fdi confidence index

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FDI Confidence IndexGlobal Business Policy Council

2005, Volume 8


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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 member-

ship is limited to a select group of corporate leaders and their companies.

The Councils 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.

333 John Carlyle Street

Alexandria, Virginia 22314

U.S.A.

1 703 739 4714 TELEPHONE

1 703 739 4741 FAX

www.atkearney.com


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A.T. Kearney | FDI CONFIDENCE INDEX 1

Emerging market countries are the 1st and 2nd

most attractive foreign direct investment (FDI)

locations in the world. Led by China and India,

emerging markets have achieved unprecedented

levels of investor confidence.

The United States dropped to 3rd place on

corporate investors lists, but remains a strong

FDI magnet. (It is too early to assess the possi-

ble impact the controversy over the Dubai ports

deal will have on the U.S. FDI market.) Western

Europe, other than the United Kingdom, lost

FDI confidence due to increasing competition

from emerging markets. But again, recent signs

of intra-European market protectionism may

have a negative impact on overall European FDI

attractiveness. The FDI prospects for Eastern

Europe appear brighter as investor confidence in

Poland, Russia, Hungary, the Czech Republic,

Turkey and Romania is rising. All of these coun-

tries, except Poland, climbed to record high

positions in the Index. Brazil and Mexico have

regained lost ground.

Investments in cross-border corporate deals

rose 2 percentthe first increase since 2000.

However, the FDI recovery may be clouded by

corporations that want to continue to save money

rather than invest it as concerns about the global

economy rise to the surface. Companies have

accumulated record amounts of cash due to linger-

ing fears of another possible economic down-

turn, new interdependent business risks, and

pressure from shareholders. However, this may

change as the penchant for holding cash bumps

against the pressure to expand overseas as the pace

of cross-border mergers and acquisitions quickens.

As companies make overseas investments, par-

ticularly in R&D, several factors dominate their

location decisions, including lower costs, higher-

quality labor, protection of intellectual-property

rights, reliable educational systems and sophisti-

cated IT infrastructures. Developing countries in

Asia and Eastern Europe are experiencing the larg-

est increases in R&D investments as these coun-

tries become integral to multinational companies

global innovation processes. R&D investments

in the industrialized world will continue, but at

a less robust pace. The pace of offshoring will

intensify, as all corporate functions, including

R&D, shift overseas.

These are among the major findings in

A.T. Kearneys year-end 2005 FDI Confidence

Index survey, which tracks the impact of likely

political, economic and regulatory changes on

the foreign direct investment intentions and

Foreign Direct Investment (FDI) is on the rise again. But the corporatesavings overhang and investor pessimism about the global econ-

omy could dull the recovery of cross-border corporate investment.

Concerns over corporate financial health, an unexpected economic

downturn, shareholder activism, and the risks associated with engaging

in FDI have caused investors to hoard cash over the past four years. As

investors face more intense competition and the lure of higher returnsoverseas, they are cautiously unloading their accumulated war chests.


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FDI CONFIDENCE INDEX | A.T. Kearney2

preferences of the leaders of top companies around

the world (see figure 1).1

Over the past seven years, we have queried

CEOs, CFOs and other key decision-makers of

the worlds largest 1,000 firms about their opin-

ions of various FDI destinations and their invest-

ment intentions. Responses from participating

executives about their views of 68 countries,

which receive more than 90 percent of global

FDI, reveal likely foreign direct investment flows

and point to the factors that drive corporate

decisions to invest abroad. Companies included

in our survey are responsible for about 70

percent of global FDI flows and generate more

than $27 trillion in annual revenues. These com-

panies represent all major regions and sectors.

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

Figure 1

FDI Confidence Index

*First time in Index

**Central Asia includes Azerbaijan, Belarus, Kazakhstan and Turkmenistan Source: A.T. Kearney

Top 25, December 2005

China

India

United States

United Kingdom

PolandRussia

Brazil

Australia

Germany

Hong Kong

Hungary

Czech Republic

Turkey

France

Japan

Mexico

SpainSingapore

Italy

Thailand

Canada

Dubai/UAE

South Korea

Central Asia**

Romania 1.017

1.030

1.036

1.039

1.040

1.050

1.055

1.0721.075

1.080

1.082

1.097

1.133

1.136

1.157

1.208

1.267

1.276

1.336

1.3411.363

1.398

1.420

1.951

2.1971

2

3

4

56

7

8

9

10

11

12

13

14

15

16

1718

19

20

21

22

23

24

25

(1)

(3)

(2)

(4)

(12)(11)

(17)

(7)

(5)

(8)

(19)

(14)

(29)

(6)

(10)

(22)

(13)(18)

(9)

(20)

(16)

(*)

(21)

(27)

(42)

(#)

Maintained ranking

Moved up

Moved down

2004 ranking

Values calculated on a 0 to 3 scale High confidenceLow confidence


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Major FindingsIndia Joins China at the Center of the

FDI Radar Screen

Investor enthusiasm for China and India is at

an all-time high, with roughly 45 percent of

global investors more upbeat about China and

India compared to last year.2 This is nearly twice

the number recorded for the next three most

positively viewed marketsBrazil, Poland and

Russia. China achieved its highest-ever score in

this years Index, while Indias score has been

surpassed only by China and the United States

in previous years. China and India took the 1st

and 2nd positions across nearly all broad sector

categories (see figure 2).

While China has held the top spot since

2002, strong investor interest in India is a more

recent development. Despite Indias successful

positioning as a business-processing and IT out-

sourcing hub, these activities often translate into

service-sector exportsrather than FDI flows

2 All references to last year in this paper refer to 2004. FDI flow figures are the latest statistics available from the United Nations Conference on Trade andDevelopment (UNCTAD) for the year 2004.

gure

China and India are the top FDI locations across all broad sectors

Source: A.T. Kearney

Percentage of investors with a more positive outlook

Percentage of investors with a more positive outlook

Manufacturing and primary

Financial and non-financial services

Telecommunications and utilities

Wholesale and retail

UnitedKingdom

UnitedKingdom

Japan

Hong Kong

Germany

Germany

Germany

Spain

Spain

Singapore

Mexico

Australia

Australia

United States

United States

United States

United States

RussiaPoland

Poland

Poland

Poland

Hungary

United Kingdom

Czech Republic

Brazil

Brazil

ItalyGermany

India

India

India India

China

China

China

25%

25%

50%

Canada

Italy

France

China

Investor attractiveness Investor attractiveness

0%

0%

1.0 1.5 2.0 2.5 2.0 1.5 1.0


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into India. Last year, India received just $5.3

billion in FDI, compared with Chinas $60.6

billion. This is partly because China attracts

more capital-intensive manufacturing and logis-

tics functions (see figure 3). India has yet to build

critical mass in FDI, mostly because it did not

initiate investment-attracting reforms until 1991.

By contrast, Chinas pro-FDI regime has been in

place since 1979. Indeed, Chinas entire compet-

itive manufacturing base has been largely estab-

lished by foreign multinational companies. We

expect this trend to continue over the next three

years as more functions are sent overseas.

India appears to be on the cusp of an FDI

takeoff. We expect the countrys attractiveness

to increase as long as the government maintains

its focus on reforms, overcomes narrow business

interests, and continues to address the countrys

infrastructure, logistics and regulatory barriers.

The United States Drops to 3rd Place

For the first time since our study began in 1998,

the United States dropped from 2nd to 3rd most

attractive future FDI location, as investors in the

financial services and light manufacturing sectors

express less interest in the U.S. market. Although

the U.S. financial sectors FDI inflows have been

robust in recent years, the United States dropped

to 6th place (from 2nd place last year) among

investors from this sector. Roughly one-third of

global insurance carriers are more negative about

the U.S. market, perhaps due to the more than

$70 billion in costs resulting from the countrys

destructive hurricane season. Investors from the

highly competitive light manufacturing segments

(including electronics, food and textiles) are less

likely to commit FDI in the United States, prefer-

ring lower-cost, faster-growing emerging markets.

China, India, Brazil, Russia, Poland, Mexico and

Hungary take the first seven positions in the light

manufacturing sector, with the U.S. coming in

8th, down from 3rd place last year.

In 2004, the United States was the largest

FDI recipient in the worldcapturing $96 bil-

Figure 3

China dwarfs India in FDI, in part because China attracts more capital-intensive functions


IT (design, supportand services)

Contact centers (callcenters, web centers)

Business processes(HR, finance, accounting)

R&D and engineering

Knowledge management

Manufacturing

Distribution and logistics

$60.6

$0

$10

$20

$30

$40

$50

$60

$70

$5.3

China India China India

Foreign direct investment ($ billions) Breakdown by business function

0%

10%

20%

30%

40%

50%

70%

100%

90%

80%

60%

Capital-intensivefunctions


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lion. This was a strong rebound from the $56.8

billion the United States received in 2003. Based

on estimates for the first half of 2005, the United

States could again achieve 2004 levels of FDI.

Indeed, the U.S. economy is unparalleled, having

produced $12.5 trillion in GDP, three times that

of Japan (the next largest market) and weather-

ing unprecedented current-account deficits and a

season of natural disasters. Investors in the primary

sector, in telecom and utilities, and heavy manu-

facturingspecifically high-technology and com-

puter equipment firmsrank the United States

among their top 5 most attractive FDI locations.

The strength of the U.S. economy, particularly

reflected in higher U.S. dollar exchange rates, is

underscored by U.S. companies that are directing

more investments overseas than ever before. Last

year, U.S. companies sent approximately $229

billion overseas, thereby reinforcing the United

States role as the primary source of FDI.

For the first half of 2005, U.S. FDI outflows

were nearly $60 billion, down from $108 bil-

lion over the same period in 2004. This decline

may be due to U.S. companies taking advantage

of tax breaks on repatriated earnings under the

Homeland Investment Act. Because the United

States accounts for nearly one-third of total

global FDI outflows, these tax-driven repatria-

tions could have a moderating effect on global

FDI flows in 2005.

FDI Prospects Dim for Western Europe

Not since 1999 have so few Western European

countries been among the top 10 FDI loca-

tions. Between 2000 and 2004, Western Europe

held between 3 to 5 spots in the top 10; this year

only two countriesthe United Kingdom and

Germanyremain in the top 10. While the

United Kingdom held onto 4th place, Germany

declined from 5th to 9th place, France moved

from 6th to 14th, Italy went from 9th to 19th,

and Spain dropped from 13th to 17th place.

Manufacturing investors reported the strongest

decline in preference for Western Europe and are

looking instead to China, India, Brazil, Russia,

Poland and Mexico.

In 2004, the EU-15 countries witnessed a

40 percent decline in FDI inflows experiencing

a six-year low of just $196 billion. Contributing

to the decline were sluggish growth, disinvest-

ments and substantial repayments of intra-firm

credits by foreign affiliates to their parent firms

overseas. This shift in investor sentiment may

have been due, at least partly, to the rejection of

the EU constitution by the electorates of France

and the Netherlands, two founding members

of the European Union, and to the shifting

political environment in Germany at the time

of the survey.

Investment confidence soars for

Eastern Europe

Eastern European markets are enjoying a sharp

increase in FDI confidence levelswith Poland

(5th), Russia (6th), Hungary (11th), the Czech

Republic (12th), Turkey (13th) and Romania

Investor enthusiasm for China and Indiais at an all-timehigh, with roughly 45 percent of global investors more

upbeat about China and India compared to last year.


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(25th) all rising in the rankings. All of these coun-

tries, except Poland, registered historic highs.

Investors rank Poland, Russia, Turkey, the Baltic

States and the Czech Republic among the top 10

countries with the most upbeat outlooks. Entry

into the European Union means greater market

access, fewer trade and investment barriers, and

increased market stability. Also, in anticipation of

EU entry, investor confidence extends to aspirant

countries such as Romania and even Turkey

both of which rank among the top 25 markets for

the first time this year. Increased investor inter-

est in the region might also be attributed to rela-

tively faster growth rates, lower corporate taxes,

and favorable productivity levels that help offset

rising costs.

Communications industry investors are the

most bullish on Eastern Europe ranking Poland

1st, Hungary 2nd, the Baltic States 4th, the Czech

Republic 5th, Slovakia 7th, Turkey 9th and Croatia

15th. FDI prospects in the Eastern European

telecommunications industry have been bolstered

by industry liberalization and deregulation, low

penetration rates of mobile phones, and grow-

ing consumer markets. Although suffering some

declines in cost competitiveness vis--vis other

developing regions of the world, Eastern European

locations score well as FDI moves up the value

chain to more knowledge-intensive investments.

Eastern Europe is also viewed positively as

an R&D location, offering both low costs and

strong scientific and engineering capabilities.

Nearly one-third of global investors are planning

R&D-oriented FDI in Eastern Europe over the

next three years.

Brazil and Mexico Regain Lost Ground

Brazil reentered the 10 most attractive markets,

taking 7th place in 2005 (up from 17th a year ear-

lier). The countrys economic recovery and rising

income levels have fueled interest from whole-

sale and retail investors who rank Brazil as their

3rd most preferred destination globally. Financial

services, telecommunications and utility inves-

tors who previously soured on Brazil in the face

of macroeconomic and regulatory instability are

now rethinking the market. With debt and infla-

tion under control, financial services investors

rank Brazil 14th while telecommunications and

utility investors rank it 16th.

Electronics manufacturers put Brazil in 6th

place last year; this year, they consider the coun-

try the 3rd most attractive market, behind China

and India. Automotive companies maintain a

strong interest in Brazil, ranking it 6th globally,

although it fell one spot from 2004. Investors

who are eager to meet global demand for a

wide range of commodities are more confident

in the Brazilian market. Their industries include

chemicals, fabricated metal, industrial machinery,

computer equipment, mining and raw material

manufacturing.

On one hand, global investors want to hold cash surpluses toweather the lean yearsand maintain shareholder confidence;

on the other, they do not want to forgo higher-return growth

opportunities overseas.


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Mexico climbed to 16th place in the Index

this year, up from 22nd in 2004a rise pri-

marily attributed to manufacturing investors.

This year, Mexico ranks 6th and 8th among

light and heavy manufacturers, up from 21st

and 15th in 2004. Mexico is benefiting from

a surge in global demand for commodities, as

raw-material investors name Mexico their 8th

preferred FDI location.

The countrys most notable improvement is

in the electronics sector where the country soared

to 4th place from 21st. Throughout 2005, global

electronics manufacturing firms were acquiring

facilities and land along the U.S. border. This

suggests the improvement in FDI into the maqui-

ladora sector, recorded in 2004, will continue.

Overall, Mexican FDI inflows increased from

$11.8 billion in 2003 to $17.9 billion in 2004.

The Savings Glut Will Cloud

Global FDI Recovery

Optimism concerning the global economy has

waned. This year, 36 percent of executives say they

are more optimistic about the global economy

compared to 31 percent who are not. Last year,

nearly 70 percent were more bullish on the global

economy and 12 percent were negative.

Since September 11, 2001, 65 percent of

global investors from the worlds largest firms

indicate they are building up significant cash

reserves. In fact, U.S. companies alone accumu-

lated more than $1 trillion in cash reserves during

this period. The top reasons cited for piling up

cash is a desire to improve corporate balance

sheets, followed by creating a cushion for the

next economic downturn and limited invest-

ment opportunities. More than one-third (36

percent) of respondents cite shareholder pressure

as the primary reason for increasing corporate sav-

ings, while 18 percent attribute it to the difficulty

in evaluating FDI risk (see figure 4).

The top-line growth imperative is again

pushing many companies overseas. Global FDI

inflows rose by 2 percent to $648 billion in 2004,

which is the first positive change in FDI since

2000. This year, 54 percent of executives say they

are planning to increase their foreign investments,

the largest number since 2000. Nearly half are

building war chests for future investment oppor-

tunities, which, if unlocked, could lead to an FDI

surge. With a rise in cross-border mergers and

acquisitions, pressure to identify overseas growth

opportunities is conflicting with the rationale for

Figure 4

Primary reasons for increasing cash savings

Improve balance sheet

Cushion againstnext downturn

Limited investmentopportunities

Shareholder pressure

Increase in perceivedinvestment risks

Rising costs

Corporate governanceconcerns

Volatility inenergy prices

U.S. economicuncertainty

Difficulty evaluatinginvestment risk

Increased government

regulation

Lack of new tech-nology or innovation

Weaker demand

Concerns aboutsecurity and terrorism

Concerns aboutexcess capacity

Percentage of total respondentsSource: A.T. Kearney

60%

38%

38%

36%

30%

20%

20%

19%

19%

18%

15%

14%

13%

11%

10%


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holding cash. Global investors face a more com-

plex FDI decision-making climate. On one hand,

they want to hold cash surpluses to weather the

lean years and maintain shareholder confidence;

on the other hand, they do not want to forgo

higher-return growth opportunities overseas.

Increased R&D Spending Will Occur in

Developing Asian and Eastern European

Countries

Nearly half (48 percent) of global investors plan

to increase R&D spending over the next three

years, and only 3 percent plan to decrease such

spending (see figure 5). Almost three-quarters of

the increased R&D spend will be allocated to

developing countries in Asia and Eastern Europe.

Roughly one in five global investors plans to

increase R&D investments in North America

and Western Europe, with about the same

number planning to reduce R&D investments

in the region. About 10 percent of global exec-

utives plan to boost R&D spending in Latin

American markets.

More R&D money is expected to go over-

seas. Investors from North America and Western

Europe are the most eager to invest their R&D

capital in developing Asia and Eastern Europe.

As a result, the most significant cuts will occur in

their home territories.

Cost and Quality Will Drive R&D Foreign

Investments

More than half of global investors choose R&D

investment locations based on three attributes:

lower R&D costs, availability and quality of local

R&D labor, and intellectual-property protection.

The quality of universities and research centers, and

IT infrastructure came in 4th and 5th respectively.

About one-third of investors consider regu-

latory environment, reputation for creativity and

innovation, and the ability to tailor products and

services as the top attributes when considering an

R&D investment location. Roughly 28 percent

consider market size critical, while 26 percent

view government R&D as the most important

factor (see figure 6).

Figure 5

Global R&D expenditures will shift to developing markets

Are you planning moreor less R&D investmentsover the next three years?

Investors planning more or less R&D expenditures overthe next three years, by region

More R&D expenditures

Less R&D expenditures


Asia Pacific(excluding

Japan)

EasternEurope

NorthAmerica

WesternEurope

LatinAmerica

JapanMore Less MiddleEast and

Africa

48% 50%

22%20%

18%

10% 9%7%

0%

10%

20%

30%

40%

50%

0%

10%

20%

30%

40%

50%

3%5%

3%

23%

18%

2%3%3%Percentageo

ftotalrespondents

Percentageo

ftotalrespondents


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Globalization of R&D Will Be a Balancing Act

China and India are the top two countries for

future R&D investments, with slightly more

than 40 percent of CEOs expecting to make such

investments in these markets over the next three

years. Almost one-third of global investors cite

Eastern European locations for R&D activities

with Poland and Russia leading the way. Investor

preference for these slowly maturing R&D loca-

tions says much about Eastern Europes future

talent base, intellectual-property protection, the

quality of educational and research communities,

as well as infrastructure.

The United States, the United Kingdom,

Japan and Germany trail China and India as

preferred future R&D investment locations. As

of 2003, the combined gross domestic expen-

diture on R&D of these four industrialized

countries amounted to approximately $520 bil-

lion, compared with an estimated $26 billion

spent in China and India. The United States

and other developed nations will likely remain on

the frontier of innovation in most fields, while

certain features of the corporate R&D process

will move to developing countries. One in 10

new R&D investments will likely go to Japan,

which is second only to the United States in total

national expenditure on R&D.

Figure 6

The most important attributes in determining R&D investment locations


Lower R&D costs

Availability and quality of local R&D labor

Intellectual property protection

Quality of universities and research centers

IT and local infrastructure

Regulatory environment

Reputation for creativity and innovation

Ability to tailor products and services

Proximity to customers

Presence of supporting industries

Local market size

Government R&D incentives

Openness to international trade

Presence of industry competitors

Proximity to manufacturing

Local firms R&D assets (such as patents)

Local firms R&D absorption capacity

Quality of life and environment

Bilateral investment treaties

Other

52%

51%

50%

46%

42%

36%

35%

29%

28%

28%

28%

26%

25%

19%

19%

16%

16%

15%

9%

3%

Percentage of total respondents


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Offshoring Intensifies, but the FDI Impact

Will VaryThe move to offshore destinations continues:

Nearly 80 percent of global investors plan to

locate corporate functions overseas over the next

three years, compared to 66 percent in 2004

and 50 percent in 2003. Corporate investors will

pursue offshoring opportunities more aggressively

across all major functions (see figure 7).

Information technology and call-center

functions will see the highest levels of off-

shoring activity, with 67 percent and 50 percent

of global investors expecting to offshore these

functions, respectively. These are followed by

business processes (for example, accounting, HR

and R&D) at 41 percent. The business models

for moving corporate functions offshore will

include captive and joint venture (both of which

result in FDI), as well as third-party outsourcing

and other non-FDI options (see figure 8).

Concerns over quality control and IP pro-

tection mean that some business processes and

functions, including R&D, knowledge manage-

ment and analytic functions, will occur primarily

through captive business models or joint ventures.

Nearly 70 percent of future R&D offshoring will

be through FDI, while the remaining offshore

R&D activity will occur through third-party out-

sourcing agreements or other non-FDI channels.

The ability to protect intellectual property rights

is central to whether or not the developing world

can actually attract R&D investments.

When sending certain business processes

and functions offshorespecifically, informa-

tion technology, call centers, distribution and

logisticsglobal investors prefer to rely on

third-party outsourcing contacts and other non-

FDI operating models. For example, about 55

Figure 7

IT and contact centers remain the highest areas for corporate offshoring


Information technology

Percentageo

ftotalrespondents


Knowledge management

Research and development

Business process outsourcing

Manufacturing

Contact centers

0%

10%

20%

30%

40%

50%

60%

70%

2003 2004 2005


13/40


percent of global investors plan to work with

an outside provider when offshoring their IT

functions. Despite the rapidly growing business

process outsourcing (BPO) market, only 28 per-

cent of global investors expect to turn to out-

side service providers to handle functions such

as human resources, and finance and account-

ing. Nearly 60 percent of investors favor using

a captive or joint-venture business model to

handle BPO functions.

Offshoring is not a simple site-provider

selection process, particularly when it comes to

sophisticated and sensitive functions. Of global

investors who have sent business processes off-

shore, 60 percent say their expectations have been

met or exceeded, 17 percent have been disap-

pointed, and the rest are unsure. This may explain

why roughly 75 percent of investors think estab-

lishing and monitoring performance measures

in offshore locations is the most critical success

factor in the offshore migration process.

In addition to performance metrics, investors

cite other less-measurable requirements for off-

shore success. For example, 77 percent cite gaining

senior-level commitment and rigorously research-

ing and selecting an offshore location or vendor

as extremely important to a successful offshore

operation. Empowering members of the program

management team and holding them accountable

for offshore initiatives is also important.

Investors See Diminished Macro Risks,

but Growing Micro Risks

Traditional operational risks such as government

regulation, and financial, political and social insta-

bility, appear to be less threatening in 2005 com-

pared to previous years. Just 38 percent of investors

consider political and social disruptions as risks to

Figure 8

Which operating model do you expect to use when offshoring?


R&D and engineering

Knowledge management and analytics

Business processes (HR, finance, accounting)

Manufacturing and assembly


Contact centers (call centers, web centers)

IT (design, support and service

0% 20% 40% 60% 80% 100%

Non-FDI FDI

Other Third party Joint venture Captive


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operations. Just two years ago, this number was

62 percent. Investors also indicate that country

financial risk is less menacing.

The risks have become more recognizable

and most executives have developed a variety of

sophisticated risk hedging, repackaging and shar-

ing tools to deal with them. Nonetheless, these

risks are inherently unpredictable and the limits

of coping mechanisms mean that the traditional

macro risks remain among the leading hazards

to operations.

Micro risks, however, are becoming more

threatening. Corporate governance, IT disruption,

product quality, safety problems and employee

fraud have all gained importance. Anxiety gener-

ated from Sarbanes-Oxley and the Basel II Accord

have mixed with rising fears about information

security.3 More than one-third of investors are

worried about governance issues compared to 25

percent who were worried two years ago. Nearly

one-third of investors consider IT disruption as

a threat to operations compared to only 19 per-

cent in 2004 and 17 percent in 2003. In addition

to the ongoing battle against computer viruses, a

series of high-profile cases where customer infor-

mation has been compromised has heightened

investors concerns over information security. With

companies aggressively outsourcing their IT and

other functions to third parties, executives are

encountering the downside of such arrangements,

including less oversight and less control of quality

and security.

Regional FindingsThe Americas

The United States dropped one spot to become the

3rd most attractive FDI location, losing ground

mainly in the light manufacturing and financial

services sectors. However, the United States ranks

among the top 5 most attractive FDI locations

among investors in the primary sector, telecom and

utilities, and heavy manufacturing (specifically in

high-technology and computer equipment firms).

Canada has not benefited from the growth in

global cross-border M&As. Foreign investment in

Canada has declined significantly since the peak

of the global M&A boom in 2000, when FDI hit

a record high of $67 billion. In 2004, Canadian

FDI was $6.3 billionan ebb not seen since

1993. However, companies from Canadas next

leading sources of FDIthe United Kingdom,

France and the Netherlandsare more eager to

commit to the market. In fact, after the United

States, the European Union is Canadas most

important trade and investment partner, with

one in four Canadian FDI dollars coming from

European companies.

Investors express more confidence in Latin

America as it enjoys continued economic recovery.

FDI inflows to Latin America increased after

four years of declinesreaching $68.9 billion

in 2004 up from $48 billion in 2003. The FDI

recovery was driven mainly by activities in the

manufacturing and the primary sectors. Still, with

the winding down of privatizations and M&A

deals, FDI has yet to return to the peak levels of

1999 when the region received $107.4 billion.

United States. Last year, the United Stateswas the largest FDI recipient in the world, cap-

turing $96 billiona strong rebound from the

3 The Sarbanes-Oxley Act, Pub. L. No. 107-204, 116 Stat. 745 (July 30, 2002), is a United States federal law also known as the Public Company AccountingReform and Investor Protection Act of 2002. Basel II Accord is the second Basel Accord and represents recommendations by bank supervisors and central bankers

from 13 countries to revise the international standards for measuring the adequacy of a banks capital.


15/40


$56.8 billion received in 2003. Several major

cross-border deals in the financial services sector

drove this performance. For example, Canada-

based Manulife Financial Group acquired John

Hancock Financial for $11.1 billion, which was

the second largest deal in 2004.

Although FDI in the U.S. financial sector has

been high in recent years, investors appear to have

cooled on the U.S. financial market. This year,

financial services investors rank the United States

6th, down from 2nd place in 2004. More than

one-third of global insurance carriers are more

negative on the U.S. market, which is likely due

to the countrys destructive hurricane season.

Investors from the highly competitive light

manufacturing segments, such as electronics, food

and textiles, are less likely to commit FDI to the

United States than to lower-cost, faster-growing

emerging markets. China, India, Brazil, Russia,

Poland, Mexico and Hungary take the first 7

spots in the light manufacturing rankings, with

the United States coming in 8thdown from

3rd place last year.

The U.S. economy remains a behemoth,

producing $12.5 trillion in GDP, three times

that of Japan, which is the next largest market.

Having weathered unprecedented current-account

deficits, massive natural disasters and interest rate

hikes, U.S. economic growth remains robust.

Underlying the strength of the U.S. economy are

U.S. companies that poured more investments

overseas than ever before in 2005approximately

$229 billionreinforcing the countrys role as

a primary source of FDI.

The Homeland Investment Act (HIA) could

affect the final tally of global FDI recorded in

2005. When the HIA expired in 2005, so did

the tax break for U.S. companies on repatriated

foreign affiliate earnings. The U.S.-Europe inter-

est rate differential and the HIA have helped

strengthen the dollar in the face of massive U.S.

deficits. With U.S. companies taking advantage

of the one-time tax break, U.S. FDI outflows

are estimated to be nearly $60 billion for the first

half of 2005 down from $108 billion over the

same period in 2004.

Canada.Canada dropped from 16th to 21st

place in the Index this yearits lowest recorded

ranking. In particular, U.S. investors, who account

for 65 percent of the countrys FDI inflows, put

Canada 8th among their most attractive FDI

locations, compared to 4th place in 2004. If the

diminished outlook among U.S. companies con-

tinues, it could mean future declines in overall

FDI for Canada. Globally, manufacturing and

financial services investors were less interested in

the Canadian market in 2005.

Food and kindred products companies are

more attracted to the Canadian market and con-

sider it their 4th most preferred FDI location.

One-third of executives in these sectors view

Canada more positively than they did a year ago.

The Canadian food market is shifting toward

packaged and convenience fooddriven by a rise

in the number of single people, longer work hours,

and dual-income households. Beer accounts for

half of all beverage consumption, with quality-

conscious Canadians demanding premium alcohol

products. Brazils Ambev acquired Canadas John

Labatt Ltd. for $7.8 billion, making it the fifth

largest cross-border deal in 2004.

The surge in prices and global demand

for commodities (particularly oil and gas) has

helped move Canada up a notch (from 14th to

13th place) in the primary sector. Canada ranks

9th among mining companiesup from 11th

in 2004. Since the 1990s, the leading sources of

Canadian job growth have gradually shifted from

cars and computers to mining and construction.

Investments in the resource-rich Western prov-

inces of Alberta and British Columbia are on the

rise, as is investment in rail systems and ports,


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which help fuel the construction sector.

Brazil. Brazil shot up 10 spots to 7th place

from its all-time lowest ranking in 2004. FDI

in Brazil increased 79 percent, reaching $18.2

billion in 2004. Much of the optimism is due

to the countrys healthy macroeconomic perfor-

mance, resulting from increased exports to China,

higher commodity prices, rising incomes and

increasing demand.

Wholesale and retail, telecom, financial and

non-financial services, primary and manufacturing

sector investors all expressed increased confidence

levels in Brazil.

Brazils natural resource markets are heat-

ing up. The mining sector posted some of the

strongest improvements in the countrys rank-

ings, moving Brazil to 7th place from 22nd.

Investments in the raw materials sector were also

positive, moving Brazil to 4th place from 14th.

Investors are encouraged by continuing strong

global demand for a wide range of commodi-

tiesfrom iron ore to soybeans.

In the chemicals sector, Brazil ranks 5th, up

from 9th in 2004. The Brazilian pharmaceuti-

cal sector has posted positive sales performance

since 2003. Many foreign companies are apply-

ing for licenses to produce generic drugs in Brazil.

In 2004, a wholly-owned Brazilian subsidiary of

Indias Glenmark Pharmaceuticals Ltd. acquired

Laboratories Klinger, a local pharmaceutical firm,

and obtained approved product registrations,

most of which were generics, in the process.

Global investors rank Brazil 9th most attractive

R&D investment location.

The Brazilian consumer is returning and

helping to fuel the countrys economic perfor-

mance. The wholesale and retail sectors are invest-

ing in Brazil againeager to tap into a domestic

market with rising incomes, increasing purchasing

power, and growing interest in premium brands.

In 2004, Wal-Mart (U.S.) acquired Royal Aholds

(Netherlands) local subsidiary, Bompreo, and

quickly expanded into Brazils Northeast region

where growth in real income has been the highest.

Meanwhile, Interbrew SAs (Belgium) acquisition

of Braco SA for $4 billion was the largest cross-

border M&A in Latin America.

Automotive and transportation equipment

investors rank Brazil slightly lower this year

(moving Brazil from 6th to 5th place in the

Index). But both sectors remain optimistic as vehi-

cle sales increase due to lower interest rates, higher

incomes and government-sponsored tax conces-

sions. Global automotive companies, including

Fiat (Italy), General Motors (U.S.), Mitsubishi

Motors (Japan) and Hyundai (South Korea),

plan future investments in Brazil. However, the

strengthening of the real is hurting export compet-

itiveness and encouraging manufacturing investors

to pursue domestic market opportunities.

Since 2000, many companies, particularly

in the telecom, electricity and financial sectors,

divested across South America due to economic

stagnation, regulatory uncertainty and macro-

economic instability. Looking ahead, however,

financial services and telecom investors are

rethinking the Brazilian market. With debt and

inflation under moderate control in 2005, finan-

cial services investors rank Brazil 14th, while

telecommunications and utilities investors rank

the country 16th. Indeed, Citigroup Brazil plans

to add 62 new branch banks, and Goldman

Sachs (U.S.) is in talks to create a joint venture

with Banco Pactual SA.

Despite renewed investor enthusiasm and the

governments economic pragmatism, Brazil still

has considerable obstacles. For example, Brazil

suffers from one of the most rigid labor markets

in the world, high business costs, heavy bureau-

cracy, and slow implementation of public-private

partnerships needed to address infrastructure

bottlenecks.


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Mexico. Mexico climbs up the Index from

22nd in 2004 to 16th in 2005 among global

investors. Mexicos turnaround is led by increased

FDI interest spurred by recent bilateral economic

agreements and increased confidence among

manufacturing investors.

Japanese investors rank Mexico their 5th

most attractive market, up from below the top 25

last year. The Japan-Mexico Economic Prosperity

Agreement (EPA), effective in April 2005, offers

Japanese companies new opportunities in Mexico.

The Mexican governments strategy to reduce

dependence on the United States by pursuing a

constellation of free-trade agreements in Europe

and Asia could be paying off.

The maquila sector is helping Mexicos FDI

inflows rebound. Mexican FDI inflows jumped

from $12.8 billion to $17.9 billion. The economic

recovery in the maquiladora sector, supported by

U.S. demand for imports, helped spur a return of

manufacturing investors. Mexico suffered a steep

drop in maquila FDI between 2001 and 2003.

BBVA (Spain) purchased its local affiliate for $3.8

billion and Holcim Ltd (Switzerland) acquired its

local affiliate for $591million. Combined, these

deals accounted for more than one-quarter of

overall FDI inflows to Mexico in 2004.

Manufacturing investors see brighter pros-

pects in Mexico. In 2005, heavy and light man-

ufacturers rank Mexico 8th and 6th respectively,

up from 15th and 21st a year earlier. Since

January 2004, Volkswagen (Germany) and Ford

(U.S.) have announced more than $3 billion

in multiyear investments. Electronics investors

are similarly optimistic about Mexico, ranking

the country 4th, up from 21st a year earlier.

Throughout 2005, leading electronics manufac-

turers, such as Motorola, acquired facilities and

land along the U.S. border, suggesting a continu-

ing FDI improvement in the maquiladora sector.

Despite rising energy prices and demand,

oil and gas investors lost confidence in Mexico,

ranking the country 16th this year, down from

7th a year earlier. As the country prepares for

the July 2006 presidential elections and as con-

tinued high oil prices help fill the states coffers

via state-run PEMEX, the much-needed energy

sector reforms are less likely in the short term.

Mexicos business climate will continue to face

higher costs and it may soon become a net oil

importer if infrastructure and technology invest-

ments to upgrade oil, gas and electricity sectors

are delayed further.

Transport services investors are optimistic

about the Mexican market. Investor confidence in

transportation services increased in 2005 as air-

line holding company Cintra SA announced plans

to sell off Mexicos two main airlines, Mexicana

and Aeromxico. With several aviation investors

eyeing the Mexican market, and as the airline

sector opens up to competition, the aviation

market could undergo a transformation over the

next few years.

A gap in human capital may limit Mexicos

R&D potential. Mexico ranks as the 15th most

attractive R&D location globally. Compared to

Investors express more confidence in Latin Americaas itenjoys continued economic recovery. FDI inflows to Latin

America increased in 2005 after four years of declines.


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19/40


help boost consumption because people are

concerned over the future of publicly funded

pensions and health-care costs. The rejection of

the EU constitution by the French and Dutch

electorates (two founding members of the EU)

and the shifting political scene in Germany have

increased the uncertainty.

Although many European firms have improved

their balance sheets and reduced debt, business

confidence remains sluggish and continues to be

a drag on growth. With the bulk of European

investment derived from other European markets,

this will likely mean diminished FDI prospects

in Western Europe. Investment outflows from

the European Union declined from $372 billion

in 2003 to $280 billion in 2004.

However, Eastern European markets are ben-

efiting from a sharp increase in FDI confidence

levelswith Poland, Russia, Hungary, the Czech

Republic, Turkey and Romania all experiencing

more FDI confidence. Countries with the most

positive outlookPoland, Russia, Turkey, the

Baltic States and the Czech Republicall rank in

the top 10.

FDI flows to the 10 new EU markets increased

from $12 billion in 2003 to $20 billion in 2004.

As a result, FDI inflows as a share of gross capi-

tal formation rose from 11 percent to 16 percent

in these countriessurpassing the average level

of the EU-15. Industry consolidation and cor-

porate restructuring across Europe are benefiting

Eastern European markets. EU membership has

removed obstacles for small- and medium-size EU

firms that were previously deterred from investing

due to border controls and just-in-time delivery

requirements.

Despite rising costs and more regulations,

new EU members are relatively more attractive

to global companies. This is due to higher levels

of productivity and better tax rates. The average

corporate tax rate among the new EU members is

20 percent, but reaches 31 percent for the EU-15.

Poland, the Czech Republic and Hungary

benefited from double-digit growth in the first

half of 2005. These countries are experiencing

strong export demand from Russia, Ukraine and

the Balkan States, which compensates for less

export demand from Western Europe. Higher

oil prices, which are eroding growth in Western

Europe, are actually fostering stronger demand

in oil-producing countries such as Russia and the

Commonwealth of Independent States (CIS). The

shifting trade patterns between West and East are

acting as a shock absorber for Eastern European

markets. Russia, Turkey and Romania also made

significant gains in FDI attractiveness this year,

further reflecting higher FDI prospects in Eastern

and Southern Europe.

United Kingdom. The United Kingdom held

steady in 4th place in 2005, behind China, India

and the United States.4 French, Canadian and

U.S. investors maintained the highest levels of

FDI confidence in the U.K. market in 2005

ranking the country their 4th, 7th and 4th most

attractive FDI destination, respectively. In 2004,

FDI inflows to the United Kingdom hit $77.6

billion, up from $27.4 billion in 2003. This was the

third largest FDI inflow to the United Kingdom

and was driven largely by a few major cross-border

M&A deals, including Santander Central Hispano

SAs (Spain) acquisition of Abbey National for

$15.8 billion, and GEs (United States) purchase

of Amersham plc for $9.6 billion.

The United Kingdom, among the worlds

leading financial markets, continues to attract

investors from banking, insurance and other

financial services sectors. Global bankers say the

United Kingdom is their 3rd most attractive

4 UNCTAD preliminary figures for 2005 puts the United Kingdom in the number one position, having attracted more than $200 billion in FDI, an increaseof 182 percent.


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FDI location, while insurance companies rank

the United Kingdom 4th. London is the worlds

largest market for cross-border bank lending

responsible for nearly one in five dollars lent

overseasas well as over-the-counter derivatives,

foreign exchange trading, and marine and avia-

tion insurance.

Business servicesmostly software, engi-

neering, accounting, research and management

companiesrank the United Kingdom their

3rd most attractive FDI location globally. Silicon

Glen (Central Belt of Scotland), Silicon Fen

(Cambridgeshire), Thames Valley/M4 Corridor,

Greater Manchester and the Midlands represent

highly advanced software clusters supporting

the United Kingdoms rapidly growing software

industry, which is estimated to be worth $40.5

billion as of 2004.

In part, the United Kingdoms strong perfor-

mance in business services is related to the coun-

trys attractive R&D capabilities. Global investors

rank the United Kingdom their 4th most attractive

R&D location globally, behind India, China and

the United States. The country boasts advanced

technical and engineering skills, strong ties

between industry and academia, and operates on

the cutting-edge of new product research, design

and development in many fields.

The largest share of U.S. and Japanese R&D

operations located in Europe are based in the

United Kingdom. Telecom and utilities investors

rank the United Kingdom, their 6th most attrac-

tive market. Although the U.K. mobile market

quadrupled between 1998 and 2003, growth

rates will slow in the coming years as penetration

rates exceed 90 percent. But content innovation

through third-generation networks (3G) allow-

ing internet access, video and data transmission

will provide further room for growth on a per user

basis. The United Kingdom is the current global

leader in 3G technology.

Telecom regulator, Ofcom, is forcing domi-

nant BT to provide greater market access to rivals

and encouraging new entrants to help improve

service, reduce prices and expand consumer inter-

net access. In a clear sign of increasing competi-

tion, Carphone Warehouses Talktalk and Onetel

are wooing customers away from BT.

Poland. Poland jumped from 12th to 5th

place in the Indexits highest ranking since

2000driven by increased interest from U.S.

and European investors. U.S. investors rank

Poland their 7th most attractive FDI location (up

from 12th a year ago), while European investors

rank Poland 3rd, up from 6th in 2004.

Most enthusiasm in Europe comes from

U.K. and Dutch investors. Both countries rank

Poland their 3rd most preferred investment

location worldwide. Italian and Swiss investors

rank Poland 5th and 6th, respectively. Notable

European investments are Germanys MAN AG,

which invested $123 million in a new factory

to start producing trucks in 2007, and Frances

Michelin, which is expanding its existing plant

in the northeast in a $306 million deal.

About one in four global investors is more

optimistic about the Polish marketonly India,

China and Brazil achieved higher levels of inves-

tor enthusiasm worldwide. One in 10 global

investors indicated they will make first-time

investments in Poland. Polands full membership

in the EU has meant the adoption of EU laws,

greater regulatory stability and reduced risk pre-

miums. Similarly, EU Structural Funds are aimed

at improving infrastructure, human resources,

competitiveness and enterprise development.

In 2004, Poland received $12.6 billion

FDI inflowsup from $4.6 billion in 2003.5

5 UNCTAD preliminary figures for 2005 reveal that FDI inflows to Poland decreased by 31 percent to $8.7 billion.


21/40


Nearly 60 percent of these flows were attributed

to greenfield investments (new investments by

entrepreneurs, as well as profits posted to pre-

vious greenfield investments). Nearly 1 in 10

greenfield investments in the European Union

went to Poland in 2004. From a sector perspec-

tive, manufacturing accounted for most FDI,

with automotive, chemical and metal invest-

ments leading the way.

Looking ahead, global communications inves-

tors are the most bullish on Polandranking it

their number one market worldwide. Poland repre-

sents the largest communication market in central

Europe. With a large population and lower mobile

phone penetration rates than the Czech Republic

and Hungary, Poland offers solid market oppor-

tunities. Vodafone (U.K.), TDC (Denmark), and

T-Mobil (Germany) are increasing their invest-

ment stakes in two Polish mobile operators.

Polands fixed-line operator, TPSA (the former

state-owned monopoly), faces little competition

and the market remains fragmented. However,

consolidation among other fixed-line competi-

tors is expected to boost growth and improve

service. Further improvements to the telecom

infrastructure would reduce consumer costs and

foster greater broadband internet access. Already,

Poland has more internet users than Bulgaria, the

Czech Republic, Hungary, Romania and Slovakia

combined.

Electric and gas investors rank Poland their

2nd most preferred investment location. Although

privatization in the electricity sector has been

slow, EU entry will require liberalization. As the

country moves away from energy-intensive indus-

tries and pursues environment-friendly policies,

coal production has declined in favor of mostly

imported natural gas. Polska Gornictwa Naftowa

i Gazownictwa (PGNiG), the state-owned gas

storage, distribution and trade company, is being

restructured and opened to foreign investors.

After joining the European Union, food

restrictions on the EU-15 markets were elimi-

nated, thus making Poland a major European

agricultural player. Food, tobacco, textiles and

apparel investors rank Poland their 5th most

attractive market, while investors in agriculture,

forestry and fishing place Poland 3rd. The food-

processing market is growing fast and the industry

is moving up the value chain.

Poland ranks 5th among fabricated metal,

industrial machinery and computer equipment

investors. The worlds largest PC maker, U.S.-

based Dell, plans to build a PC assembly factory in

Lodza move expected to generate 12,000 new

jobs and further increase the supplier market.

Polands offshoring potential is also rising.

Investors are attracted by the special economic

zone in Lodz, with Philips (Netherlands) trans-

ferring its European financial and accounting

operations there. The zone has become a hub for

on-shore call centers of domestic firms. For exam-

ple, telecom incumbent TPSA, mobile Polkomtel

and Bank Pekao all operate customer service

centers from Lodz.

Europeans rank Poland their 4th most attrac-

tive R&D investment destination globally. German-

based Siemens expanded its Wroclaw research and

development center and increased staff by 40 per-

cent. In 2002, Polands gross domestic expenditure

on R&D was $1.1 billionmore than any other

new EU member and about one-third of the com-

bined spend of the 10 new EU countries.

Russia. After tumbling from 8th place in

2003 to 11th place in 2004, Russia places 6th

in the Index. French, German and Swiss inves-

tors express the most confidence in the Russian

market, ranking it 3rd, 4th and 7th respectively.

Russia is the 4th most preferred location for first-

time investors.

Russia received $12.5 billion in 2004, up

from the $8 billion received in 2003, marking an


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23/40


make it difficult to expand beyond the major

cities of Moscow and St. Petersburg. While Russia

boasts notable investors such as IKEA (Sweden),

the absence of major U.S. companies is a striking

characteristic of the countrys retail boom.

Russia ranks 11th among telecom and util-

ities. This is a significant jump from below the

top 25 in 2004. Mobile penetration rates have

nearly doubled annually for the past four years,

making Russia one of Europes fastest-growing

mobile markets. Energy, finance and commer-

cial sectors are demanding both IT services and

an improved infrastructure. Some of the largest

cross-border deals in Russia last year were in the

telecom sector. For example, Alfa Telecom Ltd.

bought Vimpelcom OJSC for $1.4 billion and

Access Industries, Inc. (U.S.) acquired Svyazinvest

JSC for $625 million.

Rising wages, however, are stifling growth in

sectors outside energy. Without an overall strat-

egy to diversify beyond the energy sectors, Russia

could continue to suffer from Dutch Disease

and deindustrialization.

Germany. Germany fell from 5th to 9th

placeits lowest ranking since 1999. French,

Swiss, U.S., Italian and Dutch investors expressed

less interest in the German market. FDI inflows

dropped from $27.2 billion in 2003 to negative

$38.6 billion in 2004, the result of lower equity

capital and substantial repatriations of intra-

company loans. Equity capital declined from

$40.5 billion in 2003 to $21.6 billion in 2004,

while intra-company loans soaredfrom nega-

tive $8 billion to negative $46.2 billionover

the same period.

In part, the steep decline was due to revisions

to the German tax code intended to encourage

foreign companies to transfer their corporate loans

into equity capital. The tax change made it less

attractive for foreign companies to retain liquid

reserves at their German affiliates. Moreover,

the large negative intra-company loan flow was

influenced by one major $24.5 billion transaction

in the telecom sector.

Manufacturing investors soured on Germany

this year. Heavy manufacturing investors rank

Germany 10th, down from 4th place, while light

manufacturing investors rank it 15th, down from

4th place a year earlier. The desire to move closer

to export markets combined with Germanys high

payroll and compliance costs is driving manufac-

turing firms to emerging markets, including China

and Eastern European countries. Domestically,

Germanys automotive market, which is Europes

largest, suffered from sluggish growth between

2001 and 2003 and expanded only modestly last

year. Transportation equipment investors are sig-

nificantly less interested in the German market.

Germany ranks 11th among financial ser-

vices investors. Italys Unicredit created head-

lines by acquiring Germanys third-largest bank,

HVB Group, for $18.5 billion in June 2005.

The consumer finance market is becoming more

sophisticated, evident in a rise in non-mortgage

consumer loans and credit-card activity. We

expect to see a rise in corporate bonds and

equities. The elimination of state guarantees in

July 2005, has led to an increase in bank bor-

rowing costs, causing banks to lend less money

and encouraging corporations to shift to cap-

ital markets. The future, however should be

brighter. Legislation cutting future pension liabil-

ities and creating incentives to encourage private

savings will likely spur growth of retirement

savings products and services. The life insurance

business is also expected to grow due to concerns

over the public pension system.

Germany ranks 3rd among chemicals and

allied products companies. In June 2005, Novartis

(Switzerland) acquired Hexal, the generic drug

maker, while Torrent (India) purchased Heumann

Pharma. In 2004, Roche (Switzerland) poured


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money into two biotech plants in Bavaria, while

GlaxoSmithKline (U.K.) invested in a second

vaccine plant in Dresden.

Other notable chemical deals in 2004

include: Air Liquide SAs (France) acquisition of

Messer Griesheim-Ind Gas Ops for $3.4 billion,

Rockwood Specialties Groups (U.S.) purchase of

Dynamit Nobel AG by for $2.7 billion, and The

Blackstone Groups (U.S.) purchase of Celanese

AG for $2.2 billion.

Hungary. Hungary climbed to 11th from

19th place in the Index. Investment in Hungary is

buoyed by increased confidence among Western

European investors. German, Swiss, Dutch and

U.K. investors express the most enthusiasm

for the Hungarian market. Despite heightened

macroeconomic risk and one of the worlds

strongest currencies last year, Hungarian FDI rose

from $2.1 billion to $4.6 billion in 2004.

Wages rose sharply and unit labor costs in

U.S. dollar terms nearly doubled from 2000 to

2003, but slowed in 2004. Still, Hungary offers

some of the lowest wages in Eastern Europe (31

cents on the U.S. dollar compared to the EU-15

average). Hungarys recent EU-entry, rising pro-

ductivity, and a multilingual, skilled and motivated

workforce act as magnets for foreign investors.

Hungary ranks 2nd among communications

investors and 7th among electronic and electrical

equipment investors. Investments by Nokia and

Elcoteq (Finland) and Flextronics (Singapore) are

helping to position the country as a major European

hub for manufacturing mobile handsets. However,

in the price sensitive and highly competitive elec-

tronics industry, Hungarys rising wage costs and

currency appreciation have negatively affected the

market. Already, Flextronics and IBM have moved

some production from Hungary to China.

Hungary ranks 10thup from 17th last

yearamong chemicals and allied products

investors. The country inherited a solid pharma-

ceutical industry from the Communist era that

has evolved into a European platform for low-cost

production of patented compounds and branded

generic substitutes. Local pharmaceutical compa-

nies are also engaged in R&D activities.

Czech Republic. The Czech Republic is the

12th most attractive FDI locationan all-time

high in the Index. U.S. investors rank the Czech

Republic 14th (up from 20th), displaying the

largest improvement in FDI confidence this year.

European investors express the strongest levels

of FDI confidence in the Czech market, with

Germany ranking it 7th, the United Kingdom

9th and France 11th. FDI inflows more than

doubled in 2004, reaching $4.5 billion.7

Insurance, real estate and holding compa-

nies rank the Czech Republic 7th up from 13th

place in 2004. A series of central bank interest

rate hikes may dampen strong growth in the tra-

ditional banking sector, but new opportunities

are emerging in insurance and asset management.

Socit Gnrale (France) and Allianz (Germany)

are jointly expanding insurance operations in

the country, while Aegon (Netherlands) is enter-

ing the market. Concerns from the 1990s about

minority shareholder rights, asset stripping and

insider trading could be fading as wealth man-

agers launch new products to benefit from rising

Czech incomes.

The Czech Republic ranks 9th among trans-

portation equipment firms. Automakers are keen

on the market and are expected to make additional

investments over the next few years. Car exports,

mainly destined for other European countries,

comprise 23 percent of all Czech exports. And

although car ownership in the country is higher

than anywhere else in Central Europe, it is still

7 UNCTAD preliminary figures for 2005 reveal that FDI inflows to the Czech Republic increased 181 percent to $12.5 billion.


25/40


low compared to developed countries.

Hyundai (South Korea) is leaning toward the

countrys Ostrava region for a planned $1.2 bil-

lion production plant, after building a Kia Motors

subsidiary in Slovakia. Toyota Peugeot Citroen

Automobile (an auto consortium) is expected to

ramp up production at its plant near Prague.

Telecom and utilities investors rank the

Czech Republic 7th. The country has one of the

most advanced information and communications

technology (ICT) sectors in Central and Eastern

Europe. When Telefnica (Spain) acquired Cesky

Telecom in 2005, it crowned a decade of efforts

by Czech authorities to privatize the sector.

Earlier, Vodafone (U.K.) acquired major mobile

operator Oskar. With Germanys T-Mobil and

Frances Orange, the countrys entire mobile net-

work is now foreign-owned. Another promising

area of growth is in broadband services, driven by

internet use and internet shopping. In fact, one in

six Czechs shops online.

There is rising demand for professional inter-

net, e-commerce, web design and systems inte-

grator services, particularly within the banking

and government sectors. U.S. firms dominate the

software market: Microsoft, Novell, Corel, Lotus

Symantec, Sybase, Oracle and Sun Systems are all

active in the countrys IT and software sector.

Turkey. Turkey jumps to 13th place from

below the top 25. The potential for EU acces-

sionalbeit uncertainand reforms under the

International Monetary Fund stabilization pro-

gram have helped push Turkey up the Index.

The interest is buoyed by the central banks

adoption of inflation targeting strategies early in

2006, part of the last phase in a four-year process

of reforming the countrys monetary policy.

Turkey ranks 7th among countries consid-

ering first-time investments over the next three

years. In 2004, the country had $2.7 billion

in FDI inflows, a 56 percent increase over the

previous year.8 European investors are the most

optimistic about Turkey, ranking it 7th (up

from 21st), with Italian investors ranking Turkey

their number one FDI location, ahead of China

and India.

Turkey jumps to 11th place (from 20th) in

the banking sector. After the 2001 financial crisis,

the Turkish government poured capital into the

failing banking system and is now seeking FDI

through privatization. Recently, Turk Dis Ticaret

Bankasi was acquired by Fortis Bank (Dutch-

Belgium) for $1.3 billion.

Turkey ranks 12th among telecom and util-

ities investors. A consortium of Telecom Italia

(Italy) and Oger Telecom (Saudia Arabia) plans

to purchase a 55 percent stake in Turk Telekom

for $6.55 billion, while TeliaSonera (Sweden)

and Alfa Group (Russia) are expected to invest in

Turkeys wireless market.

Also, Turkey ranks 12th among heavy manu-

facturers and 9th among light manufacturers (a

jump from below 20th place). In the automobile

sector, companies consider the country a viable

export platform for Europe. General Motors

(U.S.) plans to restart its production facilities in

Turkey, and Hyundai is expanding its already-

significant investment there to meet growing

demand in Europe.

France. France drops from 6th to 14th place

in the Index. Last year, FDI inflows into France

declined 43 percent. Looking ahead, France may

see fewer FDI commitments: German, U.S.,

Dutch, Swiss and Italian investors all express less

interest in the French market, with manufactur-

ing investors the most pessimistic.

Frances brewing economic patriotism has

surprised investors. For example, PepsiCos (U.S.)

8 UNCTAD preliminary figures for 2005 reveal that FDI inflows to Turkey increased 77 percent to $4.8 billion.


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bid for Groupe Danone, the French food and

beverage firm, and HPs decision to shed work-

ers from its French subsidiary produced strong

responses from the government. They also inten-

sified the countrys ongoing debate over main-

taining its social model amid globalization. The

government expanded its list of strategic sectors

that are off limits to foreign investors, and passed

legislation that restricts shareholder rights and

helps French firms defend against hostile take-

overs. In 2004, the government helped thwart

Novartis (Switzerland) from acquiring Aventis

and government intervention blocking an Italian

takeover bid for Suez SA further fanned investor

concerns.

French FDI inflows declined last year due

to lower equity and intra-company debt trans-

actions. However, the actual number of FDI

projects in the country increased, according to

Invest in France, the economic development arm

of the government. This reveals a decline in the

number of large M&A deals, possibly due to

rising political and public sentiment opposing

such transactions.

France ranks 7th among wholesale and retail

investors, up from 10th place. FDI confidence in

France is strongest among food and apparel retail-

ers. And despite a rise in oil prices, consumer

confidence has not waned. BC Partners Ltd (U.K.)

spent $1.7 billion to acquire Picard Surgeles SA,

Frances top frozen food retailer. The French cloth-

ing market is expected to be worth $46 billion by

2009. An increase in the working-age population

combined with more women in the workforce is

expected to spur growth in this segment.

Electric and gas investors rank France 11th

in the Index, down from 10th place. Weak public

finances and sluggish growth have pressured the

government to sell key companies. In 2005, the

government sold stakes in France Telecom and

Gaz de France and expects to move forward with

the partial-privatization of Electricit de France.

However, investors initial enthusiasm for owning

shares in the nations utilities has waned, with the

government reducing the original sale price and

now planning to retain 85 percent ownership.

Spain. FDI continues to play a major role in

the Spanish economy. Market liberalization and

EU accession, which began in the late 1980s,

have led to macroeconomic stability, growth and

restructuring of the industrial base. Despite the

global FDI recession since 2000, FDI inflows to

Spain have held strong in recent yearshitting

an all-time high of $44 billion in 2002.

Increasing competition, however, undermines

the countrys future FDI potential. Facing stiffer

competition from Eastern Europe and Asia,

Spains ranking dropped for a third year in a

rowfalling from 7th place in 2002 to 17th in

2005. FDI inflows to Spain declined from $29

billion in 2003 to $18 billion in 2004, with many

foreign companies liquidating previous invest-

ments. Labor costs are part of the problem. Wages

in Spain are more than three times higher than in

Poland, the Czech Republic and Hungaryand

the country is not achieving higher productivity

rates to justify its higher wages. In fact, Spain is

the only OECD country to record negative pro-

ductivity growth rates over the past decade. Heavy

manufacturing investors downgraded Spain from

9th to 14th place.

Wholesale and retail investors rank Spain

their 10th most attractive market globally

up from 12th in 2004. Retailers are attracted

to Spains rising incomes per capita and retail

growth rates that surpassed the EU average for

most of the 1990s. The recent housing boom is

supporting growth as well. Decathlon (France),

IKEA (Sweden), Ahold (Netherlands), Carrefour

(France), Auchan (France) and Toys R Us

(U.S.) have helped transform the retail business

landscape in Spain. Although the market remains


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fragmented, Spain will likely see further consol-

idation and more large-scale malls, supermarkets

and retail outlets.

Telecom and utilities investors rank Spain

their 10th most attractive investment location

down from 9th in 2004. The entrance of Vodafone

and Frances Orange stirred-up the Spanish tele-

com market and gained the attention of foreign

corporate investors and private equity firms.

In November 2005, private equity investors

financed local operator Onos acquisition of Auna

to form a new company to challenge incumbent

Telefnica. France Telecom purchased Amena,

Spains third-largest mobile operator, which was

spun-off from Auna.

Spains R&D spending as a share of GDP is

the lowest in Western Europeeven the Czech

Republic invests more in R&D than Spain. Global

investors prefer India, China, Poland, Brazil and

Russia over Spain as an R&D location. Limited

access to seed capital and a high regulatory burden

have stifled new enterprises and entrepreneurial

activities.

In addition, Spain is slow to innovate. While

Spain has highly trained scientists and engi-

neers, they have limited links to industry and

ICT investments. To help address this prob-

lem, the Catalan government is sponsoring the

Barcelona Biomedical Research Park to recruit

both Spanish and foreign scientists and link

them with biotech venture capitalists in the

United States and Europe.

Italy. Foreign investment in Italy has risen

slightly from $16.4 billion in 2003 to $16.8 bil-

lion in 2004.9However, this is relatively low by

Western European standards: On a GDP basis,

FDI is three times higher across the EU-15 than

in Italy. Global investors rank Italy the 19th most

attractive FDI location compared to 9th place in

2004. Although North American and European

investors express less interest in the Italian market,

German investors put Italy in 10th place. The

government has implemented reforms for labor

and pension, but not for professional services.

Italy ranks 16th among financial services

investors. The Central Banks intervention in

the bidding war between Banca Popolare Italiana

and ABN AMRO (Netherlands), which are both

seeking to acquire Banca Antonveneta, could be

undermining foreign investor sentiment.

Electric and gas investors consider Italy the

3rd most attractive FDI destination globally. Italy

is among Europes largest importers of electric-

ity, but increasing demand is putting a strain on

the power grid links to France and Switzerland,

leading to blackouts and shortages. Since 2002,

when the Italian government liberalized its

electric and gas market, foreign investors have

been entering the market, led by Electricit

de France (France) and Electrabel (Belgium).

The government is expediting liberalization and

investment approval for more thermoelectric

Traditional operational risks such as government regulation,and financial, political and social instability,appear to be

less threatening in 2005 compared to previous years.

9 UNCTAD preliminary figures for 2005 reveal that FDI inflows to Italy decreased to $13 billion.


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generation plants, and is expected to sell an addi-

tional 10 percent of its stake in Enel, the state

electricity firm.

Transport services investorsair, sea and

land carriers and logistics services firmsview

Italy as their 8th most attractive FDI location

again this year. Italys robust tourism industry

continues to draw in these investors. The

expected privatization of the countrys freight and

intercity travel markets, and continued liber-

alization of roadways, will improve efficiency

and likely increase investments. The creation of

independent authorities to oversee the countrys

19 ports and privatization of port services have

helped position Italy as a more competitive hub

in the Mediterranean region.

Romania. Romania enters the top 25 most

attractive FDI locations for the first time, rank-

ing 25th. Italian and Spanish investors are the

most bullish on Romania, ranking it their 4th

and 6th most preferred FDI location, respectively.

Romania ranks 5th among electric and gas inves-

tors, as liberalization continues to offer acquisi-

tion opportunities. E.On Energie (Germany),

Enel (Italy) and CEZ (Czech Republic) are

moving into the distribution market. Investors

are attracted to Romanias substantial oil and gas

reserves and large-scale, well-developed refining

industry. Petrom was acquired by the regional

oil player OMV (Austria), the countrys largest

post-communist privatization. Gaz de France

recently won the tender for the countrys major

gas distribution and supplier Distrigaz Sud. The

anticipated privatization of electricity generators,

Termoelectrica and Hydroelectrica, may also be

spurring investor interest.

Romania ranks 10th among light manu-

facturing investors, up from below the top 25.

The electronics, paper and furniture segments are

keen on Romania and want to benefit from its

low-costs and skilled labor force.

Asia

Asias FDI inflows reached $155.5 billion, an

unprecedented $48.6 billion increase over the

year before. Asia is attracting nearly one in four

global FDI dollars compared to only one in 10

in 2000. The top five host economiesChina,

Hong Kong, Singapore, South Korea and India

account for 80 percent of the flows to the region.

Although greenfield investments continue to be

the dominant form of FDI to the region, merg-

ers and acquisitions are playing a more important

role. In 2004, cross-border M&A deals amounted

to $25 billionup from $22 billion in 2003

and were primarily concentrated in China, South

Korea and Hong Kong.

China and India are considered the worlds

1st and 2nd most attractive FDI locations

globally. China held the top spot for the forth

year in a row and India rose from 3rd to 2nd

place, surpassing the United States. Hong Kong

and South Korea dipped slightly from 8th to

10th and 21st to 23rd, respectively. Singapore

and Thailand maintained their positions at 18th

and 20th place.

Despite an additional 1.5 billion people in

the developing world (from 1981 to 2001), the

number of extremely poor people in these coun-

tries declined by more than 375 milliona feat

unimaginable two decades ago and largely the

result of progress in China and, to an extent,

India. China and India are attractive to CEOs

worldwide due to their strong growth rates, grow-

ing consumer populations, and low-cost but

highly educated labor pools. Pro-FDI reforms

and accelerated integration into the worldwide

IT network have made both countries more

attractive to investors.

China. China maintains its lead in the Index

for the fourth consecutive year. China attracted

$60.6 billion in FDI in 2004, the highest among

all developing economies. Although total inflows


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to China are much lower than to the United

States, China has a much higher number of green-

field FDI projects. The United States had 578

such projects in 2004, while China had 1,529.

The Chinese economy continues its robust

development, growing by 9.5 percent in the

second quarter of 2005. Total growth in 2005

exceeded expectations at nearly 10 percent, with

robust growth expected into 2006.

Once again, China is the top FDI location

for first time-investors, with more than half (55

percent) of investors expected to make first-

time investments there over the next three years.

This is significantly higher than the 43 percent

of investors that expected to invest in China for

the first time in 2004. One in five FDI dollars

for first-time investments will be committed to

the Chinese market. China has successfully over-

come the perceived risk associated with first-time

market entry, which is typically the biggest barrier

to generating new FDI.

Implementation of World Trade Organization

(WTO) requirements is fueling investor interest,

as is continued liberalization and deregulation

in banking, insurance, telecommunications, and

wholesale and retail segments. Policy changes to

increase foreign ownership and reduce or elimi-

nate geographic restr

fdi confidence index

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