Chapter

II Trends in Foreign Private Investment

Author(s):
International Monetary Fund
Published Date:
January 1985
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Net flows of direct investment from industrial to developing countries as a group generally increased after the 1960s; from an average of under $2 billion a year during the early 1960s they rose to an average of around $10 billion a year during 1974-82 (Table A.1). However, their share in total capital flows declined substantially, as external borrowing—particularly from commercial banks—grew rapidly. During the 1960s, direct investment accounted for well over half all private capital flows from industrial to developing countries, but by the late 1970s it represented barely one quarter of a much larger volume of such flows, most of which were accounted for by medium-term bank lending or export credits. Official development assistance also grew more rapidly than direct investment throughout most of the 1970s and early 1980s.

Although the rapid expansion of commercial bank lending to developing countries was already under way before the first large increase in oil prices in 1973–74, that event accelerated the decline in the relative importance of direct investment flows. Non-oil developing countries financed most of their larger current account deficits through external borrowing, while a number of oil exporting developing countries used part of their increased revenues to reduce the foreign share of their oil industry. In 1973, direct investment still financed some 20 percent of the combined current account deficit and net accumulation of reserves of non-oil developing countries, but met an average of only about 12 percent of the substantially larger financing needs of later years (Chart 1). Nevertheless, the growth of net direct investment flows to non-oil developing countries after the first oil price increase was still, on average, around 3 percent per annum in real terms through the 1970s, compared with an average annual real growth rate of around 5 percent for the combined gross domestic product (GDP) of these countries.1 This 3 percent growth was about ½a percent a year less than the growth in real gross direct investment inflows into industrial countries, although the average growth in industrial countries” combined GDP, at around 3 percent, was lower than that of developing countries.

Chart 1.Non-Oil Developing Countries: Financing Flows, 1973–831

(In billions of U.S. dollars)

Source: Table 1.

1 Excluding reserve-related liabilities, and errors and omissions.

Net direct investment flows into non-oil developing countries reached a peak of some $13 billion in 1981, but fell substantially in 1982 and 1983 as a result of the recession (Table 1). Nevertheless, direct investment was less severely affected by the recession than was borrowing from private creditors (including bank lending, bond issues, and suppliers” credits). Direct investment fell by 29 percent between 1981 and 1983, while net borrowing from private creditors fell by 72 percent over the same period. Almost all the decline in direct investment appears to have been concentrated in the main borrowers in Latin America; other regions were only moderately affected.

Table 1.Developing Countries: Composition of Financing Flows, 1973–83(In billions of U.S. dollars)
19731974197519761977197819791980198119821983
Non-oil developing countries
1. Current account deficit10.937.146.331.730.442.963.388.7108.585.952.6
2. Reserve accumulation9.71.7-1.714.411.616.311.74.43.7-4.710.0
Financing (1. +2.)20.638.844.646.142.059.275.093.1112.281.262.6
3. Net direct investment4.25.15.35.35.37.29.48.913.112.69.3
4. Official transfers5.58.87.17.48.28.211.512.513.112.512.0
5. Net long-term borrowing from official creditors5.77.811.812.812.713.716.919.424.323.524.5
6. Net external borrowing from private creditors5.716.522.218.618.632.436.958.166.437.118.4
7. Other sources1-0.50.6-1.82.0-2.8-2.30.3-5.8-4.7-4.5-1.6
Seven major borrowers2
1. Current account deficit2.66.414.311.39.518.422.326.635.739.811.0
2. Reserve accumulation4.94.50.75.85.07.39.52.2-1.2-16.73.3
Financing (1. +2.)7.510.915.017.114.525.731.828.834.523.114.3
3. Net direct investment1.91.72.81.62.53.74.34.26.34.62.6
4. Official transfers0.30.20.20.20.10.30.40.40.70.50.6
5. Net long-term borrowing from official creditors1.72.22.52.52.22.33.22.65.05.07.1
6. Net external borrowing from private creditors4.48.711.114.613.423.126.036.740.822.79.4
7. Other sources1-0.8-1.9-1.6-1.8-3.7-3.7-2.1-15.1-18.3-9.7-5.4
Sources: International Monetary Fund, World Economic Outlook, September 1984, Occasional Paper No. 32 (Washington, September 1984); and International Capital Markets: Developments and Prospects, 1984, Occasional Paper No. 31 (Washington, August 1984), Table 19, which this table updates.

Includes errors and omissions.

Argentina, Brazil, Indonesia, Korea, Mexico, the Philippines, and Venezuela.

Sources: International Monetary Fund, World Economic Outlook, September 1984, Occasional Paper No. 32 (Washington, September 1984); and International Capital Markets: Developments and Prospects, 1984, Occasional Paper No. 31 (Washington, August 1984), Table 19, which this table updates.

Includes errors and omissions.

Argentina, Brazil, Indonesia, Korea, Mexico, the Philippines, and Venezuela.

The shift in the composition of financing of current account deficits was reflected in the changing structure of the external liabilities of non-oil developing countries. The stock of foreign direct investment (at its book value) is estimated to have grown at an average annual rate of 11.6 percent between 1973 and 1983 while total external debt grew at a rate of 18 percent (Table 2). (However, these figures understate the relative importance of the stock of foreign direct investment; the current market value of most would be higher than its book value, which is based on historic cost.) Public and publicly guaranteed debt to financial institutions grew even more rapidly. Consequently, the share of direct investment in the total gross external liabilities of non-oil developing countries declined from an estimated 26.5 percent in 1973 to 17 percent in 1983, while the share of public and publicly guaranteed debt to financial institutions rose from 10 percent to 26 percent.2 As a percentage of exports of goods and services, the stock of direct investment in non-oil developing countries declined between 1973 and 1983, whereas the stock of external debt grew considerably (Table 2).

Table 2.Non-Oil Developing Countries: External Liabilities, 1973, 1983
Stock of

liabilities1
Average annual

growth rate, 1973–83
19731983(In percent)
(In billions of

U.S. dollars)
Foreign direct investment247.0140.911.6
Total external debt3130.1685.518.1
Short-term debt18.4110.619.6
Long-term debt111.8574.917.8
Official creditors51.0219.915.7
Private creditors460.8355.019.3
Financial institutions517.3204.128.0
(As percent of exports of goods and services)
Foreign direct investment41.531.7
Total external debt115.4154.4
Sources: Organization for Economic Cooperation and Development, Development Cooperation, OECD (Paris), various issues, and Geographical Distribution of Financial Flows to Less Developed Countries, OECD (Paris), various issues; International Monetary Fund, World Economic Outlook, September 1984, Table A.2; and Fund staff estimates.

End-of-year.

Book value; net of disinvestments and nationalization.

Excluding reserve-related credits.

Including debt not guaranteed by government of debtor country.

Guaranteed debts only.

Sources: Organization for Economic Cooperation and Development, Development Cooperation, OECD (Paris), various issues, and Geographical Distribution of Financial Flows to Less Developed Countries, OECD (Paris), various issues; International Monetary Fund, World Economic Outlook, September 1984, Table A.2; and Fund staff estimates.

End-of-year.

Book value; net of disinvestments and nationalization.

Excluding reserve-related credits.

Including debt not guaranteed by government of debtor country.

Guaranteed debts only.

Within these global trends, of course, direct investment patterns in individual countries have varied greatly, according to differences both in economic environment and policies. Much of this investment is concentrated in a small number of countries that have large domestic markets, are rich in natural resources, or have significant advantages as a base for export-oriented production. Five countries (Brazil, South Africa, Mexico, Singapore, and Malaysia) accounted for almost half of the stock of direct investment in non-oil developing countries at the end of 1983 (Table A.2). In contrast, external debt was less concentrated; the five countries with the largest external debt among non-oil developing countries (Mexico, Brazil, Argentina, Korea, and the Philippines) accounted for around two fifths of total outstanding debt of all nonoil developing countries at the end of 1983. However, some other countries that also have large domestic markets (such as India and Turkey), or that have successfully pursued an export-oriented development strategy (such as Korea), were much less reliant on direct investment. Countries that had small domestic markets and that lacked substantial natural resources or an export-oriented manufacturing base (including many in Africa) were often relatively unsuccessful in attracting direct investment, even when they offered substantial incentives and imposed few restrictions. Among the major oil exporters, direct investment grew quite rapidly in Indonesia, but stagnated in most other countries, including Nigeria and Venezuela, partly as a result of government purchases of foreign oil companies’ assets.

The wide variations in countries” reliance on direct investment were reflected in its share in gross external liabilities. At the end of 1983, direct investment was estimated to account for 5 percent or less of the stock of total external liabilities of Algeria, Korea, and Yugoslavia, but for over 28 percent of liabilities for Malaysia, about 44 percent for South Africa and Hong Kong, and over 90 percent for Singapore (Table A.2).

Although little information is available on foreign portfolio purchases of equity in enterprises based in developing countries, such purchases appear to have been very small. For instance, the total stock of equity held by U.S. residents in corporations based outside North America, Japan, and Western Europe at the end of 1983 was valued at only an estimated $1.4 billion, and a substantial proportion of this consisted of stock in companies based in Australia or in tax havens.3 Among the many causes for the slow development of portfolio equity investment in developing countries have been the restrictions imposed by some of these countries (discussed in Section IV), which are sometimes even more stringent than those applied to direct investment, and regulatory restrictions imposed on the portfolios of institutional investors in many capital-exporting countries. However, although the overall size of such investment is still very modest, there has been some growth in recent years. A number of mutual funds were recently established (such as the Mexico Fund and the Korea Fund), sometimes with the assistance of the World Bank’s affiliate, the International Finance Corporation (IFC), with the aim of investing in corporate equity of selected developing countries.

The United States has been the principal source of private direct investment in developing countries, although it, together with the two other traditional sources (the United Kingdom and France), has become less important recently, while investment from the Federal Republic of Germany and Japan has grown rapidly. The stock of U.S. direct investment in developing countries grew at an average annual rate of less than 10 percent during 1970–82, compared with growth rates of 17 percent and almost 21 percent for Germany and Japan, respectively. However, the United States still accounted for almost half of the total stock of such investment in 1982 (Table A.3). The stock of direct investment from the United Kingdom and France grew even more slowly, at less than 9 percent per annum during 1970–82, although direct investment from the United Kingdom grew more rapidly after 1979.

There has also been a small but growing level of direct investment flows from a number of developing countries, much of it directed to neighboring developing countries. If South Africa is excluded, the total recorded outflow of direct investment from non-oil developing countries amounted to an average of $640 million a year during 1980–82, compared with $120 million a year during 1973–75; Brazil, Korea, and the Philippines were the principal source countries (Table A.4).4 The outward flow of direct investment from South Africa also increased rapidly, to an average of around $700 million a year during 1980 and 1981, but dropped sharply in 1982, when there was actually a small net repatriation of capital. After the first large oil price increase, a number of major oil exporting countries also increased their overseas direct investments, mainly in the industrial countries.

Sectoral Composition

The industrial composition of foreign direct investment in developing countries has changed substantially during the last two decades, in response both to changes in economic structure and to policies designed to reduce the share of foreign capital in particular sectors of the economy. For each of four major source countries, the share of total direct investment in developing countries in petroleum and mineral extraction fell sharply, while the share in manufacturing and services generally rose (Table A.5). Direct investment from the United States demonstrated the largest sectoral shift, as the share of the extractive industries in total investment fell from almost half in 1967 to just over a quarter in 1980. Direct investment in agriculture, which accounted for only 6 percent of the stock of all foreign direct investment in developing countries in 1967, has become even less important.

The declining relative importance of direct investment in extractive industries was partly due to the efforts of some governments to increase domestic control of natural resources, either through the nationalization of existing foreign-owned assets or through regulations restricting the entry of new foreign capital into the sector. For example, since 1967 a large number of countries (including most of the major oil exporting countries, as well as Bolivia and Peru) have partially or completely nationalized the local assets of foreign oil companies; foreign investment in oil production is also wholly or largely excluded in a number of other countries (including Brazil, India, and Mexico).

Much of the increased foreign direct investment in manufacturing in developing countries was undertaken primarily to serve growing local markets and was often made in response to trade restrictions imposed as part of a strategy of import-substituting industrialization. This was especially true of investment in a number of Latin American countries, though not in some Asian countries (including Hong Kong, Korea, and Singapore) where more open trade policies encouraged manufacturing for export. Majority-owned manufacturing affiliates of U.S. companies in Latin America exported only 6 percent of their total sales between 1966 and 1976, while manufacturing affiliates in Asia had exports amounting to 24 percent of total sales. These figures refer to gross exports; the relatively low value added in some export-oriented industries may exaggerate the difference between the regions. The contrast between the regions was even larger for Japanese-owned manufacturing affiliates. However, there are indications that, in recent years, the shift in some Latin American countries toward policies designed to improve external competitiveness has encouraged increased exports from both local and foreign-owned enterprises.

The services sector has attracted a growing proportion of direct investment, much of it concentrated in finance, insurance, trade, and tourism. Direct investment in various public utilities, which was once considerable, particularly in Latin America, is now of minor importance. Since utilities are generally natural monopolies, they were early candidates for nationalization, while their regulated prices depressed profitability and discouraged new investment.

Financing and Ownership

Direct investment flows include all funds provided by the direct investor, either directly or through an affiliate. Reinvested earnings generally constitute a large proportion of these flows. During 1975–82 they accounted for some 60 percent of all direct investment from the United States to developing countries, for over half of all the direct investment flows from the United Kingdom, but for only 11 percent of total recorded German direct investment, reflecting that country’s smaller initial stock of such investment. Many of the host developing countries do not collect information on reinvested earnings, but for a group of 12 non-oil developing countries for which data covering a sufficiently long time period are available, reinvested earnings represented an average of some 39 percent of recorded direct investment during 1973–82. (These countries are: Bolivia, Brazil, Cameroon, Colombia, Costa Rica, El Salvador, Honduras, Israel, Jamaica, Mexico, Morocco, and Sierra Leone.)

Total net borrowing from the parent company or its affiliates accounted for an average of some 15 percent of all direct investment flows from the United States, compared with over 40 percent for Germany, but there were substantial year-to-year fluctuations in its importance.5 Part of the borrowing, even when classified as short term, is automatically rolled over and in practice forms part of an affiliate’s permanent capital base. Another part, however, is much less stable and can be affected by short-term movements in exchange rates and interest rates; a substantial proportion consists of net payments due on trade with the parent company or other affiliates, and is akin to trade credit.

Direct investment capital generally provides only a proportion of the total financing requirements of a foreign-controlled affiliate. The affiliate can also sell equity in the host country and can borrow from third parties, either locally or abroad. Although such external borrowing is classified as foreign debt, it would often not be possible without the direct investment relationship between the affiliate and the parent company. There is little information on the overall magnitude of such borrowing, but it appears to have been substantial. For example, by 1979 at least 17 percent of all external borrowing by Brazil was undertaken by the local subsidiaries of foreign companies; such borrowing was equivalent to around one half of total direct investment in Brazil.6 The overall pattern of financing of the affiliate’s capital expenditures determines both the extent of the foreign capital inflow as well as the apportionment of risks between local and foreign investors; both these factors can play an important role in the effects of direct investment on a country’s external adjustment.

This financing pattern is influenced by the host country’s interest rate, exchange rate, and tax policies as well as by its policies affecting the share of foreign ownership in domestic enterprises. Many developing countries have discouraged full or majority foreign ownership, and foreign investors have also increasingly sought local equity participation as a means both of sharing risks and increasing local acceptability. As a result, wholly- and majority-owned foreign affiliates have declined in relative importance. Arrangements not involving foreign equity participation, such as licensing, management contracts, and international subcontracting, have also grown rapidly in recent years.7 Although such arrangements generally do not result in any capital inflow, they do involve the transfers of technological and managerial expertise normally associated with direct investment.

Income Payments

The recent recession and decline in oil prices had sharply contrasting effects on developing countries” income payments on direct investment, and on their external debt. In discussing these, however, one should distinguish between total income payments on direct investment (i.e., remitted dividends and interest plus reinvested earnings), and payments that are actually remitted abroad. The former, broader, definition affects the external current account balance, while the latter influences the immediate foreign exchange outflow. (This is because reinvested earnings enter the balance of payments twice: once as an income outflow and once as a capital inflow of new direct investment.) In practice, total income payments on direct investment are underestimated since a number of developing countries do not collect information on reinvested earnings.

Total net recorded income payments by all developing countries on direct investment rose from $10.4 billion in 1973 to a peak of $26.7 billion in 1981, but then declined abruptly to an estimated $17.7 billion in 1983, when profits fell sharply as a result of the world recession and the decline in oil prices. Most of the increase in income payments between 1973 and 1981 came from the major oil exporting countries, while income on direct investment in non-oil developing countries rose from $3.6 billion in 1973 to $9.4 billion in 1981, before declining sharply to an estimated $6.3 billion in 1983. Most of the decline after 1981 was due to sharply reduced income on direct investment in some of the larger countries in Latin America. Remitted dividends and net interest payments (i.e., excluding recorded reinvested earnings) from nonoil developing countries rose from approximately $2 billion in 1973 to over $5 billion in 1982.8

Expressed as a percentage of exports of goods and services, total income payments by non-oil developing countries on direct investment declined gradually over the decade, to less than 1.5 percent of exports of goods and services in 1983, compared with 3 percent in 1973 (Chart 2). Meanwhile, interest payments on external debt rose from some 6 percent of exports of goods and services in 1973 to over 13 percent in 1983. The divergence in trends was even wider for the group of seven major borrowers among developing countries (i.e., Argentina, Brazil, Indonesia, Korea, Mexico, the Philippines, and Venezuela).

Chart 2.Seven Major Borrowers and Non-Oil Developing Countries: Payments on Direct Investment and Interest on External Debt, 1973–83

(As percent of exports of goods and services)

Source: International Monetary Fund, World Economic Outlook, Occasional Paper No. 27 (April 1984), and World Economic Outlook, September 1984, Occasional Paper No. 32.

1The seven major borrowers are Argentina, Brazil, Indonesia, Korea, Mexico, the Philippines, and Venezuela.

2Dividends and net interest payments plus recorded reinvested earnings.

However, a large proportion of earnings on direct investment are reinvested in the host country. For the 12 non-oil developing countries noted above that collect information on reinvested earnings, an average of 52 percent of all direct investment earnings were reinvested during 1973–82. During the same period, an average of some 56 percent of all earnings by U.S. companies” incorporated affiliates in developing countries were reinvested. Moreover, the proportion of earnings reinvested fluctuated substantially as changing economic conditions affected the profitability of new investment and consequently the need to retain earnings to finance new projects. For instance, the earnings of U.S. incorporated manufacturing affiliates in developing countries fell from around $2.6 billion in 1980 to under $1 billion in 1982, but reinvested earnings fell even more sharply, particularly in Latin America. Consequently, gross dividend remittances from these affiliates to the United States actually increased from under $0.7 billion to $1 billion over the period.9 The implication for developing countries” adjustment to economic disturbances of such divergent movements in remitted and reinvested earnings are discussed in Section VI.

Royalties and licensing fees are payments for the transfer of technology and are not exclusively related to direct investment flows. In practice, however, a substantial proportion of such payments were made between affiliates of the same parent company, reflecting the fact that much of the transfer of technology to developing countries occurred via direct investment. For instance, in 1982 payments of royalties and licensing fees by U.S. affiliates in developing countries were $1.2 billion, equivalent to about 85 percent of all such receipts from developing countries; between 1970 and 1982, these payments grew at an average annual rate of 9.5 percent, virtually as fast as the growth in the stock of U.S. direct investment. Such intrafirm transfers, however, grew more slowly over the last decade than receipts from unrelated companies, particularly for developing countries in Asia. This reflected a trend toward a transfer of technological and managerial expertise through arrangements not involving direct investment capital.

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