Foreign Direct Investment in South Asia
Authors: Lall Sanjaya 
Published: June 2023

The global scene for foreign investment has changed significantly in the past decade. Along with a resumption of high rates of growth, there have been shifts in flows, destinations, determinants and policies. It is within this context that foreign direct investment (FDI) in South Asia will have to be considered in order to have a realistic picture of the prospects for future FDI in the region. The main features of the global FDI scene may be summarized as follows: FDI flows are rising faster than almost all other indicators of economic activity worldwide. FDI has grown at around 25 per cent per annum in the latter 1980s, while trade has grown at under 10 per cent and gross domestic product (GDP) and manufacturing output at around 2–3 per cent. Thus, the share of international production under the control of multinational corporations (MNCs) is increasing rapidly. This reflects the growing economic strength of MNCs in innovation, services and finance, apart from trade. Traditional MNCs remain powerful, but there are many new sources of FDI from the Organisation for Economic Co-operation and Development (OECD) countries as well as from developing countries. While the recent recession in leading investor countries such as the United States and the United Kingdom has led to declines in the rate of growth of FDI by these countries, the rate of growth of FDI still exceeds the rate of growth of their domestic activity. Other major capital-exporting countries, with the exception of Japan, have continued to invest increasing amounts abroad in 1991. This investment behavior shows growing independence of international investors from national economic conditions. The business cycle clearly affects FDI through its effect on demand conditions and business confidence more generally. However, the effects are not as direct and immediate as they are on domestic investment and activity. Thus, recipients of FDI, to the extent that their business cycles move differently from those in capital-exporting countries, may expect to be able to attract FDI flows that depend on their domestic economic conditions rather than conditions in capital-exporting countries. The share of global FDI going to developing countries, currently about 17 per cent, has declined from the early 1980s (25 per cent) and the 1970s (33 per cent). However, the value of such FDI (in current dollars) has risen sharply in the late 1980s by 22 per cent per annum. It amounted to $32 billion in 1990. This rise has been accompanied by a growing differentiation in the destination of investments in the developing world. East and Southeast Asian countries have become the largest recipients, accounting for about 60 per cent of all flows to developing countries. There is a sharp revival in FDI in Latin America (especially Mexico) in the past two years, after a long period in which the region lost its pre-eminent place as the recipient of FDI in the developing world. However, Asia seems set to retain its new role as the leading destination because of its economic dynamism. Africa is losing its (already small) share and shows no signs of reversing this trend despite considerable liberalization of policies. The policy context for international investment has changed dramatically in the last decade. Due to a constellation of factors, i.e., the debt crisis, the evident success of outward-oriented policies in East Asia, and disillusionment with traditional interventionist strategies, there has been widespread liberalization of economic policies towards greater trade orientation, private ownership and reliance on market forces in almost all developing countries. However, since most developing countries are opening up at the same time, only those that offer real economic advantages to the operations of international firms can hope to attract increased FDI on a sustained basis. The ability to attract FDI varies by the nature of activities undertaken. In most simple manufacturing activities, the host country does not need to possess much apart from a conducive policy regime, cheap trainable labor and good infrastructure: However, the location of production facilities for more complex activities increasingly reflects current technological trends and the need for investments to be competitive in world markets. The growing technological sophistication of manufacturing and services mean that investors, faced with an increasingly open trading environment, demand the complementary inputs that make their facilities efficient by world standards. These complementary inputs are rising levels of operator, technical and managerial skills, relatively free access to world-priced inputs, a good domestic base of suppliers and services, and excellent infrastructure. Large markets do remain a major attraction, even in liberalized environments, but in every country the need for local inputs of technology and skills is much more significant than in the days of inward-oriented FDI. MNCs from advanced OECD countries are moving up-market to sophisticated activities, while the more mature, less demanding activities are being increasingly taken over by investors from developing countries, especially in Asia. The East Asian newly industrializing economies (NIEs) are now leading investors in several labor-intensive export activities, and some are moving into more complex capital-intensive and technology-intensive areas. Their dynamism and specialization make them an important source of finance and technology for other developing countries in the region seeking FDI. This is clearly an important consideration for South Asia.

With these background features of FDI, we can now turn to South Asia.