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Impact of Foreign Direct Investment on Emerging Economy

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Foreign Direct Investment (FDI) is an investment from a party in a particular country to a business in another country with the aim of lasting interest. It can be either financially investing in a foreign country or expanding one’s business to another country. A lasting interest is triggered when an investor has 10 percent of the voting power in a company. In a deep context, control is the critical factor for FDI. Besides, the practice has a significant effect on an emerging economy. In most cases, an emerging economy goal is to ensure sustainable growth is promoted across the business, which is vital for economic development. As a result, the thirst to have positive contributors in the economy act as the driving force to economic growth. Consequently, the presence of FDI in an emerging economy has a huge impact.

Impact of Foreign Direct Investment

FDI imports capital to the host country

It is a stimulus to the macroeconomic factors of the host country. It creates the opportunity to inject into the economic development process of a country and enhance growth(OECD, 2002). The imported capital influences productivity of the nation’s economy, promoting sustainable economic growth in the region. It works through the link between the FDI’s capital and the trade flow of the region (OECD, 2002). It can be viewed as additional capital to the growth of the host country and increased investment opportunities in the host country. From a broader perspective, FDI is less volatile compared to other forms of investment, affirming positive capital inflow to the emerging economy.

FDI creates employment

Additional job opportunities are the most immediate impact of FDI on emerging economies. It creates the chance to influence employment which is essential for the spending habit of the host country’s economy (Meyer, 2015). On the other hand, when many are employed, productivity is increased across the different levels of economic production. FDI offers the chance to influence growth and various sectors of a firm which is essential for growth anddevelopment(Meyer, 2015). On the other hand, it is a mechanism of triggering full employment, meaning that the host country will have minimal unemployment cases. Therefore, it maximizes the potential output of the macroeconomy and results in increased consumption, creating confidence for more business investment.

FDI increases the gross domestic investment

FDI plays an essential role in the financial development process. As a result, it is most likely to increase domestic capital accumulation by fostering the creation of attractive policies that influence investment(Aigheyisi, 2017). The capital inflow cannot be assumed since it encourages investment by ensuring the exchange rate increases, resulting in more international borrowing triggering a crowded local investment approach (Aigheyisi, 2017). Increasing consumption through employment creation provides the confidence of investing in the economy, which is essential for growth and development.

FDI generates exports

The impact of FDI on the host country’s exports can be direct and indirect. The direct effect is experienced when the Multinational Enterprises (MNEs) creates production companies in the host country and uses it to increase its product distribution capacity (Goswami & Saikia, 2012). One of the significant examples is Apple which has manufacturing companies in China, South Korea, and many other countries to improve product supply in the market. The indirect effect is the spillover effect, whereby foreign companies present the opportunity to influence technological advancement in the host country and offer the avenue for skills improvement in the labor market (Goswami&Saikia, 2012). Consequently, these factors end up improving a nation’s productivity leading to increased exports.

FDI leads to technological transfer

MNEs tend to have the highest level of technology due to the effect it has on product quality and efficiency in production (OECD, 2002). As a result, when FDI is present in an emerging economy propelled by the desire for MNEs to increase their supply, these advanced technologies will be transferred to the economy and boost technological advancement in the region (OECD, 2002). From a broader perspective, it leads to increased efficiency in the host country and can result in significant development in the technological spectrum of the host country. It is one of the significant spill over effects triggered by FDIs.

FDI leads to Human Capital Enhancement

FDI can profoundly influence the labor market. In most cases, once individuals are employed by MNEs, they undergo training or job learning programs to enhance their skills (OECD, 2002). Through such efforts, the labor market is widely improved. Also, the companies that are linked with the MNEs either through supply or other factors tend to benefit through employee enhancement procedure that makes the labor market efficiency. It should be noted that most nations foster the improvement of the labor market by either transforming education curriculum to attract FDIs, which is also a mechanism of human capital enhancement in the region (OECD, 2002). It is a broader development approach.

FDI triggers enterprise development

FDI has the potential of influencing enterprise development in the host country. In most cases, FDI propels the achievement of synergies with MNEs leading to increased efficiency and propelling identification of new activities (OECD, 2002). Through insights and spillover effect, the host country markets become full of opportunity that triggers the process and mechanisms of development in the region. In a deep context, the spillover effect can be experienced with companies unrelated to the MNEs, leading to a profound transformation in the enterprise development process (OECD, 2002). It generally gives rise to important efficiency in the host market and enterprises opportunity.

FDI triggers competition

FDI presence may exert a significant effect on the competition of the host market. MNEs trigger a spillover effect influencing business opportunities and even improve product quality. As a result, competition increase in the host country market due to increased productivity, product quality, and new business opportunity (OECD, 2002). It, therefore, influences lower prices to attain a competitive advantage easy resource allocation methods. However, it can negatively affect the level of concentration in the market-leading to decreased competition (OECD, 2002). For this reason, the host country is supposed to ensure that it offers an avenue for a standardized concentration of MNEs either by influencing quality labor or technological advancement.

Conclusion

FDI effect is significant to an emerging economy. A healthy business environment is promoted by FDIs, and transformation is profoundly significant. It should be noted the effects are not instant.

References

Aigheyisi, O. (2017). The Effect of Foreign Direct Investment on Domestic Investment in Nigeria: Any Role for Financial Development and Human Capital?. Amity Journal Of Economics. Retrieved 25 April 2021, from https://amity.edu/UserFiles/admaa/dd681Paper%201.pdf.

Goswami, C., &Saikia, K. (2012). FDI and its Relation with Exports in India, Status and Prospect in North East Region. Procedia – Social And Behavioral Sciences37, 123-132. https://doi.org/10.1016/j.sbspro.2012.03.280

Meyer, K. (2015). Foreign Investment: Direct. International Encyclopedia Of The Social & Behavioral Sciences, 324-326. https://doi.org/10.1016/b978-0-08-097086-8.71046-4 OECD. (2002). Foreign Direct Investment for Development. Retrieved 25 April 2021

Prof. Dr. Amarendra Bhushan Dhiraj is CEOWORLD magazine's Chief Executive and Editorial Director. Under Dr. Amarendra's leadership, CEOWORLD magazine has become the world's most iconic news organization, whose rigorous reporting and unsurpassed storytelling connect with millions of business leaders every day. CEOWORLD magazine is known internationally for its editorial excellence, independent, quality research, in-depth analysis, and collaborations with people and partners from around the globe. He currently sits on the company’s board of directors and global management committee. Dr. Amarendra holds a Ph.D. in Finance and Banking from the European Global School in France; a Doctoral Degree in Chartered Accountancy from the European International University Paris; and a Doctorate in Business Administration from Kyiv National University of Technologies and Design (KNUTD), Ukraine. He earned his Master of Business Administration degree in Finance and his Master's Degree In Chartered Accountancy (CA) from European Global School Paris. Dr. Amarendra also holds a Master of Business Administration degree in International Relations and Affairs from the American University of Athens, Alabama, United States. He is committed to lifelong learning. Dr. Amarendra is a Visiting Professor at Kyiv National University of Technologies and Design (KNUTD), Ukraine.

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Economy

Summit of Business within Portuguese-Speaking Countries

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President of Equatorial Guinea, Teodoro Obiang.

Long before the Portuguese-speaking countries wrapped up their first business summit in Simpopo, Equatorial Guinea that gathered approximately 250 government officials and corporate business leaders from Guinea Bissau, Cabo Verde and Sao Tome and Principe, Portugal, Brazil and Mozambique, it was described as a step directed at bringing sustained business development.

Some argued that the gathering historically provided the chance for immense business networking opportunities and building strategies. It additionally offers an important impetus for strengthening future corporate business collaboration among the countries.

According to the organisers, the primary goal was to explore ways to attract investments to the countries in bloc, as well as strengthening economic ties between member states and improving the business environment.

Opening the two-day summit, promoted by the Confederation of Businesspeople of the Community of Portuguese-language Countries (CPLP), President of Equatorial Guinea Teodoro Obiang, said frequent militant attacks in Cabo Delgado, in northern Mozambique, should be of concern to the Community of Portuguese Speaking Countries (CPLP).

“The Republic of Mozambique is the scene of aggressions perpetrated, planned and financed from outside its borders, claiming human lives, displacing populations, destroying personal and public property, and sowing terror in the north of the country,” he said.

Obiang believes that the CPLP “should not remain oblivious to this tragedy, which goes beyond the dimensions of a simple internal conflict. It is an aggression”.

He characterised it as an opportunity to identify the challenges the bloc faces and seek ways to facilitate trade between CPLP countries as well as attracting more investment. “Our wish is that the business community takes this opportunity to form a common front when it comes to facing the challenges that affect its activity. It should also make the most of its respective advantages to participate actively in promoting economic cooperation among the CPLP countries, always having as priority the member countries of our community,” the Equatorial Guinea president said.

President of Cape Verde, Jorge Carlos Fonseca, who participated in the summit virtually, advocated for the creation of customs facilities for CPLP countries within the bloc. “There is an urgent need to create joint solutions for the reciprocal protection of investments, reducing, or even eliminating, where possible, double taxation, and facilitating the circulation of public documents within our community without excessive authentication and notarisation burdens,” he urged.

President of Sao Tome and Principe, Evaristo Carvalho, spoke of the need for investments in the CPLP countries to be sustainable, especially in Equatorial Guinea, which was experiencing a boom in mineral resources. “Our appeal is to look at the country with confidence, stripped of a culture of short-termism. With thought for the country’s development, let’s seek sustainable solutions and invest in the medium and long term, he advised.

While various issues were discussed during the two days, there was particular interest in mineral exploitation, oil and gas development within the bloc. The panel session spent time analyzing widely the various dimensions and aspects of the sector.

Equatorial Guinea’s Minister of Mines and Hydrocarbons has called for a common project of the Portuguese-language countries for gas exploration, stressing the need for a longer energy transition in some African countries. “Hydrocarbon producing countries such as Equatorial Guinea, Angola, Mozambique or Brazil and Portugal, as a major consumer, it is very important that we can work on a coordinated project at the CPLP level to be able to exploit the gas for use in our economies,” Gabriel Obiang Lima said.

“It will be increasingly difficult to get funding to develop our [oil] products because worldwide there is a great motivation to carry out the energy transition from hydrocarbons to renewable energy,” he noted.

Despite this, he said, in countries such as Equatorial Guinea and others in Africa, this transition will have to take at least another 20 years. “Only then will we be at the level of developed countries,” he said.

The Equatorial Guinean Minister was speaking at a panel with government officials from Guinea Bissau, Cabo Verde and Sao Tome and Principe, as well as representatives from Portugal, Brazil and Mozambique on the role of governments in attracting foreign investment.

Speaking at the panel session, Luís Moreira Testa from the Portugal’s Socialist Party in Parliament, explained that in the new advent of renewable energy, Portugal has the potential to move from energy consumer to producer. “Hydrocarbons will serve in the coming decades as transition fuels. Portugal is a major consumer of natural gas, mainly from Algeria, and the new generation of natural gas consumption in Europe foresees the mandatory inclusion of green hydrogen,” he said.

According Luis Testa, the pipelines that bring gas from Algeria may soon take the gas produced in Equatorial Guinea or Mozambique cut with green hydrogen produced in Portugal. “This could be a great opportunity for energy communion in the CPLP,” he said.

Cabo Verde’s Minister of Trade, Industry and Energy, Alexandre Dias Monteiro, considered mobility within the Portuguese-speaking community as a critical factor for creating a favourable framework for business and foreign investment. “Mobility is a critical factor for contacts and exchanges between companies and businesspeople,” he said, stressing the progress made in this area in recent years, which should make it possible to sign a mobility agreement at the next summit of heads of state and government, in July in Luanda.

Guinea-Bissau’s Economy Minister, Victor Mandinga, advocated the creation of an investment promotion agency at the community level to link up with agencies in each of the countries. “This mechanism is essential to make legislation on investment more homogenous and the distribution of investment opportunities between countries more harmonised,” he said, adding that businesspeople lacked transversal information about the CPLP as a whole.

Sao Tome’s Foreign Minister, Edite Ten Jua, noted the importance of creating a climate of trust for attracting investment, particularly in terms of legal protection and tax justice, as well as simplifying administrative procedures, along with the existence of infrastructure and means of transport and communications.

President of the Community of Portuguese Speaking Countries Business Confederation Salimo Abdula, speaking during the opening, urged the governments of member countries to speed up the process of creating the CPLP Community Development Bank to facilitate financing for bloc projects.

“The bank will be a tool which will support projects of small, medium or large size, thus overcoming the difficulty of access to financing, which often has a high cost in CPLP countries, making projects unfeasible,” Abdula argued.

Abdula further proposed the creation of a CPLP arbitration court, because, despite being united by the same language and economic interests, conflicts between stakeholders from different member states could arise.

“This court would make it easier to settle disputes between businesspeople in the community. At this moment, this project (the CPLP Arbitration Court) is at a very advanced stage. A team was formed that is working hard on the subject and has already produced several document proposals and prepared a questionnaire aimed at defining an ideal model for the construction of such an arbitration court,” Abdula told the gathering.

The opening of the summit coincided with World Portuguese Language Day. According to Rádio Moçambique, there is an estimated 300 million speakers spread across four continents. The first CPLP Business Confederation business summit held under the motto, “Together We Are Stronger and Move the World Forward” in Simpopo, Equatorial Guinea.

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Economy

Can Sukuk Match the Growth Trajectory of Green Bonds?

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As the socially responsible investing movement in fixed income began to take off a decade ago, a great deal of ink was spilled on the similarity of green bonds and Sukuk. Both products are explicitly ethical and appeal to investors’ social consciences over and above their desire for financial returns. The thesis at the time was that an ever-increasing number of investors would seek out these types of ethical investments, leading to a steep upward trajectory in demand for both green bonds and Sukuk. MICHAEL BENNETT writes.

***

To a certain extent, that thesis has played out. Between 2010 and 2020, the annual issuance of green bonds increased from less than US$5 billion to more than US$270 billion. They have successfully transitioned from being a highly niche product to one that has a role in the portfolios of major institutional investors across the globe. Green bonds became the product that mainstreamed socially responsible investing on the fixed income side of the capital markets.

Sukuk have also increased during that time-period, going from US$53 billion of annual issuance in 2010 to US$140 billion in 2020. While a 164% increase in annual issuance volume is impressive, it clearly lags the 5,300% growth for green bonds. This divergence in the growth trajectory of the two products can also be observed in Chart 1 that looks at annual issuance volumes between 2014 and 2020:

In absolute terms, it should come as no surprise that Sukuk volumes now trail green bonds, as there is a much larger market globally for conventional instruments than for Shariah compliant ones.

Even the most passionate supporters of Islamic finance accept that the potential market for Islamic products is only a fraction of that of their conventional comparators. However, that does not explain why, in percentage growth terms, Sukuk have fallen so far behind green bonds. Why has one product exploded while the other has made only a steady climb?

Many explanations have been offered for why Sukuk have not grown at a faster pace in recent years. These usually focus on global economic hurdles that have impacted the market (eg oil price declines, COVID-19-related slowdowns).

However, many of these same issues have impacted, to one degree or another, the conventional markets as well. In addition, some economic hurdles could reasonably be expected to increase issuance volumes (eg a decrease in oil prices could cause an oil-exporting sovereign to have greater need to tap the capital markets).

Therefore, these explanations seem insufficient to fully explain how green bonds have grown at such a faster clip than Sukuk.

I believe the reason for the difference may stem in part from the fact that the Sukuk market has simply not responded sufficiently to the socially responsible investing movement. As the remarkable growth of the green bond market proves, predictions a decade ago that socially responsible, fixed income investing was about to take off were correct.

In other words, the socially responsible investing wave did indeed come. The problem for Sukuk is the product has not found the best way to ride that wave.

Sukuk are ethical instruments. They cannot be used to finance impermissible activities like gambling, tobacco and weapons manufacturing. Also, they are structured to avoid high degrees of leverage and speculation, and therefore promote a sounder financial system.

Many investors who are motivated by ethics and feelings of social responsibility should be quite happy to add Sukuk to their portfolios, regardless of whether they are adherents of Islam.

A conventional bond has none of these built-in restrictions. Therefore, to make a conventional bond an ‘ethical investment’, additional steps must be taken, for example adding covenants to limit the potential uses of the financing. This building-in of these additional prohibitions is the genesis of green bonds and other labeled sustainable development bonds. In essence, these bonds adopt the types of restrictions on the use of proceeds that already to a certain degree exist for Sukuk.

However, the Sukuk market has not sold the standard Sukuk product as ethical. Rather, it has treated Sukuk as equivalent to a conventional bond (no better or worse from an ethical perspective), and therefore sought to develop green and socially responsible labels for certain types of Sukuk that mimic the labeling that is required to make a conventional bond ethical.

I believe such labeling of certain Sukuk can have the unfortunate impact of obscuring the ethical nature of the basic Sukuk product and, at the extreme, possibly throwing the social responsibility of most Sukuk into doubt.

In other words, if certain Sukuk are labeled ‘socially responsible Sukuk’, what does that imply about all the Sukuk that do not carry that label?

While I certainly would not advocate against green and other types of labeled Sukuk, I think the Sukuk market needs to spend more time and effort to be clear that such labeled Sukuk are simply a special use of proceeds instruments within a broader universe (ie all Sukuk) that is already ethical in nature.

Such an approach would mirror the one the World Bank takes in the conventional market. The World Bank issues green and other labeled bonds from time to time, but the priority always is to stress the ethical nature of all the issuances.

By focusing on the ethical quality of the Sukuk product itself, I believe Sukuk can best benefit from the ethical investing movement, and take its place, aside green bonds, as an ethical investing success story.

World Bank

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Economy

US Sanctions Against Russian Sovereign Debt: Possible Alternatives

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The US and the EU have imposed new sanctions against Russia because of the so-called “Navalny case”. The European Union has activated the human rights sanctions mechanism approved by the EU Council in December 2020. On March 2, the EU added four Russian security officials to its sanctions list. The sanctions include a ban on entry to the EU, an assets freeze in the EU and a ban on economic transactions with persons involved in the lists. However, such officials are unlikely to have assets in the EU. Even if they exist, such assets are not significant for the Russian economy. The sanctions were introduced as a reaction to the arrest and then imprisonment of Alexei Navalny, while restrictions on the topic of the alleged poisoning were introduced back in October 2020. At the time, six high-ranking Russian officials and the Research Institute of Organic Chemistry and Technologies were subject to the restrictions. Such sanctions have zero impact on the Russian economy.

Unlike the EU, the US has refrained from imposing sanctions following the alleged poisoning of the politician last year. However, on March 2, they were introduced, both in connection with the poisoning and in connection with his subsequent arrest. That is, the topics of the use of weapons of mass destruction and human rights violations were combined. The blocking sanctions targeted seven Russian officials who were already affected by EU sanctions, as well as three research institutes. Trade sanctions were imposed against 14 companies. US government agencies have been prohibited from lending to Russia and a ban was introduced on the supply of weapons and on the provision of US financial assistance. These measures have no impact on the economy. These companies are not the backbone of the economy, Russia does not need US help, it does not buy weapons from the United States, and it does not take loans from US government agencies.

However, the new US sanctions are still fraught with uncertainty. The key question is whether the United States is imposing restrictions on Russian sovereign debt obligations. Such a measure could cause more serious damage and have an impact on the world markets.

The prospect of sanctions against Russian government bonds is related to the specifics of the Chemical and Biological Weapons Control and Warfare Elimination Act of 1991. Properly it is used as a legal basis for the imposition of sanctions in the event that a country uses chemical weapons (in the US and the EU, it is assumed that Navalny was poisoned with a substance from the Novichok group). The CBW Law envisages the imposition of sanctions in two stages. On March 2, 2021, the first stage was implemented (a ban on aid, military supplies and loans from government agencies). If, within three months after the first stage, the President does not provide Congress with evidence that the target country has not abandoned the use of CBW and has not given reliable guarantees of their non-use in the future, then the second stage of sanctions will be introduced. It is important to note here that guarantees of non-use should be determined by UN inspections or those provided by another international organisation. Obviously, Russia will not give such guarantees and will not allow any inspections. Moreover, according to the statements of the Russian authorities, Russian chemical weapons were destroyed long ago. In other words, the second round of sanctions is inevitable. The CBW Law obliges the US President to impose at least three of the six types of sanctions. The most unpleasant of these is the ban on American banks from lending to the Russian government.

There has already been a precedent for using CBW against Russia. The sanctions were imposed in connection with the Skripals case. In 2018, the first stage was carried out, and in 2019 — the second. It was secured by Donald Trump’s executive order No. 13883. The decree reflected two types of sanctions — a ban on lending to the Russian government and blocking aid through the IMF. Then trade restrictions were added. If the last two measures were symbolic, then the ban on lending potentially had more serious consequences. However, this measure was applied in an extremely limited manner. The ban applied only to Russian government bonds denominated in foreign currencies, while most of them are denominated in rubles. The sanctions also did not affect the debt of Russian state-owned companies.

In general, the issue of sanctions against Russia’s sovereign debt has been raised many times on other occasions. In 2017, within the framework of Art. 242 of PL 115-44 CAATSA, Congress ordered the US Treasury to give an opinion on the appropriateness of such sanctions. Officials noted in their report that such sanctions would hurt Russia, but were also fraught with market fluctuations and costs for American investors. Such sanctions have repeatedly been proposed in sanction bills, including the most famous ones — DASKA and DETER. However, they have never been passed into law. In 2019, the State Department criticised DASKA.

The forthcoming second round of sanctions over the Navalny case will again raise the issue of restrictions on Russian sovereign debt. Two alternatives are possible. The first is the preservation of the existing restrictions already adopted by Trump in 2019, or their cosmetic expansion. The second is a more radical tightening, including bonds denominated in rubles. The second alternative cannot be ruled out, especially if there is another escalation in the Navalny case. If the status quo is maintained, the first option is most likely.

From our partner RIAC

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