south asia intra-regional opportunities and challenges

South AsiaIntra-Regional Opportunities and Challenges

Debapriya BhattacharyaExecutive Director

Centre for Policy Dialogue (CPD)Bangladesh

Presented at:Fostering Trade through Private-Public DialogueExpert Meeting on Regional Integration in Asia

New Delhi, India28-29 March 2007

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The Logic and Experience of Intra-Regional Investment

FDI Regime in South Asia & Intra-Regional Investment

Intra-Regional Investment in Bangladesh Proposed TATA Investment in Bangladesh: A

Case of Intra-Regional Investment Intra-Regional Investment: Policy Issues

CONTENT

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Regional economic integration accelerates liberalization, deregulation and privatisation policies across economies, markets and sectors, ensuring implementation of common trade policies, standards of treatment, reduced differences in business practices and regulations, administrative procedures and business support measures.

Consequently, flow of investment heightens between economies of a region by decreasing information, adaptation and transaction costs of trade.

Thus, economic integration flattens differences between member states in production factors like wages, interest rates, economic policies and so on, influencing the flows of intra-regional investments.

1. THE LOGIC AND EXPERIENCE OF INTRA-REGIONAL INVESTMENT

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Intra-regional investments can take place in two forms, either as vertical investment or as horizontal investment.

In vertical investment, different stages of production is localized in different economies to take advantage of the differences in factor prices, producing for both the domestic market and the source country market.

As for the horizontal investment, different production facilities are placed in different economies to take advantage of the local markets as well as the local production factors, mostly targeting the domestic market.


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Intra-regional investment within Asia has picked up rapidly in recent times as large multinational firms diversified across the region and new regional production networks and channels for intra-regional investment are being created.

According to the World Investment Report 2006, intra-regional investments in South, East and South-East Asia have grown over the last few years. Currently it accounts for almost half of the total FDI inflows to the region. However, the phenomenon is prominent between and within East Asia and South-East Asia.

Japan and Hong Kong (China) have been the forerunners in this process during 1990-2002.


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Hong Kong (China), Singapore, Taiwan Province of China, the Republic of Korea, China and Malaysia are leading investors in East Asia and South-East Asia. Most investments from East Asia went to the relatively high-income South-East Asian countries.

The largest FDI flows have been within East Asia and they had been rising until recently, largely dominated by China as a key destination.

Intra-ASEAN investment accounted for 13 per cent of cumulative FDI flows in this region between 1995 and 2004, with Singapore as the leading investor.


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South Asian countries have liberalised investment regime in varying degrees since the mid-1980s to attract more investment by the private sector in all major sectors.

South Asian countries have liberalised major manufacturing and service sectors for foreign investors with the expectation of large-scale investment, mainly in a) export-oriented industries, b) industries in the Export Processing Zones (EPZs), c) high technology products that will be either import substitute or export-oriented.

But within South Asia, intra-regional investment flows have not been significant compared with other regions of Asia. FDI flows between South-East Asia and South Asia as well as East Asia and South Asia have been less significant by far as those between East Asia and South-East Asia.

2. FDI REGIME IN SOUTH ASIA & INTRA-REGIONAL INVESTMENT

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Nevertheless, liberalisation of FDI regime in South Asia has positively contributed to significant increase in overall flow of foreign investment to the region, rising from a mere US$ 0.2 billion in 1980-85 to US$1.7 billion in 1991-96 and US$ 9.8 billion in 2005. But the major share of the inflow went to India (68%) while India and Pakistan jointly holds 90% of the total inflow in South Asia in 2005 (WIR 2006).

Whether the developing countries of South Asia can follow the countries of other subregions of Asia in the process of intra-regional investment will depend on their capability to pursue deep integration and economic connectivity, as Integrated regional economies with minimum border barriers provide enterprises with the opportunity to reorganize their economic activities on various geographical scales.


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Hosts of FDI Sources of FDI

Intra regional FDI (US$ million)

India Pakistan Sri Lanka Bangladesh Nepal

India n.a. 6.0 (2.6%) 0.99 (0.2%) 5.1 (51%)

Pakistan n.a. (0.6%) 0.59 (0.1%) (0.03%)

Sri Lanka (0.01%) n.a. 0.52 (0.1%) n.a.

Bangladesh 0.59 (0.01%) 0.79 (0.08%) 0.41 (0.18%) n.a.

Nepal n.a. n.a. n.a. n.a.

Share of South Asia 0.04% n.a. 2.1% 0.4% 37.6%Source: IPS (2000), World Investment Report (2003), Bangladesh Bank (2006), Board of Investment (2007), Moazzem K. (2006).

Note: Figures in parenthesis indicates percentage share of total FDI inflow to the respective country. * Data represents different sources and different time periods and may not be always

comparable.

Only India has been investing to some extent among the South Asian countries within the region, investments directing mainly towards Sri Lanka and Nepal. 2.6% foreign investment in Sri Lanka has been coming from India, while for Nepal, Indian investments contribute to the extent of 51%.

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With the advent of economic liberalisation in Bangladesh since late 1980s, inflow of FDI registered an upward trend from a very low base.

Total FDI inflow increased from US$ 92 million in 1995 to US$ 579 million in 2000 and reached to 845 million in 2005. In 2006, however, this amount went down to US$ 490.27 million, which could be due to the political unrest prevailing in the country at that moment.

Most of the FDIs in Bangladesh are coming from extra-regional sources. However, the share of South Asian FDIs in the total inflow has shown upward trend during the last decade, increasing from 1.55% (US$ 1.4 mln) in 1995 to 1.60% (US$ 9.3 mln) in 2000 and reaching 3.82 (US$ 32.3 mln) per cent in 2005.

3. INTRA-REGIONAL INVESTMENT IN BANGLADESH

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FDI inflow in Bangladesh from South Asian Sources


Source: Compiled from enterprise survey conducted by Statistics Department, Bangladesh Bank.

FDI Source 1995 2000 2005 2006

India 0.3 (19) 8.4 (91) 2.7 (8) 1 (47)

Pakistan 1.2 (81) 0.8 (9) 25.5 (79) 0.6 (28)

Sri Lanka 0 0.1 (1) 4.1 (13) 0.5 (25)

Nepal 0 0 0.1 (0.2) 0

Bhutan 0 0 0 0

Maldives 0 0 0 0

South Asia Total 1.4 9.3 32.3 2.1

Global Total 92.3 578.6 845.3 490.3

Share of South Asia in Global Total of Bangladesh (%) 1.55 1.6 3.82 0.43

• Within the total investment coming from the South Asia region to Bangladesh, Pakistan was the single largest source (79%) in 2005 (US$ 25.5 mln), while Indian investment of US$ 1 mln was the single largest source (47%) in 2006 .

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Sources

Sectors

Agri & Food

Industry Service Misc Total

South Asia Total

0.15 1.43 0.52 0 2.1

India 0.15 0.84 0.99

Pakistan 0.59 0.59

Sri Lanka 0.52 0.52

Nepal

Bhutan

Maldives

Global Total 5.32 15.76 469.1 0.1 490.27

Share of South Asia in Global Total

2.70% 9.10% 0.10% 0% 0.40%

FDI Inflow 2006: Distribution by sectors

Source: Compiled from Board of Investment (BOI).

(Million US$)

• South Asia contributed

a negligible share of

0.4% in total FDI inflow

in 2006 (US$ 2.1 mln)

• South Asian FDI mainly

directed towards the

industrial sector

(chemical and

engineering) with US$

1.43 million.

• This is reflected in the

share of South Asia in

the global total,

consisting 9.10 per cent.

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Name of Projects Sector

Investment

EmploymentInvesting

CountryLocal (mln Tk.)

Foreign (mln US$)

1Delta Brac Housing Finance

Corporation LtdServices 1,300.00 23.64 53 India

2 STS Holding Limited Services 830.00 17.30 700 Sri Lanka

3Cosmopolitan Industries (Pvt.)

LtdTextiles 650.00 10.00 3,850 India

4American & Efird Bangladesh

LtdTextiles 427.50 7.44 151 Sri Lanka

5Bangladesh Fertilizers & Agro

Chemicals Ltd.Chemical 300.00 7.50 50 India

6 Marico Bangladesh Ltd. Chemical 162.39 2.39 103 India

7 Nilkamal Padma Plastic Pvt. Ltd Chemical 160.75 2.80 128 India

8 ACI Godrej Agrovet Private Ltd. Agro-based 153.95 2.44 114 India

9 Nandan Park Ltd Services 150.00 2.61 195 India

10Asian Paints (Bangladesh)

LimitedChemical 141.49 2.57 105 India

Major Intra-Regional Investments in Bangladesh (Implemented/Under Implementation)

Source: Board of Investment

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Source 2004-05 2005-06Cumulative total

(as on Jan 07)

South Asia Total in Bangladesh

0.80 1.90 11.90

India 0.46 1.29 6.30

Pakistan 0.34 0.61 5.10

Sri Lanka

Nepal 0.50

Bhutan

Maldives

Global Total 101.02 81.12 878.62

Share of South Asia in Global Total (%) of Bangladesh

0.79 2.34 1.35

FDI Inflow in EPZs of Bangladesh: Distribution by Sources

Source: Compiled from BEPZA

(Million US$)• The share of FDI from

South Asia increased

in FY 2006 compared

to FY 2005.

• India and Pakistan

contributes almost the

total South Asian FDI

inflow in EPZ.

• The South Asian FDI

inflow share is more in

the EPZs than that in

the DTA.

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3. INTRA-REGIONAL INVESTMENT IN BANGLADESHCumulative South Asian FDI Inflow in EPZs: Distribution by Sectors (as on Jan 07)

Source: BEPZANote: Figures in parenthesis indicates percentage share of South Asian total

Source

Sectors

TotalAgro-based

ManufacturingMisc/NEC

Total RMG

South Asia Total 2.17 3.21 2.32 6.51 11.89

India 1.67 (77) 2.97 (93) 2.08 (90) 1.65 (25) 6.29 (53)

Pakistan 0.24 (7) 0.24 (10) 4.86 (75) 5.10 (43)

Sri Lanka

Nepal 0.50 (23) 0.50 (4)

Bhutan

Maldives

Global Total 2.96 422.80 270.78 453.86 879.62

Share of South Asia in Global Total (%) 73.31 0.76 0.86 1.43 1.35

• For the Agro-based sector, South Asian sources contributes the most (73.3% of the global total). But the region contributes only 1.35% of the total foreign investment in the EPZs.• 53% of the cumulative South Asian investments in the EPZs of Bangladesh has been made by India and 43% by Pakistan.

(Mln US$)

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3. INTRA-REGIONAL INVESTMENT IN BANGLADESHFDI Inflow: Distribution of Sanctioned Units in EPZ by Sources

Source: BEPZA

2004-05 2005-06 Cumulative total (as on Jan 07)

South Asia Total 7 7 42

India 5 5 28

Pakistan 1 1 7

Sri Lanka 5

Nepal 1 1 2

Bhutan

Maldives

Global Total 33 25 288

Share of South Asia in Global Total

21.21 28.00 14.58

During 2005-06, 7 out of 25 sanction units at the EPZs came from the South Asian sources (5 from India, 1 from Pakistan and 1 from Nepal)

Out of the cumulative total of 288 sanction units made to the EPZs till January 2007, 42 has been invested by the South Asian countries (India 28, Pakistan 7, Sri Lanka 5 and Nepal 2)

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4. PROPOSED TATA INVESTMENT IN BANGLADESH:A CASE OF INTRA-REGIONAL INVESTMENT

TATA submitted an expression of interest with the Bangladesh Board of Investment (BoI) in October, 2004. TATA’s US$2 billion proposal included Steel Plant, Fertilizer, Coal Mine and Electricity.

After a long negotiation, a revised offer was submitted on April 30, 2006 amounting US$3 billion. TATA group proposed a relatively higher gas price and some new

package benefits in its revised proposal like share in the coal mining, initiatives under social corporate responsibility (CSR) - hospital, training institutes, etc.

Bangladesh Government would guarantee the supply of gas. The previous government formed a secretary-level government

negotiation committee that gave its report to the high powered ministerial committee

The ministerial committee was to place the proposal to the cabinet while the following elected government was to take the final decision. This did not happen.

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4. TATA’S REVISED PROPOSAL AT A GLANCE

Industry Investment (mil. $)

Capacity Location Market Required Gas (TCF)

Steel 1200 2.4 MTPA Pabna Domestic & Export

0.97(Northern

BGD)Fertilizer 600 1.0 MTPA Sangu Domestic &

Export0.64

(Southern BGD)

Electricity

600 475 MW Pabna (Northern

BGD)

Domestic & Steel

0.53

250-300 MW Dinajpur (Northern

BGD)

Domestic & Coal Mine

-

(500 MW if needed)

Coal 600 6.0 MTPA Dinajpur (Northern

BGD)

Domestic & Electricity

-

Total 3000 - - - 2.14

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4. TATA PROPOSAL: MAJOR DEBATES

Gas Price Proposed gas pricing is based on product linked gas pricing

formula (based on Urea and HR coil) Gas price will vary in range of $2 - $4 / MMBTU Initial period (1-6 years) floor price is $1.50 / MMBTU The local experts think that the pricing should be based on the

international oil price rather than the finished goods price The initial floor price is too low than the market price. One estimate shows that the highest proposed gas price from

Tata is $4/mcf. This price of Tata would cause loss of $9,765 million ($4.65/mcf).

The loss would be $15,015 million if we consider the minimum price of $1.50.

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Gas Price According to a suggestion by the secretary level committee, the

gas price would not have any upper limit and will be fixed on the basis of price fluctuation of the steel and fertiliser in the international market.

In this case there would be no upper limit for the gas prices, but there would always remain to lower ceiling.

The gas price would never go down below the gazetted prices for the local industries and secondly, the price would never be below the government's average purchase rate of gas from the international oil companies (IOCs).

Under the formula, as per present market rates of fertiliser, the price of gas per unit would be $ 3.70 for fertiliser plant while about $ 3.30 for steel plant.

Price of gas for steel will be paid in local currency.

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Gas Security

The guarantee for gas supply is reduced to 10 years.

Expert opinion is that it should be for five years. Then a revision should be done.

The secretary level committee suggested a ring-fencing formula in supplying gas to TATA, which means Petrobangla will supply gas to TATA from a dedicated gas field at its convenience.

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Coal Mine Lease For coal mining TATA offered joint venture (JV) with Petrobangla

(90:10). TATA will arrange 10 percent financing of Petrobangla also. TATA

had proposed to develop 6 MTPA open cast mine at Barapukuria. It had proposed not to disturb existing underground works during the tenure of the existing contract (up to 2011).

The open cast coal mining system is considered to be environmentally unsustainable in Bangladesh.

Question is raised why Petrobangla (and GOB) would allow 90 per cent ownership of an asset exclusively owned by Bangladesh.

The secretary level negotiation committee suggested the government to ask the Tata to pay $ 250 million for the Barapukuria coal mine project as such amount had already been spent on the project.

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Equity Participation One of the striking feature of the revised proposal is to offer up

to 10 per cent of equity of each project company to GOB at par and to provide for placing of equity on the Dhaka / Chittagong stock exchange subject to market conditions.

The critics remark the ownership of government should be much higher than that.

Subsequently, the secretary level committee suggested that TATA should give 10 per cent equity share of the project free of cost to the Bangladesh government.

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4. TATA PROPOSAL: LATEST STATUS

• On July 10, 2006 the TATA Group suspended the negotiation

of its $ 3 billion investment proposal in Bangladesh due to

"indecision of the Bangladesh government".• The TATA officials and BoI executives have started to revive

the current proposal recently. Whether the Caretaker

Government in Bangladesh will consider it to be its priority

task is to be seen.• Regarding investment proposal of the TATA group, the new

CTG may constitute a high-powered competent committee

which, building on outcomes of earlier rounds of negotiations,

should recommend best possible economic price for natural

gas to be supplied, and to settle other issues.

5. INTRA-REGIONAL INVESTMENT: POLICY ISSUES

Investment potential in South Asian countries emerges from resource availability, access to market, strategic locational advantage and technological aspects.

Under a common investment framework, investment potentials of all South Asian countries could be developed in a coordinated manner.

Unfortunately there are a number of challenges that exists as barriers to build strategic partnership among the countries within the region.


Regulatory Barriers Absence of a harmonized trade regime discourages investment

in South Asia. Even signing an FTA would not necessarily ensure a higher level of intra-regional trade because of the diversified set of requirements. These include different kinds of standardization and certification processes, different custom rules and regulations, different tax laws and regulations and duty structures.

Thus, harmonization of the rules and procedures and mutual recognition of the rules and standards are some of the essential means for enhancing intra-regional investment in South Asia. Prior consultation in the case of imposing countervailing duty and antidumping duty is also required.

Apart from the general problems related to investment in other regions, the obstacles with the South Asian countries also contain some distinguishing features.


Restriction over Outward Flow in South Asian Countries

Outward FDI flow from India and Pakistan is controlled (restricted by means of minimum holding periods, classes of investors etc) and partly restricted (prohibited without permission) in countries like Sri Lanka and Bangladesh.

Without further liberalising the investment regimes (at least within), the region will barely be able to benefit from any industrial restructuring or trade.

Compliance with SAFTA

The objective of creation of SAFTA is to “strengthen intra-SAARC economic cooperation to maximize the realization of the people’s potential for trade and the development of their people.”

Regional economic integration in South Asia could work as a catalyst in improving intra-regional investment and generate billions of dollars of new income, employment, trade helping the region in its fight against poverty.

Studies have shown that removal of tariff and non-tariff barriers would increase intra-regional trade by 1.6 times the existing level. (Source: The Daily Star, February 19 2006)

SAFTA was signed in 2004 but trade still remains stagnant mainly because of the existing political barriers between India and Pakistan.


Compliance with SAFTA

SAFTA’s current foreign trade is only 0.8 per cent of the total global exports and 1.3 per cent of world imports.

Intra-SAARC trade is only 5.3 per cent of overall exports of the region.

Current bilateral official trade between India and Pakistan adds up to $ 1.35 billion.


Regional and Bilateral Investment Treaties

At present, three Bilateral Treaties exist in the South Asian region between Bangladesh-Pakistan, Pakistan-Sri Lanka and Sri Lanka-India.

The recent initiative in signing a Regional Investment Treaty has not been fulfilled due to the reluctance of countries within the block in opening all sectors for intra-regional and extra-regional investment.


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5. INTRA-REGIONAL INVESTMENT: POLICY ISSUESCountries that have concluded BITs with South Asia and South East Asia (as of 1 June, 2006)

Countries

Developed Countries Developing CountriesTOTAL

WesternEurope

UnitedStates

OtherDevelopedcountries

Africa Asiaandthe

Pacific

LatinAmericaand the

Caribbean

CentralAnd

EasternEurope

South Asia

Bangladesh 10 1 1 - 13 (1) - 5 25

India 19 - 2 7 21 (1) 1 6 57

Pakistan 14 - 2 4 26 (2) - 4 48

Sri Lanka 12 1 2 1 11 (2) - 3 25

Nepal 3 - - 1 - - 1 4

Source: UNCTAD 2006

Implementation of the Regional Trade Agreements in South Asia can significantly give rise to intra-regional investment.

Signing of a Regional Investment Treaty and Double Taxation Treaties among the countries will be an important step to remove the obstacles to investment.

There is no confined evidence that shows that developing countries can make massive gains from BITs. In order to gain from BITs between the countries in South Asia, fast track trade liberalization (in form of reduction in tariff and non-tariff barriers) must be sought under SAFTA.


Infrastructural Connectivity The South Asian countries are yet to build on their

infrastructural facilities in order to operationalize intra-regional investment initiatives. Regional transport network, power grid, existence of and access to all ports by regional investors are some of the necessary elements in order to foster intra-regional investment.

Studies have shown that: The cost of industrial land is highest in Dhaka ($64/sq.m). Difficult to find suitable land for setting up industrial plant. The cost of utilities for business is highest in Colombo. The port’s in South Asia are about 15-20 percent more

expensive than the Chinese ports.


There is no specific trend as far as the benefits received by small and large economies of different trading blocks are concerned. Among the South East Asian countries, FDI to the smaller economies have been observed to go down, while similar kinds of benefits were shared by the countries in NAFTA.

Concurrently, there is an apprehension that the smaller economies in South Asia would not receive much benefit from intra-regional investment.

Existence of small and large economies in the regional block

In order to improve infrastructure at the regional level, major industrial restructuring and large scale common projects need to be undertaken. These projects can then be implemented by South Asian Development Fund (SADF) set up under SAARC in order to promote industrial, infrastructural, institutional and human resource development.


Mindset

There are large differences between the size of the economies which sometimes can become a psychological barrier towards the smaller economies.

Reluctance of India as well as other states in opening up their economies to other neighbors is another barrier towards intra-regional investment.

Lack of appreciation for each other regarding the steps and policies initiated by member countries in the block leads to information failure between the countries.


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south asia intra-regional opportunities and challenges

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