Creating a business conducive environment to attract Foreign Direct Investment in Bangladesh

Table of Contents

Lists of Figures

Lists of Tables

List of Acronyms

Chapter 1 Introduction
1.1 Motivation
1.2 Research Questions
1.3 Research Methodology
1.4 Data Collection Procedures
1.5 The time schedule of the research

Chapter 2 Literature Review:
2.1 Key Definitions
2.1.1 Foreign Direct Investment (FDI)
2.1.2 Business Friendly Environment (Business Climate):
2.1.3 Economic Growth
2.2 Current Research

Chapter 3 Theoretical Framework

Chapter 4 An overview of FDI in Bangladesh
4.1 Background
4.2 The Position of Bangladesh in South Asian Countries
4.3 Foreign Direct Investment Statistics
4.4 FDI as a Percentage of GDP
4.5 FDI as a Percentage of Total Investment
4.6 Ease of Doing Business in Bangladesh

Chapter 5 Advantages and Disadvantages for Attracting FDI in Bangladesh
5.1 Facilities and incentives for foreign investors (BOI, 2012)
5.2 Advantages for Attracting FDI in Bangladesh
5.3 Disadvantages for Attracting FDI in Bangladesh:

Chapter 6 Analytical Discussion
6.1 Survey Data Analysis and Discussion
6.2 Observation and perceptions of the respondents:

Chapter 7 Conclusion & Recommendations:

References:

Appendix 1: Interview Questions

Acknowledgement

I am very much indebted to Assistant Professor Dr. Xuan JIANG, the supervisor of my research work for her continuous support and guidance. Her valuable suggestions gave me the strength to complete my project. I owe my deepest gratitude to the government of China especially Ministry of Commerce for granting this scholarship and all out supports for my work. I also am expressing my deepest sense of gratitude to the government of Bangladesh for selecting me for this course.

At the outset, I benefited enormously from the class lecture of research design of a distinguished Professor Dr. Jun Ma, Dean, Sun Yat-Sen University. He taught us about how to formulate a research paper. I am heavily grateful to Professor Dr. Nabo CHEN for giving valuable advice during my defense of research proposal which ultimate helps a lot to reach my final goal. I am expressing deepest sense of gratitude to Mr.Mokles ur Rahman, Ex. Secretary of Anti-corruption Commission & Public service Commission and Mr. Eunusur Rahman, Secretary those who always encourage me for higher education and valuable guidance in my life.

Special thanks are due to the officials of Board of Investment in Bangladesh, Local and Foreign Direct investors those who are scarifying their time and adding their valuable comments for answering the research questions. Heartfelt thanks are due to my friend Dr. Asraf M. Dewan, Curtin university, Australia, my batch mate Mr. Bashir Ahamed, Deputy Secretary, Ministry of Public Administration, my junior colleagues Dr. Luftor Rahman , Arkansas university, USA, Mr. Azizul Islam,(Deputy Secretary) Bradford shire University , UK and my elder brother Mr. Azharul Amin , Director, National Broadcasting Authority, Dhaka, Bangladesh for giving me invaluable advice and providing necessary writings on time .

I would like to dedicate this work to my wife Dr. Mahbuba Jahan Lotus, MBBS, M.Phil, DMU and family members who have spare me for one year in China. They patiently sacrificed their time and coped with unbearable burden during my stay in China.

Abstract:

Bangladesh is a promising developing nation in South Asia region. Based on the World Bank report, Bangladesh has ranked 122 among 183 countries in 2012 globally in terms of ease of doing business. The present study attempted to investigate the major problems areas which influence FDI inflows in Bangladesh. More importantly, the inflows of FDI in Bangladesh have declined since 2008-09. This study sought to analyze the current business environment and how to create a congenial climate for attracting FDI in Bangladesh. The study also shows that the declining trend of FDI inflows in Bangladesh is directly corollary of the political situation. For creating a good business environment, Political stability of the host country is the prime determinant for attracting FDI.

Keywords: Foreign Direct Investment inflow, Business environment, congenial climate, Political situation & Prime determinants.

Lists of Figures

Figure 3.1: Porter’s Diamond Model

Figure 3.2: Diamond of National Advantage

Figure 4.1: FDI as a Percentage of GDP (in crore Taka)

Figure 4.2: FDI as a Percentage of Total Investment

Lists of Tables

Table 4.1: The position of Doing Business of Bangladesh in South Asian Countries.

Table 4.2: Doing Business in Bangladesh (ranks).

Table 4.3: Foreign Direct Investment Inflows.

Table 4.4: Flow of Foreign Direct Investment

Table 4.5: The Position of Bangladesh in Ease of Doing Business (days)

Table 6.1: Summary of Collected Data Coding and Findings

List of Acronyms

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Chapter 1 Introduction

1.1 Motivation

A favorable business climate is essential for attracting Foreign Direct Investment (FDI) and for the development of economic growth. A poor business environment –i.e., one plagued factors that impose heavy costs, delays and risks-impede economic development and can frighten away FDI (OSCE, 2006). FDI is the largest source of external finance in developing and transition country like Bangladesh. Bangladesh is well positioned to compete for FDI if she adopts pro-development policies, and laws and practices supporting investment and business development but the question is this country with relatively low levels of FDI and its trend is declining and how the flow can significantly increase its share of FDI by concerted efforts to improve the business climate.

Foreign Direct Investment is considered as one of the crucial ingredients for fostering economic development of a developing country like Bangladesh. The flow of foreign direct investment is of utmost importance in the current backdrop of overall slump in investment in the economy in recent days. FDI reduction impacts on investment, which in turn will reduce employment generation. These may cause to decline in consumption level and savings will face a downward trend. There would make a negative impact, as a result, a contagious negative pressure on the GDP growth of Bangladesh.

In Bangladesh, FDI plays a significant role in GDP acceleration and economic growth (Mottaleb, 2007). FDI has a remarkable role in the modernization of the Bangladesh economy for last two decades. It helps the country in building and boosting up infrastructure, creating more employment, enhancing skills of the labor force and developing capacity of the host country through transferring technological knowledge & advancement and managerial capacity, and helping in integrating domestic and the global economy (BBS¹, 2012). Many positive attempts of Bangladesh are now attracting the attention of the investors from both developed and developing countries. In Bangladesh, skilled and semi-skilled labors are available at relatively low wages. Moreover, there is reasonably stable macro-economic climate. These two important factors can make Bangladesh an attracting destination for foreign and local investors. Lowest wage rates among the Asian countries, tolerable and moderate inflation rate, reasonably stable exchange rate, investment friendly tax and custom regulations and attractive incentive packages make Bangladesh a favorable and friendly investment destination. Bangladesh turned into more open toward FDI policies from the last decades. These above areas will certainly create the recent advancement in FDI investment in Bangladesh by the foreign investors. But it is remarkable that after 2008-09 the FDI inflow in Bangladesh is declining sharply. The present study intends to overhaul the present situation why the FDI inflow is declining from the Financial Year 2008-09 and gives a policy recommendation how to improve this situation for attracting FDI in Bangladesh.

The consecutive failures of attracting the FDI and even meeting the targets should not be taken casually. Although Researchers have marked FDI as an important factor in accelerating economic success and wealth of a country as well as open a door for making jobs, creating more competitive environment, facilitating economy, and contributing productivity to the host country.

The targets of maintaining growth, job creation and controlling inflation may be affected in near future if the consumption growth and overall investment growth continue with these declining trends of FDI. The state needs to take immediate steps to attract FDI through increasing its business friendly environment. So the study tries to figure out the way forward to overhaul the constraints and determinants to attract FDI and how to create a business conducive environment for attracting FDI which is currently backfiring in Bangladesh.

1.2 Research Questions

Central question:

a) How can Bangladesh create a business conducive environment for attracting FDI?

Sub questions:

a) Why the FDI inflow is declining from 2008-09 to upward?
b) What are advantages and disadvantages for attracting FDI in Bangladesh?
c) How to restore the confidence of the investors in Bangladesh?

1.3 Research Methodology

This study has applied phenomenological approach and qualitative research method. For answering the research questions, a vast quantity of related prevailing literature have reviewed for this study. To gather primary data about the perceptions and experiences of the three sets of target groups has been collected through a structured interview question (Appendix 1). A structured interview has been conducted on the purposefully selected 3 target groups’- policy makers, foreign investors and local investors’. For primary data, interview protocol is used for asking questions and recording answers during this qualitative research through telephone, internet, email and Skype.

A theoretical lens (Chapter 3) has used to view the perspectives of this research work. This lens becomes an advocacy perspective that a shape the types of questions asked, informs and necessary observations how are collected and analyzed, and provided a scope for action or change. This theoretical lens or perspective is in qualitative research which provides an overall orienting lens for the study of questions. The relevant secondary data are gathered from statistics department and research department of Bangladesh Bank, Board of investment, Bangladesh, Bangladesh Economic Review, Bangladesh Bank Bulletin, World Investment Report, and other national & international articles, and journals, etc.

1.4 Data Collection Procedures

The data collection steps include setting the boundaries for the study (Creswell, J. 2007).For answering the research questions; data has been collected through structured interview questions and from related documents. During the process of research, the investigator has collected qualitative documents, journals, articles, public documents or private documents. For primary data, interview protocol is used for asking questions and recording answers during this qualitative research through telephone, internet (Skype), and email.

1.5 The time schedule of the research

The time schedule of this research is from November 2012 to July 2013.

The structure of the paper is as following features: Chapter 2 reviews the relevant literature; Chapter 3 provides a theoretical perspective; Chapter 4 presents an overview of the FDI inflow in Bangladesh; Chapter 5 analyses advantages and disadvantages of FDI in Bangladesh; Chapter 6 discusses about survey data and discussion; and Chapter 7 presents conclusion and commendations.

Chapter 2 Literature Review:

2.1 Key Definitions

2.1.1 Foreign Direct Investment (FDI)

According to the International Monetary Fund (IMF), FDI is an investment made to acquire lasting interest in enterprises operating outside of the economy of the investor. In addition, as a case FDI, the purpose of the investors is to make profit and gain an effective voice in the management of the enterprise (IMF Report, 1993 & 2003)². FDI can be considered as a large source of revenues for some countries and can revamp to economic advancement in the absence of other types of foreign capital. This is particularly important in capital-starved countries. FDI is an important factor of international investment that shows a long-term relationship between the direct investor and the enterprise. Direct investment makes a relation with initial transaction between the investor and the enterprise. It also shows the transactions and bond of relationship between them and among affiliated enterprise and other related corporations. The components of FDI are: a) Equity capital, b) Intra-company loans, and c). Reinvested earnings (Rahman, A., 2012).

2.1.2 Business Friendly Environment (Business Climate):

Business friendly environment largely depends on good governance, rule of law, political will, infrastructure of the country and rules and regulations are how much conducive and congenial to that demand. There is no precise and concrete definition of favorable business and investment environment (OSCE, 2006)³. For the purposes of this paper, the business and investment environment serves as the frameworks that enables and strengthen foreign and domestic companies to conduct business and make profits in a given country. The investment climate can be defined by three broad sets of variables:

- Macroeconomic policies such as, monetary, fiscal and trade liberalization policies;
- State Governance, political stability and institutional arrangements;
- Country’s image in abroad;
- Infrastructure;

The important role of a sound political environment in attracting FDI and helping businesses grow. Investors are discouraged by concerns about stability and security, and are attracted by increased transparency and good governance. A number of measures are needed for protecting investor rights and increasing legislative stability. Any given investment location must give potential investors a sense of predictability and security (OSCE, 2006). The World Bank website puts it as follows: “A good investment climate is an essential pillar of a country’s strategy to stimulate economic development that in turn generates facilities and opportunities for poor people to have higher income and more productive jobs”. Within the OSCE⁴ and across the world, it is the wealthier countries that tend to have more favorable business and investment climates. There is a definite link between economic growth and prosperity, investment and business climate.

2.1.3 Economic Growth

Economic growth, which is necessary for poverty reduction, is usually associated with their development of industrial and service sectors. Bangladesh however faces a number of factors that impede implementation of such growth strategy. Some constraints arise from the specific geographical location or physical conditions of these countries. Other constraints such as quality of governance and economic institutions are determined in part by the political or economic decision-making process and thus are much more amenable to change. Key risk factors that influence economic growth and stability in country range from weak governance to geographical isolation. Bangladesh has to make significant strides forward in improving its business climates and advancing its economic development.

2.2 Current Research

Foreign direct investment is as an important tool in accelerating economic growth in developing countries. Foreign direct investment is to the host country, which gives the ability and opportunity to invest beyond the level of domestic benefits and savings to achieve. Benefits of FDI are creating capital, technological progressiveness, knowledge, improving managerial capacity, increasing employment, improving competitiveness and enhancing balance of payments. OSCE Report, 2006 revealed that most important factors attracting foreign direct investment are the security & stability to host country and low country risk both economic as well as non-economic factors such as political instability and country’s image (OSCE, 2006).

Political stability and transparency meaning good governance are very influential factor for attracting FDI in developing countries like Bangladesh. Political instability may unexpectedly change the rules and regulations under which businesses operate in a probable host country (Butler and Joaquin, 1998). Adverse consequences and political austerity have a deep rooted influence on business organizations and MNCs (Boddewyn, 1988). Instability results in more unpredictable investment outcomes in a host country’s government or monetary and fiscal policies (Brewer, 1983).

Political situations like unexpected & frequent changes of government, devastating and critical attitudes of opposition political parties towards foreign investment lack of good governance in the public service, degree of nationalism, incidence of corruption, and possibilities of terrorism and unrest are seriously considered by investors in pre-investment decision making ( Uddin & Azim, 2001). Political risks and business are plausible determinants for foreign investment location. Domestic factors are also important determinants in host countries (Mudambi, 1995). Location related factors are two types in a host country. One is Ricardian type endowments, which mainly consists of most kinds of labor force, closeness to markets, and natural resources. Second, the functions of political, economical, legal and infrastructural factors are of a host country (Glaister & Tatoglu 1998). These factors play a crucial role in a firm’s decision to enter a host country (Kobrin 1976; Maclayton et al. 1980).

FDI inflow depends on the factor of condition and opportunity to efficiently & effectively utilize those resources and the availability of strategic location specific factors to the host country (Porter, M., 1980). Porter (1980) has defined these as factor endowments and factor of conditions. Overall, the factors that influence FDI decisions can incorporate the growth and size of the market of host country , economic policies like tax, exchange rates and interest rates etc., factor prices (raw materials & labor etc ) , and the protection & profitability are afforded to investing firms by tariffs and /or other measures.

Emad Ullah Mian and Quamrul Alam (2006) prepared an important study entitled "Foreign direct investment and development: The Bangladesh scenario", the study has revealed that the foreign investment is an important factor and determinant of the economic development of Bangladesh. Both governments’ lack of action against corruption and ineffectiveness in controlling corruption, improving political rivalry condition & uncertainty and establishing rule of law and failure to create physical infrastructure are the most important and influential factors for FDI in Bangladesh. It is important to sustain a favorable political and macroeconomic policy packages for successfully attract a huge of volume of foreign investments (Musila & Sigue, 2006).

The macroeconomic policies in Bangladesh are favorable for attracting foreign investment. From the beginning of BEPZA, it has boosted up economic development of Bangladesh through export promotion, employment generation, development of forward and backward linkages of industries, and technology transfer & progressiveness so on (Alam et al., 2006).

Jafari, S. et al (2011) conducted an important study entitled “Political Stability and FDI in OIC Countries”. This empirical study has revealed that population; openness, market competitiveness and GDP have positive impact on FDI, whereas political instability has a detrimental effect on FDI in OIC countries. Investors believe political unrest and insecurity in the host country are important for choosing investment locations and deciding the investment amount. Political instability is considered by economists as a serious detrimental effect to economic and investment performance. Political instability is likely to belittle policymakers’ horizons leading to suboptimal short term macroeconomic policies. It may also proceed to a more frequent change of policies, creating volatility and thus, negatively affecting macroeconomic performance and downgrading economy.

According to Sun (1998) stated that foreign investment has immensely boosted up economic growth in China by creating new employment opportunity , enriching domestic capital creation and formation, and increasing exports. Khoda (2003) stated that foreign investment can raise domestic capital, reduce unemployment by using underutilized labor, strengthen organizational strengths in the host country, transfer technology, achieve domestic and external marketing connectivity & network, and furthermore improve the technical knowledge & expertise of the Government. Mnieh and Frimpong (2004) have empirically studied and revealed a report on the foreign investment situation in Ghana that the reformation of economic policies has influence on FDI. The study also has shown that the reformation of regulations and policies have helped to increase FDI inflow in India, China, South Korea and Mexico.

OSCE’s (2006) Best–Practice Guide for a Positive Business and Investment Climate sees the promotion of a positive climate as an important priority for its work in the economic development. It paid particular attention to the problem of how to build institutional and human capacity for economic development and co-operation. Foremost among the means it focused on were the stimulation of foreign and domestic investment. It discussed the importance of creating a good business environment for countries aiming to attract investment and develop their SMEs sectors. It was agreed that the key determinants for a favorable business climate included (regional) security and co-operation, macroeconomic stability based on prudent economic policies, good governance and rule of law, sufficiently institutional and human capacity and well-developed financial and physical infrastructures.

Trade liberalization had an impact on foreign investment in Bangladesh (Mortoza & Das, 2007). Mondal (2003) found that FDI inflow to Bangladesh is constrained by six factors: (1) Political instability; (2) Excessive transaction cost of business (3); slow steps towards privatization; (4) Tax hazards; (5) financial threats; and (6) Volatile and incompetent capital market. Many researchers in finance and economics try to find the factors that affect the FDI. For example, Lucas (1990) argues that only political risk is an important factor in limiting capital flows. Investments in many developing countries are exposed to large political insecurity and risks, so FDI inflows are not encouraging for politically unstable countries. By the same token, FDI outflows are large for politically stable countries to invest in countries with large political risks.

Singh and Jun (1995) also show that political risk and business operating conditions have been important determinants of FDI for countries that have historically attracted high FDI. For countries which are with relatively low FDI, a key determinant was the degree of social and political instability and risks. A country's orientation toward exports is the strongest variable for explaining why a country attracts FDI. Chan and Gemayel (2004) find that the degree of instability associated with investment risk is a much more critical determinant of foreign investment in the Middle East and North Africa region countries than it is for developing countries.

There are other factors which are determinant for FDI. They are macroeconomic determinants (Hymer, 1960; Agmon and Lessard, 1977; Stein and Froot, 1991), intangible assets (Young & Morck, 1992; Ittner & Markides, 1994; Denekamp, 1995), capital market mispricing (Baker, Foley, & Wurgler 2009), shareholder's wealth effect (Desai, Dukas, & Fatemi, 1996; Hamaifar and Strickland , 1990), and corporate governance and stock market liberalization (Demirguc-Kunt and Levine, 1996; Henry, 2000a,b; Pfleiderer and Admati, 2000).

Nasrin, S. and et al (2010) showed their study “Major Determinants and Hindrances of FDI inflow in Bangladesh: Perception and Experiences of Foreign Investors and Policy Makers” that political unrest and infrastructure are not restricting FDI inflow. They also found that investors did not consider that political conditions are hindering the investment climate in Bangladesh.

To sum up, the literature review suggests that FDI is an important tool for the economic development in a transition & developing country of Bangladesh. Literature review also showed that there are contradicting observations & perceptions, experiences, facts, and findings about the investment climate and doing business in Bangladesh. Currently, there is a vast amount of literature pertinent to FDI in Bangladesh, but very few focus on how to boost up and why the declining attitude of FDI in Bangladesh. This paper fills in the current academic gap by examining issues (i.e., the role of government’s political attitude and the outcome of new strategies) raised in this paper and contributes to deeper understanding of creating a conducive business environment for attracting FDI inflows in Bangladesh.

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¹ Bangladesh Bureau of Statistics Report, 2012, Planning Division, Dhaka, Bangladesh.

² International Monetary Fund Report, 1993 & 2003.

³. Organization for Security and Cooperation in Europe Report , 2006

⁴ Organization for Security and Cooperation in Europe: Best Practice Guide for a Positive Business and Investment Climate