Political instability and civil conflicts have been found to be a major factor in reducing the attractiveness of South Asia as a host for foreign capital. Afghanistan, Pakistan, and Sri Lanka continue to face political uncertainties and security challenges that are likely to hinder foreign direct investment (FDI).
According to third issue of the South Asia Economic Report (SAER), released by the South Asia Department and the Central and West Asia Department of the Asian Development Bank (ADB), empirical evidence demonstrates that FDI inflows into Sri Lanka are vulnerable to the ongoing civil conflict there. Likewise, in Afghanistan, the pace of foreign investment also may be slow because of the sporadic suicide bombings, kidnappings, and attacks.
The worsening political situation in Pakistan (particularly in late 2007) may also hamper FDI inflows into that country. It is well documented that existing regulatory systems governing investment in South Asia are weak. Specifically, corruption continues to be rampant; governance remains poor; "red tape regulatory obstacles" commonly affect the conduct of business activities; capital flows are stringently controlled; and there are a lack of "facilitating harmonised frameworks on competition and infrastructure".
The 2006 Corruption Perceptions Index (CPI) of Transparency International, based on a survey of 163 countries (Transparency International 2007) showed that Bhutan is the least-corrupt country in South Asia. Conversely, the remaining countries of the region are positioned well down in CPI scores and country ranking.
Bangladesh scored as the most corrupt country in the region and positioned lowest in the ranking of regional countries. Transparency International's Bribe Payers Index (BPI), a measure of the propensity of the leading exporters in a country to offer bribes (out of a sample of 30 countries). Statistics shows that India had the worst BPI in 2006 among the 30 countries sampled, including the 8 Asian countries sampled. Transparency International notes that one of the most corrupt branches of government in South Asia is the judiciary.
According to report, FDI is a vital requirement for sustained economic growth in South Asia. It can generate employment in the host countries, in addition to supplementing domestic savings and helping meet the huge demand for investment. FDI can also bring foreign currencies into the host countries by stimulating exports of goods and services.
Expectations of significant future domestic demand, especially in countries with large populations such as those in South Asia, can result in FDI from foreign companies establishing large production bases for these domestic markets. Such FDI will expand product variety and consumer choices, and promote technology transfers and knowledge spillovers through forward and backward linkages in the host economies.
The report highlights the strong inducements for FDI offered by South Asia, such as its robust economic growth with the impressive showing of the services sector and exports, its large domestic markets, and the positive perceptions of foreign investors. However, the level of FDI inflow into South Asia is still low compared to other Asian regions. This is considered to be the result of the poor business climate, poor infrastructure, restrictive labour policy and labour unrest, political uncertainties and civil conflicts, weak regulatory systems, and rampant corruption.
According to report, South Asia exhibited robust macroeconomic performance in 2006. Economic growth was strong, with savings and investment rates high, inflation moderate, trade and foreign direct investment (FDI) expanding, and fiscal deficits lower. South Asian countries are expected to sustain high growth rates in 2007 and 2008.
Economic growth in South Asia was stronger in 2006, as aggregate gross domestic product (GDP) posted an 8.8 percent expansion. It was the second consecutive year of the highest growth rate in the region since 2003. Most economies in South Asia registered GDP growth rates exceeding 6.0 percent in 2006, largely the result of impressive performance by the services sector and the industrial sector.