A country’s investment flows (both inflows and outflows) are influenced by a host of complex economic variables, including:

(a) size of its economy,

(b) state of economic development,

(c) pattern of savings and investments in the domestic market,

(d) position of external accounts,

(e) institutional structures,

As a result, US capital flows most easily to Canada and Latin American countries. These are geographically proximate regions with existing trade and financial linkages.

Similarly, Japanese banks lend heavily to Asian entities. The European Union (EU) banking community has traditionally enjoyed stronger linkages with Russia and Central European emerging market economies.

Overseas residents have also often proved to be significant sources of external capital. The NRIs contributed significantly to the success of the Indian Resurgent India Bond issue even in extremely poor market conditions. Overseas Chinese have traditionally invested heavily in mainland China. Turkey and Lebanon are able to raise international capital from their nationals residing abroad, despite poor country ratings.

The global investment pie is huge. The world saves and invests US $ 7 trillion annually. A substantial part of these funds flow into international investments. The G-7 countries alone invest in excess of US $ 1.7 trillion every year outside their own geographical boundaries by way of direct investments, portfolio investments, lending, trade, deposits and currency flows. (Annex. 3.1)

The EU and Japan are both large net savers. They have very large current account surpluses of about US $ 100 billion each. This makes them significant contributors to global capital flows.

3.4 PROSPECTS FOR SOURCES OF FUNDS

One way to gauge the ability of countries to provide capital to other countries is to look at their current account surpluses – which is the amount of excess foreign exchange earnings theoretically available for net global investing.

Again, the EU and Japan are likely to have the largest surpluses on the current account, of the order of around US $ 100 billion, each. USA is projected to have the largest current account deficit in the world of about US $ 200 billion. USA thus requires to attract capital on a net basis to raise resources for funding this deficit. Nevertheless, it will continue to be a significant global investor, as well as a large receiver of global capital.

Current account surplus is not necessarily the only criterion to gauge the ability of countries to provide capital flows to other countries. To appreciate this, it is useful to run through the pattern of investment outflows and inflows for USA. In 1997, USA invested US $ 122 billion in direct investments internationally and

received US $ 93 billion of direct investments. USA invested US $ 88 billion in international portfolio investment assets, which were dwarfed by a much larger international portfolio investment inflow of US $ 384 billion. Other investment outflows (including loans, trade credits, and transactions in currency and deposits) of US $ 268 billion were roughly matched by other investment inflows of US $ 256 billion. Thus, on the whole, the US generated a huge surplus of US $ 255 billion on its financial accounts.

Japan’s external accounts follow a relatively straightforward pattern. It generated a current account surplus of US $ 94 billion in 1997. This was utilised to fund a net deficit of US $ 118 billion on its financial accounts. Its international direct investments totaled US $ 26 billion, with portfolio investment outflows of US $ 71 billion, and other investment outflows of US $ 192 billion (including those of banks at US $ 140 billion). Clearly, Japan is a major global investor and lender. Japan will continue to remain so, given the projections of a further increase in its current account surplus.

Emerging markets as a group attract only US $ 200 – 300 billion in annual global capital flows. Net private capital flows to emerging markets are projected to fall a little below US $ 160 billion in 1998 from US $ 240 billion in 1997 and a peak of over US $ 300 billion in 1996. This fall reflects the direct impact of the financial crises in Russia and Asia and consequential effects transmitted through financial markets. (Annex. 3.2)

Lending by private creditors, including bank lenders and bond investors, is projected to fall to US $ 42 billion in 1998 from US $ 97 billion in 1997 and US $ 180 billion in 1996. Secondary market spreads on emerging market bonds have widened very substantially after the Russian devaluation and unilateral moratorium in mid-August, although there has been significant moderation very recently. New issuances have virtually come to a halt.

Assuming spreads narrow and access to international capital markets is gradually restored for creditworthy borrowers, net flows from private creditors are projected to again reach about US $ 40 billion in 1999.

Direct equity investment has been relatively less affected by recent financial crises and, at US $ 106 billion, is projected to account for over two-thirds of private capital flows this year. About US $ 46 billion of these direct flows are accounted for by Latin America and around US $ 35 billion to be accounted for by China.

In Asia, direct investment activity seems to be picking up only in Thailand, where non-residents are making investments in the banking system. They are buying up the distressed assets of the closed finance companies.

Recent events have given rise to a general reassessment by investors of their willingness to bear risk and of the level of risk that is generally associated with investing in emerging markets. Such a reassessment has affected emerging markets across the board to some degree.

Emerging markets need to adjust to these shrinking flows by moving from current account deficits to surpluses. Asian economies affected the most by the crisis are quickly turning from current account deficits to large surpluses, as a result of sharp contraction in import demand, owing to demand compression in the domestic markets.

The current account surplus of the five Asian economies most affected by the crisis, namely South Korea, Indonesia, Malaysia, Thailand, and Philippines, is projected to reach US $ 60 billion. For China, the current account surplus is expected to narrow to US $ 18 billion this year, compared with a surplus of US $ 30 billion in 1997, and to continue to shrink in 1999.

3.7 PERSPECTIVES FOR INDIA

India has received foreign capital inflows of US $ 5 to 6 billion annually, over the last 3 years under direct and portfolio investments. This is miniscule by global standards. They represent less than 2% of the total inflows received by the emerging markets and less than 0.3% of the international investments of the major industrial nations.

India lags other countries in the emerging markets universe. Latin America and China both consistently attract Foreign Direct Investments (FDI) flows that are 20 times as big as the flows to India. It is noteworthy that Latin America continues to attract annual direct investment flows of exceeding US $ 40 - 45 billion, despite the frequent economic shocks destabilising its major economies. On the contrary, India has been lagging far behind despite its larger and more stable economy.

India, with its status as one of the ten largest economies in the world in purchasing power parity (PPP) terms and home to one sixth of humanity, can easily tap five to ten times the current level of inflows just by implementing the right policies and creating the right environment. This target has to be viewed not against the context of current level of international flows to India, but against what India can achieve, if it manages to exploit even a small part of its immense economic potential.

India can also build on its significant non-resident Indian base to attract international capital. This opportunity can be specifically exploited by floating several dual-resident schemes that unshackle NRI investments into India with relatively relaxed repatriation benefits.

FDI flows continue to be the most desired form of external inflows – they are long term and less volatile. The only class of external flows to the emerging markets that have not reversed and are sustained even today are FDI flows. FDI flows also bring several benefits to the destination country, in terms of:

1. capital at globally competitive costs,
2. technological know-how,
3. global standards for quality,
4. innovation, design, production, marketing, and management techniques,
5. higher standards of labour and total factor productivity, and
6. increased competition that prompts the local firms to move towards global levels of efficiency

The largest FDI investors into India are Mauritius (for tax reasons), the US, South Korea, Japan, Netherlands, Germany, UK, Hong Kong, and Italy. These are the linkages that India needs to specifically strengthen and target for increasing inflows of foreign capital.

However, FDI inflows into India in relation to GDP are poor and much lower than those for other Asian countries. China, Malaysia and Singapore emerge as the most favoured destinations for FDI and have attracted FDI to the extent of 4 to 5 % of their GDP in 1997. In contrast, India compares poorly at only 0.7% of GDP (Annex. 3.3)

Simple policies, transparent procedures and effective communication can lead to increased FDI flows. India has to urgently take well-thought out and decisive measures to effectively compete for global capital flows and to correct a situation in which economies of much lower consequence and potential are racing far ahead of India.

The attractiveness of India as a destination for FDI, can be enhanced by streamlining procedures, removing bureaucratic hurdles and by taking other steps that will improve returns on direct investments in India. The perceived hurdles in India often relate to:

1. poorly defined policies,
2. multi-layered bureaucratic structures,
3. perceptions of corruption,
4. delays inherent in the Indian judicial and administrative systems,
5. difficulties relating to the restructuring of businesses,
6. lack of flexibility in restructuring manpower, and
7. lack of a pragmatic exit policy for companies.

India can no longer afford to live in an island with respect to issues that concern the business and investment community. The competition for global investment capital is intense. India must act decisively to correct this anomaly in which economies of much lower consequence and significance in terms of economic, market, and business potential are able to attract much larger flows.

3.8 SUMMARY

including loans, trade credits, and transactions in currency and deposits