Asia's Choice

Prospects for Foreign Investment in Asia

Linda Y. C. Lim

Asia's Choice: Open Markets or Government Control?

Asia Society's 10th Annual Corporate Conference
Shangri-La Hotel, Makati City
February 24-26, 1999

Nineteen ninety-nine has the potential to emerge as a banner year for foreign investment in Asia. With the region's economies widely expected to bottom out in the first half of the year, asset prices have already started climbing from their nadir, currencies have stabilized, and inflation is under control. Financial reforms and corporate restructuring are under way, restrictions on foreign ownership have been liberalized, and growth should recover in the second half of the year. At the same time, local companies remain heavily indebted, and are being forced to sell stakes to mostly foreign buyers, to secure much-needed infusions of capital that will enable them to pare down debt, and to grow again. State-owned enterprises are being privatized.

Already in 1998, U.S. investors made $17.83 billion in acquisitions in Asia, up from $5.85 billion in 1886, while European investors made $13.46 billion worth, up from a mere $2.25 billion in 1997. The Institute of International Finance projects that foreign direct investments in Indonesia, Malaysia, South Korea, Thailand and the Philippines will reach $18.7 billion in 1999, more than double the total in 1998. In South Korea, foreign direct investment reached a record $8.85 billion in 1998, up 27% from 1998, and including an 87% increase in December alone, the eighth consecutive monthly increase. Even Malaysia, despite its deep recession and imposition of capital controls in September, saw the number of foreign investment applications increase slightly in 1998 over 1997, with the total value of such investments down by only 12%.

Investments in the financial sector have naturally attracted the most attention, with companies like GE Capital, T. Rowe Price, Merrill Lynch, Citigroup, AIG, Fidelity, and Goldman Sachs making large purchases in the areas of leasing, asset management, consumer finance, life insurance, retail banking and brokerage, commercial loans and real estate, mostly in Japan to date, but also in IMF clients Korea and Thailand. Within the region, institutions such as Singapore's DBS and Taiwan's China Investment Corp. have also been expanding their holdings in neighboring countries' financial institutions.

Financial investors have also been buying up industrial assets - as in the early purchase by a group of American investors of electronics manufacturing facilities in Indonesia, and the more recent purchase by AIG and Sweden's Investor Corp. of an 80% stake in Thailand's largest electronics foundry, Alphatec. The ITT conglomerate is also looking to acquire electrical and electronics capabilities in the region.

Within the manufacturing sector, many multinationals, especially the regionally-dominant Japanese, have been injecting more equity capital into their local affiliates and subsidiaries, both to keep them alive during the recession, but also to take advantage of the opportunity to increase ownership and control. A JETRO survey conducted in September 1998 showed that less than one percent of Japanese investors in Southeast Asia were thinking of leaving. Departure would not only mean giving up years of investment in capital equipment, production, training, learning, marketing, distribution and business relationships, it would also entail difficulty in re-entering when the local markets return to prosperity, as everyone believes they will, perhaps before long.

At the same time, devalued currencies have reduced the price of acquisitions in yen or dollars, while increasing the competitiveness of export sectors. Thus Matsushita, for example, is upgrading its export-oriented factories in Malaysia, and some companies - like the Japanese indicator-light manufacturer Patlite - are even taking advantage of the collapsed rupiah to set up or expand export-oriented manufacturing facilities in Indonesia. Agribusiness corporations like Indonesia's Asia Pulp and Paper have been attractive targets on regional stock exchanges, because of their ability to benefit from increased export competitiveness.

Some investments are being made to reduce competition - as, for example, in Hewlett-Packard's $126.7 million purchase of South Korea's SK Group's computer systems division - or expand inter-firm cooperation - as in Intel's $100 million investment in Samsung's memory chips operations. Others are being made to preserve lucrative contracts, as in Lockheed Martin's $150 million acquisition of a 30% stake in Asia Cellular Satellite, an Indonesian-Philippine-Thai partnership that had given it $500 million in satellite-building contracts for the regional wireless phone market.

Acquisitions are also a way of increasing market share without incurring the often substantially higher costs of greenfield investments and risk of adding to regional and global excess capacity. Thus cash-abundant General Motors and Ford have both been exploring and starting to make acquisitions in the automotive sector, as well as constructing new greenfield operations, for which they are able to obtain more attractive investment incentives than previously. Singapore Telecoms, sitting on $3.57 billion of reserves, is on a regional shopping spree and has paid $318.9 million for 20% of Thailand's biggest cellular phone operator. Other Singapore GLCs (government-linked companies) are scouting out similar opportunities.

Belief in the explosive long-term potential of the Asian market - in everything from credit cards to cement - underlies much of this new foreign investment. Even in the depths of recession, Borders Books has been doing so well in Singapore it is opening a second megastore. Starbucks is opening coffee shops in cities throughout the region, and Unilever's business is doing well in both Thailand and Indonesia. Coca-Cola has been increasing its equity in joint-venture operations in Thailand, South Korea and Vietnam, and expanding its marketing budgets in the region. Nissin of Japan has just acquired a sizeable stake in the world's largest instant-noodle company, Indofoods of Indonesia. With reduced income, many consumers can still afford to buy a book, a cup of coffee, a can or bottle of Coke, a sachet of shampoo and packet of instant noodles, even though it may be many years before they buy a new cell-phone, sign up for a credit card or return to the car market, which itself has been picking up lately.

In the longer term, favorable demographics and savings rates, improved government macroeconomic management, trade and investment liberalization, and efficiency gains from financial and industrial restructuring - all promise a return to rapid growth in this most populous part of the world. For investors from mature industrial markets like Japan, the U.S. and Europe, emerging markets still offer the best hope for long-term growth, and among emerging markets, Asia's fundamentals, especially after the crisis, are by far the best.

Asia thus forms a critical part of the growth strategies of multinationals which are reshaping themselves as globally-integrated worldwide corporations, with global production for world markets located in the most cost-effective locations and regional production bases to take advantage of logistic cost-savings and regional market synergies. Thus two of the earliest entrants into the post-crisis investment game in Southeast Asia were Switzerland's Holderbank and Mexico's Cemex, No. 1 and No. 3 respectively among global cement companies, which have been competing against each other to acquire cement companies in Thailand, Philippines and, most recently, Indonesia, despite the doldrums in the regional construction industry. In industries where global scale matters, any medium-sized country which can add to your global market share and scale economies becomes important.

Asea Brown Boveri (ABB), Europe's largest engineering company, illustrates another aspect of global integration, with its global restructuring to reduce productive capacity in high cost Europe and expand it in newly low-cost Asian countries, according to shifting comparative advantage. For example, ABB's Malaysian unit now undertakes project engineering work on Latin American plants that was once done in Switzerland. Japanese multinationals like Matsushita and Hitachi are also moving more R&D to their facilities in Malaysia and Singapore, where relatively cheap, English-speaking and Western-trained engineers help to integrate global R&D activities with their American and European subsidiaries.

This discussion has emphasized the market forces driving the expected increase in foreign investment to Asia - currently low production costs and asset prices, good long-term market expansion prospects, and global strategic considerations facing investors. Government policy has a role to play in this process largely through the lifting of ownership restrictions and the mandating of financial reforms and corporate restructuring - to date, mostly in Korea, which has concomitantly and immediately benefited from large capital inflows as a result.

Acceleration of bank recapitalization efforts and modern bankruptcy provisions in Thailand and Indonesia, the further relaxation or elimination of capital controls in Malaysia, and the establishment of social peace and political stability in Indonesia, are further necessary developments to attract more foreign investment. More rapid regional trade liberalization, for example, through AFTA and AICO measures in Southeast Asia, would also increase the region's attractiveness to direct foreign investment in manufacturing by making possible the achievement of global scale and efficiency of resource allocation according to comparative advantage among member countries.

What about government investment incentives beyond liberalization? Economists usually consider such incentives as tax breaks, training and infrastructure subsidies as distortionary or "second-best" policy options, the use of which is likely to be increasingly curtailed by WTO rules, and which also risk "beggar-my-neighbor" effects. But there is no question that they can in individual country and company cases be effective in attracting investment that would otherwise not locate in a particular place. This dilemma remains to be resolved, but my own sense is that the market-based strategic and cost reasons I have mentioned are likely to increasingly dominated over government policy incentives as motivations for investment in increasingly liberalized national and regional host environments.

It remains to consider the impact of increased inflows of foreign investment, often into previously protected or state-owned sectors, on Asian host economies and local businesses. While the inflow of much-needed capital, technology and global management best-practices has unambiguous net benefits for the host economy as a whole, local firms displaced by foreign investors and competitors and nationalistic host governments may have ambivalent reactions.

Is it the fate of the smaller countries of Asia - large or at least medium-sized though they may be by global standards - to become so integrated into the global networks of multinational industrial and financial companies that they become mere "branch-plant economies", deprived of "national champions" and integrated domestic industries and markets, and lacking alternatives to increased dependence on the global strategic decisions of foreigners - in other words, to become like Canada?

And if this is indeed their fate, is it bad, and if so, why and for whom, and what if anything can be done to reduce such dependence or to minimize vulnerability to its disruptive effects? As the financial crisis has taught us all, it may be in the protection against vulnerability to external shocks and international contagion, that the most important role for host governments may lie, rather than in the restriction or attraction of predominantly market-driven foreign capital.