The emerging market is an equivocal category as there is no universally accepted definition or criteria used to distinguish emerging market economies from among the numerous developing economies.' In the World Investment Report (WIR) published by the United Nations Conference on Trade and Development (UNCTAD), statistical data on the world economy is analyzed around three groups: developed countries, developing countries and countries of Central and Eastern Europe. Although UNCTAD makes no distinction within emergi assessment of economic and social development prospects in emerging markets do x market economies,

‘A publication by the Deutsche Bank compares the role of FDI in emerging market economies compared to other forms of financing. Past developments and implications for financial stability, Deutsche Bundesbank, International Relations Department, J2/J2-2, Frankfurt 2003, p. 3

84 The International Journal of Banking and Finance 3-4 (Special Issue): 2005-2006: 83-98 appear in the WIR reports as only areference to the data published by the International Monetary Fund (IMF) and the Institute of International Finance (IIF).?

The International Monetary Fund in the World Economic Outlook (WEO) report identifies a group of 146 developing and emerging countries, which includes all the economies not classified as advanced.’ In the WEO of 2004, the statistics referring to emerging markets focus on 32 countries,’ while the International Institute of Finance listed 29 countries as emerging markets.? Moreover, the Bank for International Settlements (BIS) in the 74" Annual Report referred to 22 emerging economies.° Finally, according to the classification used by the Standard & Poor’s rating agency, a country is classified as emerging if it has a low-or middle-income economy (as defined by the Word Bank)’ low investable market capitalization in relation to the GDP and its equity market exhibits significant features of emerging markets.* According to the data for the end of 2004, S&P distinguished 33 such economies.”

In the context of this paper, the emerging market group comprises 25 countries classified as emerging markets by The Economist. As many as 19 economies from this group appear on all the aforementioned lists, according to the 2004 data. The Economist published the list of emerging economies for the first time in January 1994, as a separate group of developing economies. The selection criteria are based on the GDP and stock market capitalization. For the first two years, the list comprised 24 countries, and has since been enlarged by one more entity, Colombia. During the period under consideration, two changes were made, first in 1998; Portugal was included in the list for the last time, and then replaced in 1999 by Egypt. Second, in 2001, Greece was removed from the list and replaced by Peru. The list of emerging market economies along with the data on GDP and stock markets capitalization is presented in Table 1.

The countries placed on the emerging markets list are quite diversified with regard to the indexes analyzed. For example, in 1993, the share of individual countries in the total world production, based on the purchasing power parity, fluctuated from 7.62 percent for China and 4.5 percent for India to only 0.17

* World Investment Report 2004, UNCTAD, New York 2004, p. 34 -36.

7 USA, Germany, France, Italy, Spain, Netherlands, Belgium, Austria, Finland, Portugal, Greece, Ireland, Luxembourg, Japan, United Kingdom, Canada, Korea, Taiwan, Australia, Sweden, Switzerland, Hong Kong, Denmark, Norway, Israel, Singapore, New Zealand, Cyprus, Iceland. World Economic Outlook 2004, International Monetary Fund, pp. 195 i 236.

*Argentina, Brazil, Bulgaria, Chile, Czech Republic, Estonia, Philippines, Hong Kong, India, Indonesia, Israel, Colombia, Korea, Lithuania, Latvia, Malaysia, Mexico, Pakistan, Peru, Poland, Russia, RPA, Romania, Singapore, Slovakia, Slovenia, Taiwan, Thailand, Turkey, Ukraine, Venezuela, Hungary. World Economic Outlook 2004, International Monetary Fund, p. 4. There is certain inconsistency here, however, since some of the aforementioned economies are also mentioned in the statistics concerning economically advanced countries. Compare footnote 3.

* Algeria, Argentina, Brazil, Bulgaria, Chile, China, Czech Republic, Egypt, Ecuador, Philippines, India, Indonesia, Colombia, Korea, Malaysia, Morocco, Mexico

The International Journal of Banking and Finance 3-4 (Special Issue): 2005-2006: 83-98 85

Economy total world per capita markets** total world per capita markets** GDP in 1993 in 1993 (04.01.1994) | GDP in 2004 in 2004 (12.01.2005) (ace, to USS (ace, to USS PPP)* (PPP)* PPP) (ppp)* China 7.62 1943.5 1132.9. 13.01 5299.1 1319.5 India 4.50 1533.4 3479.9 5.83 2 848.9 6 102. Russia 3.40 6902.3 no data 2.58 9 626.5 605.5 Brazil 2.99 5 668.5 40 064.0 2.73 8 258.0 24 509.0 Mexico 1.98 6 796.2 2 558.9 1.83 9 356.8 12 329.2 Indonesia 1.51 2 433.7 599.9 1.45 3472.7 1008.6 Korea 1.38 9 435.4 877.3 1.67 18 354.7 880.0 Argentina 1.11 99344 598.2 0.84 11 456.4 1344.1 Turkey 0.99 5099.3 22 288.0 0.92 6 948.7 26271.3 S. Africa 0.99 7869.8 5 088.3 0.91 10 271.0 12 724.8 Taiwan 0.95 13 687.0 6 070.6 1.06 24 528.1 58791 Thailand 0.92 4747.6 1753.7 0.91 7 444.2 694.6 Poland 0.77 6 020.5 13 346.0 0.84 114279 25 716.8 Philippines 0.66 3019.9 3 308.4 0.70. 4 482.0 1820.6 Colombia 0.64 5 200.4 a 0.56 6 500.9 43479 | Egypt 0.46 2540.4 - 0.50 3900.9 25 858.1 Greece 0.41 12 032.1 994.2 0.41 19 562.9 - Malaysia 0.40 6 160.0 1313.4 0.47 9 900.8 933.0 Portugal 0.39 11 967.3 2 685.3 0.35 18 428.1 - Hong Kong 0.38 19 301.4 12 201.0 0.37 28 058.8 13565.3 Venezuela 0.38 5437.3 22 286.0 0.23 4 663.7 29 922.7 Czech Rep. 0.36 10 557.3 no data 0.31 16 265.1 1066.6 Hungary 0.28 8 325.6 1228.7, 0.28 15 342.4 15 053.6 Chile 0.28 6170.5 4035.8 0.31 10 422.56 8 620.3 Israel 0.26 15 922.4 253.2 0.26 21 009.4 652.6 Peru 0.26 3 241.2 - 0.28 5170.5 3 826.3 Singapore 0.17 15 714.4 2471.9 0.20 24 407.3 2079.8

Sources: compiled on the basis of: * data published by the International Monetary Fund (www.imiforg); ** The Economist: January 8th 1994, January 15th 2005.

percent for Singapore. At the same time, Singapore was one of the countries with the highest GDP per capita, while for both China and India this index values were very low.

® Studzi_ska, K: Bezpo_rednie inwestycje zagraniczne w Polsce na tle _wiata, [in:] ,,Bezpo_rednie inwestycje zagraniczne w Polsce” (ed. Karaszewski, W.), Wydawnictwo Uniwersytetu Miko_aja Kopernika, Toru_ 2003, p. 12 - 13.

7 Converting nominal values into real ones has Bern done using appropriate conversion factors (CF). R. Sahr: Inflation ConversionFactors for Dollars 1665 to Estimated 2015, Oregon State University: http://oregonstate.edu/dept/pol_sci/fac/sahr/sahr.htm.

8 According to the UNCTAD classification this group includes: Albania, Belorussia, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Lithuania, Latvia, Macedonia, Moldova, Poland, Romania, Russia, Slovakia, Slovenia, Ukraine and Yugoslavia. UNCTAD — Handbook of Statistics On-Line (http:/}www.unctad.org).

° According to the UNCTAD classification the developed countries group includes: Austria, Belgium, Luxembourg, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Netherlands, Portugal, Spain, Sweden, the Great Britain, Gibraltar, Iceland, Malta, Norway, Switzerland, Canada, USA. UNCTAD — Handbook of Statistics On-Line (http://www.unctad.org).

86 The International Journal of Banking and Finance 3-4 (Special Issue): 2005-2006: 83-98

At the beginning of 2004, Brazil had the highest index in terms of stock market capitalization (40,064) along with 3 percent share in world GDP. Turkey and Venezuela had a high capitalization (22,288 and 22,286), but with a much lower share of the world production, 0.99 percent and 0.38 percent respectively. The lowest capitalization index belonged to Israel (253.2), but the country had one of the highest FDI reletive to GDP per capita (US$ 15,922). As of 1993, Poland s share in total world GDP was 0.77 percent, along with the GDP per capita of US $ 6,020.

Except for China, even though there was no profound change in the world production share, we noticed a significant increase in affluence, as determined by the GDP per capita (e.g. Poland, Hong Kong, Hungary, and Israel): due care should be taken of the data for China, since about a third of the GDP is that of Hong Kong added to China s GDP since the return of Hong Kong to China. As for the stock market capitalization index, despite a 50 percent decrease, Brazil still remains among those with the highest index level. The others were Turkey, Poland, Egypt and Venezuela (according to the data for 2005).

Now that the definition of what constitutes emerging market economies is somewhat clearer, the rest of the paper attempts to use this classification to examine the capital flow from FDI to these countries. The rest of the paper is organized as follows. Section 2 provides a description of the FDI flows. In the next section, the reader will find a discussion of what is the attractiveness for FDI investments. Section 4 attempts to examine the capital stock created by the FDI flow, and ranks the countries. The paper ends in Section 5 with pertinent conclusion on the potential for FDI in the group classified as emerging market economies.

FDLis defined as equity holding across national borders, either as a greenfield investment, when the FDI is used to find a new business in a foreign country, or as purchasing property rights in an already existing company, on a scale that provides for a direct participation in the management. According to the OECD

Developed countries 1,399,5 2,035,8 4,011,7 5,049,7 5,701.6 Developing economies 547,9 916,7 1,939,9 | 2,093,5 2,280,2 Central and Eastern 2,8 39,6 138,3 228,2 263,3 Europe

Source: Compiled on the basis of the UNCTAD data —Handbook of Statistics On-Line (http:// www.unctad.org) The International Journal of Banking and Finance 3-4 (Special Issue): 2005-2006: 83-98 87 definition, a direct investment enterprise is an enterprise in which a foreign investor owns at least a 10 percent share in the equity capital. However, direct investment is not just a simple transfer of finance capital. It comprises experience, technical expertise and enterprise, know how."°

Between 1990 and 2003, the World witnessed a period of soaring increase in the value of FDI, resulting in a sudden increase in the accumulated stock of FDI. The accumulated real value of FDI realized worldwide tripled! in 2003. The accumulated level of foreign investments in Central and Eastern Europe!* went 18-fold over 1990 to 2003. Meanwhile, the accumulated value of FDI in developed'* and developing countries approximately tripled.

a Developed countries Edbeveloping countries Eicentral and Eastern Europe

My own calculations on the basis of the UNCTAD data— Handbook of Statistics On- Line (http://www.unctad.org).

" Studzi_ska, K: Bezpo_rednie inwestycje zagraniczne w Polsce na tle wiata, [in:] ..Bezpo_rednie inwestycje zagraniczne w Polsce” (ed. Kavaszewski, W.), Wydawnictwo Uniwersytet Miko_aja Kopernika, Toru_ 2003, p. 12 — 13.

1! Converting nominal values into real ones has Bern done using appropriate conversion factors (CF). R. Sahr: InflationConversionFactors for Dollars 1665 to Estimated 2015. Oregon State University: http://oregonstate.edu/dept/pol_sci/fae/sahr/sahr.htm.

'2 According to the UNCTAD classification this group includes: Albania, Belorussia, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Lithuania, Latvia, Macedonia, Moldova, Poland, Romania, Russia, Slovakia, Slovenia, Ukraine and Yugoslavia. UNCTAD — Handbook of Statistics On-Line (http://www.unctad.org).

‘According to the UNCTAD classification the developed countries group includes: Austria, Belgium, Luxembourg, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Netherlands, Portugal, Spain, Sweden, the Great Britain, Gibraltar, Iceland, Malta, Norway, Switzerland, Canada, USA. UNCTAD — Handbook of Statistics On-Line (http://www.unctad.org).

88 The International Journal of Banking and Finance 3-4 (Special Issue): 2005-2006: 83-98

Source: Compiled on the basis of the UNCTAD data —Handbook of Statistics On-Line (hup://www.unctad.org).

The substantial increase in foreign investments in Central and Eastern Europe (CEE), even though drastic, is still minor in relative terms. During the same period, the accumulated value of FDI realized in the CEE countries was only 3.19 percent of the total direct investment worldwide: this is not surprising as capital accumulation takes a long time. By contrast, the accumulated value of FDI share of 4 percent in Holland was higher than the total investment in twenty CEE countries."4

In that regard, the biggest share in attracting this investment still belongs to developed countries, where the accumulated FDI value in the test period was between 66-72 percent: See Figure | and Table 3

Annual foreign direct investment stock reached their highest value in the year 2,000 (US$ 1,400 billion). Developing countries received 18 percent of this amount, and CEE countries 2 percent. The largest stock of capital inflow of FDI reached in 2002 was US$ 31.2 billion, accounting for 4.6 percent of the total world value of FDI. In the following years, FDI inflow displayed more diversity across countries (see figures 2 and 3).

“My own calculations on the basis of the UNCTAD data~ Handbook of Statistics On-Line (http:// www.unctad.org). The International Journal of Banking and Finance 3-4 (Special Issue): 2005-2006: 83-98 89

Developed countries @ Developing countries m Central and Eastern Europe

According to UNCTAD, a country’s attractiveness to foreign direct investment depends on three main factors:'> policy framework for FDI: economic, political and social stability; rules regarding entry and operations; standards of

'S World Investment Report 2002. UNCTAD, p. 24, on factors influencing a country’s attractiveness to investment; see also Bojar, E.: Bezpo_rednie inw rozwini_tych. PWN, Warszawa 2001, p. 23 — 24 and Olesinski w Polsce, PWE, Warszawa 1998, p. 40 — 51.

ie zagraniczne w obszarach s_abo

Bezpo_rednie inwestycje zagraniczne 90 The International Journal of Banking and Finance 3-4 (Special Issue): 2005-2006: 83-98 treatment of foreign affiliates; policies on functioning and structure of markets; international agreements on FDI; privatization policy; trade policy and coherence of FDI and trade policies; tax policy. The second factor is economic determinant: access to regional and global markets; country — specific consumer preferences; resource/asset — market— seeking FDI; market size and per capita income; market growth; seeking FDI; raw materials, low — cost unskilled labour; technological, innovatory and other created assets (e.g. brand names), including as embodied in individuals, firms and clusters; and physical infrastructure. The third factor is efficiency—seeking FDI: cost of resources and assets listed under resource/asset — seeking FDI, adjusted for productivity of labor resources; other input costs, e.g. transport and communication costs to/from and within host economy and costs of other intermediate products; membership in a regional integration agreement conductive to the establishment of regional corporate networks.

Business facilitation also plays a role: investment promotion (including -building and investment-generating activities and investment-facilitation services); investment incentives; hassle costs (related to corruption, administrative efficiency, etc.) and social amenities (bilingual schools, quality of live, etc.); after- investment services.

To assess the effectiveness in attracting foreign investments, we will be using two indices developed by UNCTAD. The first index (FDI Performance Index) shows the achieved FDI level in the country. It is a ratio of the given country’s inward FDI in total value of foreign direct investment realized worldwide to the country’s GDP share in the world product.'®

The second index (FDI Potential Index) is an average of the results obtained from appropriate calculations!’ based on twelve factors (variables measured on the scale from 0 to 1) influencing the given country’s potential in attracting foreign direct investment. The variables used for determining the above item from year 2001 and 2003 during the period were.'*

* GDP per capita,

¢ the rate of growth of GDP,

* — the share of exports in GDP,

* telecom infrastructure (the average of telephone lines per 1000 inhabitants and mobile phones per 1000 inhabitants), * commercial energy use per capita ,

' INDi = (FDI / FDhw) : (GDPi / GDPw), where: INDi —The Inward FDI Performance Index of the i-th country, FDIi — FDI inflows in the i-th country, FDI —World FDI inflows, GDPi - GDP in the i-th country, GDPw — World GDP. World Investment Report 2002, UNCTAD, New York — Geneva 2002, p. 34.

"(Vi-Vmin) : (Vmax — Vin), where: Vi-the value of a variable for the country i, Vin —the lowest value of the variable among the countries, Vmax — the highest value of the variable among the countries. World Investment Report 2002, UNCTAD, New York — Geneva 2002, p. 34. 'S World Investment Report 2002, UNCTAD, New York — Geneva 2002, p. 36. The International Journal of Banking and Finance 3-4 (Special Issue): 2005-2006: 83-98 91

* share of R&D expenditures in gross national income,

* theshare of tertiary students in the population,

* country risk,

¢ — exports of natural resources as a percentage of the world total,

* imports of parts and components of electronics and automobiles as a percentage of world total,

* exports in services as a percentage of the world total, and

° — inward FDI stock as a percentage of the world total.

92 The International Journal of Banking and Finance 3-4 (Special Issue): 2005-2006: 83-98

The above-named indices for emerging market economies have been compiled and included in Table 4. The indices for economies at the top and at the end of the rankings have been included in the table for comparison.

For the period under consideration, the highest /’D/ Performance Index value of 13.53 was for Belgium and Luxembourg and the lowest 2.53 to Surinam. The index value for emerging market economies fluctuated between 6.508 and —0.528. Three countries from the emerging markets group — Hong Kong, Singapore and the Czech Republic — are well ahead of the others with regard to the score Poland has been listed at number eight. The only country with negative index value is Indonesia in the period 2000-2002.

The highest FDI Potential Index was 0.659 obtained by the United States. According to this index, Singapore and Hong Kong ranked the highest among emerging markets in addition to obtaining the best marks for the FDI inflow. Also, many countries with a low FDI Performance Index values ranked high here (e.g. Korea, Russia, Taiwan, Malaysia and Poland at number eleven). The last place among the analyzed economies was taken by Colombia. The International Journal of Banking and Finance 3-4 (Special Issue): 2005-2006: 83-98

Source: Compiled on the basis of World Investment Report 2003, UNCTAD, New York 2002. 94 The International Journal of Banking and Finance 3-4 (Special Issue): 2005-2006: 83-98

As outlined in Table 5 in page 93, the countries have been classified into four groups: Group | are front-runners in attracting FDI, with the level of both indices above the average of the group of 140 countries under scrutiny. Eleven emerging market economies have been placed in this group, with the FDI Performance Indices ranging from 6.508 (Hong Kong) to 0.926 (Malaysia) and the FDI Potential Indices from 0.465 (Singapore) and 0.184 (Brazil). Poland is placed in the front- runners group with indices of 1.179 and 0.256 respectively.

Group II countries are the countries with potential. Seven emerging markets are included with many rich and highly developed with a low level of the FDI Performance Index. Also the United States have been placed in this group, showing the highest FDI Potential Index but exhibiting a low level of FDI inflow in relation to the size of their economy. For the emerging markets included in this group, the FDI Performance Index ranged from 0.807 (South Africa) to 0.286, and the FDI Potential Index — from 0.387 (Korea) to 0.182 (Egypt).

Group II economies include Columbia. This group includes countries with weak structure but with a significant inflow of foreign capital. Most countries in this group are poor countries lacking an industrial base. The group also includes

Source: Compiled on the basis of the UNCTAD data — Handbook of Statistics On-Line (http:// www.unctad.org).

The International Journal of Banking and Finance 3-4 (Special Issue): 2005-2006: 83-98 95 e.g. Albania, Moldova, and Macedonia. Group IV comprises poor countries that are not able to attain the expected share in the world FDI inflows due to the economic or political constraints. Some countries have been place lin this group as a result of a drop in foreign capital inflow due to the economic crises.

At the end of 2003, the accumulated value of foreign direct investment in 25 selected economies including the emerging markets group reached US$ 2,033 billion with sixty five percent invested in just five countries (China, Hong Kong, Mexico, Singapore, Brazil), out of which the unquestionable leaders are China (US$ 501.5 billion) and Hong Kong (US$ 375 billion). In the remaining twenty countries, the value of FDI ranged from US$ [1 to 59 billion. Foreign direct investment in Poland reached the value of US$ 52 billion, giving the country the ninth place in the group.

Source: Compiled on the basis of the UNCTAD data —/landbook of Statistics On-Line (hitp:// www.unctad.org) 96 The International Journal of Banking and Finance 3-4 (Special Issue): 2005-2006: 83-98

VIZ. S516] 7] 8] 9 [10] 11] 12] 13 [14/15] 16117] 18] 19]20]21] 22/23] 24] 25 Singapore [1 xX Hong Kong | 2 x A | Korea (3 3 2 Israel 4 x & | Taiwan |5 | x | [Malaysia | 6 x S [Russia [7 x [I & | China [3 [x 5 | Hungay |9 x 1S] 2 [Czech Rep. [10 x, = [Poland [it Xx £ Chile 12 x 5 (Mexico 13 Xx 2 Thailand [14 x [| = | Philippines [15 x 9 Ts. Africa [16 x 2 Brazil 17 XxX 3 [feet [isl [| x & Turke; 19 Xx 2 [Venezuela [20 x [Argentina [21 x a Peru [22 x Indonesia (23 x India Pal | | x Colombia |25 xX The annual value of the FDI inflow in 2003 was US$ 136.8 billion. Out of this amount, 40 percent went to China, 36.6 percent to Hong Kong, Singapore, Mexico Poland and Brazil and the remaining 26.4 percent was invested in the remaining 20 economies.

Table 6 presents the ranking of emerging markets based on the FDI Potential Index (set according to the data of 2000 - 2002) and the amount of FDI realized in 2003. The sign “X” marks the position of a given economy in both rankings.

On the basis of the data set, we can conclude that for eight economies, the inflow of investment corresponds to, or is very close to, the UNCTAD forecasts (Hong Kong, Argentina, Czech Republic, Thailand, Turkey, Singapore, Chile, and Indonesia). In many cases, however, the reality was in line with the forecasts.

For example, China, while ahead of the rest of the countries with regard to the inflowing investments in 2003, was at the far eighth rank according to the FDI Potential Index. There was also much divergence in the case of India, Brazil, Mexico (the further “X” is from the Table’s diagonal, the greater is the divergence from the forecast). Worth noting are also Taiwan and Russia — the potential indices

© Data for 2004 were not available at the moment of ing the work on this paper. The International Journal of Banking and Finance 3-4 (Special Issue): 2005-2006: 83-98 97 for these countries were high but the investments realized there in 2003 placed them low down in the analyzed group.

It must be emphasized, however, that the above analysis cannot be the basis for the final assessment of the accuracy of the UNCTAD FDI Potential In." Moreover, we must bear in mind that the indices are generated based on historical data, while the ever-changing conditions of functioning in the world’s global economy force investors to act quickly in accordance with the shifling conditions of business environment.

Emerging market economies liberalizing the internal markets and opening the economy to the global circulation of production factors are introducing financial markets to international finance. This has enabled them to enter the path of fast economic growth hoping they will soon join the group of highly developed countries. These economies are becoming a potential target for the world capital flows seeking the most profitable ways of allocation. Foreign direct investment is the most advanced — and the most wanted by the host country — form of foreign capital inflow because, besides money, it supplies know how.

Among the numerous groups of developing countries, emerging markets attract 80 percent of foreign direct investment. However, the allocation of capital within the emerging markets group is not even. Five countries (China, Hong Kong, Mexico, Singapore, and Brazil) dominate the analyzed 25 economies, attracting over 60 percent of FDI. In that regard, a large part of the analyzed group (18 countries) is assessed as having a high potential for attracting foreign capital. Itis up to the policy makers to formulate policies to reach the full potential attractiveness for capital. We propose this analysis as a preliminary for further work in this area, for example identifying the reasons for not reaching the potential.

Acknowledgement: This paper is one of eight best papers selected after a blind review process by the editors of the Journal. The paper was presented at the 3rd International banking and Finance Conference Szczecin, Poland in 2005.

Author statement: Kozun-Ciexlak Grazina is a teaching staff at Technical University of Radom, Poland. The editors of the journal have made significant changes to the submitted version of the paper, for which we record our sincere thanks. The remaining errors are the responsibility of the author. 98 The International Journal of Banking and Finance 3-4 (Special Issue): 2005-2006: 83-98