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Enhancing intraregional investment in South Asia

Aayush Poudel

Intraregional investment plays a significant role in boosting regional exports, productivity, and resilience of economies. Regional economic integration through trade and investment expands the market and trade opportunities for domestic firms in smaller countries, ultimately leading to the creation of decent jobs and expansion of output. Although South Asia is recognized as among the fastest-growing regions in the world and in spite of the efforts to achieve deeper regional economic integration—through free trade agreements—South Asian regional integration both in terms of trade and investment is low and well below potential levels.

South Asia has relatively low global foreign direct investment (FDI) flows when compared to other low- and middle-income economies. The region is home to only 1.3 percent of the global stock of inward FDI (IFDI) of US$39.5 trillion as of 2017 despite producing more than 4 percent of the global gross domestic product (GDP), according to a recent report by the World Bank. Also, in the region itself, as of 2018, IFDI stocks (US$524 billion) and outward FDI (OFDI) stocks (US$82 billion) are relatively low compared with those of other developing regions. Intraregional investment of US$3 billion (as of 2017) accounts for only 0.6 percent of IFDI from the world and 2.7 percent of OFDI to the world. Almost 75 percent of intraregional investment funds flow from India, but this amount accounts for only 2 percent of India’s total outward investment.

South Asian economies are known to be protective by limiting sectors where inward FDI is allowed. While Pakistan, India and Sri Lanka allow outward FDI, Nepal and Bhutan do not allow such investments at all. Although most IFDI policy arrangements have been progressively liberalized with reduced regulatory compliances, the lack of global standards with regard to dispute resolution mechanisms remains a major issue.

The outward investment regimes in most of the countries in the region are largely restrictive, discretionary, and nontransparent where approval from the government and central banks is required. There are region-specific policies in both inward and outward investment regimes and also significant variation across countries in the implementation of FDI arrangements. To give an example, India’s IFDI arrangements gradually liberalized its region-specific policies to allow Sri Lanka, Bangladesh, and Pakistan to invest in India in 2004, 2007 and 2012, respectively. However, all investments from and to Bangladesh are required to go through the approval route as India extended the approval route requirement for all neighbouring countries with a common land border in April 2020.

Despite shared cultural and historical roots, a lack of bilateral knowledge, connectivity, and trust in South Asia has emerged as one of the significant impediments, depressing bilateral economic engagements. Trust plays a vital role in maintaining a good diplomatic relationship between countries which in turn results in better investment prospects among them. The complicated relationship between the two largest countries in South Asia—India and Pakistan—has not only adversely affected India–Pakistan bilateral trade but overall trade and investment within the region. In South Asia, mutual trust is also affected by the differences and asymmetries in the size of their population and economy.

In addition, having knowledge about potential markets is key to making investment-related decision making. In the case of South Asia, low and polarized knowledge and information connectivity among entrepreneurs about opportunities in other countries also hinder investment decisions. The World Bank report cites Nepali entrepreneurs’ and investors’ lack of awareness about the economy and market opportunities in Sri Lanka, Pakistan, and even the Maldives. And this is applicable to the people and investors of other countries as well.

Not only intraregional investment, but intraregional trade is also low in the South Asian region which accounts for a little more than 5 percent of the region’s total trade. The region suffers from high tariffs as well as para-tariff barriers with poor transportation and logistics infrastructure and inefficient trade facilitation. Many South Asian nations trade on better terms with distant economies than with their neighbours.

South Asian economies have not been able to take advantage of the benefits of geographical and cultural proximity and this has affected the welfare of consumers, workers, firms as well as investors. Intraregional investment is crucial for deepening economic ties, and unlocking trade potential. To increase investment flows, countries need to improve knowledge connectivity and enhance cooperation through better bilateral and multilateral trade and investment agreements. Initiatives to support knowledge connectivity through various ways like network development and proper information dissemination with the respective stakeholders in different countries need to be launched. The countries in the region must implement smart IFDI promotion strategies like focusing on reducing entry costs and attracting foreign investors already in the region and investment facilitation measures. Small economies like Nepal, Bhutan, and the Maldives can target affiliates of global firms in regional hubs that have already incurred high entry costs to invest in the region.

Besides keeping the investment regulatory channels to a minimum level, a standard dispute resolution mechanism concerning investment should be in place. Since outward FDI is a bit contentious topic with many economies wary of capital flight, an experimental approach could be adopted, whereby small amounts can go through automatic routes and larger amounts can go through approval regimes. In addition, smaller nations should initially focus on investing in smaller amounts and then gradually increase their investments by learning from their experiences as exporters and engaging in less expensive forms of investment.

Mr Poudel is Programme Associate at SAWTEE. This article is based on the presentation of Dr. Sanjay Kathuria, Senior Visiting Fellow, Centre for Policy Research, India; Global Fellow, Wilson Center, made at a webinar titled ‘Regional Investment: Barriers, Opportunities and Facilitation’ organized by SAWTEE, in collaboration with The Asia Foundation (TAF) on 1 December 2022. This article was published in Trade, Climate Change and Development Monitor, Volume 19, Issue 11, November 2022.