Wednesday, June 12, 2024

Adopt right policies to maximize gains from different FDI types  

The 2017/18 Global Competitiveness Report acknowledges that developing countries compete to attract foreign direct investment (FDI) because of its potential benefits for the local economy, which include technology transfer, stronger managerial and organizational skills, increased access to foreign markets, and export diversification.

FDI can enhance productivity, increase investment in research and development, and create better-paying and more stable jobs in host countries. But these benefits are not guaranteed, nor do all types of FDI have the same potential impact. Thus, host governments must adopt right policies to maximize their gains from different types of FDI.

It is in this spirit that Botswana has since the late 1990s made concerted efforts to attract FDI into export-oriented manufacturing and services, so as to reduce reliance on diamond exports and to diversify is supply-side capacities.

The reform efforts of the authorities were consolidated under the Economic Diversification Drive (EDD), which emphasizes the critical role to be played by the private sector in stimulating balanced and sustainable growth.

The EDD strategy is largely focused on public interest objectives such as job-creation and citizen empowerment, while private sector priorities like export promotion and investment attraction take more of a back-seat, quite a downside approach.

According to the Overseas Economic Cooperation Development (OECD) Botswana Investment Policy Review of 2013, while Botswana has sound laws providing for adequate investor protection, the laws are not referred to in a single document and many investors are “insufficiently aware of their rights”.

Likewise, remaining restrictions on foreign investment, including preferences for citizen-owned companies, remain dispersed across different policies and regulations. “This lack of clarity, which may underlie some of the recent declines in business climate rankings, should be comprehensively addressed”, advises the policy review document.

According to the policy review document, several markets remain heavily dominated by the public sector – particularly infrastructure sub-sectors where the playing field for private operators vis – à – vis public enterprises is often uneven. Moreover, price rigidities complicate cost recovery for public utility providers, which are growing dependent on costly government subsidies as a result.

“Yet, Botswana’s infrastructure financing gap cannot be met through the public purse alone – especially in the energy sector, where private participation, together with regional cooperation on cross-border power projects, will be necessary in order to tackle the energy generation challenge”, states the review document adding that “attracting and structuring private participation in infrastructure will also require more independent regulation of infrastructure markets, and a strengthened legal and institutional framework for public procurement and PPPs (public-private partnerships).

The paper further observes that by developing good enabling infrastructure, the government aims to transform the country into a regional hub for FDI seeking to tap into neighbouring markets; this would also facilitate the consolidation of export niches in financial services and business process outsourcing. Infrastructure quality is significantly above average for the region, attracting considerable government attention.

“Despite the strong priority placed on infrastructure development, however, private participation in most infrastructure sub-sectors remains low and private operators often face an uneven playing field relative to public enterprises. Following a period of initial openness to foreign investment since 1966, for close to a decade Botswana indeed embarked on a trend of nationalization, creating parastatals which were intended to complement FDI and to build industrial capabilities which could later expand into manufacturing and services”, states the policy document that laments that most services (electricity, water and sanitation, airline and road) still remain state-owned and “closed to private investors”.

The policy document also acknowledged the growing recognition that a substantial change is necessary if further private sector involvement and economic diversification are to be achieved.

The policy review paper states that the ratio of gross fixed capital formation (GfCF) to gross domestic product (GDP) can provide an indication to the extent to which these GDP figures are sustainable and provide a strong basis for future growth. This ratio signals how much value-added in total domestic production has been invested rather than consumed (notably in the form of land improvements, machinery and equipment purchases, and physical infrastructure).

According to the paper, following wide variations in the 1980s, Botswana’s GfCF/GDP ratio has ranged between 22 and 26 percent for most of the past two decades, rising closer to 30 percent in the past two years. This is slightly above the standard for African countries (about 21 – 22 percent) and follows the average for industrialized countries (about 23 – 25 percent).

However, as marginal returns to additional capital are in any case low in more industrialized economies (which already have large volumes of pre-existing capital stock), Botswana could potentially do better in terms of channeling production revenues into long term investments. Indeed the GfCF/GDP ratio still falls short both of many emerging economies (for example in East Asia, where rates reach 35 – 40 percent), and of the ratio initially envisaged by the country.

According to the review policy document, net FDI inflows to Botswana ranged between US$20 million and $100 million over most of the 1980s and 1990s, before undergoing considerable expansion in the new millennium (reaching a peak of $968 million in 2009, following which the financial crisis cut the trend short). Botswana’s FDI performs holds up quite well to the SADC average. Out of non-oil producing countries, Botswana has been Africa’s sixth most attractive target of FDI between 2003 and 2011 (after Kenya, Uganda, Tanzania, Zambia and Mozambique). Investment has moreover begun recovering since the crisis, and over 2011-12 Botswana received additional investment inflows of a record P1.4 billion ($176 million), with 1 583 jobs created from these new investments.

However, these FDI volumes remain rather small in absolute terms, and have only amounted to 2 – 4 percent of GDP for most of the past two decades (with exception of a high of 8.4 percent in 2009). This far below international standards. Simultaneously, the ratio of FDI inflows to GfCF has been extremely variable, ranging from above 25 percent to under five percent over the same period.

While for larger and wealthier countries FDI does not closely influence total gross capital formation (as capital can be generated through other, domestic sources of investment), small export-dependent countries such as Botswana should exploit the potential of FDI as a major source of capital investment.

Therefore alongside efforts geared at attracting more FDI, Botswana may benefit from directing a larger share of these flows towards sectors of greater value-addition and capital creation (such as infrastructure, which has relied mostly on public sector financing so far).

According to the policy review paper, given the narrowness of Botswana’s domestic market ( a small and sparse population of a little over two million), most of FDI in the country has been export-oriented rather than domestic market seeking. Most of this FDI has traditionally been from Europe (especially Luxembourg, where the De Beers diamond company is headquartered) and from South Africa.

Over 2003 – 2011 the bulk of FDI (38 percent) has gone into diamond mining, followed by metal ores, financial services, communications, real estate and hotel and tourism.

The review paper also observes that Botswana’s economy is undergoing progressive structural change, which is increasingly visible in terms of the contributions of different economic sectors to: GDP; total value-addition; and employment. This is also reflected by an encouraging drop in Botswana’s Herfindahl-Hirschmann index over time; this indicator of economic diversification, which trends towards zero as diversification increases in the economy, had dropped by 0.24 in 2007 to 0.195 by end 2011.

It is further acknowledged that capital spending focusing on priority projects to promote economic diversification accounts for some 30 percent of the total government budget. Key structural bottlenecks (including insufficiently enabling infrastructure, and poorly tailored skills in the national labour force) may in particular be preventing Botswana from fully exploiting its potential in the financial services business process sectors.

It is reckoned that Botswana’s attractiveness as an investment destination depends on the strength and clarity regulatory and legal framework for investment. Botswana has a sound series of laws related to the investment environment, which provide for adequate investor protection in line with most international standards (including safeguards for property rights and expropriation). Nonetheless restrictions on foreign investment and ownership, including preferences for domestic investors, remain dispersed over several different strategic documents and regulations.

This hampers awareness of available investment opportunities, particularly for foreign investors. It also hinders government efforts to accurately and regularly evaluate the desirability of these restrictions and incentives on investment flows, including assessing whether the objectives of such measures might not be better attained through alternative (less discriminatory of fiscally costly) means.

The regulations governing access to land also remain excessively cumbersome for investors. This is one of the key bottlenecks that the inflexible approach to land use hampers entrepreneurial activities by restricting the availability of land for business, making it difficult for land to be re-allocated to more productive economic uses, and imposing restrictions on ownership and transfer of land. The need to relax and simplify procedures for access to land, and especially for change of land use for business purposes, is urgently highlighted by the private sector.

A related challenge is that the laws governing investor protection have so far not been grouped within a common document, and as a result investors are insufficiently aware of the availability of Botswana’s investment regime. This lack of clarity, rather than the quality of the investment regime itself, may be responsible for some of the decline in business climate rankings.

Grouping all these laws (for example in a legal text such as Investment Code, or simply within a regularly updated Investor’s Guide) would make them more easily accessible and would provide investors with greater assurance in terms of openness, transparency and predictability.


Read this week's paper