DID YOU KNOW SERIES -SPONSORED BY THE EU CENTRE FOR GLOBAL AFFAIRS SIGNATURE PROJECT ON GOVERNANCE Business Groups and Foreign Direct Investment in Asian Countries Lead Author: Sasha Lu
CONTENTS Preface 1 Key Take-home Points 1 Executive Summary 2 1. Benefits and Risk of Investing in Southeast Asian Countries 3 2. Inward FDI in Indonesia and Malaysia 3 3. Cooperation with Business Groups in Southeast Asian Countries 5 3.1. First tier foreign shareholders of business group affiliated Indonesian firms 6 3.2. First tier foreign shareholders of business group affiliated Malaysian firms 8 4. Extra information for starting a new business in Indonesia or Malaysia 10 Concluding Remarks 11 References and Further Reading 12
Preface This report has been sponsored by one of the signature projects stemming from the EU Centre for Global Affairs at the University of Adelaide focusing on providing a comparative analysis of the business environments among EU, Australian and Asian countries. This report compliments the interactive database that is available on the EU Centre s Research in Governance website. Key Take-home Points This report investigates foreign direct investment, and the extent to which foreign investors partner with business group affiliated firms, in Indonesia and Malaysia. Foreign direct investment is higher in Indonesia than in Malaysia with Singapore injecting the largest amount of cash into each of these two countries. In terms of cooperation with business groups, firms from the United States hold shares in the largest number of Indonesian and Malaysian companies, but ownership stakes are typically minimal. The finance and manufacturing sectors in Indonesia and Malaysia attract more foreign investors than other sectors, but the average percentage of ownership in the finance sector is low. Foreign investors should be cautious of foreign ownership restrictions in different countries and industries. 1
Executive Summary This report discusses foreign direct investment (FDI) in Indonesia and Malaysia from 2011 to 2015. It also investigates the extent of foreign ownership among business group 1 affiliated firms and outlines the benefits and risks in partnering with such firms in Asia. This research is motivated by the fast development of Southeast Asia s economy and subsequently increasing international collaboration between firms. Since 1980 Southeast Asia s economic development has benefited from significant inward FDI flows from developed countries in Europe as well as Japan and the United States. Inward FDI flows into Southeast Asia were initially due to in large part to the international relocation of production. However, the advantages created by geographic location and low labour costs have weakened with the emergence of innovation driven economic growth. This poses a challenge for Southeast Asian countries looking to reconfigure their foreign investment policies in order to accommodate the rapid technological change. It is also imperative for foreign investors to develop a better understanding of business environments in different countries. This research concludes that Malaysia and Indonesia strongly encourage foreign direct investment to support the continuing growth in their economies. They have each implemented a relatively lower corporate tax rate and a wide range of tax incentives for different industries. Singapore is the country which has invested the most in Malaysia and Indonesia. The tight connection among the three countries is perceived as a strategic alliance aimed at sharing resources and attracting more international investment. A large number of Indonesian and Malaysian firms that are affiliated with business groups, have sold ownership stakes to firms from the United States, despite average US ownership rates being fairly low. When foreign ownership is limited to 5 percent, Singaporean firms are the prime investor group. In general, the majority of foreign investment flows into the mining and services industries in Malaysia, and the mining and food industries in Indonesia. However, in the subgroup of firms affiliated with business groups, the finance and manufacturing sectors are the most popular in attracting global cooperation. 1 Business groups are defined as a combination of two or more corporations with the criterion that each group has at least one company which has a corporate owner or subsidiary from another industry. 2
1. Benefits and Risk of Investing in Southeast Asian Countries There are several purposes of doing business in Southeast Asian countries. First, firms might be interested in selling products or services to new customers in a new market. Second, firms might want to take advantage of price and cost differences across countries by concentrating production in low cost locations or by exploiting economies of scale. Third, firms might be interested in obtaining natural resources. Despite these benefits, foreign companies have relatively weaker connections with local governments, suppliers and a poorer cultural understanding when compared to local firms. Therefore, the possession of intangible assets (such as patents, copyrights or managerial skills) is important for them to maintain a competitive advantage. In order to facilitate FDI, governments in host countries typically undertake policy reforms, but this process is complicated and time-consuming. Instead, governments can implement investment incentives such as accelerated depreciation allowance and tax holidays for direct subsidiaries. The most controversial incentives are income tax holidays. For example, Indonesia cancelled its tax exemption incentive in 1984. Other countries in the Association of Southeast Asian Nations (ASEAN) maintain their tax holiday incentives for pioneer firms. Pioneer firms in Singapore are entitled to a 31 per cent tax exemption on profits for five to ten years after being established and a favourable profit tax rate of 10 per cent in Malaysia. Moreover, tax exemptions are encouraged for certain industries. The majority of machinery, equipment and raw materials are tax exempt in Malaysia and Indonesia. Malaysia also provides generous tax exemptions on R&D and the establishment of regional headquarters. To some extent, competition among Asian countries provides more benefits to foreign investors. 2. Inward FDI in Indonesia and Malaysia Indonesia is ranked as the 16 th largest economy in the world. It is one of the most diverse countries in terms of cultures and languages. Muslims account for the largest proportion of the population but there are millions of people who adhere to other religions. Moreover, there are more than 17,000 islands, making it difficult for firms to target individual groups of customers. Malaysia is rated as the 35 th largest economy in the world. It is undergoing a radical transformation under the plan set out in the New Economic Model (NEM). The goal of the NEM is to transform the Malaysian economy into one with high income equality and growth by 2020. As ASEAN members, both countries strongly support the ASEAN free trade area. Unlike in the EU, each member nation has their own national schedule. Indonesia and Malaysia provide various tax incentives to attract foreign investment. For example, the corporate tax rate in 2014 in both countries was 25%, which was lower than those of Australia (30%), Brazil (34%), India (33.39%), Japan (35.64%), the Philippines (30%) and the U.S. (40%). As shown in Figure 1, foreign direct investment (FDI) in Indonesia and Malaysia has experienced a steady increase over the past 25 years. Despite the continuing recovery in FDI after the 2008-2009 global financial crisis, Malaysia s ability to attract FDI relative to both earlier decades and Indonesia has been diminished. 3
Figure 1: Foreign direct investment in Indonesia and Malaysia, net inflows (billion USD) 30 20 10 0-10 1990 2000 2006 2007 2008 2009 2010 2011 2012 2013 2014 Indonesia Malaysia Source: World Bank Group Table 1: Foreign direct investment by industry in Malaysia and Indonesia - 2014 (billion USD) FDI by industry Malaysia Indonesia Agriculture, forestry and fishing 0.12 Chemical and pharmaceutical industry 2.3 Construction 0.30 Food Industry 3.1 Manufacturing 1.41 Metal, Machinery, and electronic industry 2.5 Mining and quarrying (including oil & gas) Services 4.95 3.81 Mining 4.7 Transportation ware house and telecommunication Total 10.59 Total 15.6 Sources: Department of Statistics (Malaysia) & Investment coordinating board of the Republic of Indonesia (BKPM) 3.0 Table 2: Foreign direct investment by country of origin in Malaysia and Indonesia - 2014 (billion USD) FDI by country of origin Malaysia Indonesia Singapore 2.25 Singapore 5.8 Netherlands 2.04 Japan 2.7 Hong Kong 1.02 Malaysia 1.8 Cayman Islands 0.72 Netherlands 1.7 Bermuda 0.69 United kingdom 1.6 Total 6.72 Total 13.6 Sources: Department of Statistics (Malaysia) & Investment coordinating board of the Republic of Indonesia (BKPM) 4
Table 1 and Table 2 display the amount of foreign direct investment categorised by country and industry. In 2014, FDI flows into Malaysia were USD $10.59 billion. The top five investing countries were Singapore, the Netherlands, Hong Kong, the Cayman Islands, and Bermuda. In total, these countries account for 63.4 per cent (USD $6.72 billion) of total inflows into Malaysia. These countries are listed as tax heavens by the Congressional Research Service and it may be worthwhile to conduct an investigation into these investment activities. On the other hand, total inflows into Indonesia were USD $13.6 billion in 2014. Singapore was again the largest foreign investor in 2014 (USD $5.8 billion), followed by Japan (USD $2.7 billion), Malaysia, the Netherlands and the United Kingdom. With regard to industry-based inflows, the services sector in Malaysia received the largest amount (46.6%), followed by the mining and quarrying (36%) and manufacturing sectors (13.2%). The most popular sectors in Indonesia were mining, food, transportation, warehousing and telecommunications, and chemicals and pharmaceuticals. Total foreign investment was USD $15.6 billion in 2014. It is notable that Singapore has the closest investment relationships with both Malaysia and Indonesia. These relationships can be traced back to the announcement of the growth triangle in 1989. Later in 1991, Singapore assisted Indonesia in developing an industrial park on an island named Batam. This project helped Singapore to complete its relocation of labour intensive industries as well as to strengthen its economic linkages with Malaysia and Indonesia. 3. Cooperation with Business Groups in Southeast Asian Countries The data on inward foreign direct investments for 2014 are indicative of the general trends seeing substantial capital flows into Indonesia and Malaysia. However, it is unclear to what extent foreign investors control Southeast Asian firms. The next section attempts to uncover the extent of cooperation by investigating foreign ownership stakes in Indonesian and Malaysian companies that are affiliated with business groups. Business groups are quite common in emerging markets and their structures can vary across countries. For example, Korean Chaebols are generally controlled by families with limited bank involvement, whereas Japanese Keiretsu are owned by multiple corporations often centred around a core bank (Gedajlovic and Shapiro, 2002). Business groups can have a significant impact on the growth of Asian economies. For example, the Samsung Group comprises around 20% of South Korea s gross domestic product (Iain, 2015). In China, business groups contribute roughly 60 percent of the national industrial output. There were 2,856 officially recognised business groups and 27,950 directly owned first tier subsidiaries by 2006 (He et al., 2013). Unlike in Korea, Japan, China and India, a full list of business groups has not been officially released in Malaysia and Indonesia. What s more, even though previous research has investigated the strengths and weaknesses of business groups, few studies have focused on how foreign ownership is linked to Asian firms that are affiliated with business groups. The following section summarizes first tier foreign ownership in business group affiliated Malaysian and Indonesian companies in order to address this gap in the existing research. 5
3.1. First tier foreign shareholders of business group affiliated Indonesian firms 3.1a. Business group affiliated firms with no minimum foreign ownership restriction Firms in the United States hold shares in more than 500 Indonesian business group affiliated companies, contributing the largest share of foreign investment from a single country in Figure 2a. Shares owned by the United States have mostly concentrated in the mining sector but US ownership has recently begun expanding to other sectors such as the food and financial industries. Investing in Indonesia is not only attractive due to the low cost of production, but also due to a strong domestic consumption market. Firms from the United Kingdom hold shares in almost 200 Indonesian business group affiliated firms, followed by Singapore and France which invest in around 100 firms. Figure 2b indicates that the average ownership of these foreign firms is no more than 35 per cent, except for the Netherlands where it is in excess of 50 per cent. The observed low ownership might be related to foreign ownership restrictions in Indonesia. Foreign investors are able to hold up to 100 percent in some industries, while foreign ownership is restricted to between 20 to 95 per cent in others. For example, ownership in certain oil and gas construction service sectors is capped between 49% and 75%. Fixed network telecommunications providers were similarly subject to a limit of 49% before 2014. Venture capital stakes are capped at 85% since 2014 (80% before 2014). When it comes to distribution across industries, 73.5 per cent of the companies in this study are in the finance and insurance sector (Figure 3a). In Indonesia, diversification within the financial sector is low and banking dominates the industry. Within the banking system, the top three state-owned commercial banks account for roughly one third of banking sector assets and the top fifteen banks hold around 70 per cent of total banking assets. The roles played by pension funds, insurance firms and other non-banking financial institutions are minimal. Figure 2a: Number of BG affiliated firms with foreign ownership by country Figure 2b: Average ownership in each country Number of firms 600 500 400 300 200 100 0 GB US SG FR DE HK NL JP CA CH others CH CA JP NL HK DE FR SG US GB others 0.00 20.00 40.00 60.00 Percentage of Ownership Note: code: GB, United Kingdom; US, United States; SG, Singapore; FR, France; DE, Germany; HK, Hong Kong; NL, Netherlands; JP, Japan; CH, Switzerland; CA, Canada. Source: Osiris 6
Figure 3a: BG affiliated firms with foreign ownership, by industry Figure 3b: Average ownership by industry 0.93% 2.42% 2.42% 1.02% others 56 1.21% 18.49% Industry 55 52 73.51% 44 31 31 44 52 54 55 56 others 0.00 20.00 40.00 60.00 Percentage of ownership Note: Industry code: 31, Manufacturing; 44, Retail Trade; 52, Finance and Insurance; 54, Professional, Scientific, and Technical Services; 55, Management of Companies and Enterprises; 56, Administrative and Support and Waste Management and Remediation Services. Source: Osiris 3.1b. Business group affiliated firms with minimum 5% foreign ownership Investment from the United States flows extensively into the Indonesian market, but ownership stakes in individual companies are quite low. When foreign ownership is at least 5 percent (Figures 4a and 4b), the number of relevant business group affiliated firms decreases to less than 200 in total. Singaporean firms are the largest investor class, having holdings in more than 40 Indonesian firms, followed by Japan, the United Kingdom, the United States, the Netherlands and Switzerland. This is consistent with the regional role that Singapore plays in FDI. The finance and manufacturing sectors remain as the most attractive sectors for foreign investors (Figures 5a and 5b). Figure 4a: Number of BG affiliated firms with >5% foreign ownership, by country Figure 4b: Average ownership by country Number of firms 50 45 40 35 30 25 20 15 10 5 0 Others CH NL US GB JP SG 0 20 40 60 Percentage of ownership Note: code: GB, United Kingdom; US, United States; SG, Singapore; NL, Netherlands; JP, Japan; CH, Switzerland. Source: Osiris 7
Figure 5a: BG affiliated firms with >5% foreign ownership, by industry Figure 5b: Average ownership by industry 15% 6% 6% 7% 7% 16% 44% Industry others 56 44 55 42 31 52 0 20 40 60 52 31 42 55 44 56 others Percentage of ownership Note: Industry code: 31, Manufacturing; 42, Motor Freight Transportation and Warehousing; 44, Retail Trade; 52, Finance and Insurance; 55, Management of Companies and Enterprises; 56, Administrative and Support and Waste Management and Remediation Services. Source: Osiris Figure 6a: Number of BG affiliated firms with foreign ownership, by country Figure 6b: Average ownership in each country Number of firms 900 800 700 600 500 400 300 200 100 0 GB US SG HK NL NO CH DE FR CA others Note: code: GB, United Kingdom; US, United States; SG, Singapore; HK, Hong Kong; NL, Netherlands; NO, Norway; CH, Switzerland; DE, Germany; FR, France; CA, Canada. Source: Osiris CA DE CH NL HK SG US GB others 0 20 40 60 Percentage of ownership 3.2. First tier foreign shareholders of business group affiliated Malaysian firms 3.2a. Business group affiliated firms with no minimum foreign ownership restriction As indicated in Figure 6a, firms in the United States are shareholders in nearly 800 Malaysian firms that are affiliated with business groups. Both the United Kingdom and Singapore hold shares in more than 200 business group affiliated companies. These results illustrate the fact that the United States is one of Malaysia s largest trading partners. U.S. foreign direct investment in Malaysia is led by the manufacturing, banking, and oil and gas sectors. In February 2016, the United States and Malaysia joined the trans-pacific partnership (TPP), which is an ambitious Asia-pacific trade agreement. Average foreign ownership of Malaysian 8
firms is less than 20 per cent except for ownership by Dutch and Canadian firms. Normally, foreign ownership in Malaysia is limited to 30 per cent. There are exceptions for firms that mainly produce export goods. In a trend similar to Indonesia, the majority of foreign shareholders are active in the finance industry, which accounts for roughly 77 per cent of foreign investment. In Malaysia, the life insurance industry remains dominated by foreign providers but domestic firms control the broader financial sector. Figure 7a: BG affiliated firms with foreign ownership, by industry 1.50% 2.74% 1.31% Figure 7b: Average ownership by industry others 17.13% 77.32% Industry 54 55 52 31 52 55 31 54 others 0.00 10.00 20.00 30.00 40.00 Percenatage of ownerhsip Note: Industry code: 31, Manufacturing; 52, Finance and Insurance; 54, Professional, Scientific, and Technical Services; 55, Management of Companies and Enterprises. Source: Osiris Figure 8a: Number of BG affiliated firms with foreign ownership by country Number of firms Number of BG affliated firms held by foreign investors from each country 40 35 30 25 20 15 10 5 0 Figure Figure 8b: Average 8b: Average ownership ownership by by country country Average ownership in each country Others DE CH KY JP HK GB VG SG 0 10 20 30 40 Percentage of ownership Note: code: SG, Singapore; VG, Virgin Islands; GB, United Kingdom; HK, Hong Kong; JP, Japan; KY, Cayman Islands; CH, Switzerland; DE, Germany. Source: Osiris 9
3.2b. Business group affiliated firms with minimum 5% foreign ownership Foreign ownership in Malaysian firms with a 5% minimum ownership restriction is no longer dominated by the United States. Instead, Singaporean firms dominate this sub-group. This is consistent with the fact that Singapore has contributed the most FDI to Malaysia of any nation. Companies from other countries hold shares in less than 100 Malaysian companies in total (Figure 8a). Figure 9a shows that two thirds of the firms with foreign ownership are in the finance, manufacturing and management sectors. Figure 9a: BG affiliated firms with foreign ownership by industry Figure 7a: Number of BG affiliated firms with foreign ownership, 18% by industry 5% 6% 8% 15% 25% 23% 55 52 31 23 53 11 Others Industry Figure 9b: Average ownership by industry Average ownership in each industry Others 11 53 23 31 52 55 0 20 40 60 Percentage of ownership Note: Industry code: 11, Agriculture, Forestry, Fishing and Hunting; 23, Construction; 31, Manufacturing; 52, Finance and Insurance; 55, Management of Companies and Enterprises. Source: Osiris 4. Extra information for starting a new business in Indonesia or Malaysia Table 3 provides extra information on starting a new business in Indonesia or Malaysia between 2013 and 2015. The time and costs required to start a business decreased in both countries. Starting a business in Malaysia only requires three procedures, 4 days and costs 6.7 per cent of income per capita in fees, ensuring efficient market entry for foreign firms. These figures are much lower than in Malaysia and are also lower than those of other East Asian countries where starting a business on average requires 7.3 procedures, 34.4 days and 27.7% of per capita income. 10
Table 3: Additional information on doing business in Indonesia and Malaysia. Year Indonesia Malaysia Cost to start a business 2013 21.90 7.60 (% of income per capita) 2014 21.10 7.20 2015 19.90 6.70 Time required to start a business 2013 75.50 6.00 (days) 2014 52.50 4.00 2015 47.80 4.00 Time to prepare and pay taxes 2013 259 133 (hours) 2014 253.5 133 2015 234 118 Cost to enforce a contract 2013 115.70 37.30 (% of claim) 2014 115.70 37.30 2015 115.70 37.30 Note: The value of the claim is equal to 200% of the economy s income per capita or $5,000, whichever is greater. Source: World Bank Concluding Remarks This report provides a general description of foreign investment in, and foreign ownership of, Malaysian and Indonesian business group affiliated firms. It shows that foreign direct investment flowed more into Indonesia than Malaysia during 2014, although it costs less and takes less tax preparation to do business in Malaysia. This is probably due to the relatively more restrictive foreign ownership controls in Malaysia. Singapore was the largest investor in both countries in 2014. By investigating the first tier foreign shareholders among business group affiliated firms, this report shows that firms from the United States hold shares in a large number of business group affiliated Indonesian and Malaysian firms, but with a low percentage of ownership. After accounting for minimum ownership requirements, most business group affiliated Malaysian and Indonesian firms appear to be partially held by Singaporean firms. With regard to industries, the financial and manufacturing sectors attract most foreign partnerships. Future research in this field could be targeted at examining how foreign ownership is linked to the performance of business group affiliated firms. 11
References and Further Reading Balakrishnan, S. and M. P. Koza (1993) "Information asymmetry, adverse selection and jointventures: Theory and evidence." Journal of Economic Behavior & Organization 20(1): 99-117. Buckley, P. J. and M. Casson (1976) A long-run theory of the multinational enterprise. The future of the multinational enterprise, Springer: 32-65. Dunning, J. H. (1998) "Location and the multinational enterprise: a neglected factor?" Journal of International Business Studies: 45-66. Fagre, N. and L. T. Wells Jr (1982) "Bargaining power of multinations and host governments." Journal of International Business Studies: 9-23. Gedajlovic, E. and D. M. Shapiro (2002) "Ownership structure and firm profitability in Japan." Academy of Management Journal 45(3): 565-575. He, J., Mao, X., Rui, O. M. and Zha, X. (2013) "Business groups in China." Journal of Corporate Finance 22: 166-192. Hennart, J.-F. (1982) A theory of multinational enterprise, University of Michigan Press. Hennart, J.-F. (1988) "A transaction costs theory of equity joint ventures." Strategic Management Journal 9(4): 361-374. Hennart, J.-F. (2009) "Down with MNE-centric theories! Market entry and expansion as the bundling of MNE and local assets." Journal of International Business Studies 40(9): 1432-1454. Iain M. (2015) "South Korea s chaebol problem." The Globe and Mail, Published Friday, April 24, 2015. http://www.theglobeandmail.com/report-on-business/international-business/asianpacific-business/south-koreas-chaebol-problem/article24116084/ Jemison, D. B. and S. B. Sitkin (1986) "Corporate acquisitions: A process perspective." Academy of Management Review 11(1): 145-163. Khanna, T. and J. W. Rivkin (2001) "Estimating the performance effects of business groups in emerging markets." Strategic Management Journal 22(1): 45-74. Lanz, R. and S. Miroudot (2011) "Intra-Firm Trade: Patterns, Determinants and Policy Implications", OECD Trade Policy Papers, No. 114, OECD Publishing. http://dx.doi.org/10.1787/5kg9p39lrwnn-en Verbeke, A. and A. P. L. Li (2009) "Toward more effective research on the multinationalityperformance relationship." Management International Review 49(2): 149-161. 12