COMPARATIVE ANALYSIS OF FOREIGN PORTFOLIO INVESTMENT POLICIES IN GREECE, HUNGARY, ICELAND, ITALY AND LATVIA: AN ASSESSMENT OF WHICH OF THE ABOVE

COUNTRIES IS AN IDEAL DESTINATION FOR FPI FROM A FINANCIAL RISK POINT OF VIEW

(Projec towards partial fulfilment of assessment in the subject of Financial Markets and regulatory Systems)

Submitted to:

Dr. Rituparna Das

Faculty of Management

Submitted by:

Gauri Devpura

Praneetha Vasan (930)

Prashant Singh (931)

Prithvij Beniwal (932)

Ritu Doodi (936)

VIII Semester, Business Law Honours.

National Law University, Jodhpur

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CONTENTS

Introduction: What Is Foreign Portfolio Investment.......................................................................2

Foreign Portfolio Investment In Greece..........................................................................................3

Foreign Portfolio Investment In Hungary........................................................................................9

Foreign Portfolio Investment In Iceland........................................................................................19

Foreign Portfolio Investment In Latvia.........................................................................................29

Foreign Portfolio Investment In Italy............................................................................................38

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ACKNOWLEDGMENTS

Apart from the efforts put in by us, the success of any project depends largely on the

encouragement and guidelines of many others. We take this opportunity to express our gratitude

to the people who have been instrumental in the successful completion of this project. We would

like to show our deepest gratitude to Dr. Rituparna Das, Faculty of Law for giving us an

opportunity to work on this project. Without her encouragement and guidance this project would

not have materialized.

We would also like to thank the library staff of NLU Jodhpur for providing us with all the

essential research material which we required during the course of our project. This

acknowledgement will be incomplete without thanking our parents and friends who always held

our back, their encouragement has been instrumental in motivating us and making this project a

success

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INTRODUCTION: WHAT IS FOREIGN PORTFOLIO INVESTMENT

Foreign Portfolio Investment is defined as Securities and other financial assets passively held by

foreign investors. Foreign portfolio investment (FPI) does not provide the investor with direct

ownership of financial assets, and thus no direct management of a company. This type of

investment is relatively liquid, depending on the volatility of the market invested in. It is most

commonly used by investors who do not want to manage a firm abroad.1

Portfolio Investment records financial flows related to transactions between residents and non-

residents that affect their assets and liabilities vis-à-vis each other related to securities and

derivatives. Securities are distinguished between equities and debt securities (bonds and money

market instruments). Residents’ net investment in securities issued by non-residents are recorded

under ‘Assets’ (where a positive sign indicates an increase and a negative one a decrease),

whereas non-residents’ net investment in securities issued by residents are recorded under

‘Liabilities’ (where a positive sign indicates an increase and a negative one a decrease). The

balance of Portfolio Investment is the difference between assets and liabilities.2

Portfolio investment companies Portfolio Investment companies are established under Law

3371/2005 and are exempt from all tax, stamp duties and contributions to the state or any other

third party, with the exception of capital concentration tax and VAT. Portfolio Investment

companies are taxed at a rate equal to 10% of the intervention interest rate (Euribor rate) set by

the European Central Bank increased by one (1) point. In the event the intervention rate changes,

the new tax base applies from the first day of the month following the month in which the change

was effected. The tax is calculated on the fund’s average semi-annual investments (including

available funds at current values), and is payable in the first 15 days of July and January. This tax

is final for both the fund and the investors. Withholding tax on interest no longer applies with the

exception of interest on bonds if the bonds are acquired up to 29 days prior to the day which is

set for interest payment.3

1 http://www.investopedia.com/terms/f/foreign-portfolio-investment-fpi.asp#ixzz3Xd8Dzdr72 http://www.bankofgreece.gr/Pages/en/Statistics/externalsector/balance/transactions.aspx3 http://www.investingreece.gov.gr/files/publications/DoingBusinessInGreece_230709.pdf

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FOREIGN PORTFOLIO INVESTMENT IN GREECE

ECONOMIC CONDITION IN GREECE

Greece continues to present a challenging climate for investment, both foreign and domestic. The

government has made progress in carrying out widespread economic reforms. Many of these

reforms aim to simplify the investment framework, and the government is aggressively seeking

to attract foreign investment to drive the country’s long-term economic recovery.

Greece’s rapid fiscal consolidation, improved labor cost competitiveness, and continued

membership in the Euro area have contributed to an improvement in investor sentiment in 2013-

2014. Hedge funds, followed by traditional investors, began to return to Greece in 2013 to

participate in ongoing privatization actions of state assets and to invest in the principal banks. In

April 2014, the Greek government issued its first sovereign bond since Greece lost traditional

bond market access in 2010. The auction of the five-year €3 billion bond was seven times

oversubscribed, 90% of which derived from foreign investors.

At the end of 2013, the public debt reached a high 175.7% of GDP, but it is forecast to stabilize

in 2014 and begin to decline as a % of GDP thereafter. In 2014, the economy is forecast to post

its first, modest, positive growth rate since 2008. Since 2008, Greece’s GDP has shrunk by 25%,

and depressed demand, wage and pension cuts, and high unemployment have led to a

considerable rise in banks’ holdings of non-performing loans. Following recapitalization

programs and broad finance sector consolidation in 2012 and 2013, the banking sector’s outlook

has stabilized; however, the protracted economic crisis led to a sharp contraction in bank lending

and investment.

Since July 2012, the country’s coalition government has made rapid progress in reducing

enormous national fiscal imbalances. At the end of 2013, the general government deficit was

2.1% of GDP. When the cost of debt servicing is excluded from this figure, Greece generated a

primary budget surplus of €1.5 billion ($2 billion), approximately 0.8% of GDP. Consistent with

the requirements of the EU/IMF bailout program, in force since March 2010, the government has

sought to liberalize the labor market, open closed product markets, sell state-owned assets and

enterprises to generate revenue and enhance competitiveness, cut public payrolls, reform the tax

code, strengthen tax enforcement, and streamline investment procedures. The government

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established a one-stop-shop investment promotion agency to assist interested foreign investors,

recently renamed Enterprise Greece. The government agreed with the EU/IMF to adopt and

implement most of the 329 recommendations made by the OECD in November 2013 on

improving economic competitiveness.

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GREECE BOP FOR PORTFOLIO INVESTMENT4:

4 http://knoema.com/atlas/Greece/topics/Economy/Balance-of-Payments-Capital-and-financial-account/Portfolio-investment-net-BoP-current-USdollar

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GREECE’S SOURCES OF PORTFOLIO INVESTMENT5

Portfolio Investment Assets

Top Five Partners (Millions, US Dollars)

Total Total Equity Securities Total Debt Securities

All

Countries

148,008 100% All

Countries

7498 100% All

Countries

140,510 100%

Luxembour

g

74,949 51% Luxembourg 4073 54% Luxembour

g

70,876 50%

United

Kingdom

32,936 22% Ireland 698 9% United

Kingdom

32,858 23%

Germany 2,215 1% United

States

427 6% Germany 2,106 1%

France 2,087 1% Serbia,

Republic of

241 3% France 1,946 1%

Netherlands 1,950 1% Turkey 148 2% Netherlands 1,929 1%

ATTITUDE TOWARD FOREIGN INVESTMENT

Greece continues to present a challenging climate for investment, both foreign and domestic.

However, numerous reforms, undertaken as part of the country’s international bailout program,

aim to welcome and facilitate foreign investment. The country has also undergone a rapid fiscal

consolidation, with broad and deep cuts to public expenditures and significant increases in tax

rates and enforcement. In 2013, excluding debt service payments, the government budget

generated a surplus of 0.8% of GDP. Including debt payments, the government continues to run a

deficit but, as a percentage of GDP, the deficit has rapidly declined from -9.6 % in 2011 to -

5 IMF website http://cpis.imf.org

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2.1% in 2013 (Eurostat, 4/23/2014). The public debt as a percentage of GDP increased to

175.1% in 2013, largely the result of the addition to the debt of Greece’s bailout loans and the

country’s sharply contracted GDP.

Recent Events Affecting the Investment Climate in Greece: Major bouts of political violence

have sprung up around Greece in conjunction with the recent recession, including specific

instances in which bystanders were injured, and occasionally threatening investments. Public

Order Minister Nikos Dendias has urged investors not to cancel plans, as further unemployment

could weaken the already fragile economic and political situation.

Financial Bailout: After an initial €110 billion (c. USD 147 B) bailout in May of 2010 by the

European Commission (EC), the International Monetary Fund (IMF), and the European Central

Bank (ECB) – the so-called “troika” – proved insufficient, a second €130 billion (c. USD 174 B)

multiannual financing package was approved in March 2012, payable in installments through

2014. In exchange, Greece agreed to severe fiscal austerity measures and difficult but necessary

structural reforms. The second package included a voluntary write-down of approximately 50%

of the nominal value of privately-held Greek government debt (€103 billion/c. USD 138 B in

absolute terms) and an additional €30 billion of official assistance to recapitalize Greek banks

after the bond write-down. However, an extended election period in mid-2012 slowed the pace of

needed reforms, the recession deepened, and Greece did not meet its fiscal targets in 2012.6

The terms of these bailout loans, mostly stemming from EU bilateral assistance, are very

favorable, with low interest payments and a long repayment profile. After six years of recession

in which Greece lost a quarter of its GDP, the economy is projected to return to growth of 0.6%

in 2014 (European Commission 4th Review). As a result, the high debt/GDP ratio is projected to

begin falling after 2014. The protracted economic crisis led to a contraction in bank lending and

investment. However, investor sentiment has improved since Greece carried out a substantial

number of structural economic reforms required by the terms of its bailout program and cost

competitiveness has returned to the labor market. This improvement has led to some increase in

foreign direct investment. Despite these gains, corruption and burdensome bureaucracy still

create barriers to market entry for new firms, permitting a few incumbents to maintain

6 2013 Investment Climate Statement, BUREAU OF ECONOMIC AND BUSINESS AFFAIRS, April 2013, available at: http://www.state.gov/e/eb/rls/othr/ics/2013/204649.htm

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oligopolies in different sectors, and creating scope for arbitrary decisions and rent seeking on the

part of public servants.

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FOREIGN PORTFOLIO INVESTMENT IN HUNGARY

The economy of Hungary is a medium-sized, upper-middle-income, structurally, politically and

institutionally open economy in Central Europe and is part of the European Union’s (EU) single

market. The economy of Hungary experienced market liberalization in the early 1990s as part of

the transition from a socialist economy to a market economy, similarly to most countries in the

former Eastern Bloc. Hungary is a member of the Organization for Economic Co-operation and

Development (OECD) since 1995, a member of the World Trade Organization (WTO) since

1996, and a member of the European Union since 2004.

The private sector accounts for more than 80% of the Hungarian gross domestic product (GDP).

Foreign ownership of and investment in Hungarian firms are widespread, with cumulative

foreign direct investment worth more than $70 billion. Hungary’s main industries are mining,

metallurgy, construction materials, processed foods, textiles, chemicals (especially

pharmaceuticals), and motor vehicles. Hungary’s main agricultural products are wheat, corn,

sunflower seed, potatoes, sugar beets; pigs, cattle, poultry, and dairy products7

Privatization in Hungary: In January 1990, the State Privatization Agency (SPA) was

established to manage the first steps of privatization. Because of Hungary's $21.2 billion foreign

debt, the government decided to sell state property instead of distributing it to the people for

free. The SPA was attacked by populist groups because several companies’ management had the

right to find buyers and discuss sale terms with them thus “stealing” the company. Another

reason for discontent was that the state offered large tax subsidies and environmental

investments, which sometimes cost more than the selling price of the company. Along with the

acquisition of companies, foreign investors launched many “greenfield investments”8

Reaching 1995, Hungary's fiscal indices deteriorated: foreign investment fell as well as judgment

of foreign analysts on economic outlook. Due to high demand in import goods, Hungary also had

a high trade deficit  and budget gap, and it could not reach an agreement with the IMF, either.

After not having a minister of finance for more than a month, Prime Minister Gyula

7 Youlian Simidjyiski, “Comparative Study Of The Bulgarian Law On Foreign Investment And The Foreign Investment Laws Of Hungary, Poland, And The Czech Republic Through The Prism Of The World Bank Guidelines For Treatment Of Foreign Investment” 9 FLA L J 277 at 2918 Samuel Wolff, Paul Thompson, “Securities’ Regulation in Central Europe: Hungary and Czechoslovakia” 27 Denv J Intl L Policy 103 at page 104.

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Horn appointed Lajos Bokros as Finance Minister on 1 March 1995. He introduced a string of

austerity measures (the "Bokros Package") on 12 March 1995 which had the following key

points: one-time 9% devaluation of the forint, introducing a constant sliding devaluation, 8%

additional customs duty on all goods except for energy sources, limitation of growth of wages in

the public sector, simplified and accelerated privatization9. The package also included welfare

cutbacks, including abolition of free higher education and dental service; reduced family

allowances, child-care benefits, and maternity payments depending on income and wealth;

lowering subsidies of pharmaceuticals, and raising retirement age.

These reforms not only increased investor confidence, but they were also supported by the IMF

and the World Bank, however, they were not welcome widely by the Hungarians; Bokros broke

the negative record of popularity: 9% of the population wanted to see him in an “important

political position” and only 4% were convinced that the reforms would “improve the country's

finances in a big way”. In 1996, the Ministry of Finance introduced a new pension system

instead of the fully state-backed one: private pension savings accounts were introduced, which

were 50% social security based and 50% funded. In 2006 Prime Minister Ferenc Gyurcsány was

reelected on a platform promising economic “reform without austerity.” However, after the

elections in April 2006, the Socialist coalition under Gyurcsány unveiled a package of austerity

measures which were designed to reduce the budget deficit to 3% of GDP by 2008. Because of

the austerity program, the economy of Hungary slowed down in 2007.

HUNGARY’S FINANCIAL CRISIS

Hungary was the front-runner in market reforms among the former socialist countries in Central

and Eastern Europe, gradually liberalising its economy in the 1980s. In the early 1990s, it

seemed to be in the best position to converge fast with the European Union, both in terms of

income level and portfolio quality. However, convergence has stalled since 2005. The expansive

fiscal policy and the build-up of a large external debt prior to the worldwide economic crisis in

2008 turned Hungary into one of the most financially vulnerable countries in Europe. Moreover,

recent policy measures aiming to improve the fiscal balance and the household financial position

9 EC Agreements with Eastern Nations Seen as First Step to EC Membership, 1 E.Eur. Rep. (BNA) 226 (Dec. 23, 1991).

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have undermined the security of property rights and of private contracts. By the end of 2011,

Hungary was asking the IMF for help.10

At the end of 2007, most emerging economies either had high external debt or high government

debt. Hungary was the only country with both, which made it financially very vulnerable. As the

2008 financial crisis hit, Hungary was the first to ask for IMF assistance.

Hungary’s past fiscal behaviour helps explain why public debt was high. One of the main factors

driving external debt has been that Hungarian banks borrowed heavily internationally before

2008 and offered loans denominated in foreign currency both to households and firms.

Borrowing in foreign currency meant a build-up of a large, unhedged foreign liability position in

the balance sheet of households and firms (Ranciere et al. 2010, and Csajbók et al. 2010). These

liabilities were largely denominated in Swiss francs and, to a lesser extent, in euros. By March

2009, the Hungarian currency had depreciated by 26% against the euro, and by 66% against the

Swiss franc by November 2011, both relative to September 2008. This has put a lot of strain on

many balance sheets.

In order to address the problems of the foreign currency loans, the Hungarian government passed

legislation in September 2011 that unilaterally changed the terms of all foreign currency loan

contracts by allowing debtors to make a one-off repayment of their loans at a discounted

exchange rate. The costs are to be born entirely by the banks. In mid-December 2011, the

government and the banks agreed to share the costs of further arrangements to ease the problems

of foreign-currency debtors. These arrangements have worsened the banks’ capital requirements,

prompting them to adjust by, among other things, reducing their balance sheet. This implies slow

or even negative credit growth in the near future, which hinders growth.11

Hungary’s centre-right government, which won a two-thirds majority in the parliament in spring

2010, has introduced taxes on financial institutions that are an order of magnitude higher than

similar taxes being discussed elsewhere in Europe. It has levied crisis taxes only on sectors

dominated by foreign-owned firms, introduced a 16% flat rate for personal income tax while

raising other taxes on labour, and nationalised private pensions to plug the hole in fiscal revenues

10 Ursula Vezeknyi, The Practical Problems of the Registration of Companies with Foreign Participation, in INVESTORS' GUIDE MANUAL FOR INVESTMENT IN HUNGARY 85, at 90 (Robert Ptho & Gybrgy Jutasi eds., 1991)11 Supra Note 2

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created by the flat tax. It has unilaterally changed the private loan contracts between banks and

households to ease the strain on households’ balance sheets caused by borrowing in foreign

currency before the crisis and by the large depreciation of the Hungarian currency since then.

These measures have, on the one hand, introduced new distortions across sectors, and on the

other undermined such fundamental institutions as private contracts and property rights. Such

measures are unlikely to be conducive to long-term growth.12

FOREIGN INVESTMENT IN HUNGARY DESPITE THE FINANCIAL CRISIS

Despite the recent financial crisis and continuing worries about fiscal and sovereign debt

problems, foreign portfolio investors clearly remain the top investors in the free float of the

Budapest Stock Exchange (BSE). They come primarily from the US which has clearly surpassed

the UK to become the largest investment region followed by investors based in European

countries such as France, Norway and Germany. Hungarian portfolio investors as well as Polish

and Dutch investors have significantly reduced their exposure in the free float of Hungarian

issuers. Compared to the last analysis of December 2011, especially US-based investors

increased their exposure to Hungary and Eastern Europe followed by French, German and

Russian institutions. In terms of investment style, especially passive investors (index and

quantitative strategies) have increased their positions in the BSE. As in the previous years,

uncertainty regarding political, default and governance risks were cited as the major reasons for

international investors’ cautiousness in the most recent study which covered annual ownership

changes.

OPENNESS TO FOREIGN PORTFOLIO INVESTMENT IN HUNGARY

Hungary maintains an open economy and attracting foreign investment remains a stated priority

for the Hungarian government. According to the Hungarian Investment and Trade Development

Agency (ITDH), "foreign direct investment (FDI) has been crucial in boosting economic

performance and remains the driving force behind Hungary's economic success, fueling its

strong export growth and significantly increasing productivity." With approximately USD 90

billion in FDI since 1989, Hungary has been a leading destination for FDI in Central and Eastern

Europe over the past several years. Germany is the most important country of origin with 22

12 Rebecca Hanson, “Framework for Privatisation in Hungary” 23 Law and Business International Policy Journal 441 at 453

14

percent of all FDI, followed by Austria (14 percent) and the Netherlands (13 percent). The

United States is the largest non-European investor at 4 percent of FDI. Automotive industry,

software development, and life sciences receive the highest amount of capital investment. FDI

inflow in 2008 reached EUR 4.8 billion, however due to the global financial crisis, FDI inflow

dropped and reached only EUR 1.02 billion in 2009 as companies became more cautious about

committing capital to large investments. The estimated number of companies in Hungary with

U.S. origin is 600, although the figure is closer to 1000 if representation and sales offices are

considered.13

Hungary's high-quality infrastructure, its productive and highly skilled labor force, and its central

geographic location are often cited as features that make Hungary an attractive destination for

investment. In 2010, the government passed a number of tax changes, including reductions in

personal income and business tax rates in order to increase Hungary's regional competitiveness

and attractiveness to investment. The investment promotion agency, Hungarian Investment and

Trade Development Agency (ITDH), views Hungary as a particularly well suited location for

research and development centers; manufacturing facilities; and service centers, and believes that

considerable opportunities exist in the biotechnology; information and communications

technology; software development; renewable energy; automotive; and tourism sectors.

Despite Hungary's advantages, some businesses complain that obstacles and disincentives to

investment remain, including a lack of transparency and predictability; reports of corruption,

particularly in the government procurement sector; and barriers related to excessive red tape.

Despite reductions in business and personal taxes, Hungary's new government in June 2010

announced the introduction of “crisis taxes” targeting banking, energy, telecommunications, and

retail sectors. Manufacturing was not targeted by the taxes. Originally unveiled as three year,

limited duration and extraordinary measures, the “crisis taxes” were meant to shore up the

government budget until more long-term, structural changes were made. In November 2010, the

government acknowledged that the “crisis taxes” could exist in some form until 2014, two years

later than previously discussed. Prime Minister Orban has stated publically, however, that the

“crisis taxes” will be phased out after three years. Many foreign companies have expressed

displeasure with the unpredictability of Hungary’s tax regime and the retroactive nature of some

13 Erwin Eichmann, Legal Aspects of Doing Business in Hungary 24 International Law 957 at 1003

15

of the tax measures. In December 2010, fourteen European companies filed a complaint with the

European Commission, maintaining that the taxes discriminated against foreign firms in favor of

domestic companies. The IMF has also criticized the taxes, stating, “the levies are difficult to

justify on economic grounds as they discriminate among sectors and send negative signals about

the government’s attitude towards foreign investment, which is critical for Hungary.” Many

critics have claimed that the taxes will have the adverse effect of reducing foreign investment

and economic growth, and will offset economic benefits of recently approved cuts in personal

and corporate tax rates.14

FOREIGN PORTFOLIO INVESTMENT

The most important factors for foreign portfolio investment are:

A. GENERAL

i. Stability of legal system

ii. Stability of financial system

iii. Stability of political system

iv. Currency stability

v. Clear tax legislation

vi. General economic situation

vii. Strictness of bankruptcy laws

B. MICROECONOMIC

i. Managerial qualification

ii. Productivity of the investment target

iii. Growth of the particular sector

iv. Skill level of employees of the investment target

v. Personal contacts with management

vi. Level of taxation of the investment target

C. FINANCIAL MARKETS

i. Liquidity of the individual stocks

14 Ibid

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ii. Legislation and enforcement of law

iii. Controls on capital flow

iv. Presence of strategic investors

v. Listing at a foreign exchange

In this part of the project we will be looking into the Financial Market aspect and how these

factors affect foreign portfolio investment in Hungary.

Table 1: Portfolio Structure of Western Investment Funds (2012)

Source: http://www.oecd.org/finance/financial-markets/42143444.pdf

Czech Republic Hungary Poland Estonia Slovenia Russia Total

Shares 16.1 36.6 34.4 1.4 0.7 10.8 100.0

Bonds 14.9 40.7 27.8 0.9 0.6 15.1 100.0

The table above is evidence that foreign portfolio investment is highest in Hungary among the

Central Eastern and European Countries.

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Table 1: indicators affecting foreign investment

Source: http://phd.lib.uni-corvinus.hu/433/1/elteto_andrea.pdf

ANALYSIS OF INVESTMENT STYLE – PASSIVE INVESTMENTS ON THE RISE

As for most indices or issuers, the traditional investment styles “growth” and “value” remain the

dominant styles used for investments in BSE-issuers. While investment style remains a key issue

in the analysis of a company’s and exchange’s shareholder base, with the recent volatility on the

markets, the distinction between the various styles has become somewhat blurred. Significant

volumes of money fled equities during the financial crisis in 2008 and 2011, seeking safe havens

rather than new opportunities across securities. In 2012, investors became less risk averse,

shifting allocations from bonds to equities again, and when in equities, they often picked stocks

with high dividend yields or stocks that showed opportunities in terms of intrinsic value, which

was also the case for Hungarian issuers. With respect to overall investment styles in Hungary,

growth investors have been major detractors but continue to dominate with a share of 38.4%

(from 43.4%) of all identified holdings, but are followed by stronger value (29.9% from 29.1%)

and index (15.3% from 10.2%) investors, which mirrors the global market sentiment. GARP

(growth at a reasonable price) investors remained steady around 11% (from 11.9%) of all

identified institutional holders, while the remaining styles such as quantitative, hedge funds,

asset allocation, specialty or aggressive growth all remain at low levels of below 2% of all

identified holders.

Development in terms of investment style for Hungary is largely in line with the findings for the

entire CEESEG. Ipreo identified a steady dominance of growth investors, followed by value

strategies and a strong increase of passively managed institutions (index), with GARP, yield and

specialty investors remaining at relatively low and consistent levels. On average, the CEESEG

benchmark for investment style shows growth investors (35.7% from 35.8%) followed by value

(27.1% from 28%), GARP (15.9% from 16.5%), index (14.2% from 12.9%) and other smaller

styles. Through direct market outreach and corporate access studies, Ipreo further confirmed and

identified the increased importance of extra financial or ESG-factors which come into play in

several investment strategies and add an extra level of complexity to the decision-making

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process. Corporate governance teams at the largest investors not only have an increased

influence on buying and selling of shares, but also communicate more frequently with issuers

directly via ongoing engagement processes or before general meetings. These factors also play a

role in numerous passive strategies as they can be used for so-called “enhanced” index strategies

where issuers get excluded or over-/underweighted compared to the benchmark depending on

whether they meet transparency, disclosure or governance requirements. Several of the large

institutional management groups have started to build and include these types of strategies into

their mainstream funds and investment management process, a trend to watch out for and

monitor.15

PORTFOLIO TURNOVER RATIO OF INSTITUTIONAL INVESTORS 2014

The portfolio turnover ratio indicates how often institutional investors switch securities within

their overall portfolios on average per year. The turnover ratio of active investors (high and/or

very high turnover rates) for the financial market of Budapest currently stands at 3.4% after

previously being 2.5% (2011), 9.2% (2010) and 17.3% (2009). This development is in line with

the general trend in Europe, where Ipreo has seen a decline in active institutions from over 8% to

6.1% over the last two years and an uptick to 8.5% again in 2012, probably driven by livelier

trading boosted by a revived interest in equities on a global level. However, this ratio only

partially sheds light on long-term strategic portfolio turnover, as the ratio is a slightly delayed

function of buying and selling movements which happened in recent months and which were

computed at investment group level. As investors have to re-position their portfolios irrespective

of their fundamental views, the latest activities are likely to be reflected in the next study.

General explanations for switching within portfolios are, e.g., the entry of long-term institutional

investors, inclusion or exclusion in portfolios due to extra financial criteria, redemptions or

market capitalization issues but also of short-term alpha-focused hedge funds3 that profit from

current price levels. In the present market environment, this ratio is scarcely indicative – just like

the current changes in investment style – of long-term strategic portfolio switching, because

investors are currently often confronted with the need to alter their positions without

consideration of the fundamental aspects, as well as a growing importance of OTC and dark pool

trading and limited disclosure. Currently, in several larger and developed markets in Europe, a

15 Francis Gabor, “The Quest for Transformation to a Market- Economy: Privatization and Foreign Investment in Hungary” 24 VAND J TRANSNATL L 269 at page 298

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growing portion of all trading is conducted OTC or via alternative trading platforms, hence Ipreo

sees an increased importance of proactive outreach of IR and management to active portfolio

managers. The predominant types of institutional investors – especially international ones – still

have low to moderate turnover ratios, which implies that the positioning in the BSE is generally

for the long term.

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FOREIGN PORTFOLIO INVESTMENT IN ICELAND

INTRODUCTION TO ICELANDIC ECONOMY

Iceland is a small country and has the smallest economy within the Organisation for Economic

Cooperation and Development (OECD). The small size of the Icelandic economy mainly reflects

the small size of the population, which reached 300 thousand in the beginning of 2006. Due to

the small size of the economy, many Icelandic businesses outgrow the domestic market and the

only possibility for those companies to reach greater growth is through foreign expansion. The

expansion of Icelandic companies into foreign markets has been a rapid process. Among

influences were factors in the domestic environment that came about in the last decade of the

20th century. Membership of the European Economic Area (EEA) opened up new markets to

Icelandic companies, strong pension funds provided capital for investments, and the privatization

of the banking system made new sources of financing available for companies wishing to expand

their operations. However, the extraordinarily fast international growth of many Icelandic

companies, some of which have reached the position of becoming among leading global players

in their markets in a shortperiod, has not been explainedthoroughly.

At the end of 1980s, after decades of Keynesian economic policy, theeconomy of Iceland was

faced with rampant inflation, high unemploymentand staggering economic growth. In 1983, after

a series of unsuccessfulfiscal policy attempts to cure the persistence of high inflation, the

inflationrate reached as high as over 80 percent annually, all while monetary policyremained in

status quo. Because of deteriorating conditions in thedynamics of economic growth, which

followed after the process ofdisinflation began, between 1990 and 1995, GDP grew by 0.3

percent onaverage. After the end of the World War II, Iceland repeatedly experiencedsignificant

volatility of inflation, which resulted from repeated increases in aggregate spending, which

created excessive purchasing power and led to inflation. The central bank boosted monetary

aggregates and repeatedly reduced interest rate to stabilize the business cycle and boost an

otherwise volatile economic growth.

The inability of the central bank to pursue stabilization policies was due to three main reasons:

high inflation tarnished prospects of economic growth while the central bank believed

that the expansion of the monetary base didn’t have any impact on real economic growth,

21

a negative real interest rate on general deposits meant that Icelandic banks could lend for

investment and grant consumption loans only if the central bank speeded up credit

facilities which, again, or inflationary pressures.

Fiscal policymakers believed that increasing government spending would boost aggregate

demand and, further, economic growth.

In reality, increasing government spending led to the spiral of wages and prices since labor

unions demanded further wage increases in the situation in which real purchasing power was

tarnished. Nonetheless, as wages grew too fast compared to the productivity performance, the

cycle of inflationary persistence continued. The inflationary dynamics was a result of demand-

side and supply-side features. A turbulent macro economic environment meant not only

extraordinary high inflation but also staggering economic growth and a volatile exchange rate. It

is no surprise that the Icelandic krona is one of the least stable and most fluctuating currencies in

the world. In 1991, when the new government under the leadership of David Oddsson was

formed, there was a significant change in economic policymaking.

David Oddson remains a strong advocator of privatization and believe it holds the key for

Iceland to move forward as a strong and robust economy only if coupled by strong fiscal

management and responsible leadership. Under his leadership, the Central Bank of Iceland had

been granted full independence and consequently Icelandic currency floated in the market.

ICELANDIC FINANCIAL MARKET

While many European stock exchanges can trace their history decades or even centuries back,

the Iceland Stock Exchange has just emerged from its adolescence. Established in 1985 as a joint

venture of banks and brokerage firms at the initiative of the Central Bank, ICEX has developed

very quickly in recent years.

22

Trading began in 1986 in T-bonds, which were the only listed securities for the first few years.

They were the dominant component of trading value until 1993. In 1990 housing bonds

(mortgage-backed securities with a State guaranty) were listed. The first equities were listed in

1990. In 1991 a joint effort by various financial institutions and industry groups succeeded in

generating support and momentum for the idea of building up a proper exchange for shares. As a

result, many companies began the listing process in 1992, with an average of six new listings per

year from 1992 to 1996. By the end of 1996,a total of 32 companies had been listed. A big boost

came in 1997 (19 listings) and 1998 (16 listings). Eight new companies were listed in 1999 and

nine the following year. In 2000, for the first time, a number of delistings took place as a result

of mergers and acquisitions. By the end of 2000 a total of 75 companies were listed. In 2001

more mergers and delistings resulted in a decrease of listed companies, the number at the end of

that year was 71. The same development continued in 2002, when the number of companies

decreased as a result of mergers and acquisitions, and only 64 companies were listed at year-end.

The number of de-listings reached a peak in 2003, when 18 companies were delisted, partly due

to mergers and changes in ownership. Two new companies were listed, bringing the number of

listed companies to 48 at year-end.

ICEX lists both traditional fixed-income instruments, such as Treasury bonds and bills, and

equities. Until year 2000 there was a steady increase in number of listed companies, trading

volume and market capitalisation on the stock market. The trend in equity trading in 2001 was

23

downwards, whereas the bond market bloomed after some recession in 2000. Both 2002 and

2003 were exceptionally good years as trading volume has doubled in last two years. The year

2003 will be remembered for major share price increases, extensive restructuring in ownership of

listed companies and record turnover on both the equity and bond markets. The ICEX-15 index

rose by 56% during the year. Share price rises have only once before been greater, in 1996. For

the second year in a row, all turnover records were broken. Total turnover of equities and bonds

amounted to ISK 1,577 billion (bn), an increase from the previous year of 39%. The total market

value of equities and bonds increased by 23% in 2003, rising to ISK 1,431 bn at year-end 2003

from ISK 1,163 bn at the end of 2002. The total market value of equities at year-end was ISK

659 bn and of bonds and bills ISK 773 bn.16

There are currently 42 companies listed on the ICEX Main List and the Alternative Market. The

largest sector in terms of market capitalisation is finance and insurance with a third of the total

market cap. Pharmaceutical is first the runner up with only two companies comprising nearly

20% of the total market cap. However, fisheries have the largest number of listed companies,

which is in line with Iceland’s strong position among fishing nations of the world. The market

value of listed equities is around 80% of GDP while the bond market capitalisation amounts to

90% of GDP.

Some of the ICEX listed companies have looked abroad to expand, and should for many reasons

be interesting investment opportunities for foreign investors.

The benchmark index for equities, ICEX-15, comprises the 15 largest companies in terms of

market value and turnover. The index rose by 56% during 2003, exceeding its former peak value

of February 2000 by 225 points closing at 2,114. This trend shows how fast the Icelandic market

has recovered from the downturn in 2000-2001.

FOREIGN PORTFOLIO INVESTMENT IN ICELAND

It is pertinent to understand as to what construe as foreign investment when one talks from the

perspective of Iceland. The below listed chart explains the basic concept of foreign investment

by differentiating between foreign direct investment and foreign portfolio investment.

16SprukRok, Iceland's Economic and Financial Crisis: Causes, Consequences and Implications,European Enterprise Institute, available at http://mpra.ub.uni-muenchen.de/29972/1/MPRA_paper_29972.pdf, last visited on 15th April, 2015.

24

Foreign portfolio investment (FPI) is the category of international investment that covers

investment in equity and debt securities, excluding any such instruments that are classified as

direct investment or reserve assets (OECD, 2001). The foreign investment shareholding has to be

below 10% to be classified as FPI and such trading is recorded at market value at any given time

(Central Bank of Iceland, n.d.b). FPI includes securities, mutual funds, equity capital in mutual

funds, equity capital in corporations, bonds and notes, money-market instruments and other

investments (Central Bank of Iceland, n.d.b). Basically FPI is investment in an overseas stock

market and is an indirect investment, contrary to direct investment. Portfolio investors, with a

small minority holding in the investment, exercise very little, if any, control over the asset and

thus are typically passive investors (Holsapple et. al., 2006). Many consider portfolio investment

more speculative and risky than direct investment projects because investors do not control or

manage their investments; they provide capital in exchange for interest, dividends and the hope

that share prices will rise

FOREIGN DIRECT INVESTMENT

Foreign direct investment (FDI) is considered an important driver of economic growth in

Iceland, as in other economies (OECD, 2002).

25

“Foreign direct investment occurs when an investor based in one country (the home country)

acquires an 6 asset in another country (the host country) with the intent to manage the asset.”17

FDI the investor must own a shareholding of 10% or more in the foreign enterprise. FDI reflects

the objective of obtaining a lasting interest in a foreign entity and therefore implies the existence

of a long-term relationship between the direct investor and the foreign enterprise (OECD, 1999).

By the virtue of the size of his shareholding, the investor has influence on the management of the

enterprise, but it does not imply that the direct investor has absolute control over the entity

(Central Bank of Iceland). Through FDI, companies not only aim to get control of the entity, but

also they often aim to get access to resources, increase efficiency and gain access to markets

(Arnarson, 2000). Direct investment does not only comprise the initial transactions to establish

the FDI relationship between the direct investor and the direct investment enterprise, but also all

subsequent capital transaction between them and among affiliated enterprises resident in

different economies. In other words, the direct investment relationship extends to certain other

enterprises indirectly owned by the direct investor. The lasting interest of a FDI activity may

involve either creating an entirely new enterprise (greenfield investment) or changing the

ownership of existing enterprises through mergers or acquisitions (M&A). Other types of

financial transactions between related enterprises, like reinvesting the earnings of the FDI

enterprise or other capital transfers, are also defined as FDI (OECD, 2003). Statistics regarding

FDI present both flow and stock. FDI flow is a measure of all transactions, outflow and inflow,

in a certain economy. Therefore, FDI outflow refers to the flow of capital from one economy.18

INTERNATIONAL FINANCIAL FLOWS

One of the characteristic features driving internationalization in recent years has been the large

growth and increased mobility of capital. Financial flows can be divided into three categories:

lending, portfolio investment and direct investment. In 1997, these financial flows amounted to

USD 2,600 billion worldwide.

17The World Trade Organization (1996)18AudurHermannsdottir, Anny BerglindThorstensen, SnjolfurOlafsson, Overview of foreign investment from Iceland 1998 to 2005, Institute of Business Research University of Iceland, available at http://ibr.hi.is/, last visited on 11th

April, 2015.

26

The diagram below shows the development of foreign direct investment (FDI) over the period

1985-1998, based on figures for inflows to host countries.

Statistics for inflows and outflows do not match, but the former are considered more reliable.2

The inflow amounted to USD 644 billion in 1998, an increase of 39% from the previous year.

Developed countries account for the bulk of this investment, with USD 462 billion. Some USD

165 billion went to developing countries and USD 17 billion to Central and Eastern Europe.

Widespread corporate mergers and acquisitions in developed countries in 1998 are one of the

main explanations for this greater flow. The total value involved in the 32 largest mergers and

acquisitions was in excess of USD 3 billion. In 1998 the inflow of FDI to developing countries

slowed down, following steadyincreases over the period 1985-1997. This turnaround may be

attributed to recent economic problems encountered by certain developing countries. Many

reasons underlie global growth in FDI, to some extent interrelated. The main reasons are

liberalization of intra-national and international trade, technical innovation, lower transportation

and communications costs, greater competition, abolition of monopolies and increased

privatization. Furthermore, the economies of most OECD countries have been in good shape.

ICELANDIC FDI STOCK

Historically, Icelandic FDI has largely been made by the large seafood sales and marketing

companies. Transportation and fisheries companies have also made some foreign investments. In

addition, Icelandic companies have made small-scale investments in foreign companies linked to

27

the fisheries sector. Recently the share of investment in other sectors has been increasing.

Through FDI, companies aim to gain access to resources, increase efficiency and gain access to

markets. The bulk of Icelandic FDI may be explained as market access strategies, while around

one-tenth of the stock may be attributed to access to natural resources. Icelandic FDI has been

increasing steadily over the period 1988-1998. Stock at year-end 1998 amounted to 23.5 billion

kr., having increased by 3.9 billion kr. during the course of the year, or 20%. At the same time,

13.8 billion kr. of the stock was accounted for by lending and 9.7 billion kr. by equity, a ratio

which has remained fairly steady in the past few years.. At the end of 1998, some 74% of

Icelandic FDI stock was in the fisheries sector (sales and marketing, processing and fishing).

In comparison with most other OECD nations, Iceland has a low FDI stock. At the end of 1998 it

was equivalent to 4% of GDP. Among the other Nordic countries this figure is over 20% and in

some OECD countries it exceeds 50%. In terms of individual host countries, Icelanders have

invested the most in the USA and the UK, although the relative importance of the stock there has

diminished in recent years. Over the period 1988-1991 it was in the range 80-94%, while at the

end of 1998 it had dropped to 42%. Iceland’s FDI host countries and main countries for

merchandise exports show some correspondence which is apparently becoming more marked. At

the end of 1998, 72 Icelandic parties had made direct investments in 141 foreign enterprises,

located in 33 countries and 5 continents. Most of the companies are subsidiaries, or 101.

Subsidiaries account for around 88% of the stock.

28

INTERNATIONAL COMPARISON

By international comparison, Iceland is in a league of its own in terms of both net foreign debt

and net venture capital investment, as a proportion of GDP. The net IIP of many leading

industrial countries is not similar to the asset composition of hedge funds, in that the net debt

position is negative but net equity investment4 is positive. In other words, most industrial

countries are net foreign borrowers and use these funds for outward direct and portfolio

investment. Among the G7 countries, only Japan has a positive net foreign debt position. In

Iceland’s case, outward equity investment is much greater than inward equity investment. Thus,

Iceland’s net equity investment position is positive. As a proportion of GDP, Iceland has a very

high level of outward equity investment, exceeded by only one country, the United Arab

Emirates.

CONCLUSION

Iceland has recorded a large current account deficit in recent years and the balance on income

accounted for a substantially greater share of it in 2006. Various questions arise concerning

collection of data on income receipts and expenditures and their relationship to the underlying

asset and liability stocks. Some regard Iceland’s deficit on income to be greatly overestimated.

Even if the balance on income were measured differently, it is not certain that this would affect

the current account deficit as drastically as is sometimes imagined. The reason is that the impacts

are captured on both the asset and the liability sides. However, it seems likely that residents’

foreign assets are underestimated by current methodologies. Outward FDI has been enormous in

recent years and in some cases highly leveraged. Because the debts are fairly well known values

but the value of the assets is more ambiguous and estimated using quite conservative

methodologies, some discrepancy could occur. The same applies to estimates of inward FDI in

Iceland. That amount is rather lower, so the net impact could be sizeable. The Central Bank

follows international standards in compiling its balance of payments statistics. As described

above, there is a considerable disparity between the methodologies used to estimate returns on

FDI and portfolio investment. The question arises whether international standards should be

modified, for example to take into account changes in the market value of portfolios. Arguably,

the low level of income receipts on portfolio investment is at odds with robust demand for

foreign securities in recent years. However, taking full account of changes in market value could

generate volatility in the balance of payments, which would be completely unrelated to inward

29

and outward payment flows. Thus, no obvious solution is in sight for ensuring full consistency

between the development of income receipts and expenditures and the underlying asset and

liability stocks. The proportion of outward FDI that is entered at book value is more than double

the share of inward FDI in the gross debt of the economy. Assuming that book value is lower

than actual market value (which many indicators would suggest is the case), the deficit on net IIP

is overestimated, but it is difficult to state precisely by how much, since the bulk of the

investment stock is in unlisted companies. Notwithstanding the lack of methodology for

estimating the “market value” of unlisted companies, various approaches may be applied to

produce a working approximation.

30

FOREIGN PORTFOLIO INVESTMENT IN LATVIA

INTRODUCTION

During the past 5 years, Latvia has experienced significant growth in its economy and it has

developed into one of the best economies in the European Union. Most of the industrial sectors

in the country have grown drastically and have contributed towards the country’s GDP (Gross

Domestic Product). Like most countries in the world Latvian economy took a major jolt during

the economic crisis that threatened the world economies during the third and fourth quarters of

2008, which continued during the early half of the 2009. The GPD slumped to a considerable

extent during this period.

However, the federal government of Latvia was determined to not to let the global economic

crisis affect the inward flow of foreign investment in the country. To cope with the crisis, the

government of Latvia set up several programs to attract FDI (foreign Direct Investment) in the

county and give a major boost to the national economy and pave way for growth and

development of the country and be at par with other industrially developed and technologically

advanced countries of the European Union. The country is one of the key players in the

European Union. Latvia, in the recent years have become a hot spot for investment, increasing

number of global players are looking to invest in the country and are benefitting for its

favourable investment policies. Foreign companies undertaking Portfolio Investment in Latvia

can enjoy the following advantages:

- Latvia has a very stable bureaucratic set up; this is very useful for foreign investors

looking to establish their business base in the country since they can do it without any

hassle.

- Latvia also has a transparent and non-biased legal and judicial system in place. It allows

the foreign companies to settle any issues fair and square.

- Latvia being a part of the European Union (EU), foreign investors in the country are

provided free access to market of other countries which are part of the EU. This is a very

significant advantage for investors since they can do business without borders and expand

their business base. 

31

- Latvia has a very global business outlook. The work culture throughout Latvia is world

class, most of business enterprises in the country work according to the standards of other

European nations. 

- Labour force is the backbone of any industry and in Latvia there is no shortage for it,

foreign investors in Latvia can have access to the huge base of high educated and

technically qualified workers. The labour charges in Latvia are also cheap as compared to

other countries in the European Union.

FINANCIAL ASPECT

Foreign Investment as defined in the law adopted “On Foreign Investment in the Republic of

Latvia” by Supreme Council of Republic of Latvia; Foreign Investment is defined as “long-term

investments in equity capital by foreign investors earmarked for carrying out entrepreneurial

activity in the Republic of Latvia. Conversion of convertible currency shall be made in

accordance with the exchange rate set by the Bank of Latvia on the day when the memorandum

of association of a company is signed, or on the day when amendments regarding an increase in

equity capital have been made to the articles of association.” 19

The Latvia federal government has formulated special foreign investment friendly policies to

encourage maximum investment from foreign companies. The government provides several

financial grants to foreign investors investing in the country. The grants are mainly in terms of

tax exemptions and loans at very cheap interest rates. The government of Latvia provides the

following special incentives to foreign investors investing in large projects:

- The government provides corporate tax allowance up to 40% for up to 10 years on investment

in certain sectors like real estate, technology and equipment. 

- The government also provides organizational and administrative support to businessmen to help

them establish their business. Besides the government also provides grants for training of the

labourers and development of infrastructure.

a. Key Investment Sectors:

Latvia has huge industrial sector and its economy is noted for its large manufacturing wing and

there is plenty of scope for foreign investors to investing in its diverse manufacturing sectors.

19 Latvia Investment and Trade Laws and Regulations Handbook,  By Ibpus.com, International Business Publications, USA.

32

Foreign companies can consider investing in various segments like Wood processing food

processing, textiles, machinery. Since Latvia is located in close proximity to the Baltic Sea,

foreign investors can greatly benefit from it, since it provides a perfect gateway for

transportation of goods.20

To attract foreign investment in the country’s manufacturing industry, the Latvian government is

keen to privatize the sector keeping in mind its contribution to GDP. Since the government of

Latvia has privatized the manufacturing sector barring a few sensitive industries, the inflow of

FDI was about $11.46 billion in 2009.

Latvia is truly a world class destination to invest, it has all the elements to become a industrial

hub in the future. Foreign companies investing the country are sure to earn valuable returns on

their investments.

b. Foreign Investment Statistics: Before the Adoption of the Euro

The traffic of foreign investment in Latvia has also been affected since the adoption of Euro as

its official currency in 2014, therefore it is also important to assess the impact that the Euro has

had and for that it is pertinent to take a look at the figures which show the volume of foreign

trade before the Euro, when Lats was the official currency.

20‘Invest In Latvia-Invest in EU’, Report by European Union. Available At: http://www.investineu.com/content/invest-latvia

33

Figure 121

Figure 2: Sectoral Division of FPI in Latvia

21 Source: Central Statistical Bureau of Latvia, Available At: www.csb.gov.lv/en

34

The findings imply that Latvia has an interesting advantage to attract steadier FPI by increasing

amount of FDI. Therefore, sustainability of FDI inflows is relatively more important in Latvia,

compared to other countries in the region.22 The results strongly suggest that a decrease in FPI

volatility is followed by an increase in FDI in the long-run, and this indicates economies that

advance in capital liberalization benefit from increases in FDI.

Figure 323 : Capital Financial Account

Table 124 Capital and Financial Account Projections: Latvia22Yaman O. Erzurumlu and et al., ‘Co-Movement of FDI and FPI in Central and Eastern Europe’. http://www.econjournals.com/index.php/ijefi/article/viewFile/797/pdf23 Source: Bank of Latvia24 Source: IMF, Available At: https://www.imf.org/external/pubs/ft/scr/2013/cr1328.pdf

35

Table 225 Sources of Portfolio Investment in Latvia

Investment (net transactions and positions) made by residents of Latvia in securities issued by

residents of other countries (Assets) and by residents of other countries in securities issued by

residents of Latvia (Liabilities). Portfolio investment is made with the purpose of increasing the

investment value or earning dividends or interest, without directly influencing the management

of the company. Portfolio investment includes the short-term and long-term financial

instruments. Financial instruments included under portfolio investment are freely tradable on

securities market. In the balance of payments, portfolio investment is classified based on the type

of financial instrument: into equities and debt securities (bonds and notes, money market

instruments).

Portfolio investment in equity securities (new share issues and shares traded in the secondary

market) covers acquisition and disposal of shares (units) if they represent a holding of less than

10% of a non-resident's ownership in the capital of a resident's enterprise or of a resident's

holding in the capital of a non-resident's enterprise. A holding of less than 10% in the capital of a

direct investor's enterprise (recorded under direct investment) shall be an exception. To record

the data on portfolio investment in equity securities in Latvia (liabilities) at the market value to

the extent possible, information on listed enterprises provided by the NASDAQ OMX Riga is

used, whereas data for unlisted enterprises are derived by applying the equity capital approach

(own funds at book value) recommended by the European Central Bank.

Portfolio investment in bonds and notes includes transactions where non-residents other than

direct investors or direct investment enterprises acquire and dispose of their holdings of debt

25 Source: IMF, Available At: http://cpis.imf.org/

36

securities with original maturity of over one year. The redemption of such debt securities is also

reflected under portfolio investment. Money market instruments have original maturity of up to

one year (inclusive). Each category of portfolio investment is recorded in the breakdown by

institutional sector (central bank, general government, MFIs (excl. central bank) and other

sectors).26 The principal asset items in the international investment position were reserve assets,

portfolio investment, and currency and deposits (25.8%, 23.1% and 22.1% of assets,

respectively).

Impact of Euro:

Integration with the European Union is a high priority for Latvian foreign and economic policies.

In December 1999, Latvia was invited to open its European Union accession talks. That provides

an additional stimulus for Latvia's development and obligates it to ensure compliance with the

convergence criteria established by the Maastricht Treaty, achieve harmonization, and perfect

and implement the necessary legislation. The Bank of Latvia considers compliance with the

Maastricht convergence criteria an important task for the medium term. At present, many of the

relevant indicators for Latvia are close to meeting the requirements. The results achieved in 1999

provide a solid basis for optimism in forecasting Latvia's economic development in 2000. Its

growth rate is expected to accelerate, and its economic indicators are likely to improve

considerably over 1999's. With improvements in industrial production and oil transit, Latvia's

GDP may grow as much as 4 percent in 2000.

Latvia's strict fiscal policy will help reduce the budget deficit, which, along with the Bank of

Latvia's conservative monetary policy, will help keep inflation low. Consumer prices are not

expected to rise more than 4 percent this year. By the end of 2000, unemployment may well drop

to 8 percent. Latvia's economic policies and the stability of the lats are sure to promote exports,

and the country's current account deficit may drop to 9 percent of GDP in 2000.

The achievements of the Latvian economy are recognized by both local and foreign experts. For

example, the international credit-rating agencies Moody's, Fitch IBCA, and Standard & Poor's

have repeatedly rated Latvia's bonds as investment grade, providing another piece of evidence

26 Portfolio Investment in Latvia, Available At: https://www.bank.lv/en/component/content/article/555-statistics/statistics-terms/9337-portfolio-investment?Itemid=201

37

that Latvia's economy is strong and has good potential.27 Payments to other euro area countries

will cost less, because there will no longer be any need for currency exchange, which until now

has imposed substantial expenditure for businesses. For example, the annual currency conversion

costs for the country averaged 71 million euro over the past few years. In 2009, exchange costs

reached 220 million euro. This means that businesses will have more money to spend on

development or employee compensation. Various benefits will outweigh the contribution to the

European Stability Mechanism. The currency and exchange bureaus of Latvian commercial

banks earned around 600 million euro from currency exchange services over the past five years.

Latvia's credit ratings will improve based on the economic growth and prudent economic policies

resulting from euro area membership. For businesses and people, this means reduced costs in

existing loan payments and access to new financing and favourable loan conditions. Experience

of other countries shows that as soon as a country joins the euro area, its credit rating and the

credit ratings of its leading banks increase by one or two grades. In Estonia, it took only a year

for credit ratings around the euro implementation period to increase by as much as three grades.

With its euro changeover, Latvia also gains improved access and reduced costs for capital to

increase investment, produce efficiently and export. Euro adoption will boost economic

development. The effect of euro implementation on Latvian GDP from 2014 to 2020 is estimated

at an additional 8 billion euros.

During times of economic instability, interest rates on loans in lats tended to become volatile.

With the euro, these interest rates will not only be lower, but also more predictable, allowing for

better planning of business finances and development. With the decrease of currency lender

premiums associated with currency risk, business, economic growth, and overall prosperity will

be advanced, because with the reduction of sovereign credit risk, Latvian entrepreneurs and

private individuals will borrow money at reduced costs.28

c. Why You Should Choose to Invest in Latvia:

The country's main strong points are:

27 Latvia Focus on Country Development, IMF. Available at: http://www.imf.org/external/pubs/ft/fandd/2000/09/repse.htm28 Joining the Euro Area and Benefits for Latvia, Available At: http://www.eiro.lv/en/media/media-kit/joining-the-euro-area-and-benefits-for-latvia

38

- A skilled and inexpensive workforce,

- Legislation that is harmonized with the European Union and favourable to investments;

- A simple and attractive taxation system;

- The presence of strategic transit and logistics centres;

- High productivity;

- Low taxes; and

- A strategic geographical location, which allow access to Russia and to the former Soviet

republics.

Weak Points

The country's main weaknesses are:

- The limited size of its domestic market;

- The low numbers of foreign companies in the country;

- Economic instability and high market fluctuations. In this regard, the economic crisis,

which Latvia is currently going through, has shown the country's limitations, which

remain subject to political and social instability and whose economy could deteriorate

rapidly.

Government Measures to Motivate or Restrict Foreign Investment:

Following its independence, Latvia decided to launch itself in the market economy and to

acquire the capital it was lacking. It therefore progressively opened itself up to direct foreign

investments. In order to attract foreign companies, the Latvian government offers financial

assistance. Its strategy is especially to promote the high technology industrial sector. The

different funding enable the quality of services to be improved. A loan and semi-loan plan has

also been launched to promote SMEs.

39

FOREIGN PORTFOLIO INVESTMENT IN ITALY

INTRODUCTION

Italy is a country in the southernmost region of Europe and has been a member of Eurozone

since its conception. The country has been severely affected by the Eurozone Crisis and

requires large swathes of investment to flow into the country in order to rise from the

financial slump in which it currently finds itself. Thus, Italy requires foreign portfolio

investment in large amounts. Private equity funds based in Italy continued to have a diverse

investor base in 2013. Approximately 26% of the capital raised was sourced abroad (a

significant increase from the 2012 figure of 11%). The sources of funding were:

- Funds of funds (31.5%).

- Pension funds (18.3%).

- Banks and other financial institutions (20.6%).

- Insurance companies (13.4%).

- Government agencies (3.2%).

- Individuals (12.5%).

- Private equity firms (0.1%).

- Corporations (0.4%).

EFFICIENT CAPITAL MARKETS AND PORTFOLIO INVESTMENT

The banking system in Italy has consolidated significantly since several major 2007 mergers.

Anti-trust regulations required significant reduction of personnel, sale of assets and reduction

in the number of branches follow those mergers. At the end of 2010, there were 23

subsidiaries of foreign companies or banks operating in Italy out of 760 total banks. Two of

these foreign subsidiaries figured among the Italy’s top ten banking groups, holding 9.5

40

percent of total Italian assets. Thirty-seven foreign shareholders – mainly from EU countries

– held equity interests of more than five percent in 47 banks.

Despite major strains to the financial system in Italy due to rising borrowing costs in the

second half of 2011, the Italian banking system appears relatively sound. Tensions in the

sovereign debt market in 2011 and the enforcement of new European rules for evaluating

bank assets affected banks’ ability to raise funds, which in turn squeezed bank profit margins.

Additionally, with few exceptions, Italian banks undertook capital increases in 2010 and

early 2011, which further stressed profits. Despite long-running recommendations from the

Bank of Italy to reduce fees, bank fees remain among the highest in Europe.29

Financial resources flow relatively freely in Italian financial markets and capital is allocated

mostly on market terms. Foreign participation in Italian capital markets is not restricted.

While foreign investors may obtain capital in local markets and have access to a variety of

credit instruments, access to equity capital is difficult. Italy has a relatively underdeveloped

capital market and businesses have a long-standing preference for credit financing.30 What

little venture capital that exists is usually provided by established commercial banks and a

handful of venture capital funds.

29Ferreira, Miguel A., and Pedro Matos. "The colors of investors’ money: The role of institutional investors around the world." Journal of Financial Economics 88, no. 3 (2008): 499-533.30Henisz, Witold J. "The institutional environment for multinational investment."Journal of Law, Economics, and Organization 16, no. 2 (2000): 334-364.

41

The Italian stock exchange ("BorsaItaliana") is relatively small -- fewer than 300 companies

-– and is effectively an inaccessible source of capital for most Italian firms. Italian firms

seem to prefer to get capital from banks. The London Stock Exchange owns the Milan Stock

exchange.31 The Italian Companies and Stock Exchange Commission (CONSOB),

established in 2005 after a spate of scandals, is the Italian securities regulatory body. In

January 2011, EU Member States established three EU-level regulatory agencies for financial

services and related activities: A London-based banking oversight institution (EBA), a Paris-

based financial market oversight institution (ESMA), and a Frankfurt-based insurance and

pension funds oversight institution (EIOPA).

31Mudambi, Ram, and Pietro Navarra."Political tradition, political risk and foreign direct investment in Italy."  MIR: Management International Review (2003): 247-265.

42

Financial services companies incorporated in another EU member state may offer investment

services and products in Italy without establishing a local presence. Cross-EU standardization

of regulations should address U.S. and other foreign banks’ complaints that Italian

interpretation of EU financial regulations tends to be stricter than in other countries.32

Europeans have as yet to resolve the question of authorizing non-EU financial services firms

to operate under one comprehensive regulatory regime, as opposed to several dozen national

ones.

Most non-insurance investment products are marketed by banks, and tend to be debt

instruments. Italian retail investors are conservative, valuing the safety of government bonds

over most other investment vehicles. Less than ten percent of Italian households own Italian

company stocks directly. Of those who do own stocks, the weight of direct stock

shareholding in their portfolios averages around 22 percent. A few banks have established

private banking divisions to cater to high net worth individuals with a broad array of

investment choices, including equities and mutual funds.

There are no restrictions on foreigners engaging in portfolio investment in Italy. Any Italian

or foreign investor acquiring a stake in excess of two percent of a publicly traded Italian

corporation must inform CONSOB, but does not require its approval. Any Italian or foreign

investor seeking to acquire or increase its stake in an Italian bank equal to or greater than five

percent must receive authorization from the Bank of Italy. In 2013 the Italian private equity

and venture capital market has seen a slight increase in investment activity. There has been a

growing trend for early stage and expansion investments, while some large buy-out

transactions had a significant impact on the total amount invested.

Data sourced from the AIFI Statistics demonstrates that fund-raising remains critical. The

total amount of capital raised by Italy-based funds during 2013 was recorded as EUR4, 047.

This is a remarkable increase compared to the amount raised in 2012 (EUR1, 355 million). In

2013 the total amount from new transactions was equal to EUR3, 430 million (an increase of

32Bianchi, Marcello, and Luca Enriques. "Corporate governance in Italy after the 1998 reform: what role for institutional investors?." (2001).

43

6% compared to the amount of EUR3, 230 million recorded in 2012). This was distributed

over 368 transactions (a slight increase from 2012 when the transactions were 349) and

involving 281 companies.33

The majority of resources continued to be channelled into buy-out transactions (EUR2, 151

million, a similar amount to the figure in 2012), followed by expansion investments and

replacement transactions. For the second year running, early stage transactions were

predominant (158 investments, a slight increase compared to 136 investments made in 2012),

followed by expansion and buy-out transactions. The total number of divestments in 2013

was 141 (a considerable increase of 32% from 107 in 2012), distributed over 119 target

companies, for a total amount calculated at cost (that is, not including capital gains) equal to

33Bevan, Alan A., and Saul Estrin. "The determinants of foreign direct investment into European transition economies." Journal of comparative economics 32, no. 4 (2004): 775-787.

44

EUR1,933 million (marking a significant increase of 23% compared to 2012, when the total

divested amount was EUR1,569 million).34

The Bank of Italy owns and manages the country’s official reserves in foreign currency and

gold. Article 127 of the Treaty on the functioning of the European Union-TFUE (ex Article

105 of the Treaty EC) establishes that these reserves, along with those of the other National

Central Banks (NCBs) and the official reserves of the European Central Bank (ECB), form

part of the reserves held by the Eurosystem.

The Bank of Italy also manages part of the reserves assigned to the ECB, following

guidelines set by the Governing Council.

THE NATIONAL RESERVES

One of the main reasons for maintaining national reserves is to provide additional foreign

reserves to the ECB, which it may ask the NCBs to do in given circumstances. The Bank of

Italy also uses the national reserves to service the foreign currency-denominated debt on

behalf of the Treasury (avoiding any impact on the foreign exchange market) and to fulfil its

obligations towards international organisations such as the International Monetary Fund.

Lastly, national reserves, being part of the reserves of the Eurosystem, play an important role

in building up and maintaining the ESCB’s credibility.

The profit from the management of the official reserves constitutes a major item in the

Bank’s income statement and ensures the soundness of its balance sheet as a safeguard

against the risks connected with the activity of a central bank. The main objectives of reserve

management are therefore to preserve capital value and liquidity.35 Moreover, because they

are an increasingly important component of the Bank’s assets, reserves are managed to obtain

the maximum return for an acceptable level of risk.

34Brunetti, Aymo, and Beatrice Weder. "Investment and institutional uncertainty: a comparative study of different uncertainty measures." WeltwirtschaftlichesArchiv 134, no. 3 (1998): 513-533.35Ferreira, Miguel A., and Pedro Matos. "The colors of investors’ money: The role of institutional investors around the world." Journal of Financial Economics 88, no. 3 (2008): 499-533.

45

The management of the official reserves – like the investment of the euro portfolio – cannot

be conducted with a view to the monetary financing of budget deficits, as laid down in

Article 123 of the TFUE. Consequently, primary market purchases of securities issued by

member states and Community bodies and institutions are prohibited, while purchases on the

secondary market are subject to monitoring thresholds.36

A partly decentralised approach is adopted for the management of ECB reserves, with a few

functions, such as risk management and accounting, being performed directly by the ECB

and investment and back office functions attributed to the single NCBs within the guidelines

set by the Governing Council. These guidelines translate the general objectives of reserve

management into precise rules, including lists of eligible issuers and counterparties and a set

of limits for credit and market risk.The main objective of ECB reserve management is to

ensure that a sufficient amount of liquid resources are available whenever needed for foreign

exchange policy operations. In the event of large-scale intervention, the ECB may make

further calls on the foreign reserves of the NCBs or fund the intervention without using its

foreign exchange holdings (for instance by means of foreign exchange swaps). Subject to the

stringent security and liquidity requirements implicit in the purpose of the portfolio, ECB

reserves can also be managed to maximise return.37

An important principle of reserve management, of both ECB and national reserves, is that of

‘market neutrality’. This means that investments should be made in markets that are

sufficiently deep and liquid to ensure that transactions are easily absorbed at market-

determined prices.The Bank of Italy, in addition to the national official reserves (gold and

claims on non-euro-area residents denominated in foreign currency) and to the assets related

to monetary policy operations, manages the financial portfolio that includes earmarked

investments held against reserves and provisions, including those for staff pension

obligations.38More than 90 per cent of the financial portfolio is invested in bonds, mainly

36Davis, E. Philip, and Benn Steil. Institutional investors. MIT press, 2001.37Bianchi, Marcello, and Luca Enriques. "Corporate governance in Italy after the 1998 reform: what role for institutional investors?." (2001).38Ferreira, Miguel A., and Pedro Matos. "The colors of investors’ money: The role of institutional investors around the world." Journal of Financial Economics 88, no. 3 (2008): 499-533.

46

Italian and other euro-area government securities, and the rest in equities, units of collective

equity-investment undertakings and exchange-traded funds (ETFs).

The equity component, which is for investment and portfolio diversification purposes,

consists mostly of euro-area listed securities. Investments in banking and insurance shares are

excluded.The Bank also manages the defined-contribution supplementary pension fund, for

employees hired after 28 April 1993; its assets and liabilities are shown separately in the

Bank's balance sheet.

Foreign portfolio investment in Italy has increased, both in government securities and

private-sector securities. Interest rates have declined on all maturities. In 2013 households

suffered a smaller decline in disposable income than in 2012; there was a reduction in debt

and a recovery in investment in financial assets. Low interest rates and measures to support

borrowers helped to contain the vulnerability of indebted households. It is estimated that the

47

proportion of financially fragile households would increase by only a modest margin even

under adverse macroeconomic scenarios.

Although some positive signs are emerging, the financial conditions of firms remain weak.

Several large companies have substituted bonds for part of their bank debt; for smaller firms,

difficulties in accessing credit, low liquidity and the uncertainties still surrounding the

cyclical upswing will remain the main sources of risk in the coming months. The

Comprehensive Assessment of the largest euro area banks is now in progress. The exercise,

in which 15 Italian banks are taking part, will permit uniform comparison of bank balance

sheets in different countries, helping to reduce the segmentation of European financial

markets still further.

KEY SECTORS FOR FOREIGN INVESTMENT IN ITALY

There are investment opportunities galore for foreign investors in its diverse sectors. The

sectors that promise the most profitable returns are discussed below:39

Real Estate: The Real Estate Industry has been one of the mainstays of Italian industry that

has attracted huge foreign investment. Italy is one of the few countries in the world where

majority of the population own their own homes. Today, a huge number of Italian

populations are investing in buying a second holiday homes. Several foreign immigrants in

the country are investing in buying real estate property in Italy due to the attractive living

condition and the low cost of living. The value of real estate properties through out Italy is

increasing steadily and foreign investors can enjoy valuable returns on their investment.

Experts suggest that the demand for real estate properties would continue to rise in the future

mainly due to the underlying demand from both local and foreign sources.

Tourism Sector: Italy has a huge potential for foreign investment in the Tourism sector. In

recent years, Italy has become one of the best tourist destinations in the world. While

39La Porta, Rafael, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny. "Investor protection and corporate governance." Journal of financial economics 58, no. 1 (2000): 3-27.

48

important cities like Rome, Venice and Florence continue to attract tourists from all around

the world, recently lesser known cities like Tuscany and Cinque Terre are attracting influx of

tourists.

The increase in tourism has opened up several avenues for foreign investment in the sector.

Several foreign investors are increasing in to new tourism sectors such as agri-tourism and

eco-tourism. Investors are investing in acquiring and building property to provide

accommodation facilities to the tourists.

Food Industry: Italy is known for its great food. It is the home for the two of the most popular

delicacies – Pasta and Pizza. Italians in general love good food and there are plenty of world

class restaurants in the country. The Food industry is another key sector that offers great

foreign investment opportunities. The Italian culinary tradition is greatly appreciated by both

locals and the foreign visitors. In a recent survey conducted by an Italian institute that studies

trends in tourism showed that the food is one of the prime considerations for the tourists. In

these circumstances the restaurant business is provides a good investment opportunity for

foreign investors. Since the numbers of licensed restaurants in Italy are limited there is

opportunity galore for investing in restaurant. The best approach for investing in the industry

is to buy a functioning restaurant with a good reputation so that investors have better chance

of earning good returns.

Thus, with the favorable government FDI policy and with investment opportunities in various

sectors, Italy is truly a hot sport or foreign investment. Foreign Investors investing in Italy are

in a win-win situation to earn profitable returns on their investments.

The government’s influence on capital markets is still strong, controlling a large share of

Italian private companies and most of the pension and social security system. Directly or

indirectly, the government also bears a heavy weight in the already-small domestic capital

market. For example, it controls, at either the central or the local level, a number of companies

listed on the stock exchange ‒ accounting all together for about 35% of the total capitalization

of Milan’s FTSE MIB index, with an additional 25% represented by banks, whose governance

49

we discussed above. It does not come as a surprise that a few well-connected actors have been

able to capture for years what was left of the small domestic capital market, creating a dense

web of cross-shareholdings and gentlemen’s agreements that only the current financial crisis

has been able to shake.

CONCLUSION

Portfolio Investment, net (BoP, current US$)

50

Portfolio investment covers transactions in equity securities and debt securities. Data are in

current U.S. dollars.40

Country Net Portfolio Investment

2010 2011 2012 2013

Greece 26,871,211,137 26,574,910,779 128,315,000,000 7,663,155,126

Latvia 403,600,000 620,400,000 -1,307,400,000 273,100,000

Italy 57,639,112,811 13,085,292,532 -31,581,560,943 -20,338,576,658

Iceland 456,334,537 -42,086,114 -456,873,548 1,141,982,485

Hungary 111,854,744 -8,957,603,838 -1,904,960,864 -4,027,529,601

All the countries with a large negative portfolio investment balance (namely, in order of

increasing balance, Italy, Hungary, Latvia, Greece, and Iceland) saw foreign investors reduce

their net holding of domestic securities (i.e. gross portfolio investment inflows were negative) in

2012. In the case of Greece, the surplus of the other investment balance is entirely due to the

large external assistance provided to the Greek government in 2012.

In contrast, among the four countries posting large surpluses in the portfolio investment account

(namely, in order of increasing balance, Italy, France, Belgium and Luxembourg), the first three

countries showed decreases in their residents’ holding of foreign securities in 2012 (i.e., gross

portfolio investment outflows were negative).

40 http://data.worldbank.org/indicator/BN.KLT.PTXL.CD

51