I wish to thank the IMF country teams for providing valuable information, and Julian Berengaut, Jose Fajgenbaum, Hans Peter Lankes, Paul Mathieu, Christian Mumssen, Franziska Ohnsorge, David O. Robinson, and Katrin Elborgh-Woytek for helpful comments. Mandana Dehghanian and Anna Unigovskaya provided excellent research assistance.
These are Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, the Kyrgyz Republic, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan.
Exceptions include Azerbaijan, Kazakhstan, and Uzbekistan. In the case of Uzbekistan, estimates of inward FDI flows provided by the authorities differ from their balance of payments figures and should therefore be viewed with caution.
The paper uses the European Bank for Reconstruction and Development’s (EBRD’s) CEB country grouping, which includes Croatia, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, the Slovak Republic, and Slovenia.
EBRD (1994, 2000), Lankes and Venables (1996, 1997), Garibaldi and others (2001), Zinnes and others (2001), Havrylyshyn (2003), and Kinoshita and Campos (2003) analyze the determinants of foreign direct investment.
Garibaldi and others (2001) considers the role of institutional quality in attracting foreign direct investment. Havrylyshyn and van Rooden (2000) estimates the effect of institutional quality on economic growth, drawing upon measures available in Freedom House (2001) and Heritage Foundation (2003).
These teams consist of IMF area and functional department staff assigned to conduct program and surveillance review missions.
EBRD (2000) argues that there is a close link between FDI per capita and progress intransition. In particular, Chart 4.9 in EBRD (2000) shows that there is a positive correlation between the average EBRD transition indicator and average net FDI inflows per capita in the transition economies.
The BEEPS asked firms to assess the functioning of the state in each of the following seven areas: (i) access to financing; (ii) quality of infrastructure; (iii) taxes; (iv) regulation; (v) quality of judiciary; (vi) crime; and (vii) corruption. In particular, firms were asked to rate, on a four–point scale, how problematic each of these factors were for the operation and growth of their business. Notably, these indicators show an overall improvement, on average, in the quality of the business environment in the CIS countries, even after controlling for the effects of improved macroeconomic performance. The survey also asked respondents to provide quantitative indicators such underreporting of sales by firms for tax purposes, average time spent by managers dealing with public officials, and payment of bribes.
In the last few years, the weakness in industrial country markets (including due to financial misreporting scandals) has put pressure on enterprise balance sheets and therefore reducedthe supply of investment funds in emerging markets. For instance, the financial troubles of AES—a significant investor in emerging-market energy assets—appears to have had an impact on FDI in the CIS utility sectors.
Box 2 describes trends in net capital flows into the CIS countries, including net FDI inflows. These net FDI inflows are defined in this paper (following the presentation in the IMF Balance of Payments Statistics Yearbook) as the difference between inward FDI (a positive number) and FDI abroad (a negative number). (It should be noted that inward FDI and FDI abroad are in turn also net data concepts.) In contrast to Box 2 and Figure 1, this section focuses on inward FDI flows (unless specially noted), based on data provided by national authorities. It should also be stressed that the poor quality of balance of payments data in many countries introduce some noise into measured FDI flows.
It could be argued that investment in gold mining is driven by resource availability rather than primarily the overall investment climate, which would imply that the Kyrgyz Republic and Tajikistan be added to Group A. In addition, it could be noted that Uzbekistan has significant natural gas export potential. The country groupings are made purely for expositional purposes.
Azerbaijan ranked second among CIS countries, behind Kazakhstan, in cumulative net FDI inflows per capita during 1989–2001 (see Figure 1). Inward FDI flows into Azerbaijan increased sharply in 1997 and 1998, amounting to over $1 billion in each of these two years. This was due to the start of important new oil projects. There was some decline in inward FDI flows from 1999 onwards but this had little to do with the Russian crisis.
Funds are sent offshore to avoid paying taxes, transport proceeds of criminal activity, evade capital controls, or in response to political uncertainty. See Loungani and Mauro (2000) for further discussion.
Inward FDI flows into Turkmenistan dropped from $108 million in 1997 to $62 million in 1998 in an apparent response to the Russian crisis. This drop was short lived and inward FDI flows rebounded to $125 million per annum in 1999 and 2000 and $133 million in 2001.
Inward FDI flows into the Kyrgyz Republic were mainly related to a few large projects and do not show a significant impact of the Russian crisis. However, it is possible that inward FDI flows might have been higher absent the general economic uncertainty in the region which followed in the wake of the Russian crisis.
The Capital Markets Consultative Group (CMCG) found that, inter alia, the size of the domestic market and potential for growth were key factors influencing investment location decisions (see IMF (2003)). Investors noted that a number of emerging market countries were small and therefore free trade agreements and regional trade integration schemes were often important in influencing investment decisions.
In Russia, many of these impediments are particularly severe at sub–national levels of government (see Broadman (2002)). Vandycke (2003) describes deficiencies in the environment for private sector development in the CIS–7 countries (Armenia, Azerbaijan, Georgia, the Kyrgyz Republic, Moldova, Tajikistan, and Uzbekistan).
Financial intermediation in poorer, smaller countries may also be impeded by low savings of the poor population and lack of large–scale investment opportunities.
Broadman (1999) considered how to improve competition, strengthen corporate governance and bankruptcy procedures, reduce barter and other non–cash transactions, and more generally foster enterprise restructuring, in Russia. Shleifer (1994) considers how to establish secure property rights in transition economies.
While equity investments in Russian companies remain low for the reasons discussed, corporate borrowing from abroad has picked up considerably, albeit from a low base.
Kumtor, Cameco’s Kyrgyz subsidiary, was given special tax concessions as an incentive to invest.
See EBRD (2001), Box 3.1, p. 54, for a discussion of the costs and benefits of investment incentives in transition economies.
Elborgh–Woytek and Lewis (2002) examined the recent privatization experience in Ukraine and analyzed the shift in IMF conditionality, from quantitative targets, to conditionality aimed at strengthening privatization procedures.
The near zero correlation between rankings based on the responses of IMF country teams and those based on World Bank (1997) for the CIS countries reflects differences in methodology and timing. In World Bank (1997), for instance, taxes and policy instability ranked first and second as obstacles to doing business in the CIS countries. These factors have arguably become somewhat less important over time as tax rates have started to come down in some CIS countries (e.g., payroll tax rates) and macroeconomic stability has broadly been attained.
This refers to Central and Eastern Europe and the Baltic states, which are listed in footnote 6.