Adopting correct policy to encourage FDI

Bangladesh has long been trying to attract a higher amount of FDI. Various policy measures and fiscal incentives have gone into alluring foreign investors. The country's investment policy opens up all but four sectors for outside private investment. The policy also prioritises FDI in the export-oriented industries, in the Export Processing Zones (EPZs) and the high technology sector. There is also no restriction on profit repatriation.

The Production Transformation Policy Review of Bangladesh, jointly prepared by OECD and UNCTAD, also acknowledged that since the 1980s, Bangladesh has focused on attracting FDI using simple but quite generous incentive packages. Nevertheless, the effect of the packages was 'limited by excessive complex institutional arrangement and the complexity of doing business locally'. And the review paper mentioned that the impact of the approach on attracting FDI has been limited. It is clearly reflected in the low level of foreign investment as FDI accounts for only 0.7 per cent of the country's Gross Domestic Product (GDP), which is 6.0 per cent in Viet Nam. The value of remittances received by Bangladesh is also around seven times higher than the volume of FDI.

The latest data also show that the net inflow of foreign direct investment (FDI) in the last fiscal year (FY23) declined by 7.10 per cent after registering a robust 37 per cent growth in FY22. When the country struggles to check the depletion of foreign exchange reserves, the decline in the inflow of foreign capital is a matter of concern. The annual final estimate of FDI, prepared and released by Bangladesh Bank last week, revealed that the net inflow of FDI in the last fiscal year stood at around $3.20 billion, which was $3.45 billion in FY22.

The drop in FDI clearly indicates mounting pressure on the balance of payments (BoP). The overall BoP registered a wider deficit of US$ 8.22 billion in FY23 from $6.66 billion in FY22. The central bank, in its latest quarterly report on the macroeconomic situation, pointed out that the widening deficit in BoP was due to an unusual and large deficit in the financial account of $2.14 billion in the last fiscal year (FY23). The financial account posted a record surplus of $15.46 billion in the previous fiscal year.

The decline in FDI is, however, one of the multiple factors behind the reversal of the annual financial account within a year. A drop in net aid inflow and a slowdown of medium and long-term loan inflow are two major factors in this connection. One needs also to consider the sharp decline in long-term private foreign credit, a big deficit in the trade credit, and a high repayment of the banks' foreign currency liabilities-all these together  put pressure on the country's BoPs.

In the last fiscal year, Bangladesh received some $4.43 billion as gross FDI, whereas the amount was $4.63 billion in FY22. The disinvestment against the gross inflow of foreign investment was recorded at $1.24 billion in FY23, which was $1.19 billion in the previous fiscal year. It means both the gross inflow and disinvestment declined in the last fiscal year, resulting in a decline in the net inflow of FDI. Disinvestment usually includes capital repatriation, reverse investments, loans given to parent firms and repayments of intra-company loans to parent firms.

FY23 is the third time in the past decade that the country experienced a drop in FDI. Earlier, in FY14, the net inflow of FDI dropped by 14.46 per cent. In FY20, the FDI declined sharply by 39 per cent, mainly due to the Covid-19 pandemic. Again, the average annual inflow of net FDI in the last decade stood at $2.43 billion, which is disappointing.

A sharp decline in equity capital, which came down to $0.79 billion in the last fiscal year from $1.34 billion in FY22 is also concerning. Bangladesh Bank has defined equity capital as remittances received by the incorporated or unincorporated direct investment enterprises operating in Bangladesh on account of equity participation in those by the non-resident direct investors.

A drop in equity capital indicates that fresh capital, in the form of foreign investment, drooped as foreign investors lack enough interest to invest in the country. The existing multinational entities (MNEs), on the other hand, reinvest their income to keep the operation going. That's why reinvested earnings increased to $2.37 billion in the last fiscal year from $2.04 billion in FY22.

The necessity of FDI has been spelt out in different policy documents. In his budget speech for FY24, the finance minister said that 100 economic zones (EZs) are being established in the country for environment-friendly industrialisation and to enhance domestic and foreign investment along with youth employment.

The OECD-UNCTAD review report, released last month, observed that FDI could play a bigger role in fostering diversification, learning and innovation. Although attracting FDI is among the government's top priorities, FDI to Bangladesh remains limited and concentrated in the traditional sectors. 

So, the review paper suggested that the country needs to craft a modern policy mix that encourages learning, risk-taking, innovation and provides new business opportunities for new firms and sectors. It also stressed developing a more coordinated approach between industrial, trade and FDI policies, simplifying the institutional framework for attracting FDI, and modernising the incentive packages.

As the country is set to graduate from the least-developed country (LDC) status by 2026, the goal to attract more FDI needs some policy manoeuvring. In this connection, the OECD-UNCTAD review paper outlines a set of recommendations. The core message of the recommendations is that the country needs to shift to a more targeted FDI approach and proactively look to attract more knowledge-intensive FDI. It also emphasises introducing 'conditionalities to ensure that the local economy gets the most out of FDI' in the long run.

[email protected]