VII Prospects and Policies
- International Monetary Fund
- Published Date:
- January 1985
The financing pattern that supported the upsurge in current account deficits of developing countries through 1981 is unlikely to be repeated. In particular, new net lending through the international banking system is likely to be much more constrained in the future, so that foreign direct and portfolio equity investment will probably contribute a greater share of future capital inflows. New net bank lending to countries with heavy principal payments on rescheduled debt is likely to be particularly constrained. These countries could find it advantageous to encourage a greater inflow of direct and portfolio equity capital to maintain sufficient resource inflows to support an adequate growth rate, as well as to reduce vulnerability to any future deterioration in economic conditions.
The scope and need for a larger role for direct investment can be illustrated in the context of the medium-term scenario for developing countries prepared for the World Economic Outlook.34 Over the period of the scenario, 1986–90, foreign direct investment flows to non-oil developing countries are assumed to increase by around 5 percent per annum in real terms. While this would be somewhat faster than the average growth rate of around 3 percent a year experienced from the time of the first oil price increase through the 1970s,35 the assumption is actually a modest one, since much of the growth would simply represent a recovery from the downturn in direct investment that occurred in 1982 and 1983. The volume of direct investment inflows would only reach the peak level achieved in 1981 by around 1988.
Consequently, such growth appears achievable—for the group as a whole although not necessarily for each country—provided that the generally more encouraging policies of recent years toward direct investment are maintained and that the improvements in the world economic environment assumed in the medium-term projections in the World Economic Outlook of 1984 are achieved. If the exposure of international commercial banks evolves as assumed in the “base” scenario (i.e., with total exposure unchanged in real terms, except for trade-related credits, which increase in line with imports), the share of direct investment in the total financing of the combined current account deficits and reserve accumulation of non-oil developing countries will rise moderately, to around 15 percent in 1988–90, compared with some 11 percent during 1979–81. A more substantial liberalization of policies toward foreign private investment could lead to much greater inflows.
However, the existing stock of direct investment is distributed very unevenly among developing countries, and those that have had debt-servicing difficulties in recent years have also generally attracted much less direct investment. Moreover, a recent survey of direct investment intentions suggests a sharp fall in the number of multinational companies expecting to increase their real direct investment flows to Argentina, Brazil, Mexico, and Uruguay during the period 1983–87.36 Consequently, many of the more heavily-indebted countries will need to make more substantial changes in policies toward direct investment if they are to achieve the level of inflows consistent with the growth prospects of the base scenario. This will be especially so if, as seems likely, new bank lending to countries with large rescheduled debt expands less rapidly than lending to countries with less debt.
The initial immediate impact on growth rates of more or less direct investment would probably be relatively small, since they finance only a small proportion of imports (around 2.3 percent of non-oil developing countries” total imports over the period of the base scenario). It is estimated that, assuming no other changes in the base scenario, if the annual growth rate of direct investment inflows into non-oil developing countries were 5 percentage points lower throughout the period of the scenario (which means no growth in real terms), then by 1990 the level of imports would be approximately 1 percentage point lower than in the base scenario. This would contribute to a level of GDP in 1990 that—in very approximate terms—would be ½ a percentage point lower than in the base scenario. However, the indirect impact on growth rates of lower direct investment, through the loss of its contribution to efficient resource use and the technological and managerial expertise it transfers, could well be more significant than the direct effect of a lower contribution to financing imports.
The policies of developing countries that are likely to have the greatest impact on direct investment and portfolio equity inflows are overall macroeconomic policies affecting demand management and the efficiency of resource use. The pursuit of fiscal and monetary policies that lead to greater financial stability and a more manageable external position will improve foreign investors” confidence in the longer-term viability of their investments and will reduce the risk of future restrictions on profit repatriations because of foreign exchange constraints. An appropriate set of relative prices, especially for exchange rates and interest rates, will also generally tend to both encourage investment inflows and increase the net benefits that the host country receives from such investment.
As for policies directed specifically at foreign investment, those which involve substantial direct regulation over entry or restrictions on the repatriation of profits probably represent the major obstacles to encouraging greater inflows. Other policies discussed in Section IV, including tax and subsidy policies, could in some countries play a significant role in attracting investment, but are unlikely to be sufficient by themselves if the general economic environment is not encouraging. The various controls will pose less of a barrier to new investment, and the fiscal incentives will also tend to be more effective, when they are relatively stable over time and not overly complex.
In a number of developing countries, a substantial expansion of foreign direct investment could encounter political difficulties because of concern over foreign domination of industry. These concerns may be eased by the greater willingness of many investors to consider alternative arrangements involving less than full control by the parent company, including various forms of joint ventures and production-sharing arrangements. In addition, inflows of portfolio equity capital, which in some developing countries face even greater restrictions than direct investment, do not involve overseas managerial control of domestic industry. Moreover, recent experience has demonstrated that there can also be substantial costs associated with the increased vulnerability to economic disturbances that results from heavy reliance on external borrowing at commercial rates of interest.
In this context, one proposal for reducing debt and increasing equity currently being sponsored by the IFC involves the establishment of “national investment trusts.” The basic concept is to establish a country-specific closed-end investment trust, which would issue shares denominated in foreign currency to participating commercial banks, in exchange for a small proportion of their present foreign currency loans to private and parastatal entities of the particular developing country. The proposed exchange would be a noncash transaction involving little or no discount. The investment trust would negotiate the conversion, on suitable terms, of the loans to a diversified portfolio of local currency equity and quasi-equity securities of the underlying obligors. Subsequently, at an appropriate time, the investment trust shares held by participating commercial banks could be sold via a secondary offering to institutional investors. It is reported that there has been widespread discussion of this proposal, but as yet no indication that any particular country wishes to support the concept. The reaction of commercial banks has been mixed.
Although at present policies of industrial countries do not appear to pose substantial barriers to outflows of direct investment and portfolio capital, some countries could further encourage such outflows to developing countries. This could be achieved by relaxing remaining restrictions (such as limits on the domestic financing of overseas investment), and by easing supervisory requirements on portfolio composition to allow various investment institutions in developed countries to make greater purchases of developing country securities. Further progress in modifying systems of taxation of overseas investment to encourage investment in developing countries and to allow them to reap a greater share of the global tax revenues from such investment would also be helpful. However, probably the greatest contribution that industrial countries could make to encourage greater investment flows to developing countries would be to roll back the accumulated protectionist measures of recent years, to increase the opportunities for profitable investment in those sectors where developing countries have demonstrated a comparative advantage.