Balance in Emerging Markets: The Analysis of Foreign Direct Investments Vladimir Tomsik Chief Executive Director and Bank Board Member Czech National Bank International Finance Conference, Kolkata,, India December 4,, 2009
Foreign Direct Investments - Flow 2000 1800 1600 FDI Flow (in bn USD) 1400 1200 1000 800 600 400 200 0 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 In recent 10 years, always more than 500 bn USD per year. Source: UNCTAD, IMF
Foreign Direct Investments - Stock 30 25 20 15 10 5 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 Worldwide FDI stock (in % of global GDP) Since the beginning of the nineties, the stock of total FDI has accelerated substantially. Source: UNCTAD, IMF
Foreign Direct Investments GDP Ratio FDI stock in % of GDP 35 30 25 20 15 10 5 FDI/GDP in transition countries FDI/GDP in developing countries FDI/GDP in developed countries 0 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 Rapid growth of FDI stock took place also in the transition countries. Source: UNCTAD, IMF
FDI impacts on the economy 1. Impacts on structure and volume of total investments (crowding in & crowding out effects) 2. Impacts on a structure of the economy 3. Impacts on the balance of payments: FDI Life Cycle Theory 4. Institutional environment creation
(1) FDI impacts on total investments: crowding in and/or crowding out effect? Crowding in domestic firms supply foreign entities Crowding out direct (creates a competition) or indirect effects (effects on real wages, interest rates, exchange rates) Research on crowding in/out effects: Agosin, R. M., Mayer, R.: Foreign Investment in Developing Countries Does it Crowd in Domestic Investment? Discussion Paper No. 146. UNCTAD, Geneva, 2000 Misun, J., Tomsik, V.: Does Foreign Direct Investment Crowd in or Crowd out Domestic Investment? Eastern European Economics, 2002, Volume 40, No. 2, March-April, pgs. 38-56
FDI impacts on total investments: crowding in or crowding out effect? Region Africa Asia Latin America Country Czech Republic Hungary Poland FDI and total investment relation 1.30 2.91 0.04 FDI and total investment relation 2.41 2.60 0.69 Effect crowding in crowding in crowding out Effect crowding in crowding in crowding out
(2a) Structure of the economy: FDI impacts on GDP and GNP Difference between GDP and GNP in the Czech Republic % GDP 7 6 5 4 3 2 1 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Source: OECD In a highly opened economy, an important part of GDP is made by firms under foreign control (consequence of FDI inflow). Labour and capital income of nonresidents must be subtracted from GDP in order to get Gross National Product (GNP). Income balance is the worst item within the balance of payments of the Czech Republic. In 2008, the deficit reached its record level of 7 % GDP!
(2b) Structure of the economy: FDI impacts on GDP and RGDI Price changes of export and import (terms of trade) affect strongly Real Gross Domestic Income (RGDI) in small open economies. When terms of trade are deteriorating, GDP can grow but income can stagnate at the same time, because a part of output (in domestic prices) is lost in trade (trading gains and trading losses) RHDD HDP Ex Im P Ex P Ex Im P Im In long-term, growth of RGDI was higher than GDP growth in the Czech Republic (on average by 0.5 p.p. in 1996-2008)
(3) FDI impacts on the balance of payments: FDI Life Cycle Theory Profit Dividends Reinvestments Loss I. stage: FDI Entrance II. stage: FDI Growth III. stage: Profit Repatriation Application of Consumption Life Cycle Theory (authors: Modigliani and Brumberg, 1955; and Ando and Modigliani, 1963) on foreign direct investments theory
FDI Life Cycle Theory Starting-points of the model: Economic theory requires equilibrium of the current account to be sustainable in long-term Deficit of current account has been observed in the Czech Republic since 1993, but the Czech currency keeps on appreciating (both in real and nominal terms) The purpose of the research was to define equilibriums of particular items of the balance of payments (balance of the current account, balance of trade and services, income balance and FDI balance) for all stages of the development of a transition economy (applied on the Czech Republic, Hungary, Poland)
FDI Life Cycle Theory NDI NCA NX NI Young Transition Mature Transition Post-transition Expanding
FDI Life Cycle Theory Phases of the Economic Development Saving and Investment Relationship (S, I) Balance of Goods and Services (NX) Net Income Balance (NI) Reinvested Earnings and Dividends Relationship (RE, D) Net Current Account (NCA) Net Direct Investments (NDI) Change in Foreign Reserves (ΔFR) Young Transition Mature Transition S < I (increase in investment ratio and stable saving ratio) S = I NX < 0 NX = 0 NI 0 NI < 0 RE 0 RE > D RE > 0 RE > D NCA < 0 NCA < 0 NDI > 0 (privatization and establishing of new investments) NDI > 0 (increase in reinvested earnings) ΔFR = 0 ΔFR = 0 Posttransition S > I (investments are starting to outflow) NX > 0 NI < 0 RE 0 RE < D (increase in the repatriation of profits) NCA = 0 NDI = 0 ΔFR = 0 Expanding Long-Term Equilibrium S > I S = I (decrease in saving ration because of the increase in wealth ) NX > 0 NX = 0 NI < 0 NI > 0 NI = 0 RE 0 RE < D RE = 0 NCA > 0 NCA = 0 NDI < 0 (outflow overcomes inflow of investments) NDI = 0 ΔFR = 0 ΔFR = 0
FDI Life Cycle Theory FDI impacts on the real export EX f ( FDI tg, YFt h, ERR, R, t ti ) FDI impacts on the real import IM f ( FDI tm, EX R, tn, AR, to, ERR, R, t t p ) FDI impacts on the export prices P f ( FDI t j, PIM, tk, ER EX, t tl )
FDI Life Cycle Theory Czech Republic FDIs have a positive effect on the real export growth FDIs also cause growth of the real imports Trend of a decline of reinvested earnings has been proved Poland Only in this country FDIs reduce the real imports Hungary Only in this country FDIs reduce the real export growth Further, FDIs have a negative effect on growth of the export prices
(4) FDI impacts on institutional environment Efforts to conclude Multilateral Agreement on Investment (MAI) within the WTO (formerly attempted within the OECD and UNCTAD) Some elements already embedded in the General Agreement on Trade in Services (GATS) and in the Trade Related Investment Measures (TRIMS) The primary aim of a future MAI should be liberalization of investment flows and securing equal treatment and equal conditions for all participants MAI could prevent beg-your-neighbor policies in the area of FDI (questions concerning investment incentives etc.) But interests of individual countries (but of investors as well) continue to be different
Thank you for your attention. Vladimir Tomsik Email: Vladimir.Tomsik@cnb.cz