Wartsila/Khulna Power Co. 108MW _ 35 30 28 28 28 28 28 28 28 28 28 28 Haripur (CC) 360MW - 0 0 24 24 24 24 24 24 24 24 24 Central Zone/Meghnaghat (CC) 450MW 0 0 0 33 33 33 33 33 33 33 33 Phase [sub-total 35 30 28 52 85 85 85 85 85 85 85 85 Phase 11 Haripur/Westmont (SC/CC) 130MW = = = 20 20 20 20 20 20 20 Haripur/NEPCI 10 MW 20 20 20 20 20 20 20 20 20 20 Baghabari/Midlands 115MW = = = 8 8 8 8 8 8 8 8 8 8 Central Zone GT 200MW 13 13 13 13 13 13 13 13 13 North Zone GT 200MW = == 13 13 13 13 13 13 13 13 West Zone CT 150MW 10 10 10 10 10 0o South Zone CT 150MW 10 10 10 10 10 Central Zone CT 150MW 10 lo io 10 West Zone CT 150MW 10 10 10 North Zone/S irajganj (CC) 300M W = = 29 29 29 29 29 29 29 West Zone/Khulna 450MW - - - 43 43 43 43 43 43 West Zone/Khulna ll 450MW j -_ - i 43 43 43 43 South Zone (Chittagong) 300MW 29 29 29 Central Zone 450MW _____ 43 43 North Zone 300MW _ _ 29 South Zone 450MW Li I _ Phase It sub-total _ii i_ 48 62 75 103 156 166 219 258 301 329 Total Outflows 0 0l l 0 351 301 76 113 160 188 241 251 304 343 386 414i Foreign Direct Investment in Bangladesh Appendix 3a 25 Table 1: Base Case Scenario, with fiscal adjustment Indicators (In Percent) 1999 2000 2001 | 2002-05 2006-10 (average) (average) Real Sector Growth Rate of GDP 3.4% 5.5% 5.6% 5.4% 5.4% Investment Growth (GDI) -4.7% 14.0% 6.2% 6.3% 5.1% Per Capita GDP Growth 1.7% 3.9% 4.1% 3.9%/o 3.8% Exports/GDP 13.5% 14.3% 15.0% 16.3% 17.7% Imports/GDP 19.8% 21.2% 21.7% 22.1% 22.5% Private Investment/GDP 13.9% 15.9% 16.1% 16.8% 16.3% Public Investment/GDP 5.3% 4.9% 4.9% 5.0% 5.2% Gross Domestic Savings/GDP 12.9% 13.9% 14.3/ 15. 9% 16.7% Gross iVational Savings/GDP 16.4% 17.4% 17.9% 19.3% 19.9% Fiscal Performance Total Revenues/ GDP 9.5% 10.0% 10.0% 10.6% 10.9% Total Expenditures/GDP 14.2% 14.3% 14.4% 14.5% 14.2% Government Deficitl GDP -4.7% -4.3% -4.4% -3.8% -3.3% Foreign Financing/GDP 3.1% 2.5% 2.4%/ 2.2% 1.5% Domestic Borrowing/GDP 1.6% 1.8% 1.9% 1.7%, 1.8% Sustainable Primary Deficit/GDP -3 .2%/o -4.6% -3.7% -3.4% -3.2%/. Primary Fiscal Deficit/GDP -3.3% -2.9% -2.9% -2.2% -1.5% Domestic Debt/GDP 11.4% 11.9% 12.7% 13.6% 15.3% Balance of Payments ANominal import growth rate 10.6%/ 14.6%o 9.1% 7.9% 7.1% Nominal export growth rate 6. 1% 13.0%{ 12.5% 11.0% 8.0% Current Account Deficit/GDP -2.8% -3 .4% -3.1% -2.4% -1.6% Sustainable Current Account Deficit/GDP -0.8% -1.6% -1.6% -1.3% -1.2% Primary Current Account Deficit/GDP -2.3% -3.0% -2.6% -1.9% -1.0% Gross Reserves (months imports GFS) 2.1 2.0j 2.0 2.0 2.0 External Debt External Debt/GDP 37.7% 36.7% 35.8% 33.4%/ 29.4% Debt Service/(YGS+Remit.) 10.3% 9.6% 9.5% 9.8% 9.8% Debt Service/GDP 1. 8% 1.7% 1.8% 2.0% 2.1% PV External Debt/(.YGS+Remit.) 198% 167% 142% 100% 55% PV External Debt/GDP 34% 30% 27% 20% 12% Chart la: Total Debt PV Index 103 - 102 - 101 o 100 I 99 99 98- 97- 96 Year Foreign Direct Investment in Bangladesh Appendix 3b 26 Table 2: High FDI case; Strong revenue and export performance Indicators (In Percent) 1999 2000 2001 2002-05 2006-10 _____________________________________ __ _i(average) (average) Real Sector Growth Rate of GDP 3.4% 5.6% 6.1% 6.3% 6.8%/c Investment Growvth (GDI) -3.5% 25.9% 6.7% 8.5% 7.5% Per Capita GDP Growth 1.7% 3.9% 4.6% 4.7% 5.3% Exports/GDP 13.5% 14.4% 15.3% 16.9% 20.1% Imports/GDP 19.8% 22.0% 22.7% 23.7% 24.9% Private Investment/GDP 14.1% 18.3% 18.6% 19.6% 21.3%/c Public Investment/GDP 5.3% 4.9% 4.8% 4.9% 4.8% Gross Domestic Savings/GDP 13.1% 15.6% 16.0% 17.7% 21.3% Gross National Savings/GDP 16.6% 19.1%| 19.5% 20.8% 23.6% Fiscal Performance Total Revenues/GDP 9.6% 10.4%/0 10.6% i1.4% 11.9% Total Expenditures/GDP 14.2% 14.7% 14.7% 14,8% 14.0% Government Deficitl GDP -4.6% -4.3% -4.1% -3.4% -2.1% Foreign Financing/GDP 3.1% 2.5% 2.4% 2 1% 1.4/c Domestic Borrowing/GDP 1.6% 1.8% . 7%' 13% 0.7% Sustainable Primary Deficit/GDP -3.3% -4.7% -4.1% -4.0% -3.9% Primary Fiscal Deficit/GDP -3.3%1 -2.8% -2.6% -1.9% -0.7% Domestic Debt/GDP 11 4%- 11.8%9 12.3%1 12.4%j 9.50/ Bailance of Payments Nominal import growth rate . 11.1% 19.1 /o 10.5% 9.7% 9.3% Nominal export growth rate 6.1% 145/ 14.0% 13.0% 12.6% Current Account Deficit/GDP -2.9% -4. 1 / -4.0% -3.7% -2.6% Sustainable CurrentAccount Deficit/GDP 0.8% 1 7%/ 1.7% 1,5%I 1.2% Primary Current Account Deficit/GDP -2.4% -3.7'/o -3.4% -2.9% - I .5% Gross Reserves (months imports GFS) 2.1 2.0 2.0 2.0 2.0 External Debt External Debt/GDP 37.5% 37.4'/O 37.0% 35.7% 34.3% |Debt Service/(XGS+Remit.) 1i30. 930 10.60/0 13.1% 16.9% Debt Service/GDP 1.8% 1 7%a 2.0% 2.7% 4.0% P: aDebt/(XGS-Remit.) 197%/61 169'!o 145% 104% 59% |PVExternalDebt/GDP 34%l 31%io 28% 22% 14% Chart 2a: Fiscal Deficit Chart 2b: Current Account Deficit 5 - - 4 Primary CtirTent Account Deficit | Sustainable Fiscal Defcit 3.5 r e u 4..3 _ 2.5 2] 3. wF Y 2 . Sustainable Current Account ec 2 yPrimary Fiscal Deficit 1.5 0.5 0 ~~~~~~~~0 ' o c o"& Year Year Chart 2c: Total Debt PV Index 104- 102 - 100 m m C 98 96.- Year Appendix 4 Foreign Direct Investment in Bangladesh Definitional Issues Recording comprehensive, comparable and up-to-date statistics on Forcign Direct Investment (FDI) is a prerequisite for economic analysis and policy making. The objective of this appendix is to define FDI and offer some operational guidance on how FDI should be compiled in Bangladesh to meet internationally agreed standards. IMF's Balance of Payments iVfanual, Fifth Edition 1993 (section 359) gives the internationally accepted definition of FDI as follows: FDI is the category of international investment that reflects the objective of obtaining a lasting interest by a resident entity in one economy (e.g. Malaysia) in an enterprise resident in another economy (e.g. Bangladesh). (The resident entity is the direct investor and the enterprise is the direct investment enterprise). The lasting interest implies the existence of a long-tern relationship betxveen the direct investor and the enterprise and a significant degree of influence by the investor on the management of the enterprise. FDI comprises not only the initial transaction establishing the relationship between the investor and the enterprise but also all subsequent transactions between them and among affiliated enterprises, both incorporated and unincorporated. The components of FDI capital transactions are equity capital, reinvested earnings, and other capital associated with various inter-company debt transactions. It is often referred to as an asset for the economy of the direct investor and as a liability for the economy in which the direct investment enterprise operates. Actually, the investor and the enterprise have claims on, or liabilities to, each other - although the investor usually could be expected to have net foreign claims and the enterprise to have net foreign liabilities. Market price is the basis for valuation of flows and stocks in international accounts. However, in practice, book values from the balance sheets of direct investment enterprises often are used to determine the value of the stock of FDI. Recording FDI data in Bangladesh It has been mentioned in the text that complete information on FDI transactions have not yet been captured in the balance of payments. To record the growing volume of FDI flows and stocks, it would be prudent to follow internationally recognized practices, particularly in countries or regions with significant quantum of FDI flows - OECD countries and U.K. being among them. In this regard, the OECD Benchmark Definition of FDI (third edition), which is fully consistent withIMF's BOP Manual, 1993, is a useful guide for not only defining what transactions are to be included as FDI but also for devising an appropriate system for recording and monitoring FDI inflows and outflows. Reporting metlhods 1. Reporting requirements. In some countries reporting requirements are voluntary, whereas in others they are compulsory and punishable under law for non-compliance. Though the law is seldom evoked in the countries where reporting is compulsory, the response is relatively better in those countries. The latter rule thus has merits in the Bangladesh context. Foreign Direct Investment in Bangladesh Appendix 4 28 2. Reporting period. Reporting is done on an annual basis in most countries. Bangladesh could follow the same principle on a fiscal year basis. 3. Surveys. Some countries have fairly well established annual surveys for both flows and stocks of FDI supplemented by more concise quarterly surveys. Others have very comprehensive census-type questionnaires for infrequent surveys supplemented by abbreviated questionnaires on a quarterly basis for a more limited population. Bangladesh would do well to retrieve FDI information on a quarterly basis through concise surveys using abbreviated questionnaires. 1818 HI. Street, N.W. Washington, D.C 20433. USA Telephone : 1-202-477-1234 Facsimile : 1-202-477-6391 3A. Paribagh G.P.O 97 Dhaka- 1000, Bangladesh Telephone: 880-2-8611056 Facsimile: 880-2-8613220 World Wide Web: http://www.worldbank.org