FACTORS OF ATTRACTION AND IMPEDIMENT FOR FOREIGN INVESTMENTS IN COUNTRIES OF COMMONWWEALTH OF INDEPENDENT STATES

FACTORS OF ATTRACTION AND IMPEDIMENT FOR FOREIGN INVESTMENTS IN COUNTRIES OF COMMONWWEALTH OF INDEPENDENT STATES

Dina Malgazhdarova

PhD student, Hungarian University of Agriculture and Life Sciences (MATE), Kaposvar campus,

 Hungary, Kaposvar

Imre Nagy

Dr. Sci, Profesor, University of Novi Sad,

 Serbiya, Novy Sad

ABSTRACT

Foreign investments attraction policy, investment climate in country together play an important role in the economic development of countries – members of CIS. This article examines the factors of foreign investments attraction and impediment. The study is based on analysis of the economic performance of CIS members, as well as analysis of experience of some foreign investors. The share of FDI in the CIS countries by sector fully coincides with their orientation and corresponds with the global practice. Major factors impeding FDI flows to CIS include low efficiency of legislation, high level of bureaucracy - a large number of procedures for registering a business, unfavorable conditions for doing business, insufficient participation of banking systems in the process. While among the positive factors for investment attraction are the cost and quality of factors of production, infrastructure development, geographical features, tax policy and legislation, the level of institutional development, political stability and openness.

АННОТАЦИЯ

Политика привлечения иностранных инвестиций, инвестиционный климат в стране в совокупности играют важную роль в экономическом развитии стран-участниц СНГ. В данной статье рассматриваются факторы привлечения и препятствия для иностранных инвестиций. Исследование основано на анализе экономических показателей стран СНГ, а также на анализе опыта некоторых иностранных инвесторов. Доля ПИИ в странах СНГ по секторам полностью совпадает с их направленностью и соответствует мировой практике. Основными факторами, препятствующими притоку ПИИ в СНГ, являются низкая эффективность законодательства, высокий уровень бюрократии - большое количество процедур регистрации бизнеса, невыгодные условия ведения бизнеса, недостаточное участие банковских систем в этом процессе. При этом к числу положительных факторов для привлечения инвестиций относятся стоимость и качество факторов производства, развитость инфраструктуры, географические особенности, налоговая политика и законодательство, уровень институционального развития, политическая стабильность и открытость.

Keywords: investment climate, CIS, foreign direct investments, FDI.

Ключевые слова: инвестиционный климат, СНГ, прямые иностранные инвестиции, ПИИ.

Introduction

The link between the investment environment, policy and foreign direct investment (FDI) around the world has been studied for many years. FDI is one of the important areas for economic development of states at the present stage and is named the most favorable form of international investment exchange and one of the features of globalization e.g. [7], [46] including its role in economic growth and development e.g. [2], [38]. At the same time, the theoretical problems of investment policy and attracting investment in recent years have received   fairly   wide   coverage   in   the   scientific   and   analytical   literature e.g. [9], [4], [28].

The relevance of the current study is due to the high importance of foreign direct investment flows  in the world and for member countries of Commonwealth of Independent States (CIS). According to World Bank FDI world net inward flows grew from 239,41 bln USD in 1990 to 1622 bln USD  in 2019, while in the economies of the CIS countries grew from 1,51 bln in 1992 to 47,76 bln USD  in 2019, improving bilateral communication between the Governments of the countries and investors. At the same time, the CIS countries assume that a necessary condition for development is high investment activity and attractiveness. In this regard, there was an aggravation of the competition for attracting FDI, after all, countries with economies in transition considered FDI as  a way out of a difficult economic situation and further development e.g. [8], [28]. This, in particular, was especially important in the period after the collapse of the Soviet Union. Meanwhile, the formation of a favorable investment climate is not possible without the involvement of investment attraction factor
e.g. [34], [50].

Based on their own understanding, the countries in question use a certain range of existing tools to attract  investors, which include establishing a dialogue between foreign investors and the state, concluding investment agreements, and in general reforming economic policies.

In addition, the analysis carried out by analysts of international organizations, including the OECD, the World Bank, UNCTAD, highlighted a number of strengths and weaknesses of the CIS   countries in attracting foreign investment. Researchers identify several key factors that influence and determine the volume of FDI: trade openness, wages, market size, infrastructural development, tax policy, and in recent years, the state of the institutional environment in the host country has become particularly important. An enabling institutional environment is one of the most important  conditions for FDI attraction e.g. [10], [21], [22], [52]. Meanwhile, the choice of investment direction in the CIS countries is primarily due to the presence or absence of such an advantage as fossil fuels e.g. [33], [37], [42], [47].

The purpose of this article is to identify economic and non-economic factors affecting the inflow of FDI into the economies of their host CIS member states, to assess the impact of these factors on the inflow of FDI to countries of CIS active participants in the international market and investment exchange.

Some analysis of CIS economic data

Global experience shows that countries actively participating in the international movement of capital have higher rates of economic growth and labor productivity. In this regard, in the global aspect of the investment process, it is the movement of direct investments that is of a greatest interest. Thus, attracting FDI is one of the important areas of activity for countries in transition. FDI is seen as an instrument that has a positive impact on growth and serves as a source of capital gains. For a long time, FDI has been viewed as an important factor in maintaining sustainable economic growth in all CIS countries e.g. [26], [40] - [43].

Creating an attractive investment climate is a crucial step for attracting FDI. According to Hong (1998) while natural resource abundance both advantage and impediment for both investors and hosting economies.

The main factors in the formation of the investment climate are country macroeconomic indicators, so significant improvement of the macroeconomic situation in CIS in 2000s is registered. The progress and systemic transformation of the economies and policies of the CIS member countries followed large flows of foreign capital. According to average indicators for CIS - Russia,   Kazakhstan, Uzbekistan and Azerbaijan were the main recipients of FDI. Net FDI inflows performance, the ranking of the CIS countries (see Chart 2) show that Russia is the largest recipient           of FDI in the region, while the lowest net FDI inflow is recorded in Tajikistan. The interest of investors in the CIS countries grew from year to year, however, there is a decrease in 2019, which is believed to be the result of the intensification of intra-regional competition for FDI; country policies, which affected intra-regional FDI; falling commodity prices which caused a decrease in foreign investment; the COVID pandemic which severely impacted the global economy; technological structural transformation caused by the fourth industrial revolution and the repatriation of tax profits in the United States are also named among others [17]. According to the FDI performance, CIS member countries in the early 90s of the last century and in the early 2000s was significantly lower than in the second decade of 2000s. In addition, high

FDI performance of Russia, Kazakhstan, Uzbekistan and Azerbaijan these countries in leading position in the European and Central Asian part of the CIS
(see Chart 1).

The level of political stability and the state of relations with neighboring countries as well as with the main economic partners can to one degree or another influence the behavior of investors. While, the sharp change in the political stability in country or region can lead to the expropriation of capital, an increase in taxes or tariffs, the inconvertibility of the national currency, and other consequences e.g. [3], [11].

In countries with economies in transition, including the CIS, the geopolitical situation and the associated decrease in confidence in market participants in 2018 led to a drop of inward FDI by 30% to 34.5 billion USD, while in the CIS there was a 40% drop to $ 23.8 billion. In Russia and Kazakhstan, the largest exporters of natural resources, falling commodity prices have led to a decrease of foreign investment in this industry.

Chart 1. Net inward FDI performance leaders among CIS member countries, bln. USD

Data taken from World Bank database (accessed on 20/01/2021)

An analysis of the indicators shows that in 2019, FDI inflows to the CIS countries amounted to 44.5 bln. USD, and in total in countries with economies in transition amounted to 54.9 bln. USD.

As world practice shows, the achievement of macroeconomic and financial stability is a prerequisite for the development of the national economy and cooperation. Meanwhile, the most important indicator for assessing the well-being of the CIS countries is the calculation of the dynamics of the GDP per capita. According to the World Bank data, performances of CIS member countries improved significantly between 2000 and 2019  (see Table 1).

Table 1.

CIS economic performance indicators for 2000 and 2019

Source: Statistical agencies of countries-member of CIS

For instance, in Moldova this indicator improved more than 10 times, in Kazakhstan almost 8 times, in Azerbaijan, Kazakhstan, Armenia, Russia, Tajikistan more than 6 times, in Ukraine and Belarus more than 5 times, in Kyrgyzstan more than 4 times and in Uzbekistan this indicator increased by 3 times. The indicator of Russia is especially impressive, where GDP per capita in 2019 amounted to USD 11,585, which is slightly more than the world indicator - USD 11441,8, at the same time, it is much less than indicators of the OECD countries - USD 39485,9 and EU countries – 34918,5. Such indicator as unemployment rate shows the positive tendency towards the reduction of unemployed population, while the population rate indicator show the negative trend in non-Asian part of the CIS: Armenia, Belarus, Moldova, Russia. In addition to this Armenia, together with Azerbaijan has also experienced the fastening of inflation rates.                   According to many studies e.g. [32], [6],  [37] the overall investment rank of the CIS countries is positively influenced by such economic and political determinants as: the size of the market, the cost of labor, access to raw materials, the level of infrastructure development, tax holidays, the level of institutional development, political stability and economic policy in the country, regulatory risks in the planning and implementation of investment proposals, the region's openness to foreign economic relations, geographical features.

The analysis of the data on oil rent by country based on the information provided by the World bank allows to outline three countries out of nine reviewed (see Chart 2).

Chart 3. Oil rent (as % of GDP) in countries-members of CIS, for 1990-2018

The Ukraine was added due to period considered, before leaving the CIS. Azerbaijan and Kazakhstan represent regional countries - leaders where oil rents exceed or very close to the 15% share of GDP with the average values for the 29 years period are 21,5% and 13% accordingly, while in case of Russia it is equal to 8,3%.

The minimum value for these three countries was achieved in 1998 – 3,6% for Azerbaijan, 1,7% for Kazakhstan and 1,6 for Russia. The maximum value of the index in case of Azerbaijan was achieved in 2006 which made around 39,6 % of GDP, while Kazakhstan and Russia experienced the rise of oil rent in 2005, i.e. one year earlier 23,7% and 13,14% after which it kept falling down till 2015 with the sharp drop in the year 2015, which is related to the drop of oil prices from mid- 2014 driven by booming oil production, geopolitical concerns and OPEC policies.

Despite the oil  price plunge and a slowdown in 2015 the oil rent was back on sharp rise until the year 2018 for Azerbaijan and Kazakhstan 25,3% and 15,6% accordingly, while in case of Russia it reached 10% value share of GDP.

It shall be added here, that according to the World Bank researchers, there is a correlation between overall ease of doing business in country and FDI flows. Thus, the “Doing Business” project is one of many tools, the complex one that actually can show the perspectives for investors. Even though it is focused on small to medium-size domestic firms and might not be always relevant for foreign owned firms, it is still considered by countries of CIS as the important tool by policy makers. Covering subindexes “Doing Business” tool shows the overall assessment of such aspects of business, as: the time and procedures needed to start a new business, investors protection, dealing with construction permits, taxes which includes among others the number of tax payments, getting electricity and etc., thus being very handy for investors. Majority of CIS countries have improved their positions in the Doing Business ranking over the past decade.

Among the studied group of countries, Kazakhstan, Russia and Azerbaijan significantly improved their positions in the ranking, and have risen from 58, 124 and 69 respectively in 2010 to 25, 28 and 34, respectively in 2019, showing the greatest ease of doing business among the CIS countries.    CIS countries - in terms of attracting FDI - differ among themselves. In particular, they differ significantly by their absolute indicators of population and market capacity, degree of openness of the economy, territory and population, availability of fossil fuels, geographic location. Moreover, the degrees of political and economic stability differ. This raises three major questions for: 1) what factors generally influence or hinder the attraction of FDI to countries with economies in transition, members of CIS; 2) Which factors are the most significant?

Comparison of the factors of FDI attraction and impediment

Based on analysis of macroeconomic data, SWOT analysis of FDI flows in the CIS countries was compiled. It was revealed that countries considered have a number of advantages and general disadvantages that deter investors and slow down the development of their economies. It shall be noted that, despite the differences in the scale and levels of economic development, the CIS countries have however common problems.

Table 2.

SWOT analysis of FDI use as source for economy development in CIS

Source: build with a use of information from surveys held by Investors’ organizations acting in CIS countries (AMCHAM, EUROBAK)

According to the global practice and judging from the Doing Business report assessment as well as information provided by investor’s associations functioning in CIS, the major issues appearing in CIS include low efficiency of legislation, high level of bureaucracy - a large number of procedures for registering a business, unfavorable conditions for doing business, insufficient participation of banking systems in the process. While grouping all factors, helping to attract of FDI flows to countries – members of CIS made possible singling out ones that have a greater influence than others, on foreign investors making investing decisions, which are: presence or absence of natural resources (fossil fuels); the cost and quality of factors of production, infrastructure development; geographical features; tax policy and legislation; the level of institutional development; political stability and openness.

Conclusion

Analysis of the experience of developing and transition economies implemented by many studies has allowed to identify a range of variables that explain the dynamics of FDI inflows into the economies of recipient countries and apply this classification in case of CIS. It can be pointed out that if one group of variables is based on formal hypotheses or theories about FDI, then the other is included already intuitively.

Firstly, investors to CIS pay attention to the presence, cost and quality of resources and factors of production. Natural resource endowment is among other factors attracting FDI, the investors are attracted by fossil fuels and other mineral resources available in hosting countries. However, the effect of natural resources on economic growth is contradictory in this regard, attracting greater number and amount of FDI being related with phenomenon which is referred as “resource curse”. This question shall be elaborated in further study to come.

Second factor is the infrastructure development. The level of infrastructure development in a country indicates how difficult and costly it is to find suppliers and distribute products between different markets. Well-developed transport network facilitates the process of delivering the necessary resources and contributes to a faster distribution of the manufactured products among consumers.

Third, tax policy. Investors usually look for markets with lower tax rates compared to their home countries. According to the Doing Business ranking countries of the CIS are rising gradually in their positions while implementing more efficient reforms with the regards to their tax policies. Host governments are striving to find a balance between tax incentive rates and the need to collect the desired amount of income available from an investor's point of view to ensure a competitive  environment.

Fourth, the level of institutional development of the region. The state of institutions is an important factor influencing, along with others, the decisions of potential investors. For instance, a region with developed institutions, characterized by decision-making based on clear rules and regulations, good tax collection, high level of public participation in the performance of civic obligations signals on favorable economic environment in it. The rise of FDI to CIS during the recent years shows the rising interest of investors in this region, that is where the next factor comes.

Fifth, political stability and economic policy. Foreign investors invest their capital only when they know that the country has a stable political environment and safe capital movement. Countries with political instability tend to demonstrate high rates of expropriation, which makes these countries less attractive for investment. Therefore, in order to attract FDI to a country, regulatory and government policies must be open and flexible but reliable, so it is important to achieve a balance in it.

Six, openness of the region to foreign economic relations. The degree of the region's openness is primarily associated with foreign trade, either the indicator of net exports or the indicator of the significance of trade flows in CIS economy can be taken to illustrate this factor.

Seventh, geographic features of the region. Different geographic characteristics, climate, access to the sea are also not of a small importance, as associate transactions with transaction costs, costs of negotiations, preparation of the necessary documentation, approval and coordination, etc.

In addition, most investors face regulatory risks when planning and implementing investment proposals. The rules and administrative procedures affecting FDI can be broken down into a number of elements: rules applicable to inward FDI, foreign ownership laws, protection of foreign investors and their investments, legislation governing the protection of intellectual property. The notification procedure attracts FDI more than the approval procedure, increasing the protection of foreign investors and their rights stimulates the movement of FDI. Once again, Doing Business ranking correlating with investment climate signals about more efficient reforms implemented in CIS. Relaxation of restrictions on foreign ownership have a positive effect on attracting FDI to CIS. Meanwhile, strengthening the intellectual property rights system would increase countries’ abilities to attract FDI more. This is also a question of the research to come.

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