Barriers and Challenges in Cross Border Investment
Cross Border Investment is an Investment cutting across the geographical borders with an aim to cash in the foreign market. The first and foremost requirement for a Cross border Investment to flourish is cordial relationship between the two countries i.e. the country of nationality and country of investment. Thanks to the need of most of the countries to stay closely knitted to the world, permitting inflow of cross border investments has become essential as a reciprocating measure. Of course the quantum of permissible inflow depends on the monetary and fiscal policy of the ruling Government in that nation and hence not every country can reciprocate equally. As long as the foreign company contributes to the cause of GDP, employment, export earnings and growth rate of the investee nation, things should be fine. This is the reason why developing economies will be receptive only to FDI (Foreign Direct Investments) rather than FII (Foreign Institutional Investment) in Stock market. FII inflows which are known to be 'hot monies' have high turnover and cause the domestic currency exchange rates to fluctuate a lot.
Barriers in Cross Border Investments are legal; challenges to the same are fiscal, cultural and social in terms of character (Of course challenges are not as powerful as barriers which are beyond our control).
Legal barriers definitely appear during the initial stages. No country will allow an FDI which will be harmful to domestic stakeholders or the economy at large. The general phenomenon is that more money flows from developed economies to developing ones where the product markets are generally not saturated. Hence developing countries should be ever alert to protect the interest of its resident shareholders. This is the reason for FDI limits set in various destinations for e.g.in Telecom sector, China and South Korea are said to have a cap of 49%, and India has a higher 74%. A limit of 49% is to retain majority share holdings for resident nationals and in India the limit of 74% is to not allow the foreigner easily get away with requisite special resolutions under the Companies Act 1956 in respect of principal matters such as altering the Memorandum or Articles of association. In contrast, some of the states in the US and countries in EU seem to allow as high as 100% FDI which goes to show that they are least bothered that foreign inflows are there to harm their economy. Recently the World Bank released a report titled “Investing across Borders 2010” which pointed out that around 87 countries are having FDI limits which is hampering Cross border investments equally supported by corruption, political risk and weak governance. Our own Indian Government protects the interest of an Indian coventurer in a Joint venture through Press Note 18. This requires that a foreign company which is already a coventurer in another JV with an Indian counterpart and which intends to enter into another JV in the same line of business willl have to get a Non objection declaration from the erstwhile Indian venturer.
Not having an FTA (Free Trade Agreements) is indirectly another barrier because it makes the survival difficult. Wherever there is a FTA, duty rates are lesser compared to those on consignments to Non FTA nations, subject to getting Certificate of Origin. In a FTA between lopsided countries, a small country is bound to have weaker bargains and more often than not ends up complaining of dissatisfactory liberalisation from the bigger one for which it has to lobby around. Also it is difficult for a Company to compete in a foreign country where its home country has not signed any or a more beneficial FTA, whereas the competitor's nation already has one in place. This is because duty rates will be higher thereby making its product less cost competitive or force the company to bear the duty expenses in which case margins will shrink. To cite a real example, Reports reveal that Japanese companies in EU (European Union) are reeling under pressure due to South Korea having signed an FTA with the EU which is far progressive than the EPA (Economic Partnership Agreement) between Japan and EU. Such embarassing situations might even pave the way for smuggling and other illegal attempts.
Winning over the Fiscal challenges is in the hands of the company and nothing can be laid at the doors of other Government unless there is some unscrupulous policy of discrimination by that foreign Government. An access to foreign credit market for a Company is naturally limited to its overseas credibility. For the Foreign Government to appreciate the domestic presence of the Company, it has to demonstrate not only the repayment capacity but also its statutory compliances in that country (if already existing). In general, corporate from developing economies who invest in developed countries risk facing the vagaries in exchange rate and the resultant cash flows. This is because; the repatriation usually happens in the foreign currency and has to be reconverted backyard to the domestic currency whose equation is unpredictable. It does not happen the other way (The general fact is that developed countries do not maintain reserves of currencies of all developing countries and hence will make repatriation in their own currency. Currently developing countries are exporting and importing in Dollars, Euros or Pounds but not in their own domestic currency due to weaker bargains).
Repatriation of Profits popularly happens as Dividend or Royalty. As of now, the quantum of Dividends or Royalty payable to Non residents is not restricted in many countries. But for Dividend, apart from the standard rule that it is payable only out of Profits, specific conditions may also be attached. For e.g. it is said that in UK a public company can distribute monies only if the net assets exceed the sum of Called up share capital and Undistributable reserves. In Singapore, as per their Banking companies act, a Finance company can declare dividend only after all capitalised expenditures have been written off. As far as India is concerned we know that S.205 of Companies act 1956 requires provisioning for depreciation before declaring dividend.
Taxation at the investee nation is another significant factor. The rates of withholding taxes and Dividend distribution tax are the elements to challenge if they are high. Also, if for e.g. the Dividend tax is too lesser when compared to the tax on corporate profits, perhaps companies may have to declare interim dividend quite frequently, say quarterly, to satisfy the shareholders that will impact the cash flows. (Even otherwise imagine a country like USA with spend thrift shareholders who prefer immediate consumption of income rather than look for a higher return on investment into future new projects). If the gap is small, perhaps the company may convince the shareholder about attractive returns in future which will outweigh this small tax savings. To quote some examples, in Germany, Portugal, Russia or USA the difference between the Dividend distribution tax and corporate profit tax is roughly around 4-5% which is quite narrow when compared to around 15% in China or India or a huge 34% in Brazil. Such gaps definitely influence the decision on payment of dividend. Withholding taxes may be unfavourable or doubly taxed if there is no Double taxation avoidance agreement (DTAA) between the countries.
Cost of borrowing funds in that country is also an important factor to consider. No two countries can attach the same risk profile for the same sector, because each of them will have their own assessment of the business prospect in their countries. For instance lending to a real estate sector may be risky in USA than India. Hence risk premiums will also vary. Another situation is that the All in cost of borrowing in a foreign currency will be higher if the Banker does not maintain reserves of the desired foreign currency. In this case the concerned Banker may have to borrow the same abroad from another Bank which holds this currency and lend it to the company. This reduces the available space for negotiation with the Banker and adds as commission and other costs to the transaction. Of course one of the natural determinants of cost of borrowing and rate of return is also the rate of inflation which tends to be normally high in the developing countries.
Finally, a Company setting up establishment abroad has to comprehend the culture of the population and respect the ethnicity over there. Albeit the Company can have all its Directors on Board belonging to its home country, majority of its staffs and workers may have to be sourced from the local population. Companies will have to socialise with them. Any Corporate which invests abroad shoulders more Social responsibility. For e.g. an indifferent behaviour of top management with people in the lower cadre may ignite nationalistic feelings and shape up as racial discrimination in which case the management becomes accountable to that foreign Government. In other words, any attempt by the management to thrust their native culture on the other staffs could be viewed as tyrannic behaviour and result in higher attrition.
Conclusion: "Cross the Border, not your limits"