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Table of Content
Introduction ........................................................................................................................ 7 Chapter 1 Overview of Foreign Direct Investment ........................................................ 8 Chapter 2 Foreign Direct Investments on Theoretical Perspective ............................ 10 Chapter 3 Analysis of Country Based FDI Strategies .................................................. 15 Chapter 4 Advantages and Disadvantages of FDI ........................................................ 23 Chapter 5 Recommendations to Sri Lankan Government .......................................... 28 Chapter 6 Management of Foreign Exchange Risks .................................................... 34 Conclusion ........................................................................................................................ 38 References ......................................................................................................................... 39
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Table of Figures
Figure 1: Distribution of World FDI Inward Stock by Economy ........................................ 9 Figure 2: Distribution of world FDI Inward Stock by Country ........................................... 9 Figure 3: Stages in the Product Life Cycle ........................................................................ 13 Figure 4: FDI Comparison of Developing and Developed Economies ............................. 15 Figure 5: Universal Model of Theories Determining FDI ................................................. 17 Figure 6: FDI Outflows ...................................................................................................... 21 Figure 7: FDI inflows......................................................................................................... 22 Figure 8: FDI Outflows - Sri Lanka................................................................................... 28 Figure 9: FDI Inflows - Sri Lanka ..................................................................................... 29 Figure 10: Sample Foreign Exchange Risk Reduction Approach ..................................... 36
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Introduction Assignment Objectives To provide the required level of understanding; how the International market operates for FDIs. To pave the way for the students to critically evaluate how certain countries and Multi Nationals have designed their FDI strategies / approaches to enhance their share in the global trade. Then to make Recommendations to the Sri Lankan government on how to improve FDIs to Sri Lanka. Context of the Assignment “…Most of the countries such as Sri Lanka, India, China, Brazil, Malaysia… have introduced varying strategies to attract Foreign Direct Investments’ to their countries. But Japan and South Korea, without attracting Foreign Direct Investments’ into their countries, have invested in other countries and captured the global market…” The above statement has been evaluated throughout the document under number of parameters. Firstly, the statement has been evaluated based on trade theories. Then, the different strategies followed by different countries are discussed in order to find out the reasons behind those strategies. Thirdly, the pros and cons of Foreign Direct Investments are discussed in brief. Lately, recommend strategies that can attract foreign direct investments to Sri Lanka and management of foreign exchange risks are presented as the final discussions.
Methodology The data has been collected through Web Sites, Published Journals, Business Reports, Corporate Sites, Government Approved Publications, Statistical Databases and Other documents available on the internet. No field visits has been done in order to collect data. Finally, gathered data were analysed using both quantitative and qualitative methods.
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Chapter 1 Overview of Foreign Direct Investment What is Foreign Direct Investment? “…Foreign Direct Investment (FDI) occurs when a firm invests directly in facilities to produce and/or market in a foreign country. Once a firm undertakes FDI it becomes a multinational enterprise…”
(Hil, 2007)
Even though the above definition gives a rough picture about Foreign Direct Investment, there is no clear and well accepted definition up to now. Each and every governing body have their own versions of definitions. For example Americans use an altered version of above definition by adding a percentage of 10% that need to be owned by American citizen in order to call that investment as FDI in overseas. Importance of Foreign Direct Investment FDI is important for the investor as well as to the host country. The expectation of the investor is to gain more profits than being the home country due to the factors such as low cost of production, resource availability, markets and many more. Hosting country also gets benefited due to resource transfer effect, employment effect, foreign exchange and balance of payment…etc. Importance is comprehensively discussed in the later section under advantages and disadvantages of FDI. Two Main Forms of FDI 1. Greenfield Investment is about starting operations newly in the host nation. 2. Acquisition or Merging with existing business in the host country. Inwards and Outward FDIs 1. Inward FDI happens when FDI flows in to the host nation. 2. Outward FDI happens when FDI flows out of the (home) country. Some countries mainly focus on outward FDIs while others focus on inward FDIs due to number of reasons. The differences in each strategy are discussed later in a separate section in a comprehensive manner. PPEC 140
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Horizontal and Vertical Direct Investment Horizontal FDI occurs when an organization operates in the same industry inside the host nation as at home. Vertical Direct Investment occurs when an organization operates in an industry where it take inputs from organization’s domestic (home) operations or send outputs to the organization’s domestic (home) operations. Distribution of World FDI Inward Stock The following two charts present the current situation of FDI inward Stock. According to the charts, developed nations dominate the FDI compared to developing nations. United States has continued to hold the number one being the most favoured FDI destination.
3% 28%
69%
Developed economies
Emerging economies
Transition economies
Figure 1: Distribution of World FDI Inward Stock by Economy (%) [Source: (Conferenceboard, 2009 )]
2% 37%
44%
14%
european Union
Canada
3%
United States
Other
China
Figure 2: Distribution of world FDI Inward Stock by Country (%) [Source: (Conferenceboard, 2009 ) ]
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Chapter 2 Foreign Direct Investments on Theoretical Perspective This chapter evaluates the given statement based on verity of well accepted trade theories. Mercantilist Theory, Theory of Absolute Advantage, Theory of Comparative Advantage, Extension of Ricardian Model Acquired Advantage, Hecksher-Ohlin Theory, Product Life-Cycle Theory, and New Trade Theory are selected to be evaluated. Mercantilist Theory “…The main tenet of mercantilism was that it was in a country’s best interests to maintain a trade surplus, to export more than it imported…”
(Hil, 2007)
All most all the FDIs are invested with the intention of achieving more profits. The base statement talks about two different set of countries. One set tries to attract FDIs while others focus on outwards FDIs. Inward FDI focused countries try to achieve it by letting Multi-National Corporations (MNCs) to manufacture goods in their countries and then export them in to other countries. Through that, host governments can increase their exports. However, inward FDI focused countries are not following the above theory. They are focus on low cost of production and other advantages. Some instances home countries of the MNCs may get reduced their direct exports to the host country due to MNC’s productions on host country. However there can be some instances that MNCs may demand more goods from home country as production raw material. That may increase the export of home country as well. Theory of Absolute Advantage “…A country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it: countries should therefore specialise in the production of goods for which they have an absolute advantage and then trade these for goods produced by other countries…” (Hil, 2007) Investors are always looking for competitive advantage on potential destination. However know one tries to find the absolute advantage. Different multinationals evaluate the
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competitive factor using their own ways and prioritize the destination. Still investors are more than happy to invest, if they can access to absolute advantage which is not always easy to find. Advantage factors are presented in the figure 5. For example Sri Lanka has absolute advantage over Saudi Arabia in term of garments and tea. Theory of Comparative Advantage “…According to Ricardo’s theory of comparative advantage, it makes sense for a country to specialise in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries, even if this means buying goods from other countries that it could produce more efficiently itself…”
(Hil, 2007)
This theory involves a lot in FDI arena. MNCs may start manufacturing plant in a foreign country where labour cost is comparatively low. For example, these productions may need copper coils. If the home country consists with copper, then the MNC may import copper coils to the host country as intermediate raw material. As copper is not there in the foreign grounds, it is less efficient to produce copper coils inside the host country. Likewise, MNCs may use both absolute advantage and comparative advantage during their production and manufacturing. Acquired Advantage “…This considers about technology & skill development. Through the learning process, certain countries learn / master certain processes / products better than the innovators or due to technology…”
(Mendis, 2010)
This is always can happen in MNC operation. For example, most of the American MNCs has put up their plants on Japan with the intention of learning the Japanese efficient management and operation styles. Another example is that china and Singapore has worked closely with United States (US) MNCs time to time and they have learned the basic technologies up to a level that they can copy any kind of product release to US market within weeks and put it into their market with cheaper price tag. In a way, this is a discouraging factor towards FDI as well.
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Extension of Ricardian Model “…Immobile resources, Diminishing returns, Dynamic effects and economic growth…”
(Hil, 2007)
It is hard to transfer the resources from one industry to other. For example a country may have unutilized labour that can be used for MNC operation. However, it does not guarantee that labour can be use to for the MNC operation, because the knowledge level and the skill level may totally inadequate for some industries such as IT. Therefore, MNCs should evaluate the required factors and there feasibility as well. Governments’ should also monitor the situation and in order to cope up the demand, they can invest to educate the unemployed crowd in order to increase their suitability to be hired on potential MNC activities. When consider the diminishing returns factor, government should balance the countries requirements and the MNC activities. Supporting to MNCs by pulling resources from other industries could cause lot of issues in long term. Hecksher-Ohlin Theory “…The Hecksher-Ohlin theory predicts that countries will export those goods that make intensive use of factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce…”
(Hil, 2007)
This theory is followed by the both inward and outward focus countries. For example that is why Sri Lanka importing all the electronic items. All the electronic items are usually made by robotic arms, using less labour. Countries like US do not have access to cheap labour. But they have enough machinery equipments. Therefore, they produce electronic items and import the garments. At the same time Sri Lanka doing well in garment industry by unitizing the cheap labour. Product Life-Cycle Theory “…As the domestic market and other advanced nations mature, the product becomes more standardised, and price becomes the main competitive weapon. Then domestic companies might decide to settle production plants in other countries. Other countries might then develop a comparative advantage: the
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exporter switches from being an exporter to an importer as production becomes concentrated in lower-cost foreign locations...�
(Tramezaigues, 2006)
This concept can be seen in many circumstances. Basically after innovate some product, up to some extent the company who did the innovation manufacture it. However, with the time goes on, MNCs start plants on other countries using different methods such as licensing. For example, Nike and Adidas both MNCs follow this theory. Outsourcing is also a very famous approach in the arena. It could be outsourcing to a third party MNC or to a domestic player. Currently, the MNCs are moving towards China in order to take the advantage of low cost of production. Again MNCs like Coca Cola has put up their plants in Sri Lanka, because it is cheap to produce the drinks here than exporting. At the same time MNCs can produce goods cheaply in the host country and send the goods back to home country. This is one of the most fundamental objectives of the FDIs.
Figure 3: Stages in the Product Life Cycle [Source: (Hejazi, 2007)]
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New Trade Theory “…Economies of scale have a number of sources, including the ability to spread fixed costs over a large volume and the ability of large producers to utilize specialized employees and equipment…”
(Tramezaigues, 2006)
This stimulates the MNC operations to be scaled up. One of the main objectives of setting up a plant overseas is to reduce the production cost. By following this theory, MNCs can reduce the unit cost up to a greater extends. This theory fuels the FDI activities as well. FDI outward focus countries such as Japan and Korea are more concern about the economy of scale. Foreign Direct Investments Theories Other than trade theories, there are another set of theories called ‘FDI Theories’. Those theories explain the determining factor of FDI such as exchange rate, markets, economic geography, interest rates…etc. Some of the FDI theories are ‘Capital Market Theory’, ‘Dynamic Macroeconomic FDI Theory’, ‘FDI Theory Based On Exchange Rates’, ‘FDI Theory Based On Economic Geography’, ‘Gravity Approach To FDI And FDI Theories Based On Institutional Analysis’. This chapter discusses the basic trade theories and their influence towards FDI. It is very much clear that each and every theory make at least little contribution towards the FDIs. However, it felt that sometimes a single theory can be used to explain both the inward and outward focus FDI strategies as well. The next chapter discusses the reasons behind on different focuses.
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Chapter 3 Analysis of Country Based FDI Strategies Worlds FDI Movements United States has dominated the FDI world by having FDI inward flow of 232 billion dollars. It also comprise with the biggest FDI inward stock of 2 trillion dollars. United States also dominates the top positions by having 313 billion outward flow FDIs and 2.7 trillion dollars outward stock. It is possible to get an idea about the ‘Countries Focus’ by evaluating these four factors (Inward Flow, Outward Flow, Inward Stock and Outward Stock). For example, it is clearly visible that US is balancing both while more concern on outward strategy. However, United States is also famous as a very good FDI destination due to strong and stable economy. (InvestmentMap, 2005) Top FDI outward focused countries are United States, France United Kingdom, Germany, Japan, and Korea. Top FDI inward focus countries are Russia, China, Brazil, Sweden, India, Mexico and Singapore. In another point of view, the following two charts depict the FDI domination by the developed countries. However, comparatively the gap between developed and developing nation has reduced in term of FDI inward flows.
1800 1600 1400 1200 1000 800 600 400 200 0 2000
2001
2002
2003
2004
2005
2006
2007
Developing economies Outward
Developing economies Inward
Developed economies Outward
Developed economies Inward
2008
Figure 4: FDI Comparison of Developing and Developed Economies (millions) [Source: (UNCTAD, 2002) ]
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Common Reasons for FDI Outward Strategies The model in the next page presents a comprehensive set of FDI determining factors. Even though they are called FDI determining factors, most of them are also the reasons behind MNCs Operation in foreign grounds Low cost of production. Less competition compared to home country. Easy access to resources (Capital, labour) New Market Expansions (Size, growth) Get access to global markets Risk reduction through spreading the operation plants in different economies and geographical location (Natural Disasters, Economic Downturns) Lack of resources in the home country Common Reasons for FDI Inward Strategies Economic growth and economic stabilization (direct, Indirect) Solve Balance of payment issues Get access to foreign technology, management skills and capital Reduce unemployment Reduction of imports To improve foreign exchange reserves To utilize abundant resources towards economic growth Each and every country has designed their strategies by considering the FDI determining factor. Countries evaluate the full list of FDI determining factor and select a mixture of factor to be capitalize in their own countries. This is essential, because each country is unique in tem of competitive advantage. Therefore, the Strategies that can be used to attract FDIs are also different. Outward focus countries also have different set of strategies depending on their objectives. Some countries prefer outward FDIs in order to expand their markets. Some prefers the same in order to asses to cheap labour. Likewise, the strategies of each country varying according to their leadership, economy size, willingness …etc.
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Figure 5: Universal Model of Theories Determining FDI [Source: (Bitzenis, 2003)]
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Japan It is well accepted truth that countries’ comparative advantage can be systematically changed due to accumulation of human resource, machinery and technology. This can be also called acquired advantage. Japan is looking for countries as such for their investments. In early days, Japan’s main concentration was USA and Other European countries. However, currently, Japan is more focusing in developing countries such as Association of Southeast Asian Nations (ASEAN). “…A typical example is the shifting of textile production from Japan to the Asian NICs and then further to the ASEAN-6 countries and the four ASEAN transitional economies…”
(Hiley, 1999)
Japan is more towards outward FDIs in nature. In early days, one main advantage of that strategy was that they were able to reduce the size of its textile industry and release resources for new industries. This concept is also true for other industries as well. In the current situation, Japan plays a vital role in region FDI arena since 1980s. There are four main factors that fuel the FDI outward strategy. (Hiley, 1999) 1. “Structural changes in the Japanese economy forced many production processes to relocate outside Japan.” 2. “Japanese firms increasingly commanded specific advantages in terms of technology, management skills, organisational assets and marketing properties that enabled them to realise profits through investment in a variety of overseas.” 3. “Against a background of recession and exhaustion of import-substitution growth, large scale domestic capital in ASEAN perceived that Japanese capital and technology would deliver advantages both directly through joint-venture operations and indirectly through a general stimulus to the domestic economy.” 4. “ASEAN governments perceived that Japanese capital inflow would help relieve the debt burden and regenerate economic growth without seriously disturbing delicate politico economic balances which sustained these governments in power.” PPEC 140
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Singapore Lee Kuan Yew is the leader who made his country as a favoured FDI destination. Singapore used an aggressive promotion campaign to attract inward FDIs. Those FDI played a big role behind the success of the Singapore as a nation. Singapore specially target the US multinational as a strategy. Singaporean land is quite small and they wanted to fully utilize the space they have in order to be sustaining in long term. Rather than going for agricultural economy, they selected high tech machinery involved economy system with the help of US FDIs due to that reason. At the initial stage Singapore initiated an ‘Economic Development Board’ as a strategic unit in order to facilitate the FDIs. (Wint & Williams, 2002) United States By being the super power in the world and the largest economy in the world, America was the number one FDI destination throughout the last decade. Foreign direct investment impacts the US economy in many positive ways. For example, FDIs Creates New Jobs, Boosts Wages, Increases U.S. Exports, Strengthens U.S. Manufacturing and Services, Brings in New Research, Technology, and Skills, Contributes to Rising U.S. Productivity. (InvestAmerica, 2008) Due to above reasons, America continuously facilitate inward FDIs. At the same time American MNCs have invested hugely in overseas with intention of expand their market, low cost production and acquire the power global operation chain. US is also interest to get in to overseas markets to get hold the overseas economies in favour of America as well. US mainly focus on outward FDIs with the intention of being global super power. [Refer Section 4 for more details] China By having similar economic performance compared to India, China has gained more FDIs than India. China’s FDI strategy is more towards inward FDI. The figure 6 clearly shows the different between the FDI inflows within past few years. China has taken the full advantage of the FDI inflows by developing their economy. Mainly, Chinese FDIs are operating in export PPEC 140
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markets. They facilitates inward FDI with the intention of acquiring new knowledge (pharmaceutical), creating new job opportunities to their massive population, (Fuming Jiang, 2001) and development of supporting industries within the domestic contributors. Quality of China’s financial and economic institutions, market opportunities, advanced technology and equipment, low cost of production due to cheap labour are some of the competitive opportunities that China capitalize on. (Huang, 2001)
India India is one of the biggest emerging economies. This is due to number of reason including the large population that creates world’s biggest markets. India’s FDI strategy is more towards inward FDIs. Indian government follows more strict rules compared to china. India has had more strict policies in history and still maintains some of the complex policies that discourage inward FDIs. However, India has relaxed their policies in recent past and moving more towards relaxation. The Indian culture is more anti-British culture due to the historic reasons. Therefore, due to the public pressure, government cannot open the country to FDIs in full scale. They are selectively opening the specific industries by making protectionist mechanisms towards domestic players. One good example is that opening the retail market for FDIs in 1990 and closing down in 1997 due to public pressure. Currently India only allows franchise operations in term of retail business. Another example is that India has regulated their banking sector by limiting the foreign investors to stakes no more than 10 % in the industry. Government has protected the Indian banks by getting acquired by the foreign investors. Indian FDI Strategies are impact a lot due to the public pressure.
Malaysia “…Malaysia has been one of the most successful Southeast Asian countries in attracting FDIs. It has always endeavoured to maintain the competitiveness of FDI determinants like legal infrastructure. Many policy instruments have been set up. The Malaysian government has improved the value of the present determinants and is considering new strategies to attract FDI. Malaysia has been an encouraging economy to foreign investors…” PPEC 140
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120000
100000
80000
60000
40000
20000
0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
-20000
Brazil
China
India
Japan
Korea, Republic of
Malaysia
Singapore
Sri Lanka
Figure 6: FDI Outflows (million Dollars) [Source: (UNCTAD, 2002)]
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100000
80000
60000
40000
20000
0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
-20000
Brazil
China
India
Japan
Korea, Republic of
Malaysia
Singapore
Sri Lanka
Figure 7: FDI inflows (million Dollars) [Source: (UNCTAD, 2002)]
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Chapter 4 Advantages and Disadvantages of FDI There are number of advantages and disadvantages and wide range of criticisms towards FDIs in current international arena. Due to the unethical and dominant behaviours of the multinational corporations fuels the arguments against FDIs. However, the advantages and disadvantages by categorize them in to two sections; towards host country and towards home country. Advantages of FDIs Balance of Payment Effect The balance of payments in home country gets benefited due to the earning in the foreign markets. For example when telecommunication MNC giants invest in Sri Lanka, their home countries get benefited through the earning by those MNCs. Another aspect of the benefits is that when the MNC imports materials or inputs from home country, those home countries’ exports will get increased and through that also balance of payment can get benefited. (Hil, 2007) Again when the MNCs exports the finished goods from host country to their home country, host countries balance of payment would be benefited as well. Employment Effect Home country would get benefited through the demand generate for capital equipment, intermediate products and complementary products by the FDI on foreign grounds. Those industries in home country may hire and expand their operation in order to match the demand place by the MNCs. These processes will generate number of new employment opportunities in wide range of industries. Host country will also get benefited through the jobs created by the MNC in host grounds. MNCs would hire new employees from the host country as well as home country. On the other hand number of indirect jobs will also get created due to demand on local suppliers who provides intermediate goods and materials to the MNCs. In General, MNCs may create entire new supply chain. Therefore, large number of people would get benefited through that kind of FDIs.
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The following real world examples show the befits and the gravity of FDIs “…U.S. affiliates of foreign companies (majority-owned) employ approximately 5.3 million U.S. workers, or 4.6% of private industry employment. Between 2003 and 2009, over 4,500 new projects were announced or opened by foreign companies, yielding over $314 billion in investment and about 632,500 new (InvestAmerica, 2008)
job…”
“…Thirty percent of the jobs supported by U.S. affiliates of foreign companies are in the manufacturing sector, accounting for 12 percent of all manufacturing jobs in the United States. Approximately 60 percent of all foreign investment in the United States is in the service sector, improving the global competitiveness of this critical segment of the U.S. economy…”
(InvestAmerica, 2008)
“…Affiliates of foreign companies (majority-owned) spent over $34 billion on research and development in 2006 and $160 billion on plants and equipment…” (InvestAmerica, 2008) “…U.S. companies use multinationals’ distribution networks and knowledge about foreign tastes to export into new markets. Approximately 19 percent of all U.S. exports ($195 billion) come from U.S. subsidiaries of foreign companies…”
(InvestAmerica, 2008)
Resource Transfer MNC learns valuable skills and get the exposure work in foreign market from the host country. For example, most of the United States outward FDIs choose Japan to do their operations with the intention of learning the Japanese efficient, low cost, automated operation and manufacturing processes. On the other hand host country is also get benefited when the MNCs bring capital, new technology, management and other skills to the host country. Employees in the host country will be able to learn those valuable skills that can be used towards the long term success of the country.
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Other Advantages Sub industries can get benefited by the major FDI operations. For example if an FDI produce motors in large scale, domestic industries who use motors can be benefited by low cost, training and technical expertise knowledge. With the intention of attracting FDIs to their countries, government may invest heavily on infrastructure development. Due to that reason domestic companies and citizens will also get benefited.
Disadvantages of FDI Balance of Payment Effect The current account of the home country could suffer due to number of reasons. Due to the outward FDIs, at the initial stage lot of capital will get out flowed. Again if the MNC send the manufactured goods to the home country, imports of the home country will get increased and impact on balance of payment. Finally, direct exports to the host nation will be reduced, if the MNC produce a substitute for direct export on foreign grounds. Employment Effect When the MNCs locate their production plants in foreign countries, job opportunities for the home country will dramatically reduced. Another set of jobs will be loss due to direct export reductions as well. Resource Transfer Both host and home courtiers can get disadvantages in different ways. Home countries will suffer in long term due to the transfer of their Management skills, capital and technology to the host countries. Host country could be a competitor for the home country due to this reason. Similarly, MNCs may also learn Management skills, capital and technology from the host country and dilute the host countries competitive advantage. Another disadvantage is that MNC might try to remit the funds to their home countries by using various unethical ways.
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Other Disadvantages Domestic players might get affected due to the operations of giant multinational corporations. For example this happened in Indian sometime back in retail industry and Indian government was pressurised by the public to put policies against MNCs Unethical behaviour of the MNCs can create lot of problems in the foreign ground. One good example is that the behaviour of the shell corporation. There were lot of cases were filed against shell in term of environmental issues, human recourses issues…etc. There are considerable numbers of cases filed against shell in Sri Lankan labour tribunal as well. MNCs may have lack of knowledge in term of foreign culture. Therefore they could make unnecessary problems in the foreign grounds. For examples ‘Mcdonalds’ face a problem when they start operations in India regarding beef. Later, they agreed not to offer beef to their customers, because cow is a precious animal to Indians. At any time the MNCs can leave the country. For example this happened in Sri Lanka relating to ‘Kabool Lanka’. A competition would arise in the hosting grounds between multination companies and domestic player for capital funding. As the capital is a scare resource domestic companies may suffer due to lack of capital funding Multinationals always try to find low labour. Even though MNCs may create jobs, they may pay very low salaries to the domestic employees. Nike operations in overseas is a very good case on this matter. When the multinationals become more and more powerful, they might try to control the host government by giving incentives to the government officials, threatening in term of economic terms and manipulating economic factors. Even though the host country may have cheap labour, sometimes the education and skill levels of the employees in the host country may not be adequate to be used in MNC operations.
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Relationship to the Base Statement Different countries evaluate the above mentioned advantages and disadvantages in different ways. Some countries give more priorities towards some factor over the other. For example countries like India are more concern towards the impact on domestic players due to the arrival of MNC. However, countries like Sri Lanka who is suffering from low real economic growth, do not consider any kind of disadvantages that the country may face in long term due to MNC. Sri Lanka is trying to attract FDIs as much as possible with the intention of getting the advantages in term of Balance of Payment, Effect Employment Effect, Resource Transfer, and Other Advantages. According to some economists, FDIs do not directly help for economic growth of the host country. But it can stimulate the growth towards right direction.
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Chapter 5 Recommendations to Sri Lankan Government Overview of Sri Lankan FDIs Sri Lanka is belongs to the category of countries where the main focus is towards inward FDIs. After being dominated by foreign regimes including British, Sri Lankan was suffering from a ‘War against Terrorist’ for the last 3 decades. After the independence in 1948, Sri Lanka was more in to agricultural economy. However this changed with the open economy policies introduced later by the leaders. From that point onwards, many FDIs came to Sri Lanka and started the operation. However due to the security issues, many potential investors did not come to Sri Lanka. Finally, war ended up in last year by letting the economy to get the fullest advantage of unique geographical position and other competitive advantages in Sri Lanka. The following chart depicts the growth of outward FDIs in Sri Lanka. However, it is very much less compared to the own inwards FDIs. That is strong evidence that can be used to prove the fact that Sri Lanka is more towards attracting FDIs than outward. 70 60 50 40 30 20 10 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Figure 8: FDI Outflows - Sri Lanka (In Millions) [Source: (UNCTAD, 2002)]
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Lessons through Success Stories Sri Lanka can learn lot of important lessons by evaluating the success of region countries such as Singapore, India, and China. The father of modern Singapore ‘Lee Kuan Yew’ is one great leader who developed his country with the use of FDIs. He attracts large number of US multinationals with aggressive promotion campaign in order to promote Singapore as a favoured FDI destination. China and India also used their low labour, intellectual property and skills of the domestic employees in order to attract FDIs. Most importantly, all these countries have been able to protect their domestic players by putting the policies in to action where necessary. The following comments made by cooperate giant reading India shows how well India has attracted the gratitude of the multinationals. (Government of India, 2009) “…India is a developed country as far as intellectual capital is concerned…” Jack Welch, GE
“…India has evolved into one of the world’s leading technology centres…” Craig Barret, Intel
“…India can be the test bed for developing solutions for the poorest nations…” Gerard Kleisterlee, Philips
“…India is handling the most sophisticated projects in the world. I am impressed with the quality of work…” Bill Gates, Microsoft
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Future Recommendations Comparing to the region success stories, Sri Lanka has positioned in a very low state in term of FDI attraction. Following recommendations are some of the main factor that the Sri Lankan government should seriously work it out. Currently, Sri Lankan culture and the public have changed into more anti-MNC attitude. This happened due some of the negative impact of FDI such as ‘Kabool Lanka’ case. Other than that, recent political leaders use these anti westernise attitudes to market their political agendas during the election time as well as later. Due to the enormous amount of propaganda, public has also become anti-westernized. Therefore, the public is now does not support MNCs very much. Therefore, Government of Sri Lanka (GOSL) should take necessary steps to change this attitude of the public as well as political heads. Then Sri Lanka (SL) should build strong and friendly relationships with all the countries in the world. In the current situation, Sri Lanka is friendlier towards china, Iran without focusing on western countries such as US and UK. An important factor to remember is that FDIs are usually generated in US and UK region countries not from Middle East or Asia. As a summary maintain good relationships with all the countries are important. Government should treat all the investors in a similar manner without discouraging them. Sri Lanka has not used the competitive advantage over other countries when promoting SL. Due to the war, SL could not promote those. However, now the GOSL should come up with a strategic plan to promote SL as a very good FDI destination. SL should market the factors like unique geographical positioning, comparatively low labour cost, natural resources such as large sea, 365 days consistent climate and whether conditions and less vulnerable to natural disaster …etc.
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Again, the government should relax the policies which create barriers on FDI. However it needs to be done in greatest care in such a way that it protects the domestic corporations as well. And the legal processes needs to be put in place to avid the similar cases happen again like ‘Kabool Lanka’. Determining factors of FDI have discussed under the section ‘Analysis of Country Based FDI Strategies’. By evaluating each of the factors, government can decide on what factor that SL is going to facilitate the investors. Again the leadership of the country is very much important in this kind of process, because investors are more likely to work directly with the leadership if the leader is trustable. Then the trust also needs to be preserved from the government side as well. Leaderships need to be approachable when the investor wants something and maintain rapport is also important. These leadership strategies are used in the process of promoting Malaysia and Singapore to the world. Government should invest on infrastructure in order to facilitate the FDIs. Investors do not like to invest on countries where the basic infrastructure has not developed up to some extent. Most important areas are electricity (energy), roads, airports, harbours, IT and telecommunication...etc. Another important factor is the economic conditions. Interest rates, exchange rates, tax breaks grants, foreign exchanges should be kept under control (stable). Investors do not like to invest on political and economic unstable
countries.
Government
should
maintain a consistent growth rate. The government policies, rules and regulations are also need to be consistent and predictable. Economies and political activities should be transparent and forecast-able in long term.
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Then the government should not drag the MNCs and FDIs in to political games. When it happens, MNCs might also try to make demands and start unethical behaviour by using the political games as an opportunity. Required distance should be maintained between the GOSL and the MNCs in official terms without taking them into personal interests of the political heads. This is the historic mistake that governments usually do. At the same time government should not let the MNCs to dominate the SL economy under any circumstances. Stimulation packages need to be designed and granted to MNCs to encourage them to invest in Sri Lanka. Bank loans, duty free imports and exports (up to some extend), culture familiarization support, support through government media can be include in the package. At the same time, the value of the package should be depending on the size of the investment. Big investors should get more benefits than small investors. It is always important to remember that FDI/MNC comes to a certain country with the intention of making profit. They are not coming to develop or help the host country. However, host countries also can have mutual benefits by closely working with MNCs. That is the benefit that SL also needs to focus on. Therefore, unnecessary patriotic kinds of policies that may entertain the political agendas will not help to gain the advantage or FDIs. One good example is that Sri Lanka lost an opportunity to facilitate an automobile manufacturing plant of a global reputed brand due to political influences. GOSL can maximize the benefits of FDIs by helping the domestic corporations to start the supporting business around the FDIs. For example when an MNC comes and starts manufacturing automobile, government can help domestic players to initiate supporting industries such as manufacturing spare parts or automobile manufacturing machineries. Government can support in term of providing low interest loans, duty free imports‌etc. Another important factor is the ways of promoting the country as favoured FDI destination. These promotion activities need to be carries out with greatest care. Recently GOSL undertake to hold the International Indian Film Academy Awards (IIFA) in Sri Lanka with the intention of attracting investors by spending millions and millions of public money. However, finally it became unsuccessful and could not achieve the
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objectives due to the protest which aroused in India against Sri Lanka relating to the ‘War Crimes’. The IIFA Colombo has recorded as the most unsuccessful one in IIFA history. These incidents create comparatively negative impacts on Sri Lankan image as well towards FDIs. Therefore, government should carefully selected when and where to promote Sri Lanka to get the maximum attraction, without pouring money on any kind of promotion projects. Sri Lanka should attract more FDI on education sector such as Universities and educational institutes, telecommunication and information technology, automobile, energy generation using wind power and sea. It is also important to attract wide verity of industries than attracting same kind industry.
By developing a comprehensive FDI
strategy by closely considering the above mentioned factors, Sri Lanka would be able to attract more sustainable FDIs to the country than ever before. “…There is an urgent need from the state governments in Sri Lanka to provide separate investment laws relating to infrastructure and making private participation in infrastructure mandatory. The existing strategy of attracting the FDI should be more of company oriented in specific sector than broader ones. The Government of Sri Lanka should create separate investment fund for the purpose of attracting FDI into the nation. (In India the state government of Andhra Pradesh has Infrastructure Development Enabling Ordinance)…”
“…There is no clear-cut policy framework in India for attracting FDI. Hence there is an urgent need to frame policy, which should sepal out ways and means to attract FDI. Sector-wise targets should be set and sector ministries must be made responsible for achieving these specified targets. Separate 'Investment Commission' can be created which should include eminent experts from national and international forum. The commission would work on…” (Chaitanya, 2005)
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Chapter 6 Management of Foreign Exchange Risks What is Foreign Exchange Risk Foreign Exchange Risk is something that all the FDI investors are afraid of, because it can topple an organization overnight. The idea is that due to foreign exchange rate changes, FDIs could be benefited as well as smashed. Managing these risks is called Foreign Exchange Risk Management. An management strategy has developed in order to preserve the value of currently inflows, investments and loans. These perspectives help the international business to perform in foreign market without any hesitation. Even though these management capabilities can reduce the foreign exchange risk, it cannot eliminate the risk entirely. Foreign exchange management can anticipate the potential falls in domestic currency and manage the corporate exchanges accordingly. There are number of ways that organization can use in order to deal with the foreign exchange risks such as Hard Currency Conversion, Diversifying Properly, and Hedging Strategies. Importance of Foreign Exchange Risk Management Foreign exchange risk is mainly fuelled by two types of risks; Currency risk and political risk (Bofah, 2009). Currency risk is mainly due to adverse movements of the domestic currency. Corporation that holds foreign currency lose the purchasing power when the value of the foreign currency drops against home currency. These fluctuations are fuelled by political environment as well. Political unstableness and public pressures on political leadership could also lead to appreciation or depreciation of the foreign currency. Risk Reduction Strategies Hard Currency One strategy that can help to reduce the foreign exchange risk is ‘Hard Currency’. This can be either transactions through hard currency or immediate conversions to hard currency. Hard currency is mainly the currency of highly developed countries such as ‘Group of Developed Nations’. As their currencies are backed up by strong economies
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and political stable environments, the currency exchange are also stable compared to other currencies. Therefore, the risk is comparatively less in term of foreign exchange. “…The G7 is made up of the United States, Canada, United Kingdom, France, Germany, Italy and Japan. The currencies employed are the U.S. dollar, Canadian dollar, British pound, Euro and Yen…”
(Bofah, 2009)
Diversification Another strategy is to hold number of different currencies at a time. Organizations can hold two competing currencies. Therefore, when one currency deteriorates over the competing currency, competing currency would make a gain. In that way the effect of changes in foreign exchange get neutralized Currency portfolios Similarly to the diversification, companies can hold mixture of different currencies including hard currently. In that scenario, if one currency gets deteriorated, still the affect of that would make less impact towards the organization due to other alternate portfolios. Hedging Strategies “…A foreign currency hedge is places when a trader enters the foreign currency market with the specific intent of protecting existing or anticipated physical market exposure from an adverse move in currency rates. In simplest terms, an investor or trader who is long a particular foreign currency can hedge to protect against downside risk exposure (a downward price move). An investor who is a short a particular foreign currency can hedge to protect against upside risk exposure (an upward price move). Both speculators and foreign currency hedgers can benefit by knowing how to properly utilize a foreign currency hedge…”
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However, throughout the history, number of failure on hedging was resulted time to time. Failure refers to a dramatic disadvantage towards one party over the other. For example Sri Lankan government incurred huge losses in oil exporting due to the hedging agreements made with foreign banks due to inaccurate forecasting. Hedging was made when the oil barrel was fly high but suddenly within few weeks the oil price came down substantial by incurring losses to the government. Even though this is not related to foreign direct investment, this make a good picture about what hedging strategy would do ‘Ashanti: Unexpected cash calls’, ‘Barings: Catastrophic Failure to Control Open Positions’, ‘Sumitomo: Failed attempt to manipulate market’, ‘Natwest Markets: Misvalued Derivative Positions’ are few of the famous failures in term of hedging. (CambridgeRisk, 2009) Forward Exchange “…Forward exchanges occur when two parties agree to exchange currency and execute the deal at some specific date in the future…”
(Hil, 2007)
Therefore, the transaction would be done in a negotiated fixed foreign exchange rate between predefined duration (30, 60, 90 days). Then the entire transaction would not be depending on the fluctuation of the foreign exchange rate.
Figure 10: Sample Foreign Exchange Risk Reduction Approach [Source: (ICBC, 2007)]
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Pros and Cons of Foreign Exchange Risk Management The cost of the foreign exchange risk is so much due to the expenses on procedures, forecasting, analysis, currency conversions‌etc. Again, it is also an extra headache for multinational corporations. They have to look after these risks additionally to the other activities. However, there is no easy way to get through the foreign exchange risk as well. One positive factor is that, if the corporation can predict the currency fluctuations by accurate forecasting, companies can gain a lot through by manipulating the foreign currency. However, the risk involve in those kind of activities are very high. Relationship to the Base Statement The above sections presented some of the issues relating to foreign exchange as wells the strategies to minimize the risks. The base statement of this assignment depicts that countries like Sri Lanka, India, China, Brazil, and Malaysia are focusing more towards attracting FDIs. However, the foreign exchange risk is high in these countries comparatively to the FDI outward focus countries. For example, Sri Lanka rupee is highly unstable due to the poor economy in the country. To explain the gravity of the foreign exchange rate fluctuation, the rate in the morning can be changes in the evening in Sri Lanka. In these kinds of economies, it is hard to make any predictions even for coming weeks. This is a huge barrier to attract FDIs to Sri Lanka. At the same time countries like Japan have more stable and strong currency as well as economies. This also increases the attractiveness of the country towards Inward FDIs and it also allows the Japanese investors to invest in other countries without any fear. As a summary, foreign exchange risk is a one main determining factor of FDIs. Therefore, the governments of the countries who are willing to attract FDIs need to monitor the risk and help the foreign investors to overcome the barriers. At the same time they should try to stabilize the domestic currencies in global market as well.
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Conclusion The gist of this report revolves around Foreign Direct Investments and related phenomena. A thorough investigation has been done under the given parameters in order to come up with fairly brief answers. After a brief overview about FDIs in the first section, the second section of the report has discussed the Foreign Direct Investments based on international trade theories followed by number of examples. Other than that, the Foreign Direct Investments related theories are also presented briefly in order to give a basic idea. The third chapter focuses to evaluate the different strategies based on different countries. Numbers of graphs are also presented in order to prove the ideas. Foreign Direct Investments strategies of few countries are evaluated by providing quantitative and qualitative data. The countries are selected in such a way it can cover most of the common strategies that are being followed across the world. Thirdly, the pros and cons of Foreign Direct Investments are discussed by providing wide variety of real time examples backed up with relevant statistics. After a thorough investigation, an comprehensive set of recommendation are provided in order to attract Foreign Direct Investments in to Sri Lanka by maintain the existing Sri Lankan value systems and cultural elements. Finally, the Foreign Exchange risks, there important, risk reduction strategies are discussed to wrap up the entire discussion on Foreign Direct Investments.
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