“Foreign Direct Investment in Bangladesh”

Group# 15

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University of DhakaDepartment of Banking

BBA 13th Batch

Submitted To:Mr. Md. Shahidul Islam ZahidCourse InstructorDepartment of BankingUniversity of Dhaka

Submitted BY:Nasru fuad ID-45Md. Tariqul Islam ID-03S. M. Mohaimen ID-48Md. Mehedi Hassan ID-69

Date of Submission: 18th October 2009

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Date: 18th October 2009

To The Course Teacher Department Of BankingUniversity of Dhaka

Subject: Prayer for permission to submit the term paper on “Foreign Direct Investment.”

Sir,

With due respect and humble submission we would like to present you the term paper on “Foreign Direct Investment.” Surely it has been a great learning experience for us. We got the chance to implement our gathered knowledge on the real world.

So with great honor we are asking for your permission to submit you our term paper.

Yours sincerely

Nasru Fuad

BBA 13th Batch

Roll- 45

Department of Banking

University Of Dhaka

On behalf of group members.

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First of all we would like to thank our course teacher Mr. Md. Shahidul Islam Zahid for giving us the term paper on the topic “Foreign Direct Investment in Bangladesh.” We had to go through all our taught subjects for this term paper. It was a good experience for us to know about the Foreign Direct Investment and its current prospect in Bangladesh. We have gain much and it will definitely help up us to build up our future carrier. For preparing this term paper we went to the board of investment of Bangladesh and collected the recent data on FDI and the “Bangladesh Investment Hand Book”. We also collected the information from the website of BOI Bangladesh. We are great full to all of them who helped us to preparing this term paper.

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Content Pages

Executive Summary 06

Map 07-09

Introduction 10

FDI Definition 11

History of FDI 12-13

Current Situation of FDI Inflows in Bangladesh

14-16

Relationship Between FDI And Economic Growth In Bangladesh

17-28

FID In Bangladesh 28-32

Factors Affecting FDI 32-33

Impediments Of FDI In Bangladesh 33-34

FDI In Bangladesh: Problems And Prospect

34-39

Conclusion 40

Suggestion And Recommendation 41-42

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Bangladesh has been experiencing a transitory stage from an agrarian economic composition towards an industrial economic structure. Industry has gradually been taking up the major share of the national income. In the last two and half decades, contribution of industry in the GDP nearly doubled to 29.01% while agricultural contribution declined by one-third to 21.77% during the same period. Private sector investment rose significantly to 18.7% of GDP. FDI has got the momentum and experienced the highest inflow of US$ 845 million in 2005. Recognizing the rising role of private sector as a key actor in the economy, Bangladesh is keen to ensure a sustained conducive business climate. Implementation of private sector led growth strategies, undertaking pragmatic reforms and enhancing the facilitative role of the regulatory agencies and institutions are the prime agenda of government. We envision raising private investment to 25% of GDP, driving industry's contribution to 40% of GDP, quadrupling FDI inflows, increasing GDP growth to 10% attaining 100% literacy rate and reducing the percentage of population below the poverty line to 20% by 2015. Bangladesh offers a competitive location for doing business in terms of costs, inputs, human resources, market access, facilitation etc. Investing in the appropriate sector in Bangladesh would yield higher returns than many other competing locations with lesser risks.

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INTRODUCTION

Countries that are unable to generate sufficient domestic saving to promote their economic growth are historically sought finance from other countries. The international flow of foreign capital takes two forms: public capital (or foreign aid) and privet capital. Foreign private capital consists of two elements, foreign direct investment made by nonresidents, typically but not always by multinational companies, in the enterprise located in host countries.

1. Foreign direct investment implies full or partial control of enterprises and physical presence by foreign firms and individuals.

2. Foreign indirect investment better known as portfolio investment Is the purchase of host country bonds or shares by foreigners, without marginal control.

In recent years, most of the developing countries, have considered FDI as more favorable factor for stimulating economic growth, Bangladesh is not an exception. A number of factors -lie behind this new orientation: slow down of the world economy along with political unrest in the international arena, decline trend in public capital or foreign aid and the globalization of production and services. All this issue may cause adverse impact on Bangladesh economy. So the govt. has no other choice but to relay upon FDI to meet its investment needs. Apart from transfer of capital, foreign direct investment expected to bring advanced technology, skills, know-how, and managerial capacity and access to world markets. All these benefits are available to host countries as an investment package incorporating equity capital, management, technology and marketing. To capture more of the benefits from investment package, the country undertook massive liberalization of its trade and investment policies. However, in order to keep pace with global trend, Bangladesh decide to embrace free market economy and put emphasize on private sector-led grow to strengthen the function of market economy. Moreover, several institutions have been established to provide all support to private investment. Among them establishment of board of investment (BOI), privatization commission and the development of capital market are most important. In addition to this, government should bear in mind that all these steps may not guarantee automatic flow of foreign private investment to the country. Bangladesh still remains the smallest recipient compared to other countries in the region.

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FDI DEFINITION

Foreign direct investment (FDI) is defined as an investment involving a long-term relationship

and reflecting a lasting interest and control by a resident entity in on economy (foreign direct

investor or parent enterprise) in an enterprise resident in an economy other than that of the

foreign direct investor (FDI enterprise or affiliate enterprise or foreign affiliate). FDI implies that

the investor exerts a significant degree of influence on the management of the enterprise resident in the other economy. Such investment involves both the initial transaction between the two entities and all subsequent transactions between them and among foreign affiliates, both incorporated and unincorporated. FDI may be undertaken by individuals as well as business entities. Flows of FDI comprise capital provided (either directly or through other related enterprises) by a foreign direct investor to an FDI enterprise, or capital received from an FDI enterprise by a foreign direct investor. FDI has three components: equity capital, reinvested earnings and intra-company loans.

■ Equity capital is the foreign direct investor's purchase of shares of an enterprise in a country other than its own.■ Reinvested earnings comprise the direct investor's share (in proportion to directequity participation) of earnings not distributed as dividends by affiliates, orearnings not remitted to the direct investor. Such retained profits by affiliates arereinvested.■ Intra-company loans or intra-company debt transactions refer to short- or long term borrowing and lending of funds between direct investors (parent enterprises)and affiliate enterprises. This survey has been designed on the basis of the above definition by World Investment Report.

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HISTORY OF FDI

Until the early 1980s, many of the Least Developed Countries, including Bangladesh, were skeptical of the intentions of FDI and perceived it as a tool for promoting foreign interests. Consequently, a wide array of restrictions were imposed to control FDI inflows through regulations on profit and dividend repatriations, limits on foreign equity and capital, and required royalty payments. In an increasingly globalized world economy, countries have now lifted such barriers to open their economies and take advantage of the benefits of foreign investment. FDI inflows in Bangladesh have grown from a trickle during the 1980s to above $300 million towards the end of 1990s; in 2005, it stood at about $692 million (UNCTAD 2007). Figure illustrates the rising trend of FDI inflows in Bangladesh:

Many factors have led to this dramatic rise and in order to better understand them, it is necessary to discuss the history of the economic policy implemented by the Government of Bangladesh since the country’s independence from Pakistan in 1971. Immediately after the birth of the sovereign nation, the new government attempted to establish a socialist state and adopted the Nationalization Order of 1972 to foster economic growth. 86% of the industrial sector was brought under government control including key industries such as sugar, jute, and cotton textiles . The First Five Year Plan was undertaken from 1973 through 1978 and focused on a state directed economy. The nationalized industries, however, were inefficient and the economy

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experienced low growth. The losses incurred by the public sector and its State Owned Enterprises created a build-up of political pressure and the government initiated more laissez-faire measures to encourage a larger role of the private sector. Consequently, Bangladesh has undergone a series of policy reforms to induce a more capitalistic economy by progressively increasing funding allocations to the private sector; these reforms include the 1978-1980 Two Year Plan, the 1980-1985 Second Five Year Plan, the 1985-1990 Third Five Year Plan, and the 1990-1995 Fourth Five Year Plan. Owing to the lack of financial ability, knowledge, and management within the nascent economy of a new nation, the government could not solely rely on the domestic financial market for economic growth. While other low income countries experienced a 3.8% growth of GNP per capita, Bangladesh struggled at 0.4% per year till 1985. To accelerate the development of the economy, foreign investment became a priority and in 1980, the Bangladesh Parliament approved the Foreign Private Investment Act. FDI, however, rose very little owing to the upheld trade restrictions and the Investment Act of 1989 soon followed to establish the Board of Investment (UNCTAD 2000), the primary objective of which is aimed at attracting and facilitating investment from abroad.It is important to emphasize the years between 1995 and 1998 which saw the sharpest andmost sudden rise in FDI flows. This period can be attributed to a variety of factors. During the mid-1990s, numerous foreign enterprises led exploratory research campaigns into the nation’s natural gas reserves, which have an estimated capacity greater than 10 trillion cubic feet according to the U.S. Geographical Survey (UNCTAD 2000). Given the world’s scarce resources, external pressure finally urged the Bangladeshi government into liberalizing the energy sector, a move which almost immediately attracted increasing levels of FDI5. Concurrently, the government also eased capital controls and reduced its bureaucratic red tape to allow private firms to borrow foreign loans without governmental permission , thus encouraging more joint ventures with international companies. In 1995, the Bangladesh government opened up the mobile telecommunication industry for private investment, an area which has fosteredtechnology transfers as well as hundreds of millions of dollars in FDI . All these reforms and policies combined to shape Bangladesh into the nation that it is today.

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CURRENT SITUATION OF FDI INFLOWS IN BANGLADESH

From a policy perspective, the Bangladesh Board of Investment has taken measures to transform the country into the most liberalized investment regime in the South Asian region (UNCTAD 2000). This is largely reflective of the increasingly capitalistic model of the economy where growth is fueled primarily by the private sector. Thus, foreign enterprises are allowed to reduce associated business risks by undertaking joint ventures with domestic private firms. A number of other advantages make Bangladesh a prime destination for FDI. With a 150 million population, the most abundant factor of production is low-cost labor. This attribute makes the country ideal for labor-intensive industries. The densely populated city centers also provide for an untapped, sizeable market (UNCTAD 2000). The only limit to such a market is that the products offered will either only appeal to the upper socioeconomic strata or will have to incorporate low-cost items to appeal to the general population. There is also an abundance of natural resources, such as methane gas, water, coal, and oil (www.supro.org)6. Furthermore, many areas of the Bangladeshi infrastructure remain underdeveloped and this provides a wide array of markets for incoming foreign investment with little or no domestic competition. It is also important to realize that the government has neither the capital nor the resources to expand many areas of its infrastructure and consequently has attempted to open its economy towards foreign capital, particularly in areas such as power plants, construction, transportation, etc. (UNCTAD 2000.) Hence, the country has adopted a sequence of liberalized industrial policy reforms (www.supro.org). The government has also established two export-processing zones (i.e. areas with minimized trade restrictions) in the country’s two largest cities, Dhaka and Chittagong (UNCTAD 2000), which account for most of the inward flows of FDI. It is important to note that so far roughly 90% of FDI inflows in Bangladesh have come in the form of equity and reinvestment (Bangladesh Board of Investment 2004) since there is currently is no limitation on equity participation for foreign private investment (www.supro.org). About 10% has come in the form of intercompany borrowings. In addition to the Board of Investment, two more bureaucraticBodies keep track of FDI registrations and they include the Bangladesh Export Processing Zones Authority and the Bangladesh Bank. It is important to observe that FDI inflows have increased each of these years and the above only represents the share of FDI each sector has received relative to the other (and not in absolute value). The pie charts express how the dimensions of FDI inflows have changed in recent years. The reduction in FDI shares of manufacturing demonstrates that it is no longer a stronghold for foreign investment and other sectors, such as telecom and Based on percentages gathered from the Bangladesh Board of Investment 2002, 2003, 2004 respectively. energy, are gaining prominence as well. The agro-based industry is particularly important since Bangladesh is a sub-tropical delta with very fertile land and is ideal for dairy, poultry, fruits, vegetables, shrimp and fish farms (www.supro.org). The smallest, miscellaneous proportions include services in finance, engineering, and computer software. As recently as 2003, the manufacturing sector received the majority of foreign investment inflows.

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A vital part of this was owing to the success in textiles through the ready-made garments (RMG) industry. The manufacturing sector involves productswhich fall under sub-categories such as textile, chemicals, agriculture, food, glass, ceramics, leather, rubbery, printing and publication (Bangladesh Board of Investment 2004). In 2004, however, manufacturing was overtaken by the telecommunications sector as the leading recipient of FDI. Owing to increased privatization efforts by the government, telecom has emerged as one of the fastest growing sectors in the Bangladesh economy. Much of this can be explained by the increased competition between large private corporations that have magnified efforts to attract FDI and attain better technology to optimize profits. At the same time, Grameen Phone’s efforts to loan out mobile phones to female operators in remote villages have also increased the demandfor foreign investment in telecom and satellite communication technologies. In addition, the energy sector draws in significant levels of FDI albeit in comparatively lower quantities. The country’s natural gas reserves partially explain this. Another factor is the country’s difficulty in generating electricity. The lack of production capacity causes the government to frequently ‘load shed’ power, by imposing blackouts in areas of low power usage to meet the needs of areas of higher power usage. Hence, the energy sector offers much scope for foreign investment as the government lacks the capital and liquidity of building power-grids and expanding the country’s electric capacity. Other imports in the energy sector include solar and hydro-electric generatorsbut these have been installed only in limited quantities. Further evidence of the growing credibility of Bangladesh’s investment regime can be seen from the numerous countries which have decided to invest in the country.

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More than a third of FDI originates from developed parts of the world such as North

America, Europe and Japan. Another approximate third are investments from Bangladesh’s South Asian neighbors, mostly from the rapidly growing Indian economy. Furthermore, the Bangladesh Board of Investment (2002) reports that though approximately 60% of all FDI inflows are transferred through joint ventures to hedge risk, 40% come straight from the parent company without any medium domestic firms (via the establishment of affiliate firms in the host country). In summary, there are many prospects for FDI in Bangladesh. The nation has many resources and scope to yield many advantages and opportunities for foreign investors. The government and economy have also been made very conducive to investment through a series of reforms allowing the nation to become the most liberalized trade regime of the South Asian region (UNCTAD 2000). Despite the pros, it is also important to recognize that Bangladesh lags behind its neighboring counterparts such as India and Sri Lanka. In many aspects, it is still viewed as an FDI underperformer (UNCTAD 2006) and the country is far from achieving its full potential. It will take time before Bangladesh achieves better results in attracting FDI but as long as the inflows continue to increase, the possibilities for the country’s future remain hopeful.

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RELATIONSHIP BETWEEN FDI AND ECONOMIC GROWTH IN BANGLADESH

(i) Theoretical ConceptsThere are several benefits of FDI on a macroeconomic level, particularly for a Third World Nation such as Bangladesh, where inflows of foreign investment can help broaden economic production and growth. FDI provides capital from sources abroad which the country is unable to supply domestically. Foreign investment helps to fill the saving-investment gap caused by the lack of domestic savings converting into investment (Ahmad 1990). Bangladesh specifically faces many obstacles in expanding its cities with overpopulation and low GDP per capita (Sattar 1999). The inflows facilitate capital formation and the growth of a number of economic sectors, including industry, manufacturing, infrastructure, and energy. The expansion leads to a rise in the availability of jobs and a fall in the unemployment rate11. Consequently, GDP and per capita income increase which, in a developing country, fosters poverty alleviation. In addition, FDI strengthens ties with developed countries that yield cost advantages in the form of advanced technology transfers and resulting positive externalities. Increased financial associations also lead to stronger capitalistic markets and ideals of corporate and social responsibility (www.supro.org). On the basis of this intricate link between FDI and growth/development, the trade regime of Bangladesh has been intensely liberalized to maintain the streams of investments and finances from abroad. These reasons also increase the effort of the government to try and make the country an attractive destination for FDI, which in itself has several benefits. The result has validated a reinforced incentive to educate and train the population to make Bangladesh’s labor force more competitive through higher national education expenditure. The effectiveness of domestic institutions such as the Grameen Bank, however, appears to be more effective in fostering investment in human capital (via female empowerment) than FDI. Fry (1999) finds that foreign capital in non-Asian countries has induced decreasing rates of national saving, domestic investment, and economic growth. His study suggests that in most regions FDI tends to substitute and crowd out domestic investments. In the case of South and East Asia, however, foreign investment has been beneficial in increasing capital formation and has produced positive effects similar to home investment (Fry 1999). Since there is little domestic investment to crowd out inBangladesh, foreign investment can effectively assist with economic growth to increase the country’s GDP. In a country like Bangladesh, where the economy is driven by high volumeimports, a huge capital account deficit accumulates as foreign exchange flows out. Sattar (1999) notes that FDI is a fundamental and necessary component for long-term sustainable growth in Bangladesh. In this context, FDI enables various economic sectors to become efficient and increase the production of the economy. Sattar (1999) discusses the advantages of exports and FDI outflows in this context. Outflows enable a nation to earn foreign exchange and improve its capital account; it can increase an already existing surplus or, as in the case of Bangladesh, reduce its budget deficit and possibly help bring about a surplus in the distant future. FDI inflows

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tend to deter the capital account as Fry (1999) identifies a strong association with higher imports. However, when such inflows help raise the production capacity, the economy can become more export-oriented (Fry 1999) and gain foreign exchange currency (Sattar 1999). This earned currency can finance increased imports or inflows of foreign capital and, in turn, sustain furthergrowth and development (Sattar 1999). Thus, Bangladesh has adopted a capitalistic, export-oriented growth strategy (www.supro.org). Specifically, the relatively recent success of the RMG industry exemplifies this cycle. Sattar (1999) highlights the logic that has underscored Bangladesh’s trade policy regime. Though FDI entails many positives, there remains a concern over capital flight. This notion involves outflows of domestic capital that hurts the country’s current account and foreign exchange reserves. Quazi (2004) suggests that international aid andforeign investment tends to accelerate such outflows and stun economic growth. The study suggests that the foreign currency generated by FDI helps finance the flow of domestic capital abroad as incoming foreign capital substitutes for it within the home country’s borders. Conversely, Mondal (2003) identifies reduced capital flight as a benefit of FDI. This infers that the benefits of FDI reduce the risk of home investments by stabilizing economic output and reducing the incentive to invest abroad. The number of studies examining the precise relationship between FDI and economic growth has been somewhat limited. This can be attributed to a number of reasons. In terms of the macro economy, there are a number of wide-ranging factors that can influence growth and development outside of foreign investment; not including all factors raises concerns over omitted variable bias in the empirical estimation. This occurs when a significant variable is excluded and the statistical model is underspecified, that is, it has not accounted for all relevant factors. In order for their to be bias, the excluded independent variables must affect both the dependent variable as well as other independent variables of the equation. An upward bias occurs when independent variables are neglected such that the effects of the independent variables are included in the regression are overemphasized. In contrast, a downward bias is the effects of the independent variables are underestimated. Moreover, independent variables are often times correlated with each other and create issues of multicollinearity as well, which can severely misconstrue the analysis. Ahmad (1990) notes the presence of such interdependence among variables.

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(ii) Empirical Evidence & AnalysisThis section includes a series of regressions12 to underscore the many advantages and growth prospects that FDI inflows have brought to the Bangladesh economy. The objective is to not only gain insight into the country’s economic progress in recent years but to also provide a better understanding of its limitations. The methodology of the empirics constitutes a series of regressions using the Ordinary Least Squares (OLS) model to prove a significant correlation between FDI and economic growth. In trying to analyze such effects of a Third World Nation such as Bangladesh, it is important to recognize that data on key development indicators are often times missing or inaccurate. For this reason, the data used in the analysis will begin from 1980 when FDI had just begun to flow into the nation after the era of reconstruction and war recovery. The tables express the coefficients and t-statistics of each independent x-variable to demonstrate its level of significance. The R-squared or coefficient of determination is included to represent how much variation in the dependent y-variable is captured by the regression. Moreover, the dependent variables were lagged in Table 1 to control for serial correlation. Also known as autocorrelation, this occurs when successive error terms are correlated with each other over time and the reliability of the least squares estimates are overstated (Hill 2001). The lags account for heteroskedasticity or the non-randomness of variables, in that the error term is increasing with each observation over time.

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Table 1A utilizes GDP per capita as a proxy for growth and development. Regression (1) is merely GDP per capita against FDI and serves as a benchmark to demonstrate the positive relationship between the two. It shows that a $1 million increase in FDI inflows raises GDP per capita by $0.334. Regression (2) of Table 1A significantly reduces the omitted variable bias as more independent variables are introduced into the equation. As a result, the coefficient of FDI also decreases to $0.014. In the second column, FDI is found to be significant at the 10% level and is positively correlated to GDP per capita, such that a $1 million increase in FDI inflows raises GDP per capita by $0.014. Though this does not appear to be an economically significantincrease in GDP per capita, it is important to note that in a Third World country such as Bangladesh, money has more value in that $1 (currently equivalent to about 70 Taka) has relatively higher purchasing power in Bangladesh than in the United States. GDP per capita is also limited by Bangladesh’s population, which is quickly approaching 150 million. Furthermore, the annual growth of the manufacturing sector is significant at the 1% level. A unit increase in the percent growth of manufacturing leads to a $0.668 increase in GDP per capita. As mentioned in the previous sections, manufacturing growth in textiles has assisted with domestic production and has helped the country gain momentum in development, especially through the RMG industry. However, there is some doubt as to whether this will continue in the face of increased competition once the quotas from the Multi Fiber Agreement (MFA) are dropped . Industry was not included since it is almost perfectly correlated with manufacturing such that one can substitute the other. Though insignificant, it is worth mentioning that net national savings are adjusted by the World Bank to account for factors such as education expenditure, consumption of fixed capital, environmental damage by particulate emissions and carbon dioxide, as well as the depletion of energy, mineral, and forest resources (2006). Regression (3) of Table 1A adds government stability as a new variable and replaces net national savings with saving adjusted only for education expenditure. Once again, FDI and growth in manufacturing are significant, with their correlations with GDP per capita slightly reduced in comparison to Regression (2). This may be because the effect of savings (adjusted for education expenditure) proves significant at the 1% level but is negatively correlated with GDP per capita. The inverse relationship may bebecause the size of the labor force shrinks as more people enroll to pursue education. From a historical point of view, the increased enrollment in schools would correspond with a higher number of female students and a reduction of child labor, possibly accounting for the fall in GDP per capita. Government stability has also been included to capture political unrest, which is common particularly in the form of ‘hartals’ or general political strikes aimed to stem business activity; however, it is not significant in the context of GDP per capita. A plausible explanation for this is that the Bangladeshi people have become quite resilient in managing to run offices among such strife, although commercial businesses do suffer. The ranking system used in the PRS Group’s International Country Risk Guide model could have also attributed to the insignificance of the variable.

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Table 1BEffect of FDI Inflows (as % of GDP) and Socioeconomic Variables on GDP Per Capita GrowthTable 1B examines the relationship between FDI inflows (as a percent of GDP) and the annual growth in GDP per capita, which is arguably a better indicator for economic growth since it deals with the percentage change rather than the absolute value. Regression (1) has been included as a benchmark to demonstrate the positive correlation between GDP per capita growth and FDI inflows. It suggests that a unit increase in FDI inflows (percentage of GDP) induces a 3.804 increase in GDP per capita growth. In Regression (2), the correlation between FDI and GDP growth is reduced as we add more independent variables. Nonetheless, FDI inflows and the annual growth in manufacturing are significant at the 5% and 1% level respectively. A unit increase in FDI results in a 2.535 increase in the annual percent growth of GDP per capita; similarly, a unit increase in manufacturing growth results in a 0.239 increase in GDP growth. Manufacturing has a stronger influence on GDP per capita than FDI since in recent years, the concomitant textiles industry has increased employment levels particularly among women, which has contributed to the reduction of gender inequality. For Regression (3), in addition to FDI inflows and the growth of manufacturing, savings adjusted for education expenditure is also significant and is negatively correlated with GDP per capita growth at the 5% level. Overall, the significant results of Table 1B are quite similar to those of Table 1A.

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Table 1CEffect of FDI inflows (as % of GDP) and Socioeconomic Variables on GDP Growth Table 1C examines the influence of FDI inflows (as a percentage of GDP) on the annual percentage growth of GDP. As before, Regression (1) acts as a bench mark to illustrate the positive relationship between the two; it suggests that a unit increase in FDI results in a 3.22 increase in GDP growth. Regression (2) finds that FDI net inflows, annual growth of the manufacturing sector, savings adjusted for education expenditure, and the time trend are all significant variables. Regression (3) includes additional variables such as government stability and corruption; savings adjusted for education expenditure is replaced by gross domestic savings to

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focus purely on savings. The results show that only FDI inflows and manufacturing growth are significant. Though Bangladesh has been rated as one of the most corrupt countries in the world, corruption does not appear to be significant in its effect on GDP growth as it has had very little variation since the country’s independence; government stability has also behaved similarly. This may suggest that corruption and government stability are captured by the regression as fixed effects. The International Country Risk Guide model could have also influenced the statistical regression to render both corruption and government stability insignificant. Gross domestic savings is insignificant and this can be attributed to Bangladesh’s very low level of income per capita, where many citizens do not earn enough to save and invest. It is interesting to note its negative coefficient or inverse relationship with GDP growth, since it leads to a decrease in aggregate demand, lower firm production, and a fall in the full-employment level.

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Table 2Effect of FDI inflows (monetary value) and Socioeconomic Variables on Telecom DistributionTable 2 depicts how FDI accelerates the expansion of the consumer base within the telecom sector and emphasizes another dimension within development and growth. Foreign investment allows for technology transfers from developed countries to assist Bangladesh in developing its telephone network and satellite bases. As seen in Chapter 2, telecommunications is a major recipient of FDI shares and has played an integral role in building the nation’s communications infrastructure. FDI has facilitated the recent expansion of the telecom sector, which is a large contributor to Bangladesh’s GDP and has the potential to provide more jobs to foster economic growth. Though not expressed in the regression, the spread of phone subscriptions is also indicative of growing use of the internet. Government expenditure is also significant since it helps finance the distribution of land and mobile phones and exerts a stronger effect in increasing phone subscribers.

Table 3Effect of FDI inflows (monetary value) and Socioeconomic Variables on Commodity Exports

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Table 3 reveals that foreign direct investment is positively correlated with exports at the 5% level. It suggests that a $1 increase in FDI leads to a $2.784 increase in exports. The regression demonstrates the key relationship between incoming foreign investment and exports. As FDI increases, the economy’s production capacity also increases enabling the country to export more goods ad services. This allows Bangladesh to earn foreign currency with which to further inflows of FDI and increase the economy’s production capacity even more. The analytics provide an understanding of how FDI can help sustain economic growth. GDP is not included in the equation because exports are already a part of GDP and this would account for it twice. Furthermore, household consumption and aid per capita are both significant. Consumption is positively correlated with exports since it can boost aggregate demand to encourage economic output which, in turn, enables firms to expand not only for the domestic market but for exports as well. Aid per capita is negatively correlated at the 1% level and this may because it moves opposite to exports in the latter’s representation of economic independence and self-sustainability. In addition, household consumption is correlated with exports at the 5% level

Table 4Effect of Exports and Imports (monetary value) on Bangladesh’s Current Account Table 4 simply serves as a bench mark to illustrate the effects of exports and imports on the current account. It suggests that the positive impact of exports currently outweighs the negative impact of imports on the current account. This reinforces the aforementioned importance of FDI as a way to increase the economy’s production capacity and help adopt an export-oriented trade regime to raise foreign exchange reserves. Amongst the backdrop of the current situation of high import volumes, such a gain in momentum can help improve the dynamic of the current account of Bangladesh to sustain economic growth for the long-run. Lastly, it is important to note that a deeper analysis could have been provided if more data was available but it is necessary to

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consider that Bangladesh is a relatively new nation only 35 years of age. There are not as numerous data collection agencies working domestically to convey such information while government corruption often. times leads to misconstrued information. Nonetheless, multinational organizations such as the UN and World Bank are now more involved within the Bangladeshi economy and have been able to remedy many such issues.

FDI IN BANGLADESH

5.1 Present FDI StatusAs a developing country, Bangladesh needs FDI for its ongoing development process. Since independence, Bangladesh is trying to be a suitable location for FDI. However, the total inflow of FDI has been increasing over the years. In 1972, annual FDI inflow was 0.090 million US$, and after 33 years, in 2005 annual FDI reached to 845.30 million US$ and to 989 million US$ in 2006 (UNCTAD-2005, Bangladesh Investment Handbook 2007- BOI). Contribution of FDI was not remarkable until 1980, a year of policy change. This year government enacted the ‘Foreign Investment Promotion and Protection Act, 1980’ in an attempt to attract FDI. Enacting the Act government opens all sectors for FDI other than defense equipment and machinery, nuclear energy, forestry in the reserved forest area, security printing and minting, and railways (Foreign Investment Promotion and Protection Act, 1980). The FDI inflows since 1995 were:

FDI inflows from1995-2006 (US$ in million)Year FDI Inflow1995 92.31996 231.61997 575.31998 576.51999 309.12000 578.62001 354.52002 328.32003 350.22004 460.42005 845.32006 989

The table shows a fluctuating trend of the FDI inflows over the last 12 years. Data reveals that in 1999 there was a sudden fall in the FDI, and again in 2001, 2002 and 2003 the falling trend continued for many reasons. Among others serious political unrest during the period was a major factor that discouraged foreign investment in these years and it took quite some time to regain

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the confidence of foreign investors. It stabilized afterwards but remained below the average achieved during 1997-2000. Later on during next two years period it becomes alive again. The following graphical presentation gives us clearer picture of the FDI inflows over the years

This graph portrays inconsistent proceedings of the FDI in Bangladesh since 1995. It is a matter of great concern that in spite of Bangladesh’s comparative advantages in labor-intensive manufacturing, adoption of investment friendly policies and regulations, establishment of EPZs in different suitable locations and other privileges, FDI flows have failed to be accelerated (Robin, A.I. 2006). However, the year 2005 and 2006 show a substantial improvement in FDI achievement.

FDI TrendThe increasing trend of FDI in recent years is a good sign for Bangladesh. But a sector-wise analysis of FDI reveals that the foreign investors have so far made a major shift in their investments in Bangladesh. Table 2 (Sector-wise analysis of FDI inflow) shows a shift of FDI that has been made towards power and energy, manufacturing, (especially in ready made garments) and telecommunications, whereas agricultural, industrial and trade and commerce have been neglected. Industrial sector that plays key role in the economic development of a country, got foreign investment US$ 494 million in 2000, which is the last highest amount of FDI in industrial sector till 2005.

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Owing to comparative advantages and an accommodative policy regime, a large chunk of the FDI has gone into the ready-made garment ((Robin, A.I. 2006)). In 2005 FDI inflows in Bangladesh have been widely spread among the key business sectors, where the profit is higher, concerning on telecommunication (33%), manufacturing (26%), energy & power (25%), trade & commerce (15%), services, agriculture & fishing (1%).

Sources of FDIBangladesh generally, depends on 36 countries across the globe for FDI. Among thesources, 21 countries belong to the developing and transition economies. In 2005, FDI hasbeen originated from 30 different sources dominated by the developed economies (51.45%)and a significant share of FDI also came from developing economies (43.23%).

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The above table presents a source-wise analysis of FDI inflow in the year2005. It reveals the top-5 FDI sources are UK (18.08%), USA (16.78%), Singapore (11.53%), UAE (6.55%) and Norway (6.33%). So, Bangladesh needs to maintain a continuous favorable business relation with these countries. Warm relation should also be continued with the developing countries for their significant share of FDI in Bangladesh as well as performing Bilateral Investment Treaties (BITs) and Double Taxation Treaties (DTTs) for promotion and protection of foreign investment. But it is a matter of concern that Bangladesh has yet to perform either BITs or DTTs with UAE, Norway, Hong Kong and Taiwan though these countries have 5th, 6th, and 16th position respectively in the ranking of source countries for FDI in Bangladesh. Luxembourg and Saudi Arabia require more attention though their investments are not large in amount but they have resources to invest. The table also reveals that it would be possible to get more FDI from European countries as they have a positive investment trend in Bangladesh with the highest rank in consideration of total FDI inflows of Bangladesh in 2005. The Asian countries, which have a significant FDI in Bangladesh, should get more attention in terms of creating necessary investment climate. Furthermore, Bangladesh must not loss the faith of ADB and IFC for FDI as they have a remarkable ranking in investing Bangladesh.

Total Investment and FDIInvestment either foreign or domestic brings contribute positively in an economy by providing enhancement in the growth of GDP. Enough power & energy, availability of human resources and their trainability, governance etc. are the important factors to attract investment. Handsome domestic investment is a good criterion to sense surety of these factors. Table 4 is a comparison between FDI and domestic investment, which shows that Bangladesh has become quite futile as

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its domestic investment is very insignificant in comparison to the FDI. The correlation between FDI inflows and domestic investment is negative (-0.47). The table shows that Bangladesh has been experiencing very tiny chunk of domestic investment in 1997, 1998, 2000, 2005 and 2006.

FACTORS AFFECTING FDI

InfrastructureBetter infrastructure of the host country attracts foreign investors. Inflows of the FDI depend mostly on quality and quantity of physical infrastructure like roads and highways, transport, power, telecommunications and so on. Banking and other financial services also affect the FDI inflows significantly. Good transport facilities-road, rail and air, including developed port systems, energy and water and low cost utilities like telecommunications are important infrastructural factors in attracting FDI. Business has to incur excess cost to collect information in a country with poor infrastructure. But it can be done easily and with minimum cost in a country having good infrastructure that makes FDI financed projects cost efficient and competitive in the global market.

Macro Economic EnvironmentMacroeconomic factors such as fiscal policy, monetary policy and exchange rate policies, political stability and business climate have a serious influence for FDI. Foreign investors choose a location where there is evidence of success and availability of favorable macroeconomic conditions. Investment is generally driven by profit, and foreign investors always prefer a country with a rich business sector measured in terms of GDP growth rate, rate of inflation, level of industrialization etc. than one, where the macro economic environment is sluggish.

GovernanceGovernance of a country comprises economic and business policy and regulations such as taxation system and tax rate, interest and Bank rate, drive against corruption etc. All this factors are related with the cost business and profit. Foreign investors very consciously consider the governance of a country to invest. An important aspect of governance is the ease with which investors can enter and exit a market. It is and important determinant of productivity, investment and entrepreneurship.

International integrationInternational integration is another determinant that drives investment. Countries that aggressively pursue integration with the global economy grow more quickly than those that did

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not. The low level of incoming FDI in indicates poor integration with the global economy. (Mian. M. E 2006)

Political stabilityPolitical factors like change of government, attitude of opposition group, transparencyin bureaucracy, degree of nationalism, corruption, terrorism etc. are seriously consideredby the investors in pre-investment decision making. (Mian. M. E 2006) For example,in case of Bangladesh the most sensitive issue for discouragement of the FDI is politicalunrest and corruption and red-tapism.

Human resourcesSkilled workforce leaves a country at an ease to attract investment. Development programs financed by the FDI may be interrupted for the absence of skills and adequate knowledge infrastructure. Low growth that takes place in trade and investment is the result of the use of unskilled cheap labor. Bangladesh is a country where there is ample scope for development of human resources. It is a shame for the planners that thousands of Indians and other foreign nationals are employed in the top positions of most of the multinational national corporations.

Technology infrastructureEconomic growth of a country largely depends on technological progress, which stimulates FDI. It includes more modest advances, implementation of better business processes, and involves the adoption of new technologies (Mian. M. E 2006). In this area, again, Bangladesh lags behind in comparison to its competitors.

IMPEDIMENTS OF FDI IN BANGLADESH

The FDI plays an important role in the economic development of Bangladesh in terms of capital formation, output growth, technological progress, exports and employment. But the inflow of FDI is not smooth at all in Bangladesh. The factors which are blocking foreign investment in Bangladesh would be as follows:

Complicated BureaucracyThe country has a bureaucratic system that is not at all compatible with an investment environment. The concrete implementation of investment related policies are prolonged to obstruct both local and foreign investors. An inefficient and dishonest bureaucratic system is extensively responsible for the absence of FDI in the country.

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Political UnrestThe political situation in Bangladesh is extremely vulnerable because of the continuous hostility among the political parties, which in turn pollutes the entire investment environment. It is unfortunate that Bangladesh is an exception where most of the political violence centered on industries. Even EPZs are not exempted by any means. However, the situation has been apparently improved since the present interim government has taken over.

CorruptionCulture and society have become corrupted through sick politics. The bureaucrats and regulatory bodies are steeped in corruption. For business enterprise, corruption works as taxation or lubrication cost. Many companies regard bribery as just one of the costs of doing business (‘Lubrication Cost’) and show these payments as legitimate business expenses. However the current situation in this regard is as gloomy as it was in the past.

High Inefficiency CostGovernment control and management has been extremely ineffective and inefficient. The country is suffering from inefficiency of state-owned entities in telecommunication, energy, ports, aviation, railways, banking and many other sectors. All these sectors inefficiencies push the total cost of local and foreign businesses extensively high.

Absence of Autonomous Regulatory BodiesThe politically influenced government agencies are functioning as regulatory bodies without any operational autonomy. So an effective and rapid response towards providing the necessary services to investors is apparently absent in Bangladesh.

Differential TreatmentThough are regulations to provide equal treatment of local and foreign investors, certain inequitable conventions are practiced with the foreign investors. Such inequalities are evident in cases of authorization necessities for foreign investment, barriers against capacity expansion, supplier’s credit, etc.

Insufficient Power SupplyBangladesh faces a system loss often more than 40% of the gross power generation probing with the lowest per capita power consumption and network coverage of electrification among developing countries. This creates immense discouragement for investment in the power intensive industries.

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Inconsistent Policy ImplementationBangladesh provides various favorable investment facilities and incentives under liberalized industrial policy. Bodies like the Export Processing Zones are there to promote export orientation and privatization based growth strategy. However, in reality, none of these favorable policies and strategies are implemented, thus foreign investors are being discouraged.

Tax Authority’s DiscretionThe government of Bangladesh has given its tax administrators discretionary authority and they unduly apply it to bother businessmen and investors. This authority has made many of the officials highly corrupt. At present Bangladesh is trying to get red of from this scandal.

Lack of effective cooperation of Board of Investment (BOI)The BOI of Bangladesh has a One Stop Service cell to serve and assist with various investment facilities, mostly FDI. But, materializing the service in reality is still an illusion. The least capable and least productive government personnel working for the cell naturally fail to improve the situation.

Legal AbsurdityThe system of legal suits and actions prolonged over the years puts business investors in a dilemma about placing their precious capital in businesses in Bangladesh.

Disrupting Fiscal PolicyEach year the government declares Fiscal Policy that quite often goes adverse to the investors and disrupts their regular business and operations plans and strategies both in short and long run.

Administrative coordination problemPolicies and the implementation processes are not materialized simultaneously because of lack of administrative communication and coordination among the government agencies. This situation results in high business costs and hassles for investors.

Time wasting customs processingThe inefficient and corrupt customs system quite often takes more than twenty signatories to discharge a shipment along with physical inspection by the authorized personnel. There are many other problems such as poor leadership quality, ignorant labor forces, and unorganized financial or capital markets that damage the national image of the country to the foreign investors.

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Prospects and competitive advantages

A happier news for the nation is that Bangladesh places 65th position among 155 countries in terms of Ease of Doing Business in the world bank report. This ranking is based on 39 indicators grouped into 10 categories. It recognizes Bangladesh as one of the easiest location for doing business in south Asia, better than Sri Lanka and India. Besides, persistent growth in FDI is the best testimony of a favorable business climate prevailing in Bangladesh. (Doing Business in 2006: Creating Jobs, World Bank 2006) In 2005, total FDI inflow in Bangladesh was increased by 84% amounting US$ 845 million–highest ever in any year since her independence. The growth is second highest in entire South Asia (Bangladesh Investment Handbook 2007-BOI). Bangladesh now ahead of India in terms of FDI Performance Index being ranked 116th among 200 economies while India is ranked 119th (World Investment Report 2006).

FDI InflowForeign Direct Investment in Bangladesh: Problems and ProspectsA component-wise analysis of FDI inflow in 2005 shows that about 50% of FDI came as equity, 29% as reinvestment, and the rest as intra-company borrowing. The higher reinvestment rate indicates unwavering confidence of foreign investors on overall investment climate of the country and competitiveness.

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8.1

Continued Interests of Foreign Investors

The recent years tremendous interests of foreign investors are shown to invest in Bangladesh. In FY 2005-06, major foreign investors include Dhabi Group of United Arab Emirates, Singtel of Singapore, Orascom of Egypt, YKK of Japan and Microsoft of USA. Besides, a number of large investment proposals worth about US$ 10.5 billion are at negotiation and / or approval stages. These include investment proposals from Tata Group of India, Toray of Japan, Indorama Group of Thailand, Luxon Global of South Korea, Delta Pacific Mining of United Kingdom, Dawood Group of Pakistan, Kingdom Group of Saudi Arabia and other proposals from China, Malaysia, India, Taiwan, UK, USA, Australia, Singapore, Thailand, Saudi Arabia, UAE and Kuwait.

Incentives for Foreign InvestorsThe foreign investors will choose Bangladesh for their next for investment destination as Bangladesh conducted Bilateral Investment Agreement, Double Taxation, Treaties etc. to protect the interest of foreign investors. The investors will also enjoy the following incentives investing Bangladesh.

1. Tax Exemptions : Generally 5 to 7 years. However, for power generation exemption isallowed for 15years

2. Duty : No import duty for export oriented industry. For other industry it is @5% ad valorem.

3. Tax law : i. Double taxation can be avoided in case of foreign investors on the basis of bilateral agreements. ii. Exemption of income tax up to 3 years for the expatriate employees in industries specified in the relevant schedule of Income Tax ordinance.

4. Remittance : Facilities for full repatriation of invested capital, profit and dividend.

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5. Exit : An investor can wind up on investment either through a decision of the AGM or EGM. Once a foreign investor completes the formalities to exit the country, he or she can repatriate the sales proceeds after securing proper authorization from the Central Bank.

6. Ownership : Foreign investor can set up ventures either wholly owned on in joint collaboration with local partner.

Other Competitive Advantages

LocationGeographic location of the country is ideal for global trades with very convenient access to international sea and air route.

Natural ResourcesBangladesh is endowed with abundant supply of natural gas, water and its soil is very fertile.

Human ResourcesWe have a population of more than 138.8 million who are hard working and generally intelligent. There is an abundant supply of disciplined, easily trainable, and low-cost workforce suitable for any labor- intensive industry.

Social StabilityBangladesh is a liberal democracy and mostly a one race and one religion country. The population of this country irrespective of race or religion have been living in total harmony and understanding for thousands of years.

LanguageAlthough Bengali is the official language, but English is generally used as second language. Majority of even moderately population can read, write and speak in English.

Market AccessBangladesh has a population about 140 million, which will provide a larger market for the foreign investors to place their product. They also can Bangladesh as a station of exporting their product to the neighboring countries at very low cost. Furthermore, Bangladesh products enjoy duty free and quota free access to almost all the developed countries. This access to the global

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market is further helped by the fact that policy regime of Bangladesh for foreign direct investment by far the best in South Asia.

GSP FacilityMost Bangladeshi products enjoy complete duty and quota free access to EU, Japan, Australia and most of the developed countries and quota regime to USA had been ended on 1st January 2005. However, despite quota phase out, Bangladesh apparel has successfully taken up a better position in US market and experiencing substantial growth.

Cost of BusinessOverall cost of doing business in the country is fairly competitive in the global standard.

Sustainable Competitive SectorsConsidering the strength of Bangladesh either in the form of offering substantial resource advantages or low-cost, skilled manpower and global market demand, foreign investors are getting opportunities from textile, Electronics, Information Technology, Natural Gas-based Industries, Frozen Foods, Leather, Ceramic, Light Engineering and Agrobased Industry.

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CONCLUSION

FDI is not only a strategic option for a country, but also a key factor in the national economic development. Most countries attempt to attract foreign investors through liberal The Journal of Nepalese Business Studies ization of investment environment, fiscal reforms and a package of incentive offers. FDI can transform a country's economic scenario within shortest possible time. It is not merely access to fund, but also provide transfer of technical know-how and management expertise. It is also a stabilizing factor in any economy. Following conclusions can be drawn on the FDI reality and prospect in Bangladesh:

*Political unrest hampers the FDI growth in Bangladesh.

*Bangladesh has been experiencing a stable social and political order since last January 11, 2007. Bangladesh experiencing an increasing trend of FDI since 2001.

* It is a matter of concern that the most FDI in recent years goes to Telecommunications, RMGs, Energy and Power other profitable area.

*Analysis of this papers shows that Agricultural, Industrial and Trade & Commerce get very negligible amount of FDI.

* Government has taken a lot of policies on foreign investment, which are being said liberal, supportive and focused, but yet the policies have been proven so.

* Bangladesh is being thought a wholesome investment destination to the foreign investors,as they are reinvesting their investment (29%).

It is seen in the study that there are some interrelated administrative barriers that result inferiority in policy formulation and implementation, competitive drawbacks, poor quality of skills and infrastructure, ineffective institutions, and below average governance which dampen potential of FDI. Besides, the above it has also been found out that Bangladesh is not full of hindrances of FDI, but some opportunities and prospects are also available in this host country. In very recent the quarrelsome political environment has been changed and hopefully, new era of investment for the native and foreign investors has been started.

SUGGESTIONS AND RECOMMENDATIONS

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To triumph over all the stated impediments, the government of Bangladesh and relevant bodies can consider various measures effectively as follows:

Ensure of Good GovernanceGood governance can bring about efficient and productive government, necessary reformation in judicial system, fiscal policy, infrastructural reforms and eradication of corruption, bureaucracy and dishonesty to lead a country to achieve handsome investment.

Coordinated Government AgenciesTo make the business environment and activities smooth and efficient, coordinated government agencies (ministries, departments, regulatory bodies, etc.) are a must.

Dynamic and Independent Govt. AgenciesMore dynamic government agencies can facilitate investment in Bangladesh. That is why the independence and dynamism of state agencies like Bangladesh Bank, Investment Promotion Agencies, Bangladesh Board of Investment etc. are essentially suggested to enhance FDI in Bangladesh.

Accountability and TransparencyMore accountability and transparency are recommended for the development, efficiency and competence Government and regulatory bodies in the work of investment.

Developing Diplomatic RelationBangladesh should maintain a good relation with the developed countries as well as with developing countries for significant share of FDI by developing countries.

Devoting Efforts to Shift FDI TrackIn recent years foreign investments are going to RMG, telecommunication, power and energy or other profitable areas. Bangladesh should provide appropriate attention to attract more FDI in the industrial and infrastructural areas like construction of roads and highway (especially in building large bridges, flyovers, underground ways etc.), assuring enough inducing competitive advantages to investment in these sectors.

Political ReformationIn Bangladesh Politics, volatile in nature, pushes the FDI to downstream. The politician’s desire seemed to capture the governing power of the country only rather serving the nation. This evil desire has been ruining the country since many years in every aspect. Thus political reformation is a requisite of time for Bangladesh.

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Ensuring Power and EnergyNowadays Bangladesh is badly suffering for lacking of power supply and it is a great obstacle in the smooth inflow of FDI. So the recipient country has to ensure required supply of power and energy.

Source:www.boi.gov.bdwww.google.com