New Concerns in an Uncertain World the 2007 A.T

New Concerns in an Uncertain World The 2007 A.T. Kearney FDI Confidence Index® The Global Business Policy Council is a strategic service that assists chief executives in monitoring and capitalizing on macroeconomic, geopolitical, socio-demographic and technological change worldwide. Council membership is limited to a select group of corporate leaders and their companies. The Council’s core program includes periodic meetings in strategically important parts of the world, tailored analytical products, regular member briefings, regional events and other services.

Global Business Policy Council A.T. Kearney, Inc. 8100 Boone Boulevard Suite 400 Vienna, Virginia 22182 U.S.A.

1 703 891 5500 t e l e p h o n e www.atkearney.com s 2007 turned into 2008, investors were once again operating on unstable ground. Several years of bullish recovery from an early Atwenty-first century recession ended abruptly as the subprime market crisis pummeled the world’s leading financial markets. While the current account deficit of developed markets persists, emerging markets are enjoying a current account surplus. Persistently high oil prices are dampening hopes that the deficit might decline.

Despite significant obstacles, foreign direct invest- First-wave EU accession states such as Poland, the ment (FDI) continued to rise in 2007, and global Czech Republic and Hungary all fell in the rank- investors are optimistic about opportunities in ings after initial investor exuberance in 2005. the developing world. China and India con- As investors decide how and where to allo- tinue to rank at the top of the FDI Confidence cate their capital, they weigh new considerations. Index. Six of the top 10 countries in this year’s Sustainability—economic, political, social and FDI Confidence Index are emerging markets. environmental—has become a significant world- A seventh, Hong Kong, represents an access point wide issue. Following the lead of corporate giants to the largest emerging market, China. Frontier such as General Electric, Wal-Mart and Toyota, markets such as Vietnam, the Gulf states and survey respondents have adopted new policies South Africa also broke into the top 25 as targets and invested in sustainability projects, which are for foreign direct investment over the next one expected to benefit both the environment and to three years, with multinationals tapping into the bottom line. growth opportunities in fresh target markets. Another important development is the fur- Developing countries, which are expected to ther emergence of private equity, hedge funds and account for an increasing number of large FDI state or government funds as new channels for deals, display special interest in frontier markets global liquidity. Although respondents generally as first-time investment destinations. perceive them as favorable, these channels nev- in the developed world, the United States ertheless compete with traditional FDI. Almost maintains its lead in investor confidence.E urope’s two-thirds of global investors view private equity economic recovery keeps Germany and the United as the greatest source of competition. Moreover, Kingdom in the top 10, while France ranks 13th. three-quarters of firms in the $1 billion to $5 Other European countries, however, fare less well. billion revenue range consider private equity

A.T. Kearney | new concerns in an uncertain world 1 a particular threat to their own FDI plans. cal, economic and regulatory changes on the The clout of these new investment channels is foreign direct investment intentions and pref- expected to grow, while the number of large FDI- erences of the leaders of top companies around financed M&A deals over the next three years the world.1 With responses from global execu- is expected to fall. tives spanning six continents and 17 industry These are among the major findings of sectors, the survey represents a unique window A.T. Kearney’s 2007 FDI Confidence Index® into the present and future prospects for inter- survey, which tracks the impact of likely politi- national investment flows(see figure 1).

Figure 1 2007 FDI Confidence Index®

Top 25

(1) 1 China 2.21 (2) 2 India 2.09 (3) 3 United States 1.86 (4) 4 United Kingdom 1.81 (10) 5 Hong Kong 1.78 (7) 6 Brazil 1.78 (18) 7 Singapore 1.75 (22) 8 United Arab Emirates 1.72 (6) 9 Russia 1.70 (9) 10 Germany 1.70 (8) 11 Australia 1.68 (�) 12 Vietnam 1.67 (14) 13 France 1.67 (21) 14 Canada 1.65 (15) 15 Japan 1.63 (�) 16 Malaysia 1.63 (�) 17 Other Gulf states 1.62 (�) 18 South Africa 1.61 (16) 19 Mexico 1.59 (13) 20 Turkey 1.59 Maintained ranking (�) 21 Indonesia 1.58 Moved up (5) 22 Poland 1.58 Moved down (24) 23 Central Asia 1.57 (#) 2005 ranking (23) 24 South Korea 1.57 (�) Not among top 25 (12) 25 Czech Republic 1.56 in 2005 Index

Low confidence Values calculated on a 0 to 3 scale High confidence

Source: A.T. Kearney

1 Foreign direct investment includes investment in physical assets, such as plants and equipment, in a foreign country. Holdings of 10 percent or more equity in a foreign enterprise is the commonly accepted threshold between direct and portfolio investment as it demonstrates an intent to influence management of the foreign entity. The main types of FDI are acquisition of a subsidiary or production facility, participation in a joint venture, licensing and establishment of a greenfield operation. The last is defined as a direct investment in new facilities or the expansion of existing facilities.

2 new concerns in an uncertain world | A.T. Kearney Major Findings ing markets of China and India. As a first-time investment destination, the United States is more Global FDI continues to recover from a low point attractive to developed market investors than in 2003. According to the United Nations Confer- developing market investors. ence on Trade and Development (UNCTAD), The 52 percent of respondents who plan to global FDI inflows in 2006 reached their second- increase their U.S. investments over the next three highest level in recorded history at $1.3 trillion. Preliminary UNCTAD estimates of global FDI inflows for 2007 amounted to $1.5 trillion, sur- Figure 2 passing the 2000 peak of $1.4 trillion. Developing Top five developments affecting global investors’ nations, which accumulate foreign capital as the decision-making developed world runs up its trade deficits, are increasingly active as global investors and will likely account for a growing share of outbound FDI. Percentage of respondents

55% Despite a Global FDI Recovery, Investors 45% Are Concerned about the United States’ 39% 38% 37% Economic Health As the U.S. subprime mortgage turmoil has spread to the broader U.S. housing market and asset- backed securities markets around the world, and Slowdown U.S. dollar Rising Increased Volatility tightening credit conditions and high oil prices in U.S. volatility interest government of energy exert pressures on global economic growth, global economy rates regulation prices investors are uneasy. Their top concerns in making Source: A.T. Kearney FDI decisions are the slowdown in the U.S. economy (55 percent of investors), volatility of the U.S. dollar (45 percent) and rising interest rates Figure 3 (39 percent). Also on the list are increased gov- Leading risks to the health of the U.S. economy ernment regulation (38 percent) and energy price volatility (37 percent)(see figure 2). Global investors see risks in the United States stemming from Percentage of respondents policy choices such as the cost of the Iraq war (30 30% percent) and looming protectionism (15 percent), as well as from structural problems. They worry about high consumer indebtedness (18 percent), 18% declines in the highly skilled workforce (15 per- 15% 15% 15% cent), and persistent budget and trade deficits (15 percent) (see figure 3). Nevertheless, the United States retains its Cost of the High Decline Persistent Protection- Iraq war consumer in highly budget ist backlash status as the third most attractive FDI destina- indebtedness skilled and trade against workers deficits globalization tion in the world, just behind the large emerg- Source: A.T. Kearney

A.T. Kearney | new concerns in an uncertain world 3 years are encouraged by the country’s continued Asian investors and second among European and stable macroeconomic environment, the large con- North American investors. Both developed and sumer market and robust economic growth, along developing country investors cite China as their with access to cutting-edge technology or research preferred destination for first-time investments. (see figure 4). Investors who plan to decrease or hold China holds its appeal across sectors, topping the constant their level of U.S. investment (48 percent) list for financial and nonfinancial services, light are driven by better overseas investment options, and heavy manufacturing, and primary sectors. It concerns over a major dollar devaluation and a is only surpassed by India in telecommunications slowing of the U.S. economy. This group is also and utilities. deterred by increased R&D regulation and uncer- Global investors remain optimistic about tainty surrounding the 2008 presidential election. China, with 35 percent of investors viewing China’s investment environment more positively China and India Top FDI Rankings than they did one year ago. However, investors China and India remain the top two countries in also report a number of concerns over China’s the Index. China leads the Index rankings for the investment environment. They are primarily con- fifth consecutive year. China ranks first among cerned about rule of law issues in China over

Figure 4 Investors are divided over future prospects of the U.S. economy

Planned investments in the United States over Factors leading firms to increase investments the next three years (percentage of respondents) in the United States (percentage of respondents)

79% 71% 50% 43% 29%

Stable Large Robust Access to Less overall consumer economic cutting- burdensome macro- market growth edge regulatory No change economic technology environ- environment or research ment 44% Increase 52%

Factors leading firms to maintain or decrease investments in the United States (percentage of respondents)

62% 54% 46%

23% 23%

Decrease Availability Concern Slowdown Increased Uncertainty 4% of other over U.S. in U.S. regulation surrounding overseas dollar economy of research 2008 investment devaluation and develop- elections Source: A.T. Kearney options or crash ment

4 new concerns in an uncertain world | A.T. Kearney the next five years, with threats to intellectual Figure 5 property (50 percent of investors) and uncertain- Top risks to further investment in China during ties over the political and legal environment (44 the next five years percent) topping the list (see figure 5). Next are concerns over macroeconomic stability, specif- ically dangers of a real estate and stock market Percentage of respondents

bubble (32 percent) and an overheating economy 50% (31 percent). In addition, 30 percent of inves- 44% tors fear a global protectionist backlash against 32% 31% China-manufactured goods. Recent controversies 30% over food safety and toy quality may represent only the tip of the iceberg. Forty-three percent of global investors in Threats to Unpredict- Real estate Overheating Global China prefer to put their money in wholly intellectual able political or stock economic protectionist property or legal market environment backlash owned enterprises that they can control. Equity environment bubble against in China Chinese and contractual joint ventures are favored by 26 Source: A.T. Kearney manufactures and 23 percent of investors respectively (see figure 6). These arrangements allow investors less control but spread the risks and leverage domestic market knowledge. Figure 6 india retains second place in the Index, Preferred mode of investment in China by type a position it has held since displacing the United States in 2005. FDI inflows increased 250 percent, from $6.7 billion in 2005 to $16.9 bil- Percentage of respondents lion in 2006. Preliminary UNCTAD estimates of 2007 inflows are at $15.3 billion. India continues to attract investors in the high value- added services industry sectors, particularly Equity financial services and information technology. joint ventures Multinationals seek economies of scale and pro- 26% ductivity gains in their IT and business process Wholly owned enterprises outsourcing (BPO) functions in established cities 43% such as Bangalore, Mumbai and Delhi. They are also diversifying to lower-cost cities such as Contractual joint ventures Pune and Kolkata amid attrition and wage infla- 23% tion pressures in the first-tier cities. In addition, companies are locating more sophisticated functions such as equity research and high-end analytics in India, tapping into its vast pool of Other 2% Greenfield educated and increasingly experienced talent. investment In addition, India appeals to investors across all Source: A.T. Kearney 7%

A.T. Kearney | new concerns in an uncertain world 5 other sectors, reflecting the country’s potential Proven Destinations Remain Strong, but to attract more diverse investments. Frontier Markets Attract Interest, Especially While China is the chosen investment loca- from Developing Country Investors tion of Asian investors (out of all investors with Twenty of the top 25 investment destinations on a high likelihood of investing in China, 34 per- the Index are returning from the last survey, con- cent are Asian) in the near future, India attracts firming investors’ continued confidence in desti- a broader set of global investors, gaining recent nations that have delivered results. Seven of the interest from companies such as IBM, General G-8 nations are represented, as are the BRIC Motors and Nokia. Three-quarters of respon- countries (Brazil, Russia, India and China). Of dents highly likely to invest in India over the next the 10 countries with the greatest uptick in inves- few years are from outside Asia. India also tops tor outlook compared to last year, eight are well- the list for positive investment outlook among all known investment targets: China, India, Brazil, destinations, with 36 percent of global investors Hong Kong, the United States, the United indicating more positive views compared to the Kingdom, Russia and Germany. The other two previous year (see figure 7). are the United Arab Emirates, which broke into

Figure 7 Changes in investor outlook compared to a year ago

Percentage of respondents India China Brazil United Vietnam Hong United Russia United Germany Arab Kong States Kingdom 36% 35% Emirates

30% 29% 28%

24% 23% 23% 23% 22%

–4% –5% –5% –5% –6% –6% –7% –9%

–14%

Positive change in outlook

Negative change in outlook –23% Source: A.T. Kearney

6 new concerns in an uncertain world | A.T. Kearney the list in 2005, and Vietnam, which returned Otherwise, developed country investors are turn- to the list for the first time since 2003. ing to large and popular FDI destinations such as indeed, Vietnam occupies the 12th spot in Russia and Turkey in the developing world and the Index this year, its highest ranking ever. the United States and Western European desti- Having joined the World Trade Organization nations in the developed world. These investors (WTO) in 2007, Vietnam has been named a also consider Saudi Arabia primarily as a site to leading candidate for first-time investments by serve the region’s large corporations and high net both developed and developing country investors. worth customers. Manufacturing is the main attraction for devel- By contrast, developing country investors oped country investors. U.S. chipmaker Intel is cite up-and-coming destinations for first-time building a $1 billion microprocessor production investment over the next three years. These inves- base in Ho Chi Minh City—the largest U.S. tors are interested in locations such as Nigeria, FDI project in Vietnam. Japanese companies such South Africa and Egypt in Africa and the Middle as Canon and Honda are interested in Vietnam East; Thailand, Cambodia and Indonesia in Asia; as a low-cost production base for exports. and Chile in the Americas. As first-time FDI other countries are joining the top 25. Other locations, these countries offer cost advantages, Gulf states arrive at number 17, as increased labor availability and an increasingly favorable petrodollar liquidity gives rise to new invest- investment and business climate. ment opportunities in petrochemical down- Chinese investors have started to outsource stream industries, construction and real estate, within East Asia to destinations such as Vietnam and financial services. South Africa, ranked 18th, and Cambodia. Anticipating growing trade ties has relative political and economic stability and along the shared border, Chinese producers have a concentration of key companies to attract invested in physical infrastructure as well as fac- developing country investors. Industrial and tories in Vietnam to produce for both domestic Commercial Bank of China’s (ICBC) acquisition sale and export. Chinese firms have invested in of a 20 percent stake in Standard Bank, South Cambodian raw materials such as iron ore and Africa’s largest bank, will allow China to facili- silk. China has also been active in Africa. Its finan- tate future energy and commodity investments cial commitments of $20 billion over the next on the African continent. Indian conglomerate few years have eclipsed funding by the continent’s Tata Group has also invested in multiple sectors traditional global aid agency donors.2 from IT services to cars to hotels. Elsewhere developing country investors now compete on the Index, Malaysia and Indonesia return for investment targets with developed country to the top 25, thanks mainly to interest from investors. Is this a sign of larger changes to come? Asian investors. To be sure, developing countries contributed Both developed and developing country only about 15 percent of global FDI outflows investors are interested in making first-time in 2006. Developing Asian economies have seen investments in established emerging markets such dramatic increases in outflows since 2003, with as China and India and in frontier destinations their share of world FDI outflows rising from 4 such as Vietnam and the United Arab Emirates. to 9 percent. Sustained economic growth over

2 See A.T. Kearney research on “CHIMEA”—the growing strategic alignment of China, India, the Middle East and Africa.

A.T. Kearney | new concerns in an uncertain world 7 the past decade has allowed countries to build up Holdings, with its $80 billion-plus portfolio, has huge capital pools, much of which has funded concentrated on Asian investment targets. However, internal investments or the accumulation of for- there is anecdotal evidence that Singaporean cap- eign currency reserves. China alone has parked ital has begun to move abroad. The Temasek hundreds of billions of dollars in U.S. Treasury Review 2006 reports that 44 percent of its assets bonds, in part to maintain its currency peg. are invested in Singapore, down from 52 percent Developing countries now hold more than 70 in 2004. Temasek and the Chinese government percent of world currency reserves, according to helped underwrite Barclays’s hostile bid for the latest IMF data, up from about 50 percent in Dutch bank ABN Amro. Temasek is not alone. The Chinese government has acquired a 9.9 percent stake in both the Blackstone Group and Morgan Stanley. Borse Dubai concluded Investors in Asia and Europe a bid for 20 percent of Nasdaq Stock Market and is pursuing shares in the prefer the “near abroad” London Stock Exchange. The Abu Dhabi Investment Authority is estimated to for their investments, while have nearly $875 billion for investment. Following recent subprime-related write- North American investors downs, Citigroup received a $7.5 billion investment from the Abu Dhabi Invest- tend to look outside the ment Authority and $6.88 billion from the Government of Singapore Invest- Western Hemisphere. ment Corporation. Merrill Lynch raised capital from Singapore’s Temasek Hold- ings, the Kuwait Investment Authority and the Korea Investment Corporation. Bear Stearns and UBS received cap- 1996. The problem is that countries accumulat- ital injections from the China Investment ing reserves so quickly are exposed to significant Corporation and the Government of Singapore currency risk. In the event of a major depreciation Investment Corporation respectively. Further of the U.S. dollar, these countries’ central banks expansion of the investment horizons of sover- would suffer substantial capital losses. If China eign wealth funds should be expected. and other developing economies that have been But not all countries have resorted to state- accumulating reserves move to buying real assets owned funds to increase their overseas invest- rather than portfolio assets, the FDI numbers are ment portfolio. Notably, India has become a likely to shift rapidly. major player in FDI through the actions of its Non-Western governments looking to diver- private firms. The acquisition of specialty steel sify beyond sovereign debt instruments have producer Arcelor by Mittal Steel made the newly mainly targeted investments in their home regions. formed ArcelorMittal the world’s largest steel For instance, the Singapore state investor Temasek producer. Tata Steel has responded in kind,

8 new concerns in an uncertain world | A.T. Kearney buying the Anglo-Dutch Corus Group, Singapore- FDI in the EU-15 came from other EU-15 states. based producer NatSteel Asia, and a 40 percent By 2005, that number was 79 percent. stake in Millennium Steel, a Thai steel com- Among the top 10 FDI destinations, China pany. Aluminum manufacturer Hindalco bought and Russia generate the most confidence among Novelis, a U.S. aluminum rolling firm, for $6 home region investors. Asian investor interest in billion in 2007, creating the world’s largest China spans across manufacturing and service sec- aluminum rolling company. The Economist reports tors, as the country expands its domestic market that total foreign acquisitions by Indian firms demand and deepens its know-how as an export totaled $23 billion in 2006, a new record.3 platform. Russia attracts significant interest from such major deals are likely to continue. European investors, who are also much more likely According to survey responses, developing coun- to select Russia as a first-time investment desti- try investors plan to make more than half (54 nation than are North American investors. percent) of the $500 million-plus FDI deals over on the other hand, North American investors the next three years. These large deals are expected have not shown a similar tendency to invest within to be channeled to other developing country mar- the region. Rather, they have a strong preference kets and to some extent Europe. In the United for markets outside the Western Hemisphere. U.S. States, however, political resistance may well FDI flows to Latin America were up 123 percent contain the size of such FDI investments, as evi- over the 1996 to 2006 period. During the same denced by China’s recent strategic investments time period, flows to Canada rose 200 percent and in Blackstone and Bear Stearns via government- those to Europe increased by 318 percent. FDI controlled CITIC Securities. Both shares are in Asia grew by 300 percent, and in the Middle small enough to avoid congressional review. East it increased 1000 percent. The character of investment for North American firms also varies Near-Shore Destinations Draw Asian and by region: Developed country investment occurs European Investors via reinvestment of profits earned by foreign affili- Regionally, investors in Asia and Europe prefer ates, whereas developing country investment uses the “near abroad” for their investments, while capital earned outside the target country. North American investors tend to look outside According to the Bureau of Economic Analysis the Western Hemisphere. Nine of the top 15 pre- (BEA), the United States’ outward foreign direct ferred investment destinations for Asian investors investment position at year-end 2006 increased are in Asia. Eight of the top 15 preferred invest- substantially compared to 2005, helped by out- ment destinations for European investors are in ward capital flows of $216 billion. However, net Europe. Data also suggests that investment flows outflows were still $41 billion below the post-2000 to the EU-15 (the 15 countries in the European record level of 2004.4 The Netherlands led recip- Union prior to the accession of 10 candidate ients of U.S. FDI at 15 percent of the total. countries in May 2004) increasingly come from The United Kingdom (9 percent), Luxembourg within the EU-15. In 1994, 64 percent of all (7 percent), Canada (7 percent) and Ireland

3 “Marauding Maharajas: India’s Acquisitive Companies,” The Economist, 29 March 2007. 4 The 2005 to 2006 comparison of U.S. FDI outflows would indicate much higher FDI outflow volume than the 2004 to 2006 comparison. However, 2005 is a poor benchmark due to tax provisions in the American Jobs Creation Act of 2004, which permitted foreign earnings repatriation at reduced tax rates for FY2005. The FDI outflow numbers for 2005 are therefore artificially weak due to repatriation of foreign earnings, and 2004 represents a better benchmark year.

A.T. Kearney | new concerns in an uncertain world 9 (6 percent) completed the top five recipients. have not gone unnoticed by global investors, Together with Mexico (5 percent), these coun- almost 80 percent of whom consider the growth tries accounted for nearly 50 percent of U.S. FDI of these nontraditional sources to be benign or outflows in 2006. In Asia, Japan was again the positive. Only 13 percent think they are a nega- largest target for U.S. investment, taking in 27 tive force (see figure 8). Among the three invest- percent of the $45 billion total in that region. ment channels, private equity is considered by 62 This doubled Japan’s relative share of 14 percent percent of investors as the greatest competition in 2004. to traditional FDI. Firms in the $1 billion to $5 Although Europe, South and Central billion range view private equity more negatively America, Africa and the Middle East saw increases than their larger or smaller counterparts. in U.S. FDI from the benchmark year of 2004, investors remain divided on how best to enter Asia, North America and the remaining states in new markets, with M&A, greenfield investment the Western Hemisphere experienced decreases. and joint ventures ranked more or less equally. Also according to the BEA, compared with 2004, M&A is expected to be the primary mode of entry overseas investments fell in bank and nonbank for smaller deals, but fewer investors are planning financial services, nonbank financial holding com- $1 billion-plus M&A deals. panies, professional services and manufacturing. As private equity’s acquisitions spree winds down in response to banks’ reduced appetite for FDI Faces Increased Competition from risk, sovereign investment funds, backed by huge New Investment Channels foreign exchange reserves, will likely play a more Recent high-profile investments of hedge funds, prominent role in overseas investment. To date, private equity firms and sovereign wealth funds private equity firms have relied on cheap and

Figure 8 New investment channels are competing with FDI

Investment channels considered the greatest compe- Investor views of new investment channels tition to traditional FDI (percentage of respondents) (percentage of respondents)

47%

State or government funds 31% 27%

Private equity Hedge funds 62% 13% 12% 9%

Favorable Neutral Unfavorable Don’t know

Source: A.T. Kearney

10 new concerns in an uncertain world | A.T. Kearney abundant credit to structure highly leveraged percent of respondents. Other top concerns include deals. Recently, however, private equity has found global competition for non-energy natural resources fundraising more difficult. Cerberus Capital met (47 percent) and increasing pollution from devel- with resistance in financing the final elements of oping countries (44 percent). Beyond environmen- its Chrysler buyout. The Carlyle Group’s bids for tal sustainability, the leading issue for investors is Virgin Media are reportedly running into financ- the wealth and income gap between the developed ing difficulty. Corporate M&A is gaining some and developing worlds (38 percent) (see figure 9). advantages in bidding against private equity, Corporations are taking note. Fifty-three owing to its ability to use financing mechanisms percent of investors have programs in place that other than leveraged debt. If the debt markets con- enhance eco- and energy-efficient practices, prod- tinue their deterioration, or interest rates in the ucts and technologies (see figure 10 on page 12). United States or Europe rise over inflation con- Companies are also adopting formal, written cerns, the private equity market will likely cool sustainability codes to guide corporate practices. further, diminishing the sector’s role in overseas Some of the world’s largest enterprises, including investment and acquisition. BP and Wal-Mart, are implementing corporate strategies that address critical challenges to a sus- Sustainability in Global Investments tainable future. Wal-Mart estimates that investing Investors from different regions, sectors and firm in energy-efficient building and shipping prac- sizes are all concerned about the sustainability of tices will quickly and substantially reduce over- the global economic order. The greatest single chal- all costs, along with supporting sustainability. At lenge, cited by 66 percent of respondents, is global the same time, its corporate image will benefit. competition for scarce energy reserves. Climate Wal-Mart plans to demand similar sustainable change follows closely behind, mentioned by 55 practices of its suppliers.

Figure 9 Most important challenges to the sustainability of the global economic order over the next 20 years

Percentage of respondents

66%

55% 47% 44% 38% 33% 29%

Global Climate Global Increased Wealth and Rising cost Chronic U.S. competition change competition pollution from income gap of basic fiscal and for scarce for scarce developing between services trade deficits energy reserves natural resources countries developed and (excluding energy) developing worlds Source: A.T. Kearney

A.T. Kearney | new concerns in an uncertain world 11 Figure 10 that demonstrate sustainable business practices. Most common firm responses to sustainability risks In addition, 20 percent of investors have adopted industrywide sustainability codes. one example is the Leadership in Energy and Percentage of respondents Environmental Design (LEED) Green Building

53% Rating System, developed by the U.S. Green Building Council. This system provides bench- marks for environmentally friendly design and 34% 33% building practices, and is used to certify new and 25% 20% existing construction. Approximately 1,200 projects are already certified, and 9,000 more have registered with the building council to collabo- Invest in eco- Adopt Join industry Tighten Adopt and energy- formal bodies to supplier industrywide rate with its members and achieve certification. efficient sustainability promote selection codes on Another example is the ISO-14001, an environ- practices, code sustainability critera and sustainable products or efforts switch to products mental audit standard that offers comprehensive technologies suppliers with and sustainable business guidelines for environmental management and Source: A.T. Kearney practices practices third-party certification and verification. Europe and Asia-Pacific (particularly Japan) together accounted for 87 percent of total ISO-14001 enter- Consumers are also driving environmental- prise certifications as of 2005, according to the ism. Whole Foods Market, focusing on organic International Organization for Standardization. and sustainable products, enjoys healthy prof- investor enthusiasm notwithstanding, only its in an industry of historically tight margins. 25 percent of global investors indicated that their General Electric has built a significant presence in firms tracked the return on investment ROI( ) of the wind power sector, which now enjoys a boom their sustainability initiatives. Of that group, 70 as governments and private companies worldwide percent expect returns of 10 to 40 percent. While demand wind turbines; in turn, General Electric’s only 19 percent of North American investors track suppliers have benefited as well. Meanwhile, activ- the ROI from such initiatives, they found substan- ist shareholders from large pension funds are pres- tially greater returns than investors from Europe suring firms to uphold higher standards in their and Asia. Also, larger firms ($10 billion-plus in business practices. Such shareholders are driven annual revenues) reported better ROI on their both by concern for the long-term environmen- sustainability investments than smaller firms. tal and social impact of their investments, and by Although developing country investors share good business sense. the same sustainability concerns and priorities, Furthermore, global corporations are look- voluntary standards have generally lagged behind ing outside their own organizations for solutions. government enforcement in responding to envi- Thirty-three percent have joined industry bodies ronmental challenges. But recent private sector to lobby for sustainable practices, such as swift innovations in India offer cause for optimism. regulation to combat climate change. Twenty- In 2007, Wipro Infotech—the India, Middle five percent report that they have tightened selec- East and Asia-Pacific IT business unit of Wipro tion criteria for suppliers and switched to those Limited—became the first Indian manufacturer

12 new concerns in an uncertain world | A.T. Kearney to launch a range of environmentally friendly that threaten sustainable economic growth. Rapid “GreenWare” desktops. These desktops are fully industrialization and development, coupled with compliant with EU standards on the use of ingrained attitudes about land and water resource hazardous materials in manufacturing, and the exploitation, have made it among the most pol- company eventually plans to adhere to these stan- luted countries in the world. Domestic and dards across its entire computer line. In the utilities international pressure to improve environmental sector, Tata BP Solar, a joint venture between Tata Power Company and BP Solar, ranks among the world’s leading producers of solar-powered The greatest single challenge to home solutions. Its projects include the installation of global sustainability, cited by 66 percent 1,000 solar-powered water pumps in the state of Punjab, of respondents, is global competition allowing farmers to get water without requiring time- and for scarce energy resources, followed resource-intensive routing of power lines to the region. It closely by climate change. also brought in-home light- ing to remote regions of the Himalayas using solar lantern technology. Projects such as these suggest ways for India to performance has been intense. Recent outrage in continue to move toward Western standards of the United States, Canada and Europe over pet living—regular running water and indoor light- food contaminated with industrial chemicals has ing, for example—without the infrastructure and led to greater scrutiny of Chinese food imports in pollution footprint required by Western models. general. Beijing also faces creeping desertification Continued development will require substantial that, if left unchecked, may overtake the city and investment, but there are signs that India’s boom- make it uninhabitable. Blinding dust storms are ing economy will support it. For example, New already a reality during the summer months. Ventures India has announced a $25 million ven- Fortunately, China has shown increasing ture fund targeted at green technologies and hopes interest in greener development. Top govern- to use this as a seed to attract foreign investment. ment officials seek to stem rising domestic unrest The non-governmental sector has also attempted from negative reaction to the effects of rampant to fill the gap. Programs such as the GreenR ating pollution. Still, key government initiatives, such Project provide company-level ratings by sector of as green GDP accounting (an economic growth environmental performance, and publicize both index which attempts to factor in environmental the best and the worst companies in each sector. consequences), have not yet been successfully due in part to its heavy emphasis on manu- implemented. By contrast, the private sector has facturing, China faces even more acute problems leapt to capture business opportunities associated

A.T. Kearney | new concerns in an uncertain world 13 with environmental degradation, with venture Regional Findings capital targeted at clean technology in China increasing 147 percent from 2005 to 2006. The Americas As in India, the utilities sector has realized the The United States continues to rank third among effectiveness of solar power in a country with global investment destinations, but it attracts an underdeveloped power infrastructure. In 2006, more interest from developed—rather than $2.6 billion worth of solar-powered water heaters developing—country investors. As the backlash were installed, compensating for both the lack of against China National Offshore Oil Corporation power infrastructure and China’s dependence on and Dubai Ports for their attempted acquisi- coal-fired power plants. tions of U.S. strategic assets illustrates, security China’s booming construction industry has and political concerns are becoming more promi- also begun to adapt clean technologies to its pur- nent factors in investment decisions. The expan- poses. The Shanghai Green Building Council sion of the review process for foreign acquisitions was established in 2004 to help the city prepare run by the U.S. Treasury under the Committee for the World Expo 2010. It is now adapting on Foreign Investment in the United States LEED standards to the demands of the Chinese (CFIUS) will increase the regulatory burden for climate. Green buildings, including shopping foreign investors. Indeed, regulation is very much malls, office complexes and municipal buildings, on investors’ minds: Thirty-eight percent cite are being planned for Beijing, Shanghai, Harbin increased government regulation as one of the and other cities. Among the most ambitious is top five developments affecting their investment Shui On Properties’ Xihu Tiandi development decisions. Twenty-nine percent credit a less bur- project in the city of Hangzhou—a mixed-use densome regulatory environment as a reason for location featuring shops, restaurants and other increasing investment in the United States, and cultural activities. Built in cooperation with 23 percent will maintain or decrease investment U.K.-based engineering firm Arup, it received because of greater regulation of R&D. a best-in-class LEED Platinum rating from the despite macro concerns, the U.S. economy U.S. Green Building Council. still exerts a powerful pull on FDI. Investors plan- if India and China continue and expand ning increases to their U.S. investment positions their major sustainability initiatives, global mar- in the next three years cite the size of the market, kets will certainly feel the effects. Companies the overall stability of the macroeconomic envi- locating operations in these countries would ronment and robust economic growth as primary face the higher costs of complying with more considerations. These responses were recorded stringent regulations. Furthermore, increased during a period of 2007 when the financial fall- demand for sustainability products could lead out from the housing market decline repeatedly to shortages, such as today’s worldwide wind- roiled markets and created doubts about future mill shortage which is driven by the popularity consumer demand. of the wind energy industry. On the other hand, Although Mexico and Brazil recorded similar these initiatives might also dramatically alter FDI receipts in 2006, global investors are more the profitability of goods and services targeted optimistic about Brazil as an investment desti- at sustainable markets, and lead to significant nation in the future, according to investors sur- economies of scale. veyed. Out of the $19 billion of FDI inflows into

14 new concerns in an uncertain world | A.T. Kearney Mexico in 2006, 61 percent went to manufac- the country dependent on oil for 90 percent of its turing investments, mostly by foreign firms seek- export revenue, the exit of major Western firms ing to produce for the U.S. market within the and their technology will certainly have repercus- NAFTA trading area. Brazil followed at a close sions. The volatility of these flows suggests that second with $18.8 billion in inflows, of which 55 investors are responding to short-term political percent went to the service sector, in particular and economic moves by the ruling governments financial services and utilities. The United States, while they attempt to discern what the long term the Netherlands and Switzerland accounted for holds for both countries. the majority of these flows. For the first time, FDI outflows exceeded inflows for Brazil, owing to the acquisition of Inco, a Canadian mining concern, by Investors planning to increase their the Brazilian firm Companhia U.S. investment positions in the next Vale do Rio Doce (or Vale, as it is now referred to after a recent three years are considering market size, corporate rebranding).5 More than half of the overall macroeconomic stability global investors surveyed consider rising populism in Latin and robust economic growth. America as negative, with 55 percent indicating that it deters their investments in the region. FDI flows into countries where populism is a concern have been volatile. After Finally, with trade negotiations around the a 43 percent drop in 2004, Venezuela’s FDI Doha Development Agenda stalled, the United receipts rose 95 percent to $2.6 billion in 2005, States has taken to negotiating separate trade but then fell to minus $543 million in 2006. deals with many of its major Latin American The United Nations credits this downturn to the trading partners. In the current Washington cli- distribution of profits from state-run oil giant mate, Congress has forced these deals to include PDVSA to foreign shareholders, which the gov- conditions on labor and environmental stan- ernment had held up since 2003. Bolivia’s FDI dards—as reflected in the United States-Peru intake fell 66 percent from 2003 to 2004, and Trade Promotion Agreement (signed in 2006) turned negative in 2005 before finally rising to and the United States-Panama Trade Promotion $237 million in 2006.6 More recently, both Agreement (signed in 2007). Thirty-nine percent ExxonMobil and ConocoPhilips refused ultima- of respondents viewed these standards positively, tums to enter into joint ventures with PDVSA while only 7 percent thought they would erode in order to keep pumping oil in Venezuela. With investment attractiveness.

5 United Nations Economic Commission for Latin America and the Caribbean, Foreign Investment in Latin America and the Caribbean, 2006. 6 Ibid.

A.T. Kearney | new concerns in an uncertain world 15 United States. In addition to holding third billion in the hotels and casino operator MGM place in the overall Index, the United States Mirage by buying shares and half of a major Las also ranks third for first-time investments from Vegas project. developed country investors. However, develop- short-term investment prospects in the ing country investors place it 13th. Regionally, United States appear to be mixed. Compared to North American investors are the most optimis- a year ago, 23 percent of investors report a more tic about prospects for American investment, positive outlook, whereas 23 percent report a ranking the United States first, while European more negative outlook. On the one hand, a slow- and Asian investors rate it fourth and seventh down in the economy coupled with concerns respectively. about exposure to the U.S. subprime market The growth in FDI inflows to the United should mean a less favorable climate for invest- States—from $101 billion in 2005 to $175 bil- ment. However, a countervailing trend is the lion in 2006, and to an estimated $192.9 billion depreciated value of the dollar compared to the in 2007—reflects investor optimism. Investors in euro and Canadian dollar, making mergers and light manufacturing sectors (including technology acquisitions by companies in those countries less and health care products), telecom and utilities are expensive and thus more tempting. the most bullish on the U.S. market. For example, Brazil. Brazil continues to be a favorite of France’s Vivendi has announced plans to buy the international investors in this year’s Index, rising video games maker Activision. GlaxoSmithKline one place in the FDI Confidence Index from has agreed to buy Reliant Pharmaceuticals, a pri- seventh in 2005 to sixth in 2007. FDI inflows rose vately held drug company specializing in heart 25 percent, from $15 billion in 2005 to $18.8 therapies, for $1.65 billion. In the utilities sector, billion in 2006 and further to an estimated $37.4 the U.K. firm National Grid acquired the U.S. billion in 2007. gas and electricity group KeySpan for $11.8 bil- investors in the primary, manufacturing, tele- lion, boosting National Grid to become the sec- com and utilities sectors are especially confident ond-largest utility group in the United States. about investment in Brazil. Regionally, Asian Investors in the heavy manufacturing and the investors are most interested, ranking Brazil fourth primary sectors are also upbeat about the U.S. behind China, India and Vietnam as a favored FDI economy. For example, Saudi Basic Industries destination, while European and North American Corporation recently paid $11.6 billion in cash investors rank the country eighth and seventh for General Electric’s plastics business. respectively. In addition, 30 percent of investors ranking lower, but still upbeat, are invest- hold a more positive outlook on Brazil in 2007 ment prospects in the financial services and non- than in 2006, compared to 25 percent who felt financial services sectors. The recent perfect storm more positive in 2005 than in 2004. of a devalued U.S. dollar and the subprime mort- The United States and Europe remain the gage debacle is prompting investments in finan- largest sources of FDI in Brazil, but that lead is cial services firms.O ne example is the $7.5 billion narrowing as Asian investors play a larger role. stake in U.S. banking giant Citigroup that the In 2007, the Indian steelmaker ArcelorMittal Abu Dhabi Investment Authority acquired in late bought out minority shareholders in its Arcelor 2007. In the nonfinancial services arena, Dubai Brasil arm in a deal reaching more than $3 billion, World reportedly plans to invest up to $5.2 and Nippon Steel Corporation unveiled an $8.4

16 new concerns in an uncertain world | A.T. Kearney billion capacity expansion plan at its Brazilian affil- will be 4.1 million barrels of crude oil a day, 61 iate Usiminas to narrow the production gap with percent more than in 2005. Foreign investments ArcelorMittal. Other recent investments in the in sectors such as mining also remain important. manufacturing sector include Fiat’s $2.8 billion As stated earlier, the Brazilian mining company expansion of its assembly plant in Betim, which Vale recently purchased Canadian nickel pro- will make it the firm’s largest assembly facility. ducer Inco for $17 billion, the largest acquisition High commodity and energy prices have ever undertaken by a Latin American company. boosted investor interest in the energy and com- The new government’s focus on continuing modities sector. Brazil has a comparative advantage reforms by lowering taxes, maintaining fiscal sur- in biofuels, and foreign investors are optimistic pluses and continuing debt reduction has con- about increasing production there. Norwegian tributed to investor optimism. Tight commodity energy group Statoil and Petrobras recently signed markets, federal budget surpluses and a current an agreement to look for joint biofuel ventures account surplus combined with the subprime and to enhance their existing cooperation in oil mortgage meltdown in the United States have and gas exploration and production. The service pushed the Canadian dollar above parity with the sector also remains an important destination for U.S. dollar. This gain creates favorable conditions FDI. The Irish firmE xperian, for example, agreed for Canadian firms to acquire assets in the United to pay $1.2 billion for a 65 percent stake in the States, but its potential to decrease exporters’ com- corporate credit consultancy Serasa. petitiveness is already causing concern in Canada. President Luiz Inácio Lula da Silva’s reelec- Mexico. Mexico’s overall ranking of 19th is tion, macroeconomic stability, buoyant growth three places below its spot in 2005. FDI inflows and the success of the central bank in control- into the country declined slightly to $19 billion ling inflation are driving Brazil’s continued FDI in 2006 from $19.7 billion in 2005, but reached attractiveness. a new high of $36.7 billion in 2007 according to Canada. Canada is rising in the FDI the latest UNCTAD estimates. North American Confidence Index this year, moving from 21st in investors rank Mexico as the 10th most favorable 2005 to 14th place in 2007. Canada’s booming destination for FDI. economy attracted FDI inflows of $69 billion in it is not surprising that North American inves- 2006, up 140 percent from 2005. tors are most confident about Mexico, because Primary sector investors show the greatest con- almost two-thirds of FDI inflows come from fidence in Canada. In the face of strong demand the United States and Canada. North American and tight commodities markets, they are increas- investors are especially interested in manufac- ing investments and riding the boom. High oil turing, which accounts for almost one-half of prices have made extracting oil from the tar sands all Mexican FDI inflows. One example is invest- in Alberta province economically viable, leading ment in auto manufacturing, which has contin- to an influx in oil exploration money and rising ued to develop since NAFTA was signed. Mexico’s fortunes in Calgary. These deposits are expected five top automakers are General Motors, Ford, to contain an estimated 180 billion barrels of oil, DaimlerChrysler, Nissan and Volkswagen, all of the largest oil reserves in the world after Saudi which produce for the American market. Locating Arabia’s. Canada’s National Energy Board has in Mexico allows auto companies to integrate pro- forecast that by 2015, Canada’s total oil output duction, easily shipping cars and parts northward

A.T. Kearney | new concerns in an uncertain world 17 by truck and rail. Analysts predict the continuing Argentina. Argentina has not ranked among integration of Mexico’s manufacturing industry the Index’s top 25 countries since its 2002 finan- into the U.S. production chain. cial crisis and debt default. Its reputation does Trade agreements with the EU, Asia and Latin appear to be recovering somewhat, however, and American countries also underpin investment in North American investors rate it 15th as an invest- Mexico. Although Mexico competes with China ment destination. for manufacturing investments, its proximity to FDI inflows remained nearly constant at U.S. markets will likely keep it competitive for $5 billion in 2005 versus $4.8 billion in 2006, before lowering to an estimated $2.9 billion in 2007. This is still up from $1.6 billion in 2003, but FDI The United States and Europe remain remains below the 1990 the largest sources to 2000 average of more of FDI in Brazil, than $7 billion a year. but that lead is narrowing as Asian One reason for North American investors’ optimism investors play a larger role. is Argentina’s growth rates of at least 8.5 percent a year since the crisis. A measure of stability has returned to the country, and, as of this investment in heavy goods, such as vehicles, trans- writing, President Cristina Fernández de port equipment and large consumer durables. Kirchner is expected to restructure $6.3 billion The commodity boom has also benefited in defaulted debt—a barrier to investor con- Mexico, as government officials predict that $15 fidence—owed to the Paris Club group of billion will be invested in mining over the next five creditor nations. As part of the deal, Argentina years. Canada’s Goldcorp, for example, expects to will probably revisit its 2005 debt restruc- invest $1.2 billion in its Peñasquito project in the turing and try to improve relations with the Mexican state of Zacatecas, where it has proven International Monetary Fund (IMF). Despite reserves of 13 million ounces of gold and 864 that progress, inflation, export bans, price controls million ounces of silver, among other precious and electricity shortages still limit Argentina’s mineral deposits. Mexico’s tourism industry also potential for investment, and will have to be has significant potential for further development tackled if Argentina is to attract the levels of and investment. investment it attained before the crisis. The contentious 2006 presidential elec- Chile. While not among the top 25 FDI des- tion caused some concern among investors, but tinations, Chile ranks 14th among developing President Felipe Calderón’s acceptance by the country investors as a destination for first-time electorate and his ability to garner approval for investments. Inflows to Chile rose 14 percent pension and fiscal reforms this year, against expec- from 2005 to 2006, reaching nearly $8 billion. tations, have eased investor concern. 2007 estimates are even higher, at $15.3 billion.

18 new concerns in an uncertain world | A.T. Kearney In addition to free trade and economic agreements the 1997 financial crisis, with many of the coun- with countries in the region, Chile has also signed tries most implicated in that crisis—Indonesia, economic agreements with China and India, and Thailand, Singapore and the Philippines—seeing is in negotiations with Malaysia. These agreements positive growth in FDI receipts. promise to boost future trade and investment activ- investors in Asia-Pacific generally report ity. Apart from commodities, Chile can also act improved views of its headline economies. More as a regional production and service platform for than 25 percent of respondents indicate more adjacent markets in North and South America. positive views of China’s, India’s and Vietnam’s Andean Region. At the time of the 2005 investment environments than a year ago. Their Index, analysts speculated that forthcoming concerns are primarily economic. Rising energy bilateral trade deals with Andean countries such costs top the list, with 59 percent of investors con- as Peru would boost U.S. interest in the region. cerned that such costs would negatively affect the However, the recent United States-Peru Trade economy. Beyond energy, the prospects of slow- Promotion Agreement was held up in Congress down in the major economic growth engines for until environmental and labor standards were Asia—China and the United States—are of simi- added to the terms. At the time, many analysts lar magnitude, mentioned by 46 percent and 44 assumed that these standards would make inves- percent of respondents respectively. Global protec- tors less likely to move to Peru (or Panama, where tionism—damaging to the export-based growth similar restrictions were required). But the 2007 model of so much of Asia—is fifth in the list of survey suggests otherwise. A majority of respon- concerns, cited by 43 percent of respondents. dents indicated that the inclusion of environmen- China. Despite topping the charts in FDI tal and labor standards had either improved the attractiveness, China’s FDI inflows fell slightly investment attractiveness of these states (39 per- from $72.4 billion in 2005 to $69.5 billion in cent), or had no effect (29 percent). 2006. Estimated inflows for 2007 are at $67.3 billion. Starting in February 2006, China’s Ministry Asia-Pacific of Commerce stopped reporting deal values, Global investors indicate strong confidence in hoping to keep officials from inflating deal sizes the Asia-Pacific region, with such countries repre- to reap bonuses. The decline, or apparent decline, senting 11 of the top 25 most attractive investment in inflows may be an unintended consequence destinations. Not only do established markets of this effort. such as China and India remain at the top, but in the longer term, however, the government Singapore, Hong Kong, Vietnam, Malaysia and in Beijing has taken steps that should encourage Indonesia are also on the rise. Inbound FDI to future FDI. Past restrictions on foreign partici- Asia-Pacific reached a new high in 2006 and is pation in Chinese capital and investment mar- expected to climb to more than $270 billion in kets, as well as on foreign ownership of large 2007. China and Hong Kong continue to dom- enterprises, have loosened. The new enterprise inate the investment landscape, accounting for income tax law, which took effect on January 1, $120 billion of the total. Singapore comes in 2008, replaces the different tax rates for foreign third at an estimated $36.9 billion, Japan fourth and domestic companies with one common rate at $28.8 billion, and India fifth at $15.3 billion. of 25 percent. Tax incentives for venture capital Overall, the region continues its recovery from and social investment were also announced in

A.T. Kearney | new concerns in an uncertain world 19 2007. These changes will likely help to reduce ment in traditional manufacturing and textiles the “round-tripping,” or double-counting, of sectors remained flat. Among the investors were domestic Chinese capital—which refers to “FDI” HSBC and Citigroup. Each received permission first sent through tax havens such as Hong Kong from the government to incorporate domestically and later reintroduced back into the country and tap into Chinese savings. ABN Amro, Bank of as FDI—inflating Chinese investment figures. East Asia and Hang Seng Bank have also entered Beijing has also instituted new rules that should the market. As China continues to open its domes- allow greater access for foreign banks to operate in tic financial markets to foreign firms, investment its capital markets. UNCTAD, in its Investment in the financial sector should accelerate. Brief No. 2, published in 2007, estimates that of the respondents whose firms are invested FDI inflows to the financial sector grew nearly in Asia, nearly two-thirds include Chinese assets fourfold from 2004 to 2005, and that FDI in in their FDI portfolio. Wholly owned enterprises real estate was nearly $8.8 billion, or more than in China are preferred by a nearly two-to-one 10 percent of total inflows and an estimated 15 ratio over either equity or contractual joint ven- percent of the total Chinese real estate market. tures with Chinese firms. Greenfield investment Major financial institutions such as Citigroup is less common, however, and is the favored mode have begun acquiring assets in the prime markets of entry of only 7 percent of respondents. of Shanghai, Guangzhou and Beijing. Merrill While investors’ attitudes toward China are Lynch targeted $30 million for a residential proj- generally positive, several drawbacks were noted. ect in Nanjing, and Hutchison Whampoa shifted Intellectual property rights remain a concern for $5 billion into investments in several major 50 percent of investors in China. The political Chinese cities. and legal regime, in a state of flux as it attempts This flurry of investments has raised fears of to adapt to China’s rapidly changing economy, an asset bubble. To dampen such fears, the govern- concerns 44 percent of respondents. Meanwhile, ment began in 2006 to restrict foreign investment the symptoms of an overheating economy— in Chinese real estate markets, part of a broader a real estate bubble and a tight market for high- series of moves designed to rein in the overheat- skilled labor—concern 32 percent and 31 per- ing credit market. Whether it can maintain these cent of respondents respectively. Thirty percent restrictions in the face of regional pressures from of respondents with investments in China noted Shanghai and other cities to attract foreign direct the foreign protectionist backlash against Chinese investment is unclear. Shanghai announced in manufactures, and troubles with adulterated raw May 2007 that it would loosen some of Beijing’s materials have received wide publicity. restrictions on foreign property ownership to India. India retains its number two position avoid discouraging foreign investors. in this year’s Index. India is also ranked second by The effects of China’s changing banking reg- both developed and developing country investors ulations, stemming from its commitment under for first-time investment. Regionally, European the WTO to liberalize the banking sector, are investors rank India first, while Asian and North already visible. Financial services sector investors American investors place it second and third rank China as their top FDI destination. Indeed, respectively. That optimism was complemented 2006 marked significant foreign investment in the by a leap in inward FDI from $6.7 billion in 2005 Chinese financial services sector, even as invest- to $16.9 billion in 2006. Preliminary UNCTAD

20 new concerns in an uncertain world | A.T. Kearney estimates put 2007 inflows at a slightly lower but investors are drawn to India for a variety of still strong figure of $15.3 billion. reasons. The Indian economy is booming, and, investors from across all sectors show con- according to the IMF, that growth appears to be fidence in India. Telecom and utilities investors on a solid footing. Strong investment and pro- are the most optimistic. According to India’s ductivity gains have translated to higher potential Planning Commission, the country needs to growth. While investors welcome these devel- invest $500 billion in road, port, housing, rail- opments, potential bottlenecks remain. Political way, airport and telecommunications infrastruc- resistance to privatization remains high, the labor ture over the next five years. The government is market is relatively inflexible, and poor infra- seeking public-private partnerships to meet this structure will impede FDI inflows. Restrictions backlog of investment. Recent interest in the on FDI also dampen its potential. Carrefour telecom sector includes AT&T’s announcement and Wal-Mart have both run into roadblocks in that it is considering a major wireless acquisi- planned investments. The Indian government is tion in India. responding to such concerns, however. In April Both heavy manufacturing and primary 2009, the government will review restrictions sector firms are looking at major projects. In on foreign banks’ ability to compete with their addition to interest from companies such as IBM, domestic rivals. Foreign banks seek a more open General Motors and Nokia, Kuwait Petroleum market and fewer limits, such as a cap on the Corporation is in talks with Indian firms, includ- number of branches they can open. ing Reliance Industries Limited, to build a large Hong Kong. Hong Kong ranks fifth on the refinery and petrochemical plant in India, Asia’s Index, up from 10th in 2005. About one-quarter third-largest oil consumer. Bolstering the trend of investors indicate a positive outlook toward toward increasing research and development Hong Kong, with only 4 percent holding nega- investments, U.S. chemical maker DuPont plans tive views. Hong Kong ranks 10th among Asian to double its previously announced investment investors, 14th among European investors, and in an R&D center in Hyderabad to $51 million. fifth among North American investors.D eveloped investors in the financial and nonfinancial country investors rate Hong Kong 13th as a services sectors are also bullish on investment in first-time investment destination. India. Besides the high value-added services sec- Hong Kong’s FDI success continues to tors, where India has gained a global reputation, be shaped by its relationship with the main- the real estate sector is gaining investor interest. land’s booming economy. International inves- United Arab Emirates-based property develop- tors looking to get a piece of the China pie see ment company Rakeen has formed a joint ven- Hong Kong’s familiar regulatory environment as ture with the Indian firm Trimex Group, to be an attractive staging ground for mainland oper- called Rakindo Developers. It plans to spend ations. Hong Kong’s unique position as an FDI $5 billion over five years to develop 50 million conduit to China no doubt helped its overall square feet of residential and commercial space. FDI receipts rise 28 percent from 2005 to 2006, American International Group, the world’s largest to $43 billion. Estimated 2007 figures are even insurer, has agreed to buy Indian mortgage lender higher, at $54.4 billion. On the other hand, Weizmann Homes to get a stronger toehold in mainland companies wishing to test international India’s growing market. waters use Hong Kong, with its recognizable

A.T. Kearney | new concerns in an uncertain world 21 cultural links, as their broker to the world. in a mainland bank was lowered from $10 billion Hong Kong ranks third among both financial to $6 billion. A foreign company can take advan- and nonfinancial services investors. The territory’s tage of CEPA if it is incorporated in Hong Kong, foreign investment climate is highly flexible, with has operated for three to five years, is liable to pay no restriction on foreign ownership of property Hong Kong profits taxes and employs 50 percent or companies and no foreign exchange controls. of its staff locally. The service sector enjoys first-mover advantage The territory intends to maintain its financial in China thanks to liberalization occurring under center status through closer ties with the main- the Mainland and Hong Kong Closer Economic land. The “1-3-5 financial development blue- Partnership Agreement (CEPA). CEPA reduces print,” drafted by the Hong Kong Monetary Authority in response to China’s 11th Five-Year Plan (spanning the years 2006 to 2010), plots out Rising energy costs top investors’ how Hong Kong’s efficient financial system concerns about Asia, followed by the can help spur improve- prospects that Asia’s major economic ments in the mainland and strengthen the growth engines — China and the United links between savers and investors on both States — will experience a slowdown. sides of the causeway. Banking in renminbi, the Chinese national currency, is now offered by 38 banks, and in January or removes geographical, financial and ownership 2007 mainland financial institutions were granted restraints for companies in 28 service sectors— the right to issue renminbi-denominated bonds including legal, accounting, medical, construction, in Hong Kong. Major Chinese companies are transport and information technology—wishing turning to Hong Kong to raise funds. For exam- to access China. Supplement III to CEPA, which ple, ICBC set records in October 2006 when took effect in January 2006, allows Hong Kong it reaped $21.9 billion from its IPO. China service suppliers access to the mainland ahead Construction Bank also acquired Hong Kong’s of China’s WTO timetable. CEPA was further Bank of America (Asia) Limited in 2006, to the expanded in 2007, with Supplement IV granting tune of $1.2 billion. The Qualified Domestic access to 11 new service areas including environ- Institutional Investor Program, launched in 2006, mental services and public utilities. Forty more further liberalized foreign exchange regulations, liberalization measures were introduced across with Hong Kong well positioned to take advan- additional service sectors. In the banking sector, tage of the market. Under the system, commercial for instance, the minimum total asset requirement banks are allowed to sell financial products denom- for a Hong Kong bank acquiring a shareholding inated in renminbi to domestic customers and

22 new concerns in an uncertain world | A.T. Kearney pool the funds to buy foreign exchange and invest investment destination among developed and in offshore fixed income products. Additionally, developing country investors, who both rank qualified securities agencies are allowed to issue the country 14th, evidence that Singapore’s foreign currency investment products in the main- geographic diversification efforts have yielded land and use their clients’ foreign currency to invest dividends. Singapore’s Economic Development in overseas securities. According to the Economist Board has launched a concerted effort to draw Intelligence Unit, $16 billion has been raised Asian and Middle Eastern companies to the under the scheme since September 2007, with country. Over the past five years, the number the majority of the capital thought to be headed of companies from the two regions investing in to Hong Kong. Singapore has doubled to 13,000. Major invest- Companies continue to have confidence in ments last year include Kuwaiti-based Proclad’s Hong Kong as a destination for light manufac- establishment of an oil equipment manufactur- turing FDI, ranking it eighth despite the gradual ing facility, the Indonesian company Pan Sino’s migration of factories northward. Textiles, print- new cocoa processing plant, and a manufac- ing and food processing are the key manufactur- turing and R&D center opened up by India’s ing subsectors within Hong Kong. Targeted R&D Bahar Industries. efforts are underway to support the development An accommodating business environment of high-value electronics and promote the sec- and foreigner-friendly investment rules make tor’s synergies with telecommunications, biotech- Singapore the distribution hub and financial nology and precision engineering. For instance, center of Southeast Asia. Among nonfinancial the Hong Kong Science and Technology Park is services companies and financial services compa- set to double in size later this year. However, the nies surveyed this year, Singapore scores seventh enthusiasm on the part of light manufacturing and fourth, respectively, as a top FDI destination. companies again may reflect Hong Kong’s unique Tax holidays for companies that locate regional position as a channel for “re-exports” from China, or international headquarters in the country and whereby goods produced in China are marketed, strong intellectual property regulations are among financed and shipped through the territory. the incentives that fuel FDI flows. Corporations Singapore. Singapore’s challenge as com- stand to benefit further through investor-friendly petition from neighboring countries heats up measures outlined in the 2007 budget. The is to maintain its role as a regional hub. This corporate tax rate is slated for a reduction from year’s Index suggests that in the near term, the 20 percent to 18 percent (by comparison, Hong foreign-investor friendly nation has accom- Kong’s rate is 17.5 percent), and a change to plished just that. Global investors are bullish the partial tax exemption regulations enables 80 about Singapore, ranking it seventh, up from percent of companies to pay an effective tax rate 18th previously. FDI inflows rose from $24.2 of less than 10 percent. billion in 2006 to an estimated $36.9 billion singapore has leveraged its strategic position in 2007. Asian investors are particularly inter- between China and India and its stellar infrastruc- ested, ranking Singapore sixth among all des- ture to attract professional services companies tinations and first among developed countries, ranging from consulting firms, IT services com- just above the United States and the United panies and logistics and supply-chain manage- Kingdom. Singapore is popular as a first-time ment firms. DHL underscored the importance

A.T. Kearney | new concerns in an uncertain world 23 of these assets in 2007 by relocating the spurring growth through innovation. In 2006, regional headquarters of its two logistics divi- the Ministry of Trade and Industry unveiled its sions—DHL Global Forwarding and DHL Science and Technology Plan 2010, which com- Excel Supply Chain—to Singapore. PayPal just mits $4.9 billion to R&D in select industry clus- opened its new international headquarters and ters. In 2007, Prime Minister Lee Hsien Loong technology development center in Singapore, granted additional financial support to the taking advantage of the country’s headquarters National Research Fund, which channels sup- promotion and hoping to tap into its highly port to projects in electronics, chemicals, marine educated pool of local professionals. engineering and biomedical sciences. According Financial services FDI has long streamed to the Economic Development Board, Singapore into the country. Twenty-four foreign banks had also attracted 158 R&D projects from abroad centralized their regional and global process- in 2006, worth a total of $1 billion. ing operations in Singapore by the end of 2006. Building on its strong history as a base for The trend should continue, as the financial ser- oil refining, Singapore continues to attract multi- vices sector in Singapore grows unabated, led by billion dollar contracts in the energy sector. Shell the emerging wealth management industry which Eastern Petroleum’s plans for a combined ethyl- has surged by 9.5 percent annually for the past six ene cracker and mono-ethylene glycol (MEG) years. An expanding pool of high net worth indi- plant will increase Singapore’s ethylene output viduals and increasingly sophisticated domestic by about 800 kilotons per year and bolster devel- and regional investors underpin the growth of opments in the petrochemical sector. In 2006, wealth management, private equity, philanthropy Singapore carved out a new space in the alter- and trust foundations. native energy sector by securing the Danish singapore’s manufacturing sector has contin- company Vestas Wind Systems’s Asia-Pacific ued to be a magnet for FDI: Fully 81 percent of headquarters and R&D center. Additionally, in investment commitments in manufacturing came 2006 global renewable energy group Natural from abroad in 2006.7 Light manufacturing com- Fuel Limited of Australia began construction panies rank the country as the sixth most attrac- on what will be the world’s largest biodiesel pro- tive destination in this year’s Index. Electronic duction plant. products and components and chemicals and Australia. Australia remains in the FDICI chemical product sectors are the main recipients top 25 at 11th place, but it dropped from eighth of FDI, but the government has launched plans place in 2005. North American investors are most to diversify this mix further, singling out phar- bullish on Australia, ranking it eighth overall. maceuticals and biomedical products for devel- Australian FDI receipts recovered from the net opment. Singapore currently hosts six of the top $35 billion outflow in 2005, reaching $24 billion 10 pharmaceutical conglomerates, key industry in 2006. Nevertheless, that sum is below the 2004 players and a growing base of medical technol- record level of $36 billion. ogy companies within the Tuas Biomedical Park. investors in the primary sector are the most Recent years have seen a flurry of funds commit- optimistic. The Australian extractive industries ted to economic-driven R&D, with the goal of are a primary source of foreign direct investment

7 Economist Intelligence Unit, Industry Overview: Manufacturing, 17 May 2007.

24 new concerns in an uncertain world | A.T. Kearney and have fueled investor confidence. Steel com- Vietnam. Vietnam’s Index ranking has panies Tata Steel and POSCO of South Korea climbed sharply since 2005, reaching 12th in have both expressed interest in buying Australian 2007 from below the top 25 in 2005. In par- assets or forming joint ventures to secure addi- ticular, Asian investors are most bullish, ranking tional materials sources. Other investments in the Vietnam just behind China and India. Twenty- sector include Chevron’s Gorgon natural gas proj- eight percent of global investors indicate a more ect off of Western Australia, estimated to be worth positive outlook toward Vietnam compared to more than $10 billion. High commodity prices a year ago, behind only India, China, Brazil have also meant Australian mining firms are bull- and the United Arab Emirates. Both developed ish about outward investment. BHP Billiton, for and developing country investors favor Vietnam example, jointly listed in the United Kingdom as a first-time investment destination, ranking it and Australia, made a $150 billion all-share take- seventh and third respectively. over proposal to acquire its smaller mining rival Vietnam’s accession to the World Trade Rio Tinto. Rio rejected the offer, but BHP is still Organization in 2007 and its robust economy— pursuing the deal. GDP growth has increased from 6.8 percent investors in the nonfinancial services sector in 2000 to more than 8 percent in 2005 and are also optimistic about Australia’s prospects. 2006—are driving investor optimism. Inward Mexico’s Cemex, the world’s top building mate- FDI flows reached $2.3 billion in 2006, up from rials company by revenue, recently acquired $2 billion in 2005 and $1.6 billion in 2004. its Australian rival Rinker for $16 billion. Early indicators suggest that 2007 FDI inflows Another recent example is the Japanese group will be substantially higher. The Vietnamese Kirin Holdings’s acquisition of the Australian Ministry of Planning and Investment estimates dairy and fruit juice producer National Foods that Vietnam attracted more than $15 billion of for $1 billion. FDI in the first 11 months of the year. Australia’s high ranking is a result of world investors in the heavy manufacturing, non- demand for its commodities and its strong macro- financial services, telecom and utilities sectors are economic and economic policy performance over the most optimistic about investment in Vietnam. the last decade. Labor candidate Kevin Rudd’s Manufacturing has been an especially important victory over John Howard of the Liberal Party sector for investment. Vietnam’s share of GDP is not expected to change that. While economic from industry has grown from around 23 percent policy may be tweaked, in the labor market for in the early 1990s to 41 percent in 2006. Beyond example, early indications point to consistency. Intel’s planned $1 billion investment cited earlier, Rudd’s plan for tax cuts was only slightly less Asian, European and developing country inves- generous than Howard’s. However, these cuts, tors have also showed interest in manufactur- coupled with new spending, strong domestic ing. Examples include Thailand’s Siam Cement’s demand and tight labor markets, could be infla- plans to build a $3.7 billion petrochemical com- tionary. Still, the fundamentals of the economy plex in Vietnam, and the Italian firm Piaggio will are strong, the fiscal position is good, and it seems invest $30 million in a plant to produce scoot- likely that Australia will maintain its commit- ers for the Vietnamese market. Japan’s Hitachi ment to free trade, so the election has been met Construction Machinery Company is also con- with equanimity by investors. sidering investing in a manufacturing plant.

A.T. Kearney | new concerns in an uncertain world 25 recent announcements indicate that foreign American investors are more bullish about Japan investors are also showing interest in Vietnam’s than are Asian investors. financial services sector. HSBC plans to pay FDI inflows to Japan are expected to rebound roughly $255 million for 10 percent of Bao Viet, in 2007 to $28.8 billion, from a net outflow of becoming the sole foreign investor in Vietnam’s $6.5 billion in 2006. It is speculated that the largest insurer. Deutsche Bank recently bought a yen carry trade—borrowing in yen to purchase 10 percent stake in the Vietnamese lender Hanoi higher-yielding assets in other currencies—has Building Commercial Joint Stock Bank. been a factor behind at least some of the 2006 Along with membership in the WTO, recent outflow. reforms in legislation governing private enterprise The sector most bullish on Japan is light and investment should improve the investment manufacturing, which includes health care and climate. Other drivers fueling investment include pharmaceuticals. One influential factor is a large and growing elderly population with ample dispos- able income. Pfizer Inc. has announced that it wants to Investors in both developed expand its research and development activities in Asia, and developing countries favor including Japan. On a related note, the Carlyle Group is Vietnam as a first-time invest- looking to tap the growing demand for senior hous- ment destination, ranking it ing among a fast-aging population by forming a seventh and third respectively. joint venture with a unit of Tokio Marine & Nichido Fire Insurance Company to buy and refurbish buildings for seniors. The financial services two decades of economic reform, a stable political sector was active in 2007. Citigroup’s $7.9 bil- situation and proximity to other booming econ- lion buyout of the brokerage firm Nikko Cordial omies. Despite these efforts and high growth, was the biggest deal. Another notable effort was however, inflation may prove troubling. Vietnam the bid of $1.8 billion for up to 32.6 percent also needs to continue to strengthen the financial of Shinsei Bank by a group of investors led by sector, reform state-owned enterprises and reduce U.S. buyout firm J.C. Flowers & Co. bottlenecks in infrastructure. Japan’s policies and economic growth offer Japan. Japan retains the 15th spot in the a mixed bag for investors. Japan has pushed Index from the previous survey. Developed coun- through reforms to attract foreign investment, try investors consider Japan the 14th most attrac- including a recent move to allow so-called tri- tive first-time investment destination. North angular mergers, in which a foreign company’s

26 new concerns in an uncertain world | A.T. Kearney Japanese subsidiary can use its parent company’s gradually being eased in the face of capital migra- shares to buy a local company. Japan’s keiretsu tion and rising competition in the region. Rules system of interlinked business relationships and pertaining to foreign ownership of manufactur- shareholdings, however, still can act as a practical ing have been flexible since 2003. In 2007, affir- barrier to foreign investment. Japan’s fundamen- mative action requirements were dropped for six tals are good and it is paying down the debt it service industries in the Iskandar Development accumulated in the 1990s. Compared to the rest Region (IDR). Foreign businesses that operate of Asia, Japan’s economic growth is relatively low in this zone are also offered a 10-year tax exemp- and is expected to remain so for the foreseeable tion and no restrictions in the hiring of foreign future. But the Japanese economy has recovered employees. Recently, four Gulf-based investment from its slump in the 1990s, consistently reaching funds committed $1.2 billion in the IDR. growth of more than 1.5 percent since 2003 (and Indonesia. Indonesia reenters the Index’s top up to 2.7 percent in 2004), which has reawakened rankings in 21st place, with Asian investors rank- investor interest. ing it 11th. Developing country investors consider Malaysia. Malaysia’s ranking rose to 16th it the 15th most attractive destination for first- place on the 2007 Index after falling below time investments. Realized foreign direct invest- the top 25 in the last survey. Asian investors ment in the first half of 2007 rose to $3.5 billion, are most interested, ranking it ninth. In 2006, up by 17 percent in a year-on-year comparison FDI inflows to Malaysia rose to $6.1 billion, according to the Investment Coordinating Board. the highest level since the Asian financial crisis. The upsurge in confidence over the past few years Estimated inflows in 2007 are an all-time high may be the result of President Susilo Bambang of $9.4 billion. According to the Malaysian Yudhoyono’s active courting of the international Industrial Development Authority, Japan and the business community, an outreach effort that Netherlands led the pack of investor countries, marks a departure from past practice. In February with the Asian region as a whole accounting for 2006, the Presidential Instruction No. 3/2006 close to half of the total investment. outlined a plan to improve the investment climate The electronics sector has been a princi- through targeted enhancements in five areas: gen- pal recipient of flows (40 percent in 2006). One eral provisions, customs, labor, taxation and small attraction for electronics manufacturers is the and medium-sized enterprises. The new invest- availability of quality manpower at costs 40 per- ment law of March 2007 strengthened foreign- cent lower than in Singapore and Hong Kong. ers’ property rights, restructured the bureaucratic Sony, Samsung, Dell and Motorola all have oper- process for investment applications, streamlined ations in the country. Under the Third Industrial the tax regime and clarified the range of industries Master Plan, released in 2006, electronics and open to foreign investment. Although the law was other key sectors such as petrochemicals, pharma- greeted with praise, implementation will be criti- ceuticals, transport machinery and wood-based cal to the continued successful attraction of FDI. products are targeted for further development and rich in natural resources, Indonesia ranks high promotion. In the past, foreign investment in cer- on the list for primary sector investors. Foreign tain sectors has been limited or subject to affirma- investment has been encouraged in the country tive action rules requiring 30 percent Bumiputra, due to the technical sophistication required in or indigenous, ownership. These regulations are its extractive industries. However, an uncertain

A.T. Kearney | new concerns in an uncertain world 27 regulatory environment has kept foreign enthu- legislation in order to attract foreign partners in siasm in check. The recent acquittal of the U.S. addition to Gazprom—such as ConocoPhillips, mining company Newmont Mining and its presi- Chevron, PETRONAS, Royal Dutch Shell and dent of polluting a bay near its mine improved BP, many of which are already established in the confidence in the country’s operating environ- region. China is also interested in the country’s gas ment. The Japan-Indonesia Economic Partnership resources, and has set 2009 as the completion date Agreement concluded in August of 2007 provided for a 7,000 kilometer pipeline it is financing and a boost to Japanese involvement in the energy building that will stretch from Turkmenistan to sphere. For example, Mitsubishi invested in a Shanghai in the east and Guangzhou in the south. gas-refining project involving two energy firms in in the finance sector, the Italian bank exchange for Indonesia’s commitment to export UniCredit acquired Kazakhstan’s ATF Bank for the final product to energy-scarce Japan. $2.1 billion, the biggest foreign investment to date Central Asia. Central Asia as a region moves outside the oil sector. UniCredit hopes the acquisi- up a notch from 24th to 23rd place on the Index, tion will provide a hub to expand in Central Asia. with Kazakhstan ranking 22nd as a first-time To expand beyond exploiting its energy investment destination. Kazakhstan is the clear supplies, the region is attempting to improve leader, with FDI inflows that total more than its infrastructure. One such plan is the prelimi- all the other Central Asian countries’ inflows nary agreement among China and seven coun- combined. According to UNCTAD, net inflows tries in Central Asia—Afghanistan, Azerbaijan, grew from $1.9 billion in 2005 to $6.1 billion Kazakhstan, Kyrgyzstan, Tajikistan, Uzbekistan in 2006 and an estimated $8.3 billion in 2007. and Mongolia—to invest in a $19.2 billion infra- Turkmenistan, with its gas resources, is the structure development described as a modern second-highest recipient of FDI in the region Silk Road trade route. The plan calls for invest- with $731 million in 2006. FDI grew from ment over the next decade in six new transport 2005 to 2006 in all Central Asian countries. corridors, mainly roads and rail links, to connect Much of the interest in the region stems from the region better to China, Russia and the rest its energy resources. Oil production remains a of Europe. major source of FDI for Kazakhstan, and pro- South Korea. South Korea remains in the top duction is expected to triple over the next decade. 25 for 2007 at 24th place, only a slight decline Beyond oil, companies are also investing in from 23rd in 2005. FDI inflows were down nearly mining. China National Nuclear Corporation, 30 percent, at $5 billion in 2006 compared to $7 for example, is forming a joint venture with billion in 2005. North American investors are Kazakhstan’s state-owned nuclear energy com- most bullish about South Korea, ranking it 14th. pany Kazatomprom to invest in uranium produc- The United States is the largest source of Korea’s tion in Kazakhstan. FDI, and ratification of the United States-Korea Turkmenistan’s energy resources have become Free Trade Agreement—the largest trade deal for an even bigger lure for investors than in the past, the United States since the North American Free because the death of former President Saparmurat Trade Agreement (NAFTA) with Mexico and Niyazov has meant that the country has tenta- Canada—will no doubt increase investor inter- tively opened up. Already the biggest gas producer est in the future. However, uncertainty still exists in Central Asia, the country is revising its energy over ratification due to opposition in particular

28 new concerns in an uncertain world | A.T. Kearney sectors such as beef and auto, as well as protection- to show that there is strong interest in Thailand. ist voices within both legislatures. Additionally, ICBC and Malaysia’s CIMB Group are competing free trade talks with the EU and Canada promise to buy a 19.3 percent share in the Thai bank ACL. future investment into South Korea. The Dutch financial groupI NG recently acquired However, free trade negotiations cannot mask a 24.9 percent stake in TMB Bank. Dubai World’s the increasing threat that South Korean exports, real estate firm Nakheel Group also announced particularly in the key economic sectors of heavy it would pursue projects in Thailand. and light manufacturing, face from large emerg- A decade after the Asian financial crisis, ing economies such as China. But South Korea Thailand seems to have recovered in investors’ does not only face cost competition. Investment perceptions, especially those of Asian investors. in the manufacturing of high-end products Over time, the financial sector has been signifi- such as mobile handsets and flat-panel TVs also cantly strengthened, but the IMF continues to faces vigorous competition from China, Japan recommend further reforms to address remaining and Singapore. The South Korean government vulnerabilities, improve regulatory oversight and has been actively positioning its free economic broaden and deepen capital markets. zones (FEZs)—Incheon, Busan-Jinhae and Gwangyang—as business hubs of Asia. These Europe efforts are paying off: Incheon, for example, has Boosted by Europe’s economic recovery, Western attracted companies such as GM Daewoo, DHL Europe continues to be a major FDI target, even and New York-Presbyterian Hospital to expand as regional investors eye new destinations further operations there. The upcoming World City Expo east. Its share of world FDI inflows held steady 2009 in Incheon also promises to showcase Korea’s at 45 percent from 2005 to 2006. The United vision of a future “ubiquitous” city and related Kingdom retains fourth place on the Index, innovations, including robots, high-speed trains, while Germany and France rank 10th and 13th multimedia networks and biomedical technolo- respectively. Nearly half of total FDI inflows to gies, in the hope of drawing more global invest- Europe, or $263.4 billion, went to these three ment. The event is expected to attract more than core European economies. The investment in 10 million people over three months. these three countries alone is greater than the FDI Thailand. Thailand has dropped off the flowing to all of Asia in 2006. 2007 Index, due in part to investor concerns over FDI inflows to theE U-15 have declined since political stability following the military coup in their zenith at the end of the dot-com boom, as September 2006. But Thailand ranks 11th as a they have in developed economies elsewhere. first-time investment destination among devel- Despite a post-2003 recovery, overall inflows in oping country investors. Asian investors main- 2006 fell 12 percent below their 2000 levels. But tained their interest, ranking the country 12th as prospects for recovery in FDI inflows remain an investment destination. FDI inflows continue strong. For example, union wage restraint during to recover since the financial crisis in the 1990s. the past several years has made Germany among Inflows to Thailand grew 9 percent from 2005 the most competitive advanced industrial econ- to 2006, reaching $9.7 billion. omies. German unemployment, formerly more despite investor concerns about political than 10 percent, was projected to fall to 8.3 stability, recent investment decisions continue percent in 2007. Furthermore, political trends

A.T. Kearney | new concerns in an uncertain world 29 seem poised to continue this recovery. President Republic, 27 percent in Slovenia, 25 percent in Nicolas Sarkozy in France and Prime Minister Poland and Hungary, 22 percent in Slovakia and Gordon Brown in the United Kingdom both 17 percent in Lithuania.9 profess to be economic reformers, though it However, these states now face new competi- remains to be seen how far Sarkozy will be able tion from further east. The accession of Romania to push the reform-averse French. and Bulgaria introduced two new low-wage locales The 2004 entrants to the European Union into the EU customs union. European inves- (collectively known as the EU-10) continue tors list Romania sixth and Bulgaria 13th in their to attract investors, although they may soon be top FDI destinations in the future, closely trail- eclipsed by the new 2007 members, Bulgaria ing Poland at fifth place and the Czech Republic and Romania. From 2000 to 2006, FDI inflows at 12th place respectively. With Romanian wages to the 10 states that joined in 2004 increased by at 12 percent and Bulgarian wages at 7 percent 78 percent to about $39 billion. While Poland of the EU average, investors have begun to seek and the Czech Republic remain in the top 25, out these regions as new production centers. Poland slipped 17 spots from fifth to 22nd, and Romania, building on its car manufacturing the Czech Republic slipped from 12th to 25th. history, is now the heir apparent to Slovakia as These countries continue to enjoy advantages as the auto production capital of Eastern Europe. production centers for goods destined for markets Investors are also interested in access to markets inside the Common Market, and wages remain far on Europe’s periphery (43 percent), the region’s below Western European labor market standards. highly skilled workforce (40 percent) and the abil- Indeed, 48 percent of respondents cite low labor ity to “offshore” while remaining within the EU costs as a factor in pursuing investments in (34 percent). These factors point to Romania’s Central and Eastern Europe. Another attraction is and Bulgaria’s potential as both customer markets the EU-10’s flat-tax regimes: The average implicit and supply hubs. In addition, investors appreci- tax burden in the EU-10 is approximately 19.4 ate these countries’ improving infrastructure. The percent, compared with almost 27.6 percent in EU’s Trans-European Transport Networks pro- the EU-15.8 With this investment, however, have gram will further encourage this shift of produc- come rising living standards and wages. Between tion eastward. Within the next decade, high-speed 2000 and 2006, average labor costs rose 173 per- rail and motorway links will tie the new member cent in the Czech Republic, 128.9 percent in states to the major consumer markets of Western Hungary, 123 percent in Lithuania, 110 per- Europe via the capitals of Central Europe. The cent in Latvia, 103 percent in Slovenia and 87.5 rapid increase in logistical capacity promised by percent in Poland. By comparison, the average these infrastructure improvements should make increase for the entire EU-27 over the same period Romania and Bulgaria even more attractive invest- was only 60 percent. That said, average wage costs ment destinations in the future. in the new member states remain low in compari- europe has waded into the international son to the European average: For example, labor M&A boom, with $413 billion in deals occurring costs are 31 percent of the average in the Czech in 2005, an increase of more than 200 percent

8 Tax data taken from Eurostat. 9 All calculations based on labor cost per hour data from the Economist Intelligence Unit.

30 new concerns in an uncertain world | A.T. Kearney from the market’s 2003 nadir. This activity, how- than for any other Western European country. The ever, was highly concentrated in the advanced United Kingdom ranks highly as an investment economies of Western Europe, with France, destination for both Asian and North American Germany, the Netherlands and the United investors, at sixth and eighth place respectively. It Kingdom accounting for two-thirds of the over- is also the top developed country destination for all transaction value. developing country investors making first-time Finally, it should be noted that most European FDI comes from within Europe—and that this contribution has steadily risen over the past 30 years. Internal The 2004 entrants to the EU con- EU-15 investment flows now account for nearly 80 percent tinue to attract investors, although of gross FDI inflows to EU-15 countries. Private equity contin- they may soon be eclipsed by new ues to play a substantial role in these investment flows. Across 2007 members due in part to labor Europe, private equity and venture capital accounted for $70 cost considerations. billion in investment for 2005, 27 percent over the 2004 figure. From 2004 to 2005, the latest year in which data is publicly available, private equity funds raised for use in investments. Both financial and nonfinancial ser- Central and Eastern Europe tripled, from $625 vices sector firms indicate high interest in the million to $1.9 billion.10 The market remains vol- United Kingdom. The higher transaction costs atile, however. About $317 million was invested imposed on U.S. markets by the Sarbanes-Oxley in Bulgaria in 2004, but nothing in 2005. By con- Act of 2002 have made London a more attrac- trast, investment in the Czech Republic increased tive financial services hub. U.S. politicians look- more than sixfold, from $23 million in 2004 to ing across the Atlantic have cited London as the $160 million a year later. world’s premier financial center, both for its con- United Kingdom. The United Kingdom solidated regulatory environment and its ability retains fourth place in the Index. It received $140 to attract top-quality people and skills. Record billion in FDI in 2006, making it the leading profits in 2006 were rumored to have yielded recipient of foreign investment in Europe by a $17.3 billion in bonuses to London bankers. margin of nearly two to one over France at $81 Furthermore, high oil prices have enlarged one billion. Estimated 2007 inflows amount to $171.1 of the traditionally large streams of money flow- billion. Twenty-three percent of investors report ing to the city—namely, petrodollars from the a more positive outlook over the past year, more Middle East looking for reinvestment.

10 European Private Equity and Venture Capital Association, Central and Eastern Europe Statistics 2005.

A.T. Kearney | new concerns in an uncertain world 31 Private equity also had a banner year in However, investors in Russia are split as to its 2006, with British private equity firms investing future prospects. The 45 percent who indicated $41 billion, almost twice the 2005 level and up they would increase investment in Russia did so more than threefold since 2001. Moreover, while for economic reasons: Russia’s recently improved nearly half went to investments in the United economic performance, its large consumer market, Kingdom, the same share was directed at conti- its energy reserves and its skilled labor force. Of nental Europe. Industrial and consumer goods those looking to increase investments, 35 percent firms received 60 percent of the total investment cite Russia’s economic growth and 31 percent its funds.11 growing consumer markets as primary drivers. several uncertainties affect the future invest- eight percent of investors have decided to ment environment. What the power transition at decrease investments and 48 percent to hold con- No. 10 Downing Street will mean for the British stant, for explicitly political concerns: Seventeen economy remains to be seen. percent are motivated by the threat of national- Russia. Russia falls three places in the Index ization of their assets by the Russian government. from 2005, coming in at ninth place in 2007. Russia Sixteen percent cite the erosion of the rule of law, received $28.7 billion in FDI in 2006, more than 14 percent the political uncertainty surrounding double the $12.8 billion from 2005. Estimates the upcoming retirement of Putin, and 13 per- for 2007 reach $48.9 billion, reflecting continued cent the threat posed by organized crime. Nearly investor interest in the country’s resource extrac- 14 percent of respondents said their assessment tion and resource-dependent industries. Despite of Russia’s economic outlook had worsened in this increase, tightening resource extraction reg- the last year. Investor ambivalence about Russia ulations may affect investors’ future confidence. should not be surprising. As Royal Dutch Shell, Russia attracts mostly European investors, secur- Chevron and BP have all experienced in their ing third place after India and China, while rank- energy operations in Siberia, the Kremlin under ing 14th among Asian investors and below the Putin has become a force in the economy, setting top 15 for North American investors. As a first- the terms under which firms may participate in time investment destination, Russia interests major industries. both developed and developing country investors, russia faces significant challenges in diversi- ranking fourth and fifth respectively. Investors fying its economy, improving the health of its cit- are most interested in Russia’s primary sector, izens, addressing serious environmental problems ranking it just below China for investments in and achieving peaceful relations with its neigh- the sector. Investors in heavy manufacturing are bors. The country’s dependence on oil revenues also bullish. Oil wealth has given a generation to provide rising standards of living and fund the of Russians purchasing power not seen in recent government has made the energy industry of par- memory, leading foreign firms to set up shop amount importance. However, Russian Finance in Russia despite the risks. One example is the Minister Alexei Kudrin has estimated that, with- auto industry. Toyota, Nissan and Renault all out additional investment and imported Western either opened plants in 2007 or have plants under technology, Russia will be unable to meet its construction. contractual commitments to deliver energy in a

11 British Private Equity and Venture Capital Association, Report on Investment Activity 2006.

32 new concerns in an uncertain world | A.T. Kearney five-year timeframe. Reflecting concern about this media, television and communications industries issue, Turkmenistan is routing a gas pipeline to being the top three recipients of foreign invest- Russia through Kazakhstan rather than along a ment in 2006. shorter trans-Caucasus route. some of this improvement may be due to Germany. Germany falls one place in the ongoing economic reform. In July 2007, the Index rankings from 2005, but still secures 10th Bundestag approved legislation to cut the German place. At least one significant foreign divest- corporate tax rate from 39 to 30 percent, plac- ment shook German FDI in 2006: that of Wal- ing Germany in the middle of the tax range in Mart, following disappointing sales figures at its Europe and well below the 35 to 40 percent range German stores. The 85 stores were sold to domes- prevailing in the United States. This should gen- tic rival Metro at a loss speculated to be in the erate significant investment interest from overseas $100 million range on top of an additional $1 companies and continue the impact of reforms billion hit to Wal-Mart’s bottom line.12 begun in former Chancellor Gerhard Schröder’s still, investors are bullish about Germany, government. Whether such reform continues, with 22 percent indicating a more positive outlook however, is less clear. The governing Grand compared to the previous year. While European Coalition under Chancellor Angela Merkel, having investors rank Germany 11th among their top reached the halfway mark between elections, may investment locations, Asian and North American be destined for a period of relative inaction. Labor investors rate the country 15th and 13th respec- market reforms beyond the Hartz IV measures tively. FDI inflows rose 20 percent from $35.9 of the Schröder government appear unlikely due billion in 2005 to $42.9 billion in 2006, and to fundamental disagreements between the main further to $44.8 billion in 2007. coalition partners—the Christian Democratic investors in heavy and light manufacturing Union and Christian Social Union on the one sectors are most bullish about Germany, ranking side, and the Social Democratic Party on the it among their top 10 investment locations over other. In contrast, the success of private industry the next three years. Anecdotal evidence suggests and company-level wage moderation measures a vibrant FDI market. UPS opened a major new agreed to by both management and unions has logistics hub in the region around Cologne and had a much larger impact, significantly improving Bonn at a price tag of $135 million. Dell launched German competitiveness. a new customer service hub supplying 1,500 jobs France. France places 13th in the 2007 at an undisclosed cost. Italian chemicals pro- Index, up from 14th in 2005. The $81 billion in ducer Menarini, after years of high growth in its FDI flows to France in 2006 were roughly equal German operations through its subsidiary Berlin to their 2005 level. 2007 estimates are higher, at Chemie, is expanding operations in the eastern $123.3 billion. With $40 billion in international parts of Germany. Verisign spent $273 million to M&A transactions, France accounted for 8.8 per- acquire Jamba!, a leading provider of wireless ser- cent of the European total. Among European vices in Germany. Data from the Bundesbank— investors, France ranks as the ninth most attractive Germany’s central bank—mirrors this anecdotal destination. It is also a popular destination for evidence, with the chemicals, transport, and the North American investors. According to the Invest

12 Kate Norton, “Wal-Mart’s German Retreat,” BusinessWeek, 28 July 2006.

A.T. Kearney | new concerns in an uncertain world 33 in France Agency, a quarter of the 40,000 new of Electricité de France might presage a new era jobs generated by foreign companies in France in of openness in the French energy market. But 2006 came from American businesses. France also since then, French state activism has manifested ranks 11th as a first-time investment destination itself, with the creation of a French mega-utility among developed country investors. through the government-sponsored merger of The election of President Nicolas Sarkozy Gaz de France and SUEZ. has promised some liberalizing reforms for Turkey. Turkey ranks 20th among global the French economy: labor laws skirting the investors in the FDI Confidence Index. FDI 35-hour work week, greater labor flexibility for inflows to Turkey more than doubled from 2005, French firms and an improved education system. reaching $20 billion in 2006 and an estimated However, Sarkozy has also revived protectionist $19.4 billion in 2007. UNCTAD reports that motor vehicles-related investment accounted for 13 percent of Turkey’s inward FDI flow in 2006. Among major Investors are split as to Russia’s investors, Robert Bosch invested $240 million in future prospects — encouraged by 2005 to build auto parts and other manufactures, economic performance and growing and plans to invest millions more in its Turkish opera- consumer markets, but discouraged tions. In other industries, Indian Oil has applied for by political concerns. a permit to build a $6 billion refinery at the oil port of Ceyhan, and Austrian refiner OMV bought a $1.1 billion stake in Turkish oil and gas talk about national champions and said he would concern Petrol Ofisi. Cross-border M&A deals reopen questions concerning how the European included the $1.6 billion purchase of telecommu- Central Bank sets monetary policy. Financial nications firm TurkcellI letisim Hizmetleri by CTF commitments made during the election might Holdings, and Vodafone’s purchase of Telsim well widen the budget deficit, possibly putting Mobil for $4.6 billion. France in violation of the limits it agreed to Nonetheless, uncertainties about Turkey per- under the Stability and Growth Pact—a treaty sist. Turkey’s prospects for EU accession remain framework for coordinating the economic poli- questionable at best, with French President Nicolas cies of countries in the European Economic and Sarkozy stating that he would not allow Turkey Monetary Union. to accede during his presidency, which will last Telecom and utilities sector investors are until at least 2012. In 2005 and 2006, Turkey and most confident in France as an FDI destination. Brussels continued to disagree over the Cyprus The 2005 FDI study predicted that privatization question and internal human rights issues.

34 new concerns in an uncertain world | A.T. Kearney Poland. After rising in the Index rankings 2005 to 2006, slipping to $5.9 billion (a figure in 2005, Poland falls from fifth to 22nd place in which was nevertheless 20 percent higher than its 2007. This drop can be attributed in part to the 2004 intake). Estimated 2007 inflows are slightly last two years of significant economic and politi- higher, at $7.6 billion. cal turmoil, which raised investor concerns about As with its neighbor Slovakia, the Czech the future of economic reform in Poland. Under Republic continues to attract auto manufacturing the Law and Justice Party, the government was investment from Western Europe. Major recent openly antagonistic both toward Russia and the investments include a $74 million plant for French European Union over issues such as trade, secu- auto parts manufacturer Faurecia. In the IT arena, rity and political representation in the European Hitachi and the LCD display maker IPS Alpha Commission. Former Prime Minister Jarosław Technology recently announced plans to invest Kaczy´nski indicated a desire to reopen the priva- $89 million and $166 million respectively in tization process that had concluded in the mid- twin display factories in the former Czech airbase 1990s, on the grounds that many who benefited at Žatec. Indian software giant Infosys opened a had tainted legacies from the Communist era. 400-seat BPO delivery center in Brno to provide After the liberal Civic Platform’s parliamentary services to European clients. Finally, a wide range victory over the Law and Justice Party in October of U.S. companies, from high-tech giants Hewlett- 2007, however, the government signaled it would Packard and Microsoft to consumer products follow a less populist path. leader Procter & Gamble and industrial goods firm still, Poland leads Central and Eastern Ingersoll-Rand, established R&D facilities in the Europe in FDI inflows, with net inflows of Czech Republic in 2006. The Czech government $13.9 billion in 2006 and an estimated $18.1 is encouraging investment, having recently lowered billion in 2007. It is the top-ranked EU desti- the corporate tax rate from 28 to 24 percent. nation among European investors, at fifth place Hungary. Hungary, which had been 11th overall. Investment in the real estate sector has place in 2005, does not rank in the 2007 Index’s boomed, especially in retail and office properties. top 25. FDI inflows fell from $7.6 billion in Telecom and utilities firms continue to capitalize 2005 to $6 billion in 2006. In that year, Hungary on market liberalization opportunities. The ques- experienced significant political turmoil after tion is whether Poland can hold on to European newly elected Prime Minister Ferenc Gyurcsány investment in the face of new, low-cost competi- admitted to misleading voters during the elec- tors further east as well as other 2004 accession tion campaign. Though several days of massive states such as the Czech Republic and Slovakia. demonstrations in Budapest did not overturn the Poland’s staying power will depend on continued government, it did remind Hungarians and inves- progress in infrastructure improvements, upgrad- tors alike that political reforms have some way to ing of human capital and the sustained growth of go before full political stability is achieved. consumer markets to fuel domestic demand. Hungary’s wage and cost advantages over Czech Republic. The Czech Republic drops Western European production areas have been to 25th place in the rankings, 13 spots below its eroded by the entry of Romania and Bulgaria into 2005 ranking. Nevertheless, it is still the 12th most the EU. While Hungarian wages are 25 percent of attractive destination for European investors. FDI the EU average, Romanian wages are 12 percent inflows to the CzechR epublic fell $6 billion from of the average and Bulgarian wages 7 percent.

A.T. Kearney | new concerns in an uncertain world 35 Spain. Spain falls from 17th place in 2005 its banking market seems to have drawn closer out of the top 25 in 2007. European investors to that of the EU. Brussels has actively encour- are particularly negative about Spain’s prospects. aged European banking consolidation within the FDI flows to Spain dropped 20 percent, from Common Market. $25 billion in 2005 to $20 billion in 2006. Some Ukraine. While Ukraine is not ranked among of this decline was due to the reduced level of the top 25, it is the seventh most attractive invest- private equity activity after a record year in ment destination among European investors. FDI 2005, when two U.K. private equity firms—BC inflows in 2006 fell by one-third from 2005, to Partners and Cinven—bought the IT com- $5.2 billion. Some of this decline no doubt stems pany Amadeus for $5.7 billion, and the telecom- from Ukraine’s ongoing political instability and munications firm Auna sold its cable subsidiary associated concerns about the pace and direction to Spanish rival Ono for $3.4 billion, much of of economic reform. Elections in October 2007 which was provided through a consortium of were followed by more than a month of delay as U.S. private equity firms. Also in 2006, the the leading parties proved unable to form a gov- Spanish real estate bubble, in which housing erning coalition. Previously, the 2004 Orange prices nearly doubled between 1997 and 2005, Revolution led to two years of governmental insta- began to deflate. The bubble burst amid struc- bility. Meanwhile, tensions with Russia have per- tural concerns for Spanish competitiveness, while sisted since January 2006, when Russia abruptly rising inflation reduced prospects for Spanish shut off oil flows to Ukraine. economic growth in the near term. Nevertheless, Nevertheless, foreign investment has con- Spain remains one of the faster-growing econo- tinued in certain sectors. Czech manufacturer mies in the Eurozone. Škoda Auto now produces 19,000 cars annu- Italy. Italy drops from 19th place in 2005 to ally in Ukraine, and has announced further plant below the top 25 in the 2007 Index. However, investment for the future. Škoda’s parent com- European investors rank it 22nd and North pany, Volkswagen, has also moved some produc- Americans 18th as an investment destination. tion capacity to Ukraine. Future prospects for With $39.2 billion in FDI receipts, Italy was the FDI in the banking sector should improve with fifth-largest recipient of FDI in Europe in 2006. Ukraine’s 2006 opening of its banking sector to Nearly one-third of this came from the acquisition foreign firms, under the auspices of WTO nego- of Banco Nazionale del Lavoro by BNP Paribas tiations. UniCredit has already taken advantage of for $11 billion, part of a wave of Italian banking this change, acquiring Ukrsotsbank for $2.1 bil- consolidations. Foreign interest in Italian banks lion in July 2007. Russian oil money is rumored continued into 2007, with Danske Bank spend- to be involved in significant purchases in Ukraine, ing $5 billion for Cassa di Risparmio di Parma. though offshore banking intermediaries make These cross-border banking deals represent a shift verification difficult. from Italian policy in 2005, when the Berlusconi Romania. Romania falls out of the Index government intervened to prevent foreign acqui- in 2007 after debuting at 25th place in 2005. sition of UniCredit. Following both the scandal However, European investors rank Romania sixth that accompanied that policy and the election among investment destinations, second only to of Prime Minister Romano Prodi’s administra- Poland among member states that have joined tion, Italy’s attitude toward foreign entry into the EU since 2004.

36 new concerns in an uncertain world | A.T. Kearney After a small decline in 2005, FDI inflows to Middle East Romania grew from $6.5 billion to $11.4 billion in The Middle East attracted a total of $59.9 bil- 2006. In particular, its auto industry has become a lion in foreign direct investment in 2006, up magnet for investment. Among the major players from $41.6 billion in 2005. Two countries, the was automobile firm Renault, which spent nearly United Arab Emirates ($8.4 billion) and Saudi $750 million to upgrade an old Dacia plant to Arabia ($18.3 billion), account for almost half produce its $7,000 Logan car. In the process, of this total. Renault convinced its suppliers to set up opera- The region remains of concern to inves- tions in Romania. As a result, Romania now has tors because of chronic geopolitical challenges. a substantial auto industry with well-established Investors cite the continued instability in Iraq (74 networks of foreign parts suppliers, as well as geo- percent), the possible outbreak of war with Iran graphic proximity to Western European markets. (70 percent), the risk of terrorism (57 percent), Further investments are to be expected, particu- anti-Western bias (48 percent), and ethnic con- larly given Romania’s much lower wage structure flicts in the region (35 percent) as deterrents to compared with Central European counterparts foreign investment. However, investors also see such as the Czech Republic or Hungary. access to the wealthy regional market as a top Bulgaria. European investors rank Bulgaria opportunity for investment (78 percent), fol- as the 13th most attractive investment target in lowed by the availability of services industry hubs the world. Foreign direct investment to Bulgaria such as Dubai (65 percent). A fast-growing popu- rose 34 percent from 2005 to 2006, reaching a lation (61 percent) and access to capital (61 per- total of $5.2 billion. Much of this improvement cent) are also among the top assets for the region. is probably due to Bulgaria’s accession to the EU. Interestingly, a substantially smaller share of After years of negotiations, Bulgaria and Romania investors (39 percent) considers access to energy finally entered the European Union on January 1, reserves as a major asset. 2007. Shortly before accession, the government United Arab Emirates. The United Arab boosted Bulgaria’s attractiveness to investors by Emirates has risen from 22nd on the 2005 Index cutting the corporate tax rate to 10 percent to to eighth in 2007. Among Asian investors, the match that of Cyprus as the lowest in the EU. United Arab Emirates ranks fifth, and among Foreign investors appear to have responded. European investors it ranks 10th. The relative lack The real estate market has attracted interest of interest from North American investors may in the Black Sea resort areas and in the capital, partly be attributable to corporate concerns over Sofia. Foreign investment in real estate doubled potential political backlash at home. Compared between 2005 and 2006 to $1.6 billion. Retail with a year ago, 29 percent of investors report a giant Carrefour spent $120 million to anchor its more positive outlook toward the United Arab Boulevard Tsarigradsko Shosse project in down- Emirates—behind only India, China and Brazil. town Sofia.O utside retail, the Italian cement firm The United Arab Emirates ranks favorably Italcementi committed $271 million to upgrade among financial services and nonfinancial ser- the facilities at its Bulgarian subsidiary Devnya vices firms, owing in part to continued progress Cement. Belgian firm Solvay invested $105 mil- in reforms and attractive incentives at the Dubai lion to upgrade thermal power facilities through International Financial Centre (DIFC), includ- its Bulgarian subsidiary Deven AD. ing permission for 100 percent foreign ownership

A.T. Kearney | new concerns in an uncertain world 37 and zero tax on profits and income. In addition, oil to financial services, Borse Dubai is buying the country ranks favorably among primary and a 20 percent stake in Nasdaq Stock Market. heavy manufacturing investors. Dubai continues Istithmar, one of Dubai World’s real estate invest- to attract major foreign corporations interested ment firms, has just opened its first office overseas in setting up Middle Eastern headquarters. For in Shanghai. example, Halliburton, the energy firm and ser- Other Gulf states. The Gulf region, rich vices provider, decided in May 2007 to move its in capital from elevated oil prices, has followed corporate headquarters to Dubai from Houston. Dubai’s model of diversifying its economic base, Keen investor interest translated into FDI inflows investing in infrastructure and reforming institu- of $8.4 billion in 2006, down from a record high tions to attract foreign FDI. As a result, the other of $10.4 billion in 2005. Gulf states debut in 17th place in the 2007 Index. FDI flows tell the same story. According to UNCTAD, inward FDI to Bahrain was $1 billion in 2005 but jumped to $2.9 billion Reforms in some Middle Eastern in 2006, a 177 percent increase in one year. Oman’s inward countries have improved the FDI grew from $900 million to $952 million in the same investment climate; corporate period, and Qatar’s increased from $1.2 billion to $1.8 bil- investors are attracted to wealthy lion. Conversely, Kuwait, which has focused less on reform and regional markets and services diversification, brought in only $110 million in 2006, down hubs such as Dubai. from $250 million in 2005. Investors from the heavy manufacturing sectors, in particular, hold positive views of the region. Chemicals are a growing in the last two years, the United Arab sector, with much of the capital flow in chemi- Emirates has become a major investor and not cals being regional. Leading world firms are also simply a target for foreign investment. As a result investing: Dow, Total, ExxonMobil and Royal of the petrodollar boom, the state-owned Abu Dutch Shell all have stakes in chemical joint Dhabi National Energy Company, in the largest- ventures throughout the region and are planning ever North American takeover by a UAE com- further investment in Qatar. pany, agreed in September 2007 to buy Canada’s investors from the financial services sector PrimeWest Energy Trust for $5 billion in cash and are also optimistic about the region’s prospects. assumed debt. The government of Abu Dhabi also In November 2007, Deutsche Bank officially bought a 7.5 percent stake in the Carlyle Group opened its first branch in Qatar to offer invest- for $1.35 billion. In an effort to diversify from ment banking and private wealth management

38 new concerns in an uncertain world | A.T. Kearney services. Aon applied for a license to operate in our survey, investors from the financial from the Qatar Financial Centre and plans to services sector are most positive about Saudi open there next year. In Bahrain, Allianz launched Arabia. This is borne out by recent announce- an Islamic insurance operation, Allianz Takaful ments from major players in the sector. Morgan (Bahrain), and is establishing a central office to Stanley plans to form a banking venture with the monitor its regional operations. Saudi firm the Capital Group, and Goldman Sachs As a region, the Gulf states have been open- is forming an investment banking venture with ing markets and increasingly using public- the state-owned National Commercial Bank. private partnerships to invest in infrastructure. Egypt. Although Egypt did not make it into According to the IMF, the Gulf Cooperation the top 25 in the 2007 Index, developing coun- Council (GCC) countries have made “signifi- try investors ranked the country 12th among cant advances” in legislative and financial sector first-time investment destinations. FDI inflows reforms. They are also modernizing the super- also demonstrate rising interest on the part of visory and regulatory frameworks governing the investors in the country. FDI inflows of $10 financial markets. Both Bahrain and Qatar are billion in 2006 and an estimated $10.2 billion creating the infrastructure and regulatory frame- in 2007 represent almost double the 2005 figure work needed to excel in financial services. of $5.4 billion. For example, Thailand’s PTT Saudi Arabia. Saudi Arabia is the 10th most International signed a contract to buy a 25 per- popular first-time investment destination for devel- cent stake in Egypt’s East Mediterranean Gas oped countries. Saudi Arabia was the largest single for $487 million. recipient of FDI in the Middle East, drawing in in 2006, Egypt’s FDI flowed mostly from the $18.3 billion in 2006, up 51 percent from 2005. United States ($4.6 billion) and the European The increase in FDI is fueled in part by Saudi Union ($2.9 billion). The United Kingdom Arabia’s attempts to diversify the economy with accounted for more than 50 percent of net EU planned investments through public-private part- outflows to Egypt, although the French cement nerships in infrastructure and real estate. This is company Lafarge’s 2007 agreement to buy in addition to reforms in the 1990s encourag- Orascom Cement for $12.9 billion shows that ing growth in the broader economy. According to the rest of Europe is noticing recent improve- the IMF, the reforms have had results, with non- ments in the Egyptian economy. Middle Eastern oil exports increasing by more than 20 percent countries invested $554 million in financial year per year from 2000 to 2006. These changes are 2005-2006. improving investors’ confidence in the country. investments—often through joint ventures— Africa in the oil, gas and chemicals sectors constitute a Africa’s year-on-year FDI performance was pos- large portion of Saudi Arabian FDI. Saudi Arabia itive, with overall investment inflows rising 22 accounted for nearly 63 percent of total GCC percent in 2006, after a 78 percent increase in investment in petrochemical projects in 2006. 2005. But the continent still attracted only $36 Japan’s Sumitomo Chemical Company and Saudi billion in total investment, less than the island Aramco recently announced plans to expand Petro territory of Hong Kong. Rabigh, their petrochemical joint venture, with despite Africa’s traditional dependence on additional investment of at least $1.8 billion. primary industries, investors are most interested

A.T. Kearney | new concerns in an uncertain world 39 in Africa for services investment. Sixty-nine per- european Union firms remain the largest cent of respondents indicate that services provide investors in South Africa. German firm Bilfinger the greatest investment opportunities, compared Berger announced plans in June 2007 for a $14 to 38 percent for agribusiness, 35 percent each for million plant to make boiler parts. Engine and auto raw materials (excluding energy) and retail, and 23 manufacturer Rolls-Royce purchased a 15 percent percent for traditional energy. The Index suggests stake in specialty alloys manufacturer Avalloy. that the bulk of this interest is directed at South German optics maker Carl Zeiss has purchased 70 Africa, which ranks 18th in investor confidence. percent of Denel Optronics, the opto-electronics despite emerging opportunities in the oil- arm of state-owned defense contractor Denel. rich African states, Africa continues to lag behind And the DaimlerChrysler plant in the auto- the rest of the developing world in terms of vis- producing city of East London has attracted ibility to global investors. When asked about the foreign parts makers, including Johnson Controls greatest risks to investing in Africa generally, and Feltex Fuhrer. In short, companies across investors place political instability at the top of the industrial spectrum have found South Africa the list (77 percent of respondents), followed by to be an attractive target. insufficient public infrastructure (69 percent), Nigeria. Nigeria ranks 10th among develop- low workforce skill level (58 percent), poor IT ing country investors as a first-time investment infrastructure (58 percent) and bureaucratic destination. Recent FDI data confirms investor overhead (54 percent). When asked what steps activity in the country. The oil economy made would improve the investment environment, Nigeria the continent’s top destination in 2006, one response stands out: the streamlining of with $5.4 billion in inflows, a substantial rise government bureaucracy (92 percent of respon- from $3.4 billion in 2005. dents). This answer is well ahead of financial and tax incentives (69 percent), public-private invest- Conclusion ment partnerships or partnerships with local firms As developed markets feel the effects of finan- (46 percent each), or better vocational train- cial turmoil and emerging markets draw growing (27 percent). Firms have long been used to ing numbers of investors, the locus of power operating in areas where they must develop their in FDI may be shifting. While still dominating own networks or train their own workers. But the majority of outward FDI flows, developed the perceived bureaucratic overhead of operating markets also face unprecedented competition in Africa is considered outside firm control. from emerging market capital. At the same South Africa. South Africa debuts in the time, as investment targets, many developed FDI Confidence Index at 18th place. Among markets are at a crossroads. They recognize the developing country investors, South Africa ranks need for fundamental reforms to help their sixth as a first-time investment destination. FDI countries regain global competitiveness and inflows to South Africa fell dramatically between attract investment. Yet their electorates are press- 2005 and 2006, from a record high of $6.3 billion ing strongly to preserve national interests and to a net outflow of $323 million. This was due domestic jobs. largely to sales of foreign equity shares to local Emerging markets, amid investor exuberance, firms. FDI inflows are expected to rebound to face a variety of new global challenges. Investors an estimated $5 billion in 2007. are increasingly concerned about the progress of

40 new concerns in an uncertain world | A.T. Kearney reform and the stability of the macroeconomic of FDI continue? The answer depends not only and political environment. Furthermore, there is on the fundamental attributes that attract global a growing worldwide focus on environmentally investors. It depends very much on policymakers’ and socially sustainable development. ability to address investor concerns and distin- in an increasingly uncertain global invest- guish their countries among the crowded, com- ment environment, will the geographical shift petitive field of investment destinations.

Authors

Paul A. Laudicina is managing officer and chairman of the board of A.T. Kearney, and chair of the Global Business Policy Council. He can be reached at [email protected].

Janet Pau is a manager with the Global Business Policy Council. Based in the Washington, D.C., office, she can be reached at [email protected].

The authors wish to acknowledge the contributions of their colleagues David Beffert and Samantha King.

A.T. Kearney | new concerns in an uncertain world 41 Methodology

The FDI Confidence Index® was constructed using primary data from a proprietary survey administered to senior executives of the world’s leading corporations. The respondents were selected from the Global 1,000 population as determined by 2006 revenues, as well as the largest corporations in emerging economies. Participating companies represent 60 countries and span 17 industry sectors across all six inhabited continents. Together, the companies comprise more than $3.8 trillion in annual global sales and more than $35 trillion in global assets. They are responsible for more than 75 percent of global FDI flows.R espondents included not only C-level executives, but also regional and business heads. The survey was conducted in July and August 2007, just as the subprime market crisis was beginning to unfold.

The Index was calculated as a weighted average of the number of high, medium and low responses to questions about the likelihood of direct investment in a market over the next three years. Index values are based on non-source country responses. For example, the Index value for the United States was calculated without responses from investors based in the United States. Higher index values indicate more attractive investment targets.

Since the inception of the FDI Confidence Index in 1998, the 10 most attractive FDI destinations have consistently received 40 percent or more of global FDI inflows roughly one year after the survey. Over the same period, on average, the top five countries captured 35 percent of global FDI inflows, and the top 25 countries more than 70 percent of global inflows. There is an even stronger correlation between the Index rankings and future bricks-and-mortar FDI, especially after correcting for anomalies, such as those stemming from tax havens.

FDI flow figures are the latest statistics available from the United Nations Conference on Trade and Development (UNCTAD). Other secondary sources of information used in this year’s FDI Confidence Index include the International Monetary Fund, the European Statistics Agency (Eurostat), the Economist Intelligence Unit and the U.S. Green Building Council. Additional sources of information include country investment promotion agencies, central banks, ministries of finance and trade, and major periodicals.

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