Foreign direct investment (FDI) is a phrase that is a reflection of the objective of acquiring a lasting interest by a resident party of a particular economy (direct investor) in an entity that is the occupant of another economy (the direct investment entity). Essentially, the “lasting interest” denotes the prevalence of a long-term connection between the direct investor and the direct investment entity and a considerable extent of influence on the management or running of the latter. FDI entails both the original transaction that establishes the affiliation between the investor and the entity as well as all ensuing capital dealings between them and among associated entities, both incorporated and unincorporated. Governments have a key role to perform in determining the success of their nation’s FDI policies.
FDI inflows in Latin America and the Caribbean have been deteriorating since their highest in 2011 and this trend has sustained in 2017. Nevertheless, it is important to note that most of this deterioration is focused in the primary sector, in which investors have been discouraged due to lower commodity prices. FDI directed into the primary sector deteriorated by approximately 53% between the years 2011-2012, at the height of the boom in commodities, and 2015-2016 (the most recent years with comprehensive availability of data), but deteriorated by only 5% in the services sector and appreciated by 3% within the manufacturing. This decline can be attributed to various factors including government policies and it is important for the relevant parties to take measures that will mitigate this trend.
Part 1: Limits to Latin America’s FDI policies
According to the most recent data, inflows of FDI to Latin Americas have sustained their decline for a period of four years. Owing to the fact that there is no established consensus concerning the effectiveness of the existing policies and approaches applied toward FDI, the general region has seen considerable institutional variations. With the most recent deterioration in 2016, Latin America recorded the most diminished performance of any region in the world. The decline in FDI inflows into Latin America has been diversified across regions and nations. For example, in Mexico and the Caribbean Basin, the number of inflows has diminished to a lower degree, while South America has experience greater effects. Within the South American region, inflows maintained relative stability but declined more strongly in nations such as Brazil. In addition to this, investment in particular sectors have experienced the most decline due to recent events. Particularly, FDI in the banking sector and utilities have experienced the greatest effect by higher sensitivities to regulatory risks coupled with lower than projected profits and growth projections.
In spite of the appreciation in the value of currencies, healthy stock markets, and declining national risk premiums, various nations across Latin America have lesser ability presently to implement the required reforms and the economic policies which are necessary to uphold long-term growth and, in comparison to the standing several years back. In addition to this, initial reforms spawned lofty expectation that in many nations are yet to be match by a rise in public services, employment levels and real wages. Various reforms have, in actual sense, made a direct contribution to the insecurity that is manifest in particular populaces. Trade liberalization has also make various firms more susceptible to intense competition and hence to place pressure for efficiencies in costs. More significantly, the largest proportion of individuals in the Latin American region are skeptical about present market reforms owing to their incapability to secure basic social amenities. Subsequently, the populations disgruntlement with unrelenting inequality in spite of years of reform, in combination with the recessions that affect various nations, have undermined political consensus concerning market centered policies.
Some of the Caribbean nations have endeavored to enforce more severe restrictions with Mexico being the most restricted economy. Specifically, while none of the other nations forbid foreign ownership in its entirety, Mexico places sanctions on foreign ownership in eight key sectors, comprising electric power transmission and distribution, oil and gas, television broadcasting, and generation of electricity. Another sector that is strongly restricted is transportation. Particularly, internal waterways freight transportation and global passenger air transport are to a certain extent limited in two of the focus nations. The internal waterways freight transportation is restricted to 49% in Mexico and Chile and global passenger air transport is restricted to 20% in Brazil and 49% – with a probability of appreciating to 70%- in Peru. Remarkably, Mexico allows for full foreign ownership with relation to the international passenger air transport sector. In spite of the nations’ relatively open economy in comparison to other nations, several key sectors in Mexico continue to be branded by a high extent of market concentration. For instance, a small number of public private corporations control the telecommunications, oil, and electricity sectors of the economy.
Part 2: Future Prospects for Foreign policy
While expansion for the year 2019 is anticipated to be in general stable or flat, the overall outlook for the Latin American region remain moderately optimistic for the short term and largely optimistic in the long term. Over the course of the past 10 years, regional expansion had been driven by three key impetuses. To begin with, the boom in commodities, which yielded an excess cash flow that emerged from exports and permitted the governments in Latin America as well as the private sector to boost investment and consumption. Second, the increase in the statistics of the middle class in various nation and a sprouting young population. Finally, and most importantly, a trend is emerging centered on structural reform in various Latin American nations, coupled with key infrastructure investments.
This expansion trend has garnered the interest of foreign investors, specifically venture capital and private equity investors, which have permeated the region with considerable capital amounts. Despite the fact that the prices of commodities are not as elevated as they were over the past 10 years, the second and third factors indicated will continue being influential, contingent on historic volatility in the region. A deterioration in the demand of certain commodities – for instance, oil and substitutes- is having a considerable impact in the production of oil as well as mining an annual basis. Looking forward, economist anticipate that general growth is seemingly stable in most regions of Latin America with some slump in Argentina and Brazil. This projection continues to appeal to investors.
Most the striking development in the region entail tax reform and an increased recognition that legal reforms are centered in safeguarding foreign investors. Specifically, Brazil has in history been a leader in the development of a tax regime that is focused in attracting FDI, permitting for dividends on invested capital to be remitted in the absence of tax implications, complemented by an intricate legal system of investments made via tax-incentivized financial pools, typically referred to as FIPs. In the capital markets, some of the countries in the region have made it more seamless for investors to register requisite accounts to make investment in shares of companies that are traded locally on the BOVESPA. Some other jurisdictions are offering ‘stability agreement’ to willing investors to ensure that the government is abiding by a given set of legal requirements – for instance, stable tax regimes and non-discrimination with regard to local investors – in a fixed time frame. Other jurisdictions provide tax holidays as well as tax credits for incoming investors on the basis of the magnitude of the investment. In line with this, nations such as Brazil have continued offering tax incentives with the aim of stimulating foreign direct investment, including a decrease of State ICMS tax. This however, is threatened by the fact that some of the courts are seeking to outlaw some of the state tax incentives due to their unconstitutional nature.
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