South Asia Intra-Regional Opportunities and Challenges

1
South AsiaIntra-Regional Opportunities and
Challenges

• Debapriya Bhattacharya
• Executive Director
• Centre for Policy Dialogue (CPD)
• Bangladesh

Presented at Fostering Trade through
Private-Public Dialogue Expert Meeting on
Regional Integration in Asia New Delhi,
India 28-29 March 2007
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CONTENT

• 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

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1. THE LOGIC AND EXPERIENCE OF INTRA-REGIONAL
INVESTMENT

• 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.

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1. THE LOGIC AND EXPERIENCE OF INTRA-REGIONAL
INVESTMENT

• 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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1. THE LOGIC AND EXPERIENCE OF INTRA-REGIONAL
INVESTMENT

• 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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1. THE LOGIC AND EXPERIENCE OF INTRA-REGIONAL
INVESTMENT

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

• 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.

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2. FDI REGIME IN SOUTH ASIA INTRA-REGIONAL
INVESTMENT

• 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 US1.7 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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2. FDI REGIME IN SOUTH ASIA INTRA-REGIONAL
INVESTMENT
Hosts of FDI  Sources of FDI  Intra regional FDI (US million) Intra regional FDI (US million) Intra regional FDI (US million) Intra regional FDI (US million) Intra regional FDI (US million)
Hosts of FDI  Sources of FDI  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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3. INTRA-REGIONAL INVESTMENT IN BANGLADESH

• 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.

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3. INTRA-REGIONAL INVESTMENT IN BANGLADESH
FDI inflow in Bangladesh from South Asian Sources
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
Source Compiled from enterprise survey conducted
by Statistics Department, Bangladesh Bank.

• 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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3. INTRA-REGIONAL INVESTMENT IN BANGLADESH
FDI Inflow 2006 Distribution by sectors
(Million US)
Sources Sectors Sectors Sectors Sectors Sectors
Sources 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

• 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.

Source Compiled from Board of Investment (BOI).
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3. INTRA-REGIONAL INVESTMENT IN BANGLADESH
Major Intra-Regional Investments in Bangladesh
(Implemented/Under Implementation)
Name of Projects Sector Investment Investment Employment Investing Country
Name of Projects Sector Local (mln Tk.) Foreign (mln US) Employment Investing Country
1 Delta Brac Housing Finance Corporation Ltd Services 1,300.00 23.64 53 India
2 STS Holding Limited Services 830.00 17.30 700 Sri Lanka
3 Cosmopolitan Industries (Pvt.) Ltd Textiles 650.00 10.00 3,850 India
4 American Efird Bangladesh Ltd Textiles 427.50 7.44 151 Sri Lanka
5 Bangladesh 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
10 Asian Paints (Bangladesh) Limited Chemical 141.49 2.57 105 India
Source Board of Investment
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3. INTRA-REGIONAL INVESTMENT IN BANGLADESH
FDI Inflow in EPZs of Bangladesh Distribution by
Sources
(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.

Source 2004-05 2005-06 Cumulative 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
Source Compiled from BEPZA
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3. INTRA-REGIONAL INVESTMENT IN BANGLADESH
Cumulative South Asian FDI Inflow in EPZs
Distribution by Sectors (as on Jan 07)
(Mln US)
Source Sectors Sectors Sectors Sectors Total
Source Agro-based Manufacturing Manufacturing Misc/NEC Total
Source Agro-based Total RMG Misc/NEC Total
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
Source BEPZA Note Figures in parenthesis
indicates percentage share of South Asian total

• 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.

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3. INTRA-REGIONAL INVESTMENT IN BANGLADESH
FDI Inflow Distribution of Sanctioned Units in
EPZ by Sources
  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
Source BEPZA

• 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 BANGLADESHA CASE
OF INTRA-REGIONAL INVESTMENT

• TATA submitted an expression of interest with the
  Bangladesh Board of Investment (BoI) in October,
  2004. TATAs US2 billion proposal included Steel
  Plant, Fertilizer, Coal Mine and Electricity.
• After a long negotiation, a revised offer was
  submitted on April 30, 2006 amounting US3
  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. TATAS REVISED PROPOSAL AT A GLANCE
Industry Investment (mil. ) Capacity Location Market Required Gas (TCF)
Steel 1200 2.4 MTPA Pabna Domestic Export 0.97
Steel 1200 2.4 MTPA (Northern BGD) Domestic Export 0.97
Fertilizer 600 1.0 MTPA Sangu Domestic Export 0.64
Fertilizer 600 1.0 MTPA (Southern BGD) Domestic Export 0.64
Electricity 600 475 MW Pabna (Northern BGD) Domestic Steel 0.53
Electricity   250-300 MW Dinajpur (Northern BGD) Domestic Coal Mine -
Electricity   (500 MW if needed) Dinajpur (Northern BGD) Domestic Coal Mine -
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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4. TATA PROPOSAL MAJOR DEBATES

• 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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4. TATA PROPOSAL MAJOR DEBATES

• 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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4. TATA PROPOSAL MAJOR DEBATES

• Coal Mine Lease
• For coal mining TATA offered joint venture (JV)
  with Petrobangla (9010).
• 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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4. TATA PROPOSAL MAJOR DEBATES

• 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.

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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.

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5. INTRA-REGIONAL INVESTMENT POLICY ISSUES
Apart from the general problems related to
investment in other regions, the obstacles with
the South Asian countries also contain some
distinguishing features.

• 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.

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5. INTRA-REGIONAL INVESTMENT POLICY ISSUES

• 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.

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5. INTRA-REGIONAL INVESTMENT POLICY ISSUES

• Compliance with SAFTA
• The objective of creation of SAFTA is to
  strengthen intra-SAARC economic cooperation to
  maximize the realization of the peoples
  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.

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5. INTRA-REGIONAL INVESTMENT POLICY ISSUES

• Compliance with SAFTA
• SAFTAs 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.

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5. INTRA-REGIONAL INVESTMENT POLICY ISSUES

• 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 Developed Countries Developed Countries Developing Countries Developing Countries Developing Countries Developing Countries T O T A L
Countries Western Europe United States Other Developed countries Africa Asia and the Pacific Latin America and the Caribbean Central And Eastern Europe T O T A L
South Asia South Asia South Asia South Asia South Asia South Asia South Asia South Asia 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
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5. INTRA-REGIONAL INVESTMENT POLICY ISSUES

• 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.

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5. INTRA-REGIONAL INVESTMENT POLICY ISSUES

• 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 ports in South Asia are about 15-20 percent
  more expensive than the Chinese ports.

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5. INTRA-REGIONAL INVESTMENT POLICY ISSUES

• 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.

Existence of small and large economies in the
regional block

• 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.

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5. INTRA-REGIONAL INVESTMENT POLICY ISSUES

• 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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