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Due to economic slowdown, highunemployment, and sovereigndebt risks in developed economiesafter the nancial crisis, investment isgradually owing to rapidly growingemerging and developing economies.South Asia has drawn the attentionof investors as a result of impressivegrowth rates, investment reforms,expanding domestic markets andgood macroeconomic conditions.However, despite the increasing levelof investment, several investmentclimate constraints, which are notentirely common to all countries, are

Pakistan. FDI as a share of GDP ishighest in the Maldives (8.58 percent),followed by India, Pakistan, Sri Lanka,Bangladesh, Bhutan, Afghanistan andNepal (Figure 1).

The amount of FDI inows toSouth Asia was increasing rapidlyuntil 2008, reaching US$50.28 billionfrom US$575 million in 1990.1 In 2010,it dropped to US$28.34 billion, whichrepresented 2.28 percent of total worldFDI inows. The average annualFDI inows during 19902000 wereUS$2.56 billion, which increased toUS$21.5 billion during 20012010. TheFDI inows are not distributed evenlyin South Asia. Indias share of totalFDI inows to South Asia was 41.18percent in 1990, which reached 86.95percent in 2010 amounting to US$24.64billion. It reects investors condence

in the Indian economy, its reform pro-cess and the rapidly growing domesticmarket.

Obstacles to investmentCompared to the global investmentlevel, the relatively low shares of FDIand GFCF in GDP indicate a range ofobstacles faced by investors, discour-aging them from scaling up invest-ments in the region. Overall, the majorconstraints to investment, as perceived

by rms in South Asia, are lack of ad-equate supply of electricity, access to

still restraining potential investment.While acknowledging that sound mac-roeconomic conditions are crucial forincreasing investment, this article willfocus on country-specic rm-levelchallenges to investment.

Investment in South AsiaIn South Asia, latest available datashow that Bhutan has the highestgross xed capital formation (GFCF)as a share of gross domestic product(GDP) (41.33 percent). It is followed

by the Maldives, India, Sri Lanka,Bangladesh, Nepal, Afghanistan and

Figure 1

GFCF and FDI (share of GDP), 2010

Note: GFCF for Bhutan and the Maldives refer to 2009 and 2005 respectively; FDI for Nepal refers to 2009.

Source: World Bank, World Development Indicators.

45 10

n GFCF n FDI9

8

7

6

5

4

3

2

1

0

40

35

30

25

20

15

10

5

0

GFCF(%ofGDP)

FDI(%ofGDP)

Maldiv

esInd

ia

Pakist

an

SriLan

ka

Banglad

eshBh

utan

Afgha

nistan

Nepa

l

investment climate

Challenges to investment in

South Asiachndn Sko

Despite the increasing level of investment, several investment climate constraints,

which are not entirely common to all countries, are still restraining potential investment.

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31Trade Insight Vo. 8, No.1, 2012

nance, political instability, tax rates,corruption, access to land, security, in-formality, tax administration hassles,lack of human capital, rigid labourregulations and transportation, amongothers (Figure 2).2

Country-specifc constraintsThe South Asian average of perceptionof challenges to investment climatemasks country-specic obstacles toinvestment. Hence, a closer look atcountry-specic challenges to invest-ment is warranted.

AfghanistanAround 20 percent of rms in Afghan-

istan perceived that crime, theft anddisorder were the biggest obstacles toinvestment. Other main obstacles werelack of adequate electricity supply(17.9 percent), access to nance (16.8percent), political instability (16.4 per-cent), access to land (12.2 percent) andcorruption (8.4 percent). Constraintssuch as tax rates, courts system, hu-man capital and labour regulationswere considered less worrisome thanthe ones mentioned earlier. Speci-

cally, about 45 percent of rms paidextra for private security, whichincreased cost by 2.8 percent of annualsales. The number of electrical outagesin a typical month averaged 20 and itlasted for 11.5 hours, inicting lossesof about 6.5 percent of annual sales.Consequently, 71.1 percent of rmsowned or shared a generator, whichwas used to supply about 74.9 percentof power demand by rms. It takes 46days to get electrical connection uponsubmitting an application. Regardingaccess to nance, only 3.4 percent ofrms had a bank loan and 1.4 percentof them were using banks to nanceinvestments. Furthermore, 79 percentof loans required collateral and itsvalue amounted to almost 254 percentof the loan amount.

BangladeshAround 43 percent of rms in Bangla-desh perceived lack of adequate sup-ply of electricity as the main obstacle

to investment. Other top constraintswere access to nance (34.9 percent),

political instability (11.4 percent),corruption (4.3 percent) and accessto land (4.1 percent). Specically, thenumber of power outages in a typicalmonth averaged 101, which lastedfor 1.1 hours and increased cost by10.6 percent of annual sales. About 52percent of rms owned or shared agenerator, which supplied 23.6 percentof total electricity demand by rms. Ittakes approximately 50 days to obtainan electrical connection upon submit-ting an application. Approximately24.7 percent of rms used banks tonance investments and only 17.1 per-cent of total investment was nanced

by banks. Regarding corruption, 85

percent of rms reported that theyexpected to give gifts to public ofcialsto get things done, especially to getan operating licence, import licence,construction permit, electrical connec-tion and water connection. Mean-while, 54.4 percent of rms expectedto give gifts during meetings withtax ofcials and 18.4 percent of rmsidentied courts system as a challengeto better investment climate.

BhutanAround 22 percent of rms in Bhutanperceived access to nance as the mainobstacle to better investment climate.The other major constraints were taxrates (12.6 percent), inadequatelyeducated workforce (10.5 percent),

labour regulations (9.7 percent) andtransportation (9.1 percent). Access toland, courts system, electricity supplyand political instability were perceivedto be less problematic for investors.Approximately 64 percent of rmsused banks to nance investments andalmost all rms needed loans. Fur-thermore, 97 percent of loans requiredcollateral, whose value was about 283percent of loan. Investors felt that taxadministration hassles and high taxrates (40.8 percent of prot3 ) were alsodiscouraging investors. Regardinghuman capital, there were virtually nopermanent skilled full-time workersin the manufacturing sector and only

23.3 percent of rms were offeringformal training. Cumbersome labourregulations and inadequately edu-cated workforce were also problem-atic for investors. While real annualsales growth and annual employmentgrowth were 17.9 percent and 13.1percent respectively, annual labourproductivity growth was just 5.7percent.

India

Approximately 35 percent of rmsidentied electricity as the mainobstacle to investment. The other mainchallenges were tax rates (16.8 per-cent), corruption (10.7 percent), tax ad-ministration hassles (8.5 percent), andaccess to nance (4.5 percent). Political

Figure 2

Percepon of obstacles to beer investment climate in South Asia

Source: International Finance Corporation, Enterprise Surveys.

Electricity

Access to financePolitical instability

Tax rates

Corruption

Access to land

Crime, theft and disorder

Practices of the informal sector

Tax administration

Inadequately educated workforce

Labour regulations

Transportation

Business licensing and permits

Customs and trade regulations

Courts

28.7

14.313.4

6.5

5.8

5.2

4.6

4.1

3.6

3.5

2.6

2.2

1.6

0.5

0 5 10 15

Percent of firms

20 25 30

3.3

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32 Trade Insight Vo. 8, No.1, 2012

investment climate

instability, business licensing andpermits, crime and theft, and courtssystem were not considered majorchallenges to investors in India. Theaverage duration of a typical electricaloutage was 3.6 hours and the averageloss was 6.6 percent of annual sales.Almost 41.4 percent of rms ownedor shared a generator, which supplied9.8 percent of demand for electricityby rms. It takes 30 days to obtain anelectrical connection upon submittingan application.

Regarding tax administration, 6.7percent of senior managements timewas spent in dealing with the require-ments of government regulation. The

total tax rate is equal to 61.8 percent ofprot.4 Additionally, only 46.6 percentof rms were using banks to nanceinvestments and the proportion of in-vestments nanced by banks was just27.9 percent. Around 74.3 percent ofloans required collateral and the valueof collateral needed was 126 percent ofloan amount.

NepalAround 62 percent of rms identi-

ed political instability as the mainchallenge to investment. The othermain obstacles as perceived by rmswere electricity supply (26.5 percent),labour regulations (2.6 percent), accessto nance (2.5 percent) and transpor-tation (2.4 percent).The number ofelectrical outages in a typical monthaveraged 52 and the average durationwas 6.5 hours, inicting loss of about27 percent of annual sales. Some 15.7percent of rms owned or shared agenerator, which satised 24.6 percentof electricity demand by rms. It takes9 days to get an electrical connectionupon submitting an application. Inves-tor condence is low due to lossesarising from civil unrest (44 days ayear on average) and power outages.

The rigid labour regulation and theexcessive unionism in the industrialsector have led to closure of domesticas well as multinational companies.5Furthermore, only 17.5 percent ofrms used banks to nance invest-

ments and the proportion of invest-ments nanced by banks was 12.4

percent. The proportion of loans thatrequired collateral was 81 percent andthe value of collateral needed was260 percent of total loan amount. Thelack of adequate infrastructure (roadconnectivity and electricity) is identi-ed as the most binding constraint toeconomic activities in Nepal.

PakistanAround 67 percent of rms perceivedelectricity supply as the biggest obsta-cle to investment. The other main chal-lenges were corruption (11.7 percent),crime, theft and disorder (5.5 percent),access to nance (3.9 percent), andtax rates (3.7 percent).The number of

electrical outages in a typical monthaveraged 40 and the average durationwas of 2.3 hours. The loss due to elec-trical outages amounted to 9.2 percentof annual sales. Almost 26.3 percentof rms owned or shared a generator,which satised 29.3 percent of demandfor electricity by rms. It takes 106days to obtain an electrical connectionupon submitting an application.

Regarding corruption, 48 percentof rms expected to give gifts to public

ofcials to get things done. Addi-tionally, 49 percent of rms paid forprivate security, inicting extra costof around 2.3 percent of annual sales.While almost all rms needed loans,only 9.7 percent of them used banks tonance investments and the banks -nanced just 8.4 percent of investments.The proportion of loans requiring col-lateral was 76 percent and the value ofcollateral needed was 68 percent of theloan amount. Total tax rate is equal to35.3 percent of prot.6

Sri LankaAround 16 percent of rms perceivedthat a large informal sector was the

biggest obstacle to investment. Othermain challenges were access to nance(14.1 percent), tax rates (11.9 percent),electricity (11.4 percent) and access toland (9.8 percent). When comparedto these constraints, rms were least

bothered by security of investment,corruption, political instability and

courts system. Approximately 47.4percent of rms competed against

unregistered or informal rms, lead-ing to loss of markets and prots dueto unfair competition. Regardingaccess to nance, 43.6 percent of rmsused banks to nance investmentsand banks nanced 35.4 percent ofinvestments. The proportion of loansrequiring collateral was 79.2 percentand the value of collateral needed was194 percent of total loan amount. Totaltax rate is equal to 105.2 percent ofprot.7

ConclusionOverall, the challenges to investmentin South Asia are country-specic.While investors in countries like

Bhutan with adequate electricity sup-ply do not think power outages as achallenge to investment, investors inother countries perceive it as a strongconstraint. Similarly, while compet-ing unfairly with the informal sectoris the main headache for rms in SriLanka, investment in other countriesis crippled by insecurity, inadequateaccess to nance and poor infrastruc-ture. Tackling them by introducingnew reforms, earnestly implementing

the already enacted ones, promotingand protecting investments while atthe same time maintaining good mac-roeconomic conditions might boostinvestment.n

Notes

1 uNctaD, World Investment Report 2011.2 Soh asn rgon vrg of nd-

ors s omd y kng smvrg of onry-v on sms.Unless otherwise noted, the fgures

nd oss o nvsmn m rsord from enrrs Srvys.

th srvy yr for afghnsn s 2008,bngdsh 2007, bhn 2009, ind2006, Sr lnk 2011, N 2009 ndpksn 2007.

3 Word bnk, Doing Business 2012.4 ibid.

th o x s h sm of h dffrnxs nd onrons y fronng for ow ddons ndxmons.

5 S Sko, chndn. 2011. imrdnnons & wk ndsrs. Republica, 27

ags, 6.6 No 3.7 No 3.