WORLD TRADE
ORGANIZATIONWT/WGTI/W/95
2 February 2001
(01-0526)
Working Group on the Relationship
between Trade and Investment
FOREIGN DIRECT INVESTMENT AND THE BALANCE-OF-PAYMENTS
Note by the Secretariat
I. INTRODUCTION
1. This note has been prepared in response to a request from the Working Group for additional
information on the effects of FDI1, in particular when and why certain effects might be viewed as
being "negative" for the development and economic growth of host countries as has been suggested
during the Working Group's discussions by some delegations.2  Most of these delegations have stated
that they are not suggesting the overall effects of FDI should be judged solely by one or other of its
many effects, nor questioning that the overall effects of FDI can be positive;  they are interested,rather, in exploring what policy implications migh t be drawn to allow governments to maximize the
positive and minimize the negative effects of FDI, such as they are.
2. An earlier Secretariat note (WT/WGTI/W/65) covered the technology and other know-how
transfer and spillover effects of foreign direct investment (FDI) for host countries.  This one covers
the effects of FDI on a host country's balance-of-payments.
II. BALANCE-OF-PAYMENTS CONCERNS
3. A few studies have been made of the "net" or "overall" balance-of-payments effects of FDI.
These were reported on by UNCTAD in its contribution to the Working Group's discussions in
September 1997, drawing on survey material and original data contained in its World Investment
Report of that year.3  UNCTAD noted that the potential for FDI to have negative effects on the
balance-of-payments of developing countries figured prominently in two studies undertaken on FDI in
the 1970s4, but that since then conditions and policy orientation have changed, which could give rise
to doubts as to the relevance of these studies to current analysis.5  Those doubts were echoed in an
OECD contribution to the Working Group.6
4. One condition in particular that has changed since the 1970s is that FDI is no longer
concentrated to anything like the same degree in protected, import substitution activities in host
countries ("market-seeking" FDI) with little potential to generate exports.  This is relevant ininterpreting the earlier literature, which identified the existence, or lack of, a competitive environment
in which the foreign subsidiaries surveyed were operating as the key determinant of whether FDI had
                                                     
1 The original request is recorded in WT/WGTI/M/5, paragraph 12.
2 See WT/WGTI/M/2, 3, 4, 5 and 6.
3 WT/WGTI/W/8/Add.1.  UNCTAD, World Investment Report, 1997, pp. 85-94.  See also UNCTAD
(1999) Series on issues in international investment ag reements:  "Foreign Direct Investment and Development",
pp. 25-27, which covers some of the same ground.
4 UNCTAD cites Lall, Sanjaya. and Paul Streeten (1977), Foreign Investment, Transnationals and
Developing Countries, (London:  Macmillan Press), and the U.N. Centre for Transnational Corporations (1981),
Transnational Corporations: Direct Effects on the Balance-of-payments, (UN document No. E/C.10/84, 6 April).
5 UNCTAD, World Investment Report, 1997, p. 88.
6 WT/WGTI/W/26.WT/WGTI/W/95
Page 2
a "positive" or "negative" effect on national income.  In addition, UNCTAD noted that developing
countries are no longer subject today to the same kind of binding foreign exchange constraint to their
growth which they faced earlier, given much higher international mobility of capital7.
5. In its World Investment Report for 1997, UNCTAD provides estimates of the net trade and
current account effects of FDI in China, Malaysia, Singapore and Thailand in the first half of the
1990s, with mixed results in terms of net surpluses and deficits (see below), and UNCTAD and the
OECD cite recent studies by Fry8 showing that in the cases he examined FDI initially worsened the
current account balance but improved both the trade and the current account balance in the long-run.
6. In their written contributions to the Work ing Group, both UNCTAD and the OECD noted that
the effects of FDI on the balance-of-payments are bound to be country specific, and sensitive to the
type of investment made and its age structure.9  Both noted that an assessment of the balance-of-
payments effects of FDI depends crucially on a proper specification of the counterfactual:  whatwould have happened to the balance-of-payments in the absence of FDI?  Both pointed also to the
complex direct and indirect effects of FDI on a host country's balance-of-payments, encompassing not
only the external trade and financial transactions of foreign affiliates but also those of domestic
enterprises that develop around them (transactions which are likely to mature and alter over time) as
well as the cumulative effect of increased economic activity stimulated by FDI on a host country'ssavings-investment relationship, the ultimate determinant of its balance-of-payments situation.
7. In a static sense, FDI can generally be regarded as an initial capital inflow (whether it
represents greenfield investment or M&A activity) coupled with subsequent capital inflows (new
injections of capital) and outflows (repatriation of profits, royalties, etc.), and trade inflows (imports
of capital goods and intermediate inputs associated with the investment) and outflows (the substitutionof domestically-produced goods and services for imports as well as exports of goods and services).
There may also be balance-of-payments effects of new domestic economic activity in the host
economy that is generated by the presence of FDI and which would not have taken place in its
absence, for example new import-substitution activity to supply FDI with goods and services or new
export-oriented production that develops as a spin-off from FDI (e.g., through diffusion in the hosteconomy of FDI's technology and managerial know-how).
8. The need to view these effects holistically for the purposes of policy analysis was brought out
in a contribution to the Working Group by Japan, which noted that grouping together selected effects
of FDI on a host country's balance-of-payments can give a thoroughly misleading impression of the
overall effect.
10  For example, focusing on increased imports by FDI affiliates in the short-term
coupled with their repatriation of profits over the mid- to long-term is likely to give the impression of
an overall "negative" effect, but doing so ignores the potential "positive" effects of a foreignsubsidiary importing capital, generating exports, producing import substitutes, and so on.
9. Disentangling empirically the effects of FDI on the balance-of-payments of a host country is
difficult, and is in any case unlikely to have much practical relevance for balance-of-payments policy-
making for several reasons.  First, FDI is generally not the most important factor influencing a
                                                     
7 UNCTAD (1997), Op cit.
8 Fry, Maxwell (1993), Foreign Direct Investment in Southeast Asia: Differential Impacts, (Institute of
Southeast Asian Studies, Singapore), and (1996), "How foreign direct investment in Pacific Asia improves the
current account", Asian Economics , 7, 3, pp. 459-486.
9 In a more recent study, UNCTAD states, for example, that:  "… investments in non-export oriented
firms in general and in non-tradeable products in particular (most services, construction), usually have negativedirect balance-of-payments effects, since most such projects require imported inputs and neither generate norsave foreign exchange on the output side."  (UNCTAD, Foreign Direct Investment and Development, 1998,
p. 26).
10 WT/WGTI/W/11.WT/WGTI/W/95
Page 3
country's balance-of-payments position, given that FDI's contribution to gross domestic investment in
host countries rarely exceeds 15 per cent.11  Second, since the balance-of-payments is an essentially
macroeconomic variable, and since foreign investors' investment and operating decisions tend to be
formulated as an integral whole, policies targeted at improving just one aspect of the balance-of-
payments effects of FDI (for example its import-intensity) can have offsetting effects on others (forexample its export-intensity).  Third, a supposed "negative" balance-of-payments effect of FDI (for
example, increased imports of capital goods and machinery) may equally be counted as a "positive"
effect when viewed from other perspectives on a host country's growth and economic development
(for example, capital formation or technology transfer).
10. With these qualifications in mind, the followin g sections review those individual aspects of
FDI which some delegations have suggested can produce negative effects on the balance-of-payments
of host countries.  Their concerns fall broadly into four categories:  increased imports of capital goodsand intermediate inputs;  transfer pricing;  the repatriation of profits, dividends and royalty payments;
and FDI and balance-of-payments management, particularly in the light of the recent financial crisis
in emerging economies.
III. FDI AND IMPORTS OF CAPITAL GOODS AND INTERMEDIATE INPUTS
11. Generally, FDI produces its largest impact on a host country's balance-of-payments through
the trade flows associated with it.  Leaving aside the case of a totally closed host country, all FDI will
result in some increase in imports, if only by virtue of its effect on the level of domestic economic
activity.  Most probably FDI itself will create a new source of demand for imports, and so will
domestic enterprises that develop around the activities of foreign affiliates.
12  Attention will be
focussed here only on imports consumed directly by foreign affiliates in the host country, since thisappears to be the main source of concern of those delegations that have raised this issue in the
Working Group's discussions.
12. A greenfield FDI project in a developing host c ountry will most probably require initial inputs
of imported machinery and equipment as well as intermediate goods and services.  Beyond the
establishment phase, many factors seem to play a role in determining the extent to which a foreign
affiliate will continue to rely upon imports of goods and services.  They include the particular sector
or industry of the host economy in which FDI operates (FDI in the agriculture, mining and many
service sectors, for example, tends to be rela tively less import-intensive on the whole than in
manufacturing), and the age of a project (as a project matures over time foreign affiliates tend to
become less dependent upon imported inputs as domestic component suppliers and subcontractors
develop).  It is nevertheless not easy to generalize on the basis of what little empirical evidence exists.
13. One end of the spectrum has been described as follows by the OECD: "Many of the most
export-oriented foreign investors located in export processing zones throughout Southeast Asia and
elsewhere are heavily dependent on imported inputs.  Imports as a percentage of exports of finished
goods in the automatic data processing equipment industry in Malaysia, for example, represent
95 per cent of exports.  On average, in the electronics sector in the three Southeast Asian countries,
imports are the equivalent of 80 per cent of exports, suggesting a very low level of local content inthis sector".
13  Low local content of material inputs, however, does not equate necessarily to low
                                                     
11 In 1998, for example, inward FDI accounted for 10.5 per cent of gross fixed capital formation in
Asia, 14.7 per cent in sub-Saharan Africa, and 16.6 per cent in Latin America. (UNCTAD, World Investment
Report 2000).
12 UNCTAD suggests that even as local sourcing increases, there may still be an increase in imports to
satisfy the demand from local component suppliers.  See World Investment Report, 1997 citing  U.N. Centre for
Transnational Corporations (1981) op cit.
13 OECD, (1998), Foreign Direct Investment and Economic Development: Lessons from six emerging
economies, (Paris), p. 56.WT/WGTI/W/95
Page 4
domestic value-added, so that even looked at in this narrow sense FDI can be a "positive" net
generator of foreign exchange for the host countrie s concerned, and evidently that was so in the cases
cited by the OECD.
14. UNCTAD cites a similar case-study which, from a survey in 1995 of 18 of the largest foreign
affiliates in the electrical and electronic industries in Malaysia, found that the value of importedmaterials and components accounted for 78 per cent of their total inputs, which is much higher than
the average for all manufacturing industries.
14  As UNCTAD goes on to note, however, this is a global
and highly competitive industry which is dependent on specialized inputs that meet precise quality
standards, and it cites studies pointing to encouraging signs of foreign affiliates forging backward
linkages and replacing imported inputs by domestically produced substitutes.15  In comparison,
UNCTAD notes, FDI based on extractive industries in Malaysia require relatively fewer imported
inputs and produce higher domestic value-added per unit of output.16
15. Hill and Athukorala note with respect to FDI in export processing zones "… the criticism that
EPZ activities tend to be footloose, with shallow linkages, ignores the inevitable time taken by new
entrants to EPZs to forge those linkages with the domestic economy.  There is convincing evidence
[which they cite] that EPZ firms te nd to increase their local purchases and shift to more sophisticated
production processes as their operations mature, provided the local business environment is conduciveto such behaviour."
17
16. UNCTAD has estimated the trade flows associated with FDI in China and Malaysia in the
period 1990-1995.18  While noting the serious data constraints involved in a task of this nature, it
found that in China, FDI produced large trade deficits during the reference period but that exports
attributed to FDI were growing somewhat more quickly than their imports.  UNCTAD adds, however,that a substantial proportion of the imports consisted of investment goods for the non-processing trade
of foreign affiliates, and that the import intensity of processed exports of foreign affiliates showed a
marked decline from 92 per cent in 1994 to 78 per cent in 1996.  In the case of Malaysia, exports and
imports attributed to FDI were more equally matched, producing net trade deficits in three out of the
five years covered, but imports of foreign affiliates were growing somewhat faster than their exports.
17. It needs to be borne in mind, of course, that comparisons of this nature can be misleading
since they take no account of imports "saved" through the production by foreign affiliates of import
substitutes in China and Malaysia.  This can be considerable, as was shown in data provided to the
Working Group by Japan
19:  in 1994, Japan estimated that while Japanese FDI in ASEAN increased
ASEAN imports by more than it increased ASEAN exports ($26.4 billion against $19.9 billion), the
import substitution effect was substantially greater still ($30.3 billion) and produced an overall trade
surplus effect of Japanese FDI on ASEAN's balance-of-payments.
                                                     
14 Ariff, Mohamed and Yew Siew Yong (1996), "Transnational corporations and industrial
restructuring in developing countries:  the case of Malaysia" (Kuala Lumpur: University of Malaysia), mimeo,cited in UNCTAD (1997) op cit.
15 Athukorala, Premachandra and Jayant Menon (1995), "Developing with foreign investment:
Malaysia", The Australian Economic Review, 1st quarter, pp. 9-22;  and Sivalingham, M. and Siew-Peng Yong
(1993) "TNCs and industrialization in Malaysia:  organisational behaviour and local and regional impacts",
Regional Development Dialogue, 14, 4 (Winter), pp. 40-64, cited in UNCTAD (1997) op cit. , p. 91.
16 UNCTAD cites Sivalingham and Yong (1993), op cit. , as finding that the local content of total input
in resource-based FDI in Malaysia in 1983 was 76 per cent.
17 Hill, Hal and Prema-chandra Athukorala (1998), "Foreign Investment in East Asia:  A Survey",
(Asian-Pacific Economic Literature, volume 12, 2, November).
18 UNCTAD, (1997) World Investment Report, p. 89.
19 WT/WGTI/W/11.WT/WGTI/W/95
Page 5
18. In the same study noted above, UNCTAD reported that for Thailand: "A decomposition
analysis of the sharp increase in the import to GDP ratio from 25 per cent in 1985 to 40 per cent in
1991 showed that this was largely due to a rise in import dependency, which was related to the
growing role of FDI.  Foreign investment pr ojects imported 90 per cent of all machinery and
equipment and over 50 per cent of raw materials.  The trend towards intra-regional networks of FDIand trade may have further strengthened this dependence.  In 1995, the ratio of total merchandise
imports to GDP increased even further to over 42 per cent.  However, import dependency that is
related to FDI, especially that involving imports for processing, is likely to be cyclically sensitive.
Hence imports will probably decrease as capacities in affected industries become less fully utilised.
Moreover, considering that over 43 per cent of total imports in 1990-1995 were capital goods, the
current BOP constraint resulting from such imports has to be weighed against future growth in income
and savings".
20
19. In the case of FDI in Singapore, UNCTAD concluded that:  "The presence of many local
firms that supply and service foreign affiliates in Singapore implies that domestically-sourced inputs
and value-added are likely to be significant."
20. A significant feature of FDI in the Asian region in this context has been intra-affiliate trade in
several key industrial sectors, whereby the imports of goods and services by subsidiaries located inone country in the region represent exports of goods and services from subsidiaries located in others.
21
This highlights again the potentially misleading results derived by analysing the import-intensity ofFDI activity in isolation from its other effects on a host country's balance-of-payments.
21. Several studies provide evidence that import requirements per unit of output of foreign
affiliates tend to decline as local sourcing increases over time.  McAleese and McDonald found that tobe the case in Ireland for the period 1952-74, as did Orr in the case of Japanese foreign affiliates in the
United States for the period 1967-89, and Fry confirmed this in host countries in the Asia-Pacific
region in the 1980s.
22  UNCTAD found that local procurement of Japanese affiliates in Asia increased
from 27 per cent of total procurement in 1981 to 44 per cent in 1988, although this had fallen back
again to 34 per cent by fiscal year 1994.23  In Latin America, UNCTAD found there was a steady
increase in the ratio from 28 per cent in 1981 to 39 per cent in fiscal year 1994.24
22. Korea has provided evidence of this trend to the Working Group25, where it noted that:  "In
the early 1980s, the import inducement effect [of FDI] was significant, as foreign affiliates procured
raw materials, capital goods and equipment from home countries.  But the import substitution effect
progressively increased as a result of the localization of foreign affiliates, countervailing the import
inducement effect noted above."
23. One policy response that has been used to try to reduce the import-intensity of FDI, and hence
this aspect of the "negative" balance-of-payments effects of FDI, in host countries is requiring
subsidiaries to meet a certain proportion of domestic content.  In a recent study, Moran26 notes that:
                                                     
20 UNCTAD (1997) op cit. , p. 92.
21 See, for example, Dobson, W. and S. Y. Chia (1997), "Multinationals and East Asian integration",
(Institute of Southeast Asian Studies, Singapore).
22 Orr, James (1991), "The Trade Balancing Effects of Foreign Directr Investment in U.S.
Manufacturing", FRBNY Quarterly Review , Summer, pp. 63-76;  Fry, Maxwell (1993 and 1996), op cit.
23 UNCTAD, (1997), op cit. , fn.63, p. 104.
24 Ibid.
25 WT/WGTI/W/16.
26 Moran, Theodore H. (1998), Foreign Direct Invest ment and Development, (Institute for International
Economics, Washington D.C.), p. 32, citing Grossman, Gene (1981), "The Theory of Domestic Content
Protection and Content Preferences" (The Quarterly Journal of Economics, 96, No. 4),  Davidson, Carl, Steven
J. Matusz, and Mordechai E. Kreinin (1985), "Analysis of Performance Standards for Direct ForeignWT/WGTI/W/95
Page 6
"Grossman (1981) and others (Davidson, Matusz, and Kreinin 1985;  Herander and Thomas 1986;
Rodrik 1987) have found that the domestic content mandate may reduce a country's export potential
so much that it leads to a deterioration in the balance-of-payments".
IV. FDI AND TRANSFER PRICING
24. Transfer pricing refers to the pricing of tran sactions conducted within a single multinational
enterprise, between the parent company and its affiliates, and among the affiliates.  According to
UNCTAD:  "The terms of these transactions (prices in particular, but also delivery and payment
conditions etc.) are determined on the basis of internal calculations which may or may not fully reflect
the corresponding terms in the arm's-length market.  Firms sometimes abuse the possibilities offered
by such transactions to avoid income or other taxes, import duties or exchange controls.  Transfer
pricing and related transactions can also be used as a restrictive business practice to eliminate
competition".27
25. Very little empirical information is available on this subject.  UNCTAD28 briefly places
transfer pricing in the context of possible balance-of-payments concerns of host countries, citing
Vaitsos29, but like other commentators it gives most attention to transfer pricing in the context of
concerns that it may be used to evade taxes in host countries.  UNCTAD states that evidence exists of
abusive transfer pricing in this context.30  UNCTAD states also that transfer pricing was a serious
concern of host countries in the 1970s.31  "At that time, profit remittances were often restricted, and
profit taxes in host countries were often higher than  those in home countries.  It is of less concern now
as foreign investors can remit profits with greater ease and as income tax rates on foreign company
profits have tended to decline in most developing countries, which now usually apply national
treatment to TNCs on tax matters".  UNCTAD goes on to state that the issue is still important, andthat the more complex is the relationship between parent firms and foreign affiliates, the greater are
the opportunities for abusive transfer pricing.  Nevertheless, in UNCTAD's view: "The signing of
double taxation treaties goes a long way towards solving the problem, because it removes much of the
incentive for transfer pricing".
32
V. FDI AND THE REPATRIATION OF PROFITS AND DIVIDENDS, AND PAYMENTS
OF ROYALTIES
26. FDI most often takes the form of equity capital which, as opposed to debt-creating
instruments, imposes no obligation to make fixed interest payments or to reimburse the principal at a
pre-determined date.  It does, however, set up a future outflow of repatriated profits, repayments of
loans from affiliates to parent companies or to other foreign creditors, and payments for royalties,
licence fees and technical assistance.
                                                                                                                                                                    
Investments" (Canadian Journal of Economics, 18, No. 4), Herander, Mark G., and Christopher R. Thomas
(1986), "Export Performance and Export-Import Linkage Requirements" (The Quarterly Journal of Economics,
101, No. 3), and Rodrik, Dani (1987) "The Economics of Export-Performance Requirements" (The QuarterlyJournal of Economics, 102, No. 3).
27 UNCTAD (1996), World Investment Report, p. 186.
28 UNCTAD (1997), World Investment Report, p. 86.
29 Vaitsos, Constantine V. (1973), "Policies on foreign direct investment and economic development in
Latin America" (Brighton, Institute of Development Studies, University of Sussex).
30 UNCTAD (1996), "Transfer pricing regulations and transnational corporation practices:  guidance
for developing countries" (Geneva, mimeo), cited in UNCTAD, World Investment Report, 1996, p. 186.
31 UNCTAD (1999), Foreign Direct Investment and Development, (Geneva), p. 27, citing Plasschaert,
Sylvain, ed. (1993) Transnational Corporations, Transfer  Pricing and Taxation, (U.N. Library on Transnational
Corporations, vol. 14).
32 Ibid, p. 28.WT/WGTI/W/95
Page 7
27. UNCTAD has noted that payments of direct investment income are likely to increase over
time as they are a function of the stock of inward FDI;  it adds that such payments necessarily begin
only after new investments become productive and/or profitable.33
28. According to UNCTAD:  "… since FDI inflows ev entually give rise to outflows of profits,
associated with repayments of loans to foreign affili ates as well as payments for licences and technical
assistance, outflows could eventually  exceed inflows.  More precisely, the issue revolves around the
comparison between the inflow of foreign exchange associated with an investment project and the
present value of future values of profits, using as the discount factor the international interest rate at
which the country can borrow.  Normally, one can expect that discounted future outflows will be
larger than the capital originally invested since profit rates, particularly in developing countries, tend
to be well above international interest rates."34
29. A comparison of the kind suggested here by UNCTAD warrants a reference back to the
qualifications made at the beginning of this Note about the potentially misleading impression that can
be left from aggregating only selected aspects of the effects of FDI on a host country's balance-of-
payments, as well as the importance of stating the proper counterfactual:  for example, what "positive"
balance-of-payments effects are created by a foreign affiliate in the process of generating profits and
consuming licences and technical assistance?;  what proportion of profits are retained for reinvestmentin the host country?;  and what access to international capital markets does a host country have in the
absence of FDI, and on what terms (particularly in the aftermath of the recent financial crises in
emerging market economies)?
30. Empirical evidence of the financial flows associated with FDI is difficult to find.  Noting the
serious data constraints involved, UNCTAD estimated that in the case of Malaysia profit remittancesand other direct investment income payments rose from about $2 billion in 1990 to over $5 billion in
1995, by which time they were exceeding new capital inflows of FDI, whereas in China in 1995 direct
profit remittances and direct investment income payments were recorded at about $10 billion and new
capital inflows of FDI at about $36 billion.
35
31. It is hard to draw conclusions in the absence of better statistics.
VI. FDI, BALANCE-OF-PAYMENTS MANAGEMENT AND FINANCIAL CRISIS
32. Deficits in the current account of the balance-of-payments are not necessarily a cause for
alarm for developing countries.  Efforts to boost domestic investment and economic growth may
necessitate increased reliance upon imported capital to supplement domestic savings.  The key issue is
the sustainability of a current account deficit over time.  This depends importantly on the extent to
which increased export earnings become available to meet external financial obligations arising from
the foreign capital inflow.  The level and composition of net external assets is also important, sinceincreased export earnings may take some time to build up and external economic shocks may disrupt
expected net inflows of foreign capital in the meanti me.  It is in this context, especially in the
aftermath of the recent financial crisis in emerging market economies which began in Asia in 1997,
that concerns have been expressed by some delegations over the potentially damaging effects that a
sudden net outflow of capital can cause to the balance-of-payments of a host country.
                                                     
33 UNCTAD (1997), World Investment Report, p. 86.
34 UNCTAD (1999), Foreign Direct Investment and Development, p. 25.
35 UNCTAD (1997), World Investment Report, p. 89.WT/WGTI/W/95
Page 8
33. In its written contribution to the Workin g Group, the OECD examined concerns that
excessive reliance on external financing may make an economy vulnerable to sudden reversals in
financial market conditions and investor sentiment.36  It concluded as follows:
"Evidence suggests that FDI is less likely to raise such problems than other types of capital
inflows.  Direct investment involves much mo re stable and generally smaller amounts of capital
than portfolio investment and credits.  Because  the transaction costs, and therefore the risks
involved, are considerably higher when an invest or establishes an enterprise compared to the
purchase of short-term Treasury bills for example,  green-field direct investments represent long-
term, carefully selected investment projects  which cannot be liquidated at short notice.
Furthermore, direct investment most often takes the form of equity capital, which, as opposed to
debt creating instruments, imposes no obligations on the debtor to make fixed interest payments
and to reimburse the principal at a determined date; a foreign investor may be unable orunwilling to liquidate his shares unless he can find a counterpart willing to buy them at the
desired price.  Finally and perhaps even more importantly, in the absence of perfectly fluid
financial markets and substitutable financing instru ments, direct investment can be expected to
contribute to the financing of productive investme nt in a higher proportion overall than portfolio
investment and credits, thereby enhancing the host country’s capacity to assure the service of its
debt through increased exports at a later stage."
34. In a subsequent submission, the OECD discusse d how allowing greater foreign participation
in financial services helps reduce the risk of banking crises in host countries by increasing
competition and efficiency and improving the quality of banking regulation
37, points that were
supported on the basis of experience by a member of the Working Group.38
35. Other studies have reached similar conclusions.  In assessing prospects for FDI in Asia
shortly after the financial crisis began, UNCTAD expressed cautious optimism about the
maintenance, and even increase, of FDI flows to the region, including the most affected countries, on
the grounds that economic fundamentals (high domestic savings rates, skilled and flexible human
resources, substantial infrastructural capacity, and access to regional markets) remained sound andattractive:  "Since FDI is mainly a real investment in firms, its mobility is limited by factors such as
physical assets, networks of suppliers, the local infrastructure, human capital and the institutional
environment;  FDI stocks are generally not footloose".
39
36. The record of international capital movements in the wake of the financial crisis supports
these conclusions.  Annex Table 1 shows net priv ate capital flows to emerging market economies
during the 1990s.  In 1995, net FDI flows overtook net portfolio investment as the most important
source of foreign financing for these economies, and these flows continued growing throughout theperiod of financial crisis while portfolio investment and bank lending collapsed.  The countries
concerned continued to liberalize their policies towards inward-FDI throughout the decade, and FDI
responded positively to this as well as to the underlying economic fundamentals.
40  Net FDI flows are
now an important component of current account financing for many of these countries, and make an
important and increasing contribution to domestic capital formation and to GDP.
                                                     
36 WT/WGTI/W/8, pp. 19-21.
37 WT/WGTI/W/26.
38 WT/WGTI/M/4, para. 11.
39 UNCTAD/ITE/IIT/Misc.13, "The Financial Crisis in Asia and Foreign Direct Investment:  An
Assessment", September 1998.
40 UNCTAD, World Investment Report 2000.WT/WGTI/W/95
Page 9
ANNEX 1
TABLE:  NET PRIVATE CAPITAL FL OWS TO EMERGING MARKETS, 1992-99
(IN BILLIONS OF US DOLLARS)
1992 1993 1994 1995 1996 1997 1998 1999
Emerging markets
Total net private capital inflows
Net foreign direct investmentNet portfolio investmentBank loans and other112.6
35.4
56.121.0172.1
59.4
84.428.3136.3
84.0
109.6
-57.3226.9
92.6
36.997.4215.9
113.2
77.824.9147.6
138.6
52.9
-44.075.1
143.3
8.5
-76.780.5
149.8
23.3
-92.5
Africa
Total net private capital inflows
Net foreign direct investment
Net portfolio investmentBank loans and other-4.0
0.6
1.8
-6.4-1.8
1.9
1.0
-4.72.9
2.3
2.0
-1.410.9
2.2
1.47.37.5
4.8
1.31.416.7
7.4
3.75.611.5
5.2
4.32.014.8
9.5
4.40.9
Asia
Total net private capital inflows
Net foreign direct investment
Net portfolio investment
Bank loans and other20.8
15.7
9.0
-3.957.4
33.9
21.8
1.763.6
47.1
11.8
4.7104.9
46.6
14.2
44.1104.1
53.1
12.9
38.1-1.4
55.5
3.5
-60.4-42.6
58.3
-17.9
-82.9-27.0
49.9
-5.6
-71.3
Five crisis-affected Asian countries1
Total net private capital inflows
Net foreign direct investmentNet portfolio investment
Bank loans and other29.0
7.3
6.4
15.331.8
7.6
17.2
7.036.1
8.8
9.9
17.474.2
7.5
17.4
49.265.8
8.4
20.3
37.1-20.4
10.3
12.9
-43.6-25.6
8.6
-6.0
-28.2-24.6
10.2
6.3
-41.1
Europe
Total net private capital inflows
Net foreign direct investmentNet portfolio investment
Bank loans and other6.5
5.1
2.3
-0.827.4
6.7
12.4
8.41.8
6.1
21.5
-25.848.8
14.6
14.6
19.726.7
14.4
19.6
-7.432.2
20.3
23.3
-11.416.3
21.7
0.7
-6.118.0
24.2
6.6
-12.8
Middle East
Total net private capital inflows
Net foreign direct investmentNet portfolio investmentBank loans and other33.7
0.2
12.720.822.3
3.5
5.1
13.618.6
5.4
7.65.69.1
4.6
3.80.85.6
1.4
3.01.214.6
2.3
3.39.019.9
2.0
6.7
11.220.6
2.6
7.3
10.8
Western Hemisphere
Total net private capital inflows
Net foreign direct investmentNet portfolio investmentBank loans and other55.6
13.9
30.311.466.8
13.4
44.0
9.449.4
23.1
66.7
-40.453.1
24.7
3.0
25.572.1
39.5
41.0
-8.485.5
53.1
19.213.270.0
56.1
14.7
-0.854.1
63.6
10.6
-20.1
Current account
Emerging markets
AfricaAsiaEuropeMiddle East
Western Hemisphere-72.7
-10.0
3.6
-6.6
-25.1
-34.5-110.3
-11.2
-13.2-14.5-25.4
-46.0-73.8
-11.5
-4.4
5.8
-11.5
-52.2-112.5
-16.5
-50.4
-3.1-5.7
-36.8-96.0
-7.0
-38.5-20.0
7.8
-38.3-77.4
-7.4
18.0
-29.4
5.4
-64.1-49.5
-20.0
114.9
-23.6-32.2
-88.621.5
-16.8
103.1
-6.6-4.1
-54.2
As percent of emerging markets' GDP
Direct investmentPortfolio investmentBank loans and other0.7
1.10.41.0
1.50.51.4
1.9
-1.01.4
0.61.51.6
1.10.41.9
0.7
-0.62.1
0.1
-1.12.1
0.3
-1.3
Sources:  IMF, International Capital Markets , September 2000.
1Indonesia, Korea, Malaysia, Philippines, and Thailand.
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