Define foreign direct investment (FDI).

What are some of the policies and incentives provided by the

local government to boost FDI in Malaysia?

DEFINATION OF FOREIGN DIRECT INVESMENT (FDI)

FDI means an investment abroad, usually where the company being invested in is controlled by
the foreign corporation. An example of FDI is an American company taking a majority stake in a
company in Malaysia. FDIs can be broadly classified into two types: outward FDIs and inward FDIs. This
classification is based on the types of restrictions imposed, and the various prerequisites required for
these investments. An outward-bound FDI is backed by the government against all types of associated
risks. This form of FDI is subject to tax incentives as well as disincentives of various forms. Risk coverage
provided to the domestic industries and subsidies granted to the local firms stand in the way of outward
FDIs, which are also known as 'direct investments abroad.' Different economic factors encourage inward
FDIs. These include interest loans, tax breaks, grants, subsidies, and the removal of restrictions and
limitations. Factors detrimental to the growth of FDIs include necessities of differential performance and
limitations related with ownership patterns. Other categorizations of FDI exist as well. Vertical Foreign
Direct Investment takes place when a multinational corporation owns some shares of a foreign
enterprise, which supplies input for it or uses the output produced by the MNC. Horizontal foreign direct
investments happen when a multinational company carries out a similar business operation in different
nations. Foreign Direct Investment is guided by different motives. FDIs that are undertaken to
strengthen the existing market structure or explore the opportunities of new markets can be called
'market-seeking FDIs.' 'Resource-seeking FDIs' are aimed at factors of production which have more
operational efficiency than those available in the home country of the investor.Some foreign direct
investments involve the transfer of strategic assets. FDI activities may also be carried out to ensure
optimization of available opportunities and economies of scale. In this case, the foreign direct
investment is termed as 'efficiency-seeking.' 

Concept and Definition of FDI In MALAYSIA

FDI in a country is established following the holding of at least 10 per cent of the total equity in a
resident company by a non-resident direct investor. Any subsequent transactions in financial assets or
liabilities that occur between nonresident direct investors and resident companies that are linked by a
foreign direct investment relationship (FDIR) are also classified as FDI. The transactions could be
between the companies in Malaysia with its immediate parent, ultimate parent or fellow companies as
shown in the diagram below. Besides Malaysia, Canada also adopts FDIR to determine FDI transactions.
In other words, direct investment can also be established by the existence of lasting interest between
the direct investors and the enterprises and a significant degree of influence by the investors on the
management of the enterprises.
The FDI position analyses in this paper is based on IIP statistics, which
represents stocks of external financial assets and liabilities at a particular point of
time, usually at the end of the year. In this regard, emphasis is given to relevant
indicators namely component, sector and country, of the FDI position. In addition,
this paper also illustrates the investment income of FDI by component and
sector.

Guidelines provided by IMF (BPM5) describe FDI components as equity capital,

reinvested earnings and other capital. The explanations are as follows:

• Equity Capital - comprises equity in branches, all shares in subsidiaries

and associate companies (except non-participating preference shares),

• Reinvested Earnings (RE) - consists of direct investors’ shares of earnings

not distributed as dividends by subsidiaries or associates and earnings of
branches not remitted to direct investors, and
• Other Capital - consists of debt securities, trade credits, loans, deposits
and others.
policies and incentives Foreign Direct Investment
Malaysia faces stiff competition from regional countries in attracting FDI inflows. In this regard, the
Government has relaxed conditions and simplified procedures for foreign companies to operate in
Malaysia. Khazanah Nasional Berhad and Permodalan Nasional Berhad will enhance collaboration with
foreign investors in education, tourism and infrastructure. The Government will further intensify efforts
to attract FDI by allowing equity ownership in companies and joint ventures in local projects. We have
taken aggressive steps to attract investors from Middle East, China and India. This initiative has yielded
positive results. Following my recent visit, a company from Saudi Arabia has invested USD1.5 billion in a
high-impact project in collaboration with 1Malaysia Development Berhad (1MDB), a Government-
owned sovereign wealth fund, which also invested USD1 billion in the project. I often remind the private
sector and Government-linked companies (GLCs) not to neglect their social responsibilities in their quest
for profits. In line with this, for a start, 1MDB will establish a corporate social responsibility fund totalling
RM100 million as a start to finance community activities.FDI in Malaysia is an important catalytic factor,
increasing exports, knowledge and provides an economic vehicle towards the Malaysian 2020 vision.
THE MALAYSIA PLAN AND THE NEW ECONOMIC POLICY FRAMEWORK The Malaysian government uses
economic planning to achieve economic and socio-economic goals in close coherence with the New
Economic Policy (NEP) and the National Development Policy (NDP). The Fifth Malaysia plan and the
Long-term Industrial Master Plan Malaysia, in particular, indicate specific future objectives and
economic trends. Objectives. The Malaysian economic policy framework is based upon the NEP, which
was launched in 1974.
The political and economic objectives of the NEP is to reduce poverty by increasing income levels for all
Malaysians and to restructure the Malaysian society in order to erase all racial identification in economic
terms. In other words, the NEP calls for a financial redistribution from the minority of wealthy non-
Bumiputra (native Malaysians also known as "Princes of the Soil") racial groups to the Bumiputras
(Goldsworthy 1991: 51). The goal is to achieve corporate equity of 30 percent Bumiputra, 30 percent
foreign and 40 percent other-Malaysians (Onn 1988: 8). This goal can only be facilitated with an
expanding economy, so that no racial group should suffer from economic or social deprivation. Other
specific economic goals include; maintain high sustainable growth, low unemployment rates and ensure
the stability of economic factors such as inflation. Under the NEP, FDI incentives were d! esigned to
achieve social rather than economic objectives (Goldsworthy 1991:53).
According to the Malaysian Industrial Development Agency (MIDA), "Malaysia received political stability
from the NEP. Racial turmoil attracts neither foreign nor local investments."(Appelbaum et Al: 1993,
180) The National Development Policy (NDP) replaced the NEP when it expired in 1990. This new policy
can be considered an add-on document to the NEP, the objectives of which were not achieved in 1990.
Furthermore, it provides a framework towards Dr. Mahathir's new vision 2020 plan symbolizing "the
way forward" policy towards a "developed" nation in 2020. This will require the nation to maintain a 7-
plus percent growth rates for the next 25 years. Prime Minister Mahathir believes raising workforce
quality and developing expertise in sophisticated industries are decisive elements in the country's road
to economic success and development (Brown 1993: 43).
In order to facilitate these growth requirements, the NDP has relaxed many of the FDI restrictions
imposed by the NEP such as equity and licensing requirements and procedures. The Fifth and the Sixth
Malaysia plans (1986-1997) place great emphasis upon the privatization process of certain government
owned industries and utilities. For instance, the major motor-highways now belong to "Plus", a privately
owned entity which is responsible for the construction of such transportation infrastructure. According
to Dr. Mahathir, "The Malaysia Incorporated concept requires the private and public sectors see
themselves as sharing the same fate and destiny as partners, shareholders and workers within the same
'Corporation', which in this case is the nation.."(Huq 1994: 189).
The overall objective of this policy is rationalization of the government sector and to foster more
initiatives from the private sector. The private sector is the driving force to economic prosperity and the
government will provide the needed support. In close cooperation with the NDP, the Sixth Malaysia plan
is the driving motivation for development. The purpose of the Industrial Master Plan which was
formulated by the United Nations Industrial Development Organization (UNIDO) is to focus private and
government agencies on core competencies and develop industries with great export potentials in the
next 15 years (Please refer to Appendix 3 for such industries). Export Facilitation. In the South East Asian
region, most of the incoming FDI has been exported oriented rather than intended for domestic sales
(World bank 1993: 318). Presently, Malaysia has one of the world's highest export to GDP ratios (Petri
1994: 11).
The economic rationale of Malaysia to promote exports provides the nation with three important
advantages. First, it generates foreign-exchange that can reduce the amount of foreign debt needed to
fund development. Second, it contributes to developing a competitive industry infrastructure from
learning from investors- a move that brings technological excellence leading to higher value-added
exports. By the promotion of specific industries, such as the semi-conductor industry, has speeded
technology acquisition and enhanced the nation's competitive Worldwide positioning. Finally, FDI
provides employment in the industry sector, which to a large extent is attracted from the agricultural
sector. Critics argue that Malaysia has become largely dependent on foreign technology and failed to
develop its own technology base (Goldsworthy 1991: 58).
For instance, it is true that Malaysia is the world's largest manufacturer of Air conditioners, but it is also
true that Japanese companies account for 90 percent of all exports. In this relationship, Malaysia is
"sitting between Japanese capital and these sorts of exports"(Goldsworthy 1991: 58) If Malaysia cannot
develop its own competitive industry with a solid technological base, it may be difficult for the nation to
achieve its 2020 vision. In the case of Malaysia, the critical success factors of FDI lay in the economic
policy. FDI incentives such as taxable income deductions linked to domestic performance and local
content, other tax allowances, location incentives, double deduction for promotion of exports and
political and economic stability have all contributed to the massive influx of FDI and increase of exports
(Carrol, Errion 1991 21). In addition, nine Free Trade Zones (FTZ) provides tax-free areas with liberal
custom controls for manufacturers that assemble at least 80 percent of their products. Import
Substitution. Economic development in Malaysia was first built on the basis of Import Substitution,
indicated by the large shift of GNP distribution from agricultural sectors to manufacturing sectors.
Import substitution has increased in mainly three areas, transport equipment, Industrial chemicals and
fertilizers and in Industrial machinery (Onn 1988: 28). However, exports constitutes the main source of
growth in the manufacturing sector from 1970-1990 (refer to appendix 6). This trend can be explained
by economic policy that places great emphasis on improving industrial competitiveness as a vehicle
towards vision 2020. TRADE RESTRICTIONS. According to Richards, "Malaysia has benefited considerably
from its liberal trade policy" (1993: 29). Such policy has increased worldwide competitiveness through
strategic exposure and promoted economic growth.
Presently, Malaysia has one of the most liberal trade policies in the East Asian region. The nation's policy
of liberalizing trade is not only incorporated with the WTO and AFTA objectives, but also micro-
economic objectives. Reducing tariff levels will not only decrease inflationary pressures in the expanding
economy but also increase the competitiveness of Malaysian industry throughout strategic exposure.
Liberalization can also enhance export incentives from FDI's as seen in the nine FTZs. In line with
microeconomic change, trade restrictions have been aligned with development strategies which are
often based upon the notation of comparative advantage. Selective protection promotes the
development of industrial subsectors that have the potential to produce high value added products,
which are intended "to replace light manufacturing activities as the main exporters" (Brown 1993: 45).
Tariff Structure As a link to the policy of maintaining a stable economy with past budget strategies of
controlling inflation, there have been major reductions and abolition of import duties on goods and
services. The 1995 budget proposes a reduction of tariffs imposed on over 2,600 items of which a
majority are food items (Budget 1995: 22).
Also, tariffs on building materials and household appliances have been reduced. These measures will not
only control inflation, but also enhance the quality of life and favor the over all climate for investments.
However, Ad Valorem taxes are imposed on imported goods and services (refer to Appendix 4). Strategic
Exposure Strategic exposure represents a crucial component in Strategic Trade Theory. The rationale
behind lowering barriers to trade and exposing local industry to foreign competition is to create a more
competitive domestic industry (Hamilton 1989: 4). Such a Level Playing Field policy will force local firms
to increase their competitiveness to survive. Strategic exposure represents a direct link to becoming an
industrialized nation by 2020 and the realization of economic goals.
Incorporating FDI as a strategic measure to enhance technological know-how can reduce domestic
learning and experience curves in selected industries. By giving foreign investors considerable tax
deductible incentives in areas such as training of local employees, research and development and in
promotion of exports Malaysia has been able to increase World wide competitiveness as demonstrated
by increasing exports and GDP (Carrol, Errion 1991: 21). Malaysia aims for the year 2000 to have at least
1.6% of GDP spent on R&D and is predicting that at least 40% will come from the private sector.
Furthermore, all firms operating in Malaysia are expected to employ and train Malaysian and Bumiputra
personnel so that the over-all employment represents the ethnic break-down of the nation (30:40:30).