71514 v1 The Investment Climate In South Asia September 2006 Finance and Private Sector Development Unit South Asia Region The World Bank THE iNVESTMErH Cll~M TE tr\l SOUTH ASIA © 2006 The International Bank for Reconstruction and Development! THE WORLD BANK 1818 H Street, I~.w. Washington, D.C. 20433, USA The material in this work is copyrighted. No part of this work may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or inclusion in any information storage and retrieval· system, without the prior written permission of the World Bank. The World Bank encourages dissemination of its work and will normally grant permission promptly. For permisSion to photocopy or reprint, please send a request with complete information to the Copyright Clearance Center, Inc, 222 Rosewood Drive, Danvers, MA 01923, USA Telephone 978-750-8400, Fax 978-750-4470, www.copyright.com All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA, Fax 202-522-2422, e-mail pubrights@worldbank.org Designed & Printed by; Ari Investments Limited 19, St. Joseph Road, Nugegoda, Sri Lanka. Tel 0094-11-2852410 Fax 0094-11-2822615 e-mail ariyaw@sltnetlk II THE irNESTMENT CLIMATE IN SOUTH ASIA TABLE OF CONTENTS Acknowledgments ............................................................. IV Acronyms and Abbreviations ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. V Executive Summary ............................................................VII Chapter I: South Asian Investment Climate in International Perspective. . . . . . . . .. 1 A. South Asian Performance in an International Perspective . . . . . . . . . . . . . . . . .. 2 B. Performance Diversity across South Asian Countries ..................... 5 C. Differences within Countries ......................................... 8 Annex to Chapter I: Data Caveats ....................................... 9 Chapter II: The Many Dimensions of the South Asian Investment Climate . . . . . . .. 11 A. Macroeconomic Environment ....................................... 11 B. Infrastructure ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 11 C. Factors of Production . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 19 D. Regulatory Burden and Corruption ................................... 30 E. Risk and Uncertainty ............................................... 34 F. Trade ............................................................ 36 Chapter III: The Costs of a Deficient Investment Climate. . . . . . . . . . . . . . . . . . . . . . . .. 39 Chapter IV: What to Do? Policy Recommendations .............................. 44 i\. Infrastructure ....... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 44 B. Factors of Production .............................................. 47 C. Regulatory Burden and Corruption ................................... 49 D. Risk and Uncertainty ............................................... 50 Annex: Country Profiles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 53 III THE INVESTMENT CliMATE Ir~ SOUTH ASiA ACKNOWLEDGMENTS This report was prepared by Guillemette Sidonie Jaffrin, (South Asia Finance and Private Sector Development Department - SASFP,) and Syed A. Mahmood, SASFP, under the guidance of Simon C. Bell, sector manager, SASFP. Mona Mehta Steffen helped prepare individual country profiles based on a standardized set of investment climate data. Comments on earlier drafts were received from Asya Akhlaque, Nagavalli Annamalai, Simon Bell, Alain R. Locussol, Samuel Munzele Maimbo, and Vladislav Vucetic. Maria Espiritu and Kadija Jama provided valuable inputs to the preparation of the report. The report benefits from a short note prepared on the subject earlier by Eric Manes. IV THE iNVESTMENT GUM/ITE IN SOUTH ASiA ACRONYMS AND ABBREVIATIONS AISA Afghanistan Investment Support Agency BTTB Bangladesh Telegraph and Telephone Board DABM Da Afghanistan Breshna Moassesa GDP Gross Domestic Product GNI Gross National Income ICA Investment Climate Assessment IR Indian Railways NBFI Nonbank Financial Institutions NGO Nongovernmental Organization NWFP North West Frontier Province OECD Organisation for Economic Co-operation and Development R&D Research and Development SEB State Electricity Board SMEs Small and Medium Enterprises TEWA Termination of Employment of Workers Act TFP Total Factor Productivity UNCTAD United Nations Conference on Trade and Development VAT Value Added Tax v THE INVESTMENT CLIMATE IN SOUTH ASIA EXECUTIVE SUMMARY The investment climate of a country, province, Pakistan), more than 35 percent of firms or region describes the policy, regulatory, identify access to finance as a major constraint. institutional and governance environment, Among the comparators, only Brazil has more both present and expected, that influences than 35 percent of its firms express a similar entrepreneurship, supports well-functioning concern. Corruption is another problematic markets, and affects the returns and risks area. In four countries (Afghanistan, associated with investment. Investment Bangladesh, Maldives, and Pakistan), climate assessments (ICAs) have been carried corruption is a major constraint for more than out for all countries in the South Asia region.! 40 percent of the firms. In the comparator This report summarizes the findings of these countries, only Brazil and Indonesia have firms assessments. It compares South Asian that complain widely about corruption, with 67 countries to countries in other regions (Brazil, percent and 42 percent, respectively, saying that China, Indonesia, South Africa, Turkey, and it is a major constraint. South Asian firms also Vietnam), analyzes similarities and differences appear much less inclined to offer formal within the region, and identifies the way training to their employees than those in the forward in improving the investment climate. comparator countries. In four countries (Afghanistan, Bhutan, Nepal, and Pakistan), less than 20 percent of firms offer formal South Asian Investment Climate in training to their employees. In the comparator International Perspective countries (with the exception of Indonesia), The first chapter of this report assesses the investment more than 50 percent of firms offer formal climate in South Asia vis-ii-vis a number of training. In other areas-such as transport, labor comparator countries. In a number of areas, (regulations and availability of skilled labor), South Asian countries appear to be doing innovation, and technology-the average South significantly worse than the comparator Asia performance is comparable to the countries. These areas include electricity comparator countries. supply, access to finance, corruption, and formal training of staff. Electricity is the most While there are Jew areas uJ/Jere South Asia, as a whole, is doing better than the comparator economieJ~ striking area: in five of the eight South Asian individual South Asian countries are good performers countries, more than 30 percent of firms on several dimensions of the investment climate. For identify electricity as a major constraint for the example, Sri Lanka and India do reasonably operation and growth of their businesses. Among the comparator countries, only in well with regard to access to finance. Shortage of skilled workers is a major problem in China is the ratio greater than 30 percent. In Bhutan and Maldives, but much less of an issue Turkey and South Africa, barely 10 percent of in India. In Bangladesh corruption is the 2nd firms rate electricity supply as a major constraint. In four South Asian countries most important constraint, but in Sri Lanka it is the 10th most important constraint. The (Afghanistan, Bangladesh, Maldives, and These countries are Afghanistan, Bangladesh, Bhutan, India, Maldives, Pakistan, and Sri Lanka. VII THE iNVESTMENT CLiMATE IfJ flS!,\ expenence of firms with customs and trade contrast, cheap, reliable electricity is among regulations also varies widely within South Bhutan's biggest competitive advantages over Asia. In Afghanistan, Bangladesh, and other countries in South Asia. Electricity Pakistan, more than 30 percent of firms prices in Bhutan are less than half those of its consider these regulations to be a major closest competitor in South Asia and only a constraint for business. At the other end of fifth of the prices in other important locations the spectrum are Bhutan and Nepal, where less in the region. Getting electricity connections than 5 percent of all surveyed firms cite are not easy. In India, it takes 45 days for a excessive regulations as a major concern. small-business start-up to connected to the Similarly, while only 34 percent of firms in public grid. A business start-up in Pakistan Pakistan communicate with their customers or expects a 40-day waiting period before getting suppliers by e-mail, this figure stands at 62 an electrical connection-double the wait it faces percent in India and 97 percent in Maldives. in China. The quality of the power supply is another problem. In some areas of Nepal, The surv~ys also highlight notewortf?y differ"ences in the firms report power outages of more than 30 inveJtment climates of .rpecijic regions within .south times per month. In Bangladesh, firms report Asian countries. India is a good example with experiencing power outages and surges about significant differences in the investment 250 days a year on average-and many report climate across states, because of differences in outages and surges every day they operate. the level and quality of investment and growth Inadequate and unreliable supply has led South rates. The factors affecting the investment Asian firms to resort to the more costly option climate also differ considerably within a of generators. The proportion of firms using particular country. For example, in Bangladesh generators is highest in Afghanistan (76 there are important differences in the key percent) followed by Sri Lanka, Bangladesh, factors affecting the investment climate in Maldives, India, and Pakistan. The Dhaka from those cited as important for comparable figures for China and Brazil are Chittagong. The same differences can be and 17 percent, respectively. Many factors are observed in Pakistan and Sri Lanka. responsible for insufficient and poor-quality power supply, such as inadequate generation The Many Dimensions of the South capacity and deficiencies in transmission and Asian Investment Climate distribution (for example, in Sri Lanka and Bangladesh), insufficient cost recovery but high The second chapter analYzes further the dimensions of tariffs for industry (India, Sri Lanka), weak the South Asian investment climate. In almost all public sector capacity (Afghanistan), or South Asian countries, the quality of inadequate regulatory framework to attract infrastructure is a major constraint. Businesses private investment (India). cite electricity as a major problem; they complain less about transport, Poor-quality roadJ, inefficient ports, and inadequate telecommunications, and water supply. The transport services are common features in Jotfth Asia. two polar cases about electricity in South Asia To be effective, entrepreneurs need a quick and are Afghanistan and Bhutan. In Afghanistan, easy way to get their goods to market. Many grossly insufficient generation capacity and South Asian firms do not have appropriate inadequate transmission and distribution road networks. For example, India currently capacities have led firms to cite power as the has no interstate expressways linking its major number one constraint to doing business. In economic centers, and only 3,000 kilometers of VIII THE INVESTMENT CLIMATE IN SOUTH ASI.A four-lane highways (while China has built about the quality of water used in production, 25,000 kilometers of four- to six-lane, access- and in Nepal, nearly a third of the firms controlled expressways in the past 1 years). Because the freight transport system is ° indicated that they have problems with the amount of water supplied. In Kathmandu, unreliable, firms are forced to carry more stock many firms receive service for only one hour than they need to deal with uncertain supply. per day. Firms have thus had to invest in Inefficiency in ports is another problem. This alternative sources of water. In Nepal, many is particularly felt in Bangladesh where it has firms have either invested in wells or purchased been said that the inefficiencies of the water brought in by private tankers. Chittagong Port have given Bangladesh all the An inadequate financial {ystem makes J outh Asian characteristics of a landlocked country. jirms reliant on internal sources for funding. Access Railways used to be an important means of to finance is the most serious constraint transportation, but their use in South Asia has affecting the investment climate in Maldives. gone down with declining efficiency. With a In Sri Lanka, finance is one of the top three network of 63,028 kilometers, the Indian constraints to doing business. The situation is Railways is the second-largest rail network in relatively better in India, where 27 percent of the world and one of the country's major firms rate access to finance as a major-to- national institutions. However, congestion on severe obstacle to business operations or main lines is steadily increasing long-haul growth. Most finance available is short term in delivery times, and the rapidly deteriorating all South Asian countries. Because of the poor quality of rolling stock is undermining the access to external finance, many South Asian railways' attractiveness as a transport provider. firms rely on retained earnings and equity as The quality qf telecommunications services draws fewer their most important sources of working complaints from the business community in capital. At one extreme is Maldives, where only South Asia than does power or transportation. 11 percent of working capital requirements and There have been significant improvements in 17 percent of investment capital come from telecommunications in South Asia in recent domestic commercial banks. The situation is years, but they cannot fully make up for better in India, where 54 percent of small deficient fixed Jines. The average business in businesses have active bank credit lines or Sri Lanka waits 61 days, and in Pakistan 42 overdraft facilities, which is much higher than days, before a new fixed-line telephone the figure for China but lower dIan for Brazil. connection-three times as long as in China, Within countries, access to formal finance Malaysia, and the Philippines. The quality of varies by regions and sectors. Access to credit service also appears to be a problem in many is also highly correlated with size; a much South Asian countries. In Pakistan and greater proportion of large firms than small Bangladesh the shortage of fixed-line firms have access to external finance. connections has impeded the development of the information technology and software of factors limit access to finance for South t1aliety Asian firms. The factors constraining finance industries. for small and medium enterprises (SMEs) in In water, as in electricity, poor supply from the national India provide a glimpse of the root causes of system forces jirms to find their own supplY sources. In the problem. Specific constraints include (i) Maldives, less than a third of the difficulty in using land as collateral and manufacturing firms surveyed complained nonrecognition by lenders of other types of IX THE iNVESTMENT CliMATE IN SOUTH ASIA collateral, (ii) difficulty 1n collateral The hJ)o major labor issues in South Asia are the rigidity enforcement and loan recovery, (iii) rif labor markets in several countries and the shortage rif insufficient credit information on SMEs, (iv) skilled labor in most countries. Labor regulations are poor SME credit-assessment practices, (v) a key constraint for firms in India, Nepal, poor lending technologies and overreliance on Pakistan, and Sri Lanka, while they tend to be collateral rather than cash flow analysis, (vi) a less of an issue in other South Asian countries- bankruptcy framework that prevents easy exits for example, few firms in Bangladesh believe for troubled firms, and (vii) lenders' low that labor issues impede their growth. The confidence in the contract enforcement absence of a well-functioning labor market can mechanisms of the courts. These constraints offset the benefits of a well-educated workforce, are exacerbated by the shallowness of financial as can be seen from the experience of India and systems in most South Asian countries (for Sri Lanka. Many South Asian firms face a example, in Sri Lanka, private- sector credit shortage of skilled workers, with the most amounts to about 38 percent of gross severe complaints voiced in Bhutan, Maldives, domestic product (GDP) , compared to 125 and Nepal. The shortage of skilled labor has a percent in China). Capitalization of equity variety of origins. In Bangladesh, illiteracy markets in India is 30 percent but only 15 remains high despite recent improvements in percent in Sri Lanka, compared to about 40 school enrollment. Sri Lanka has among the percent in China. In addition, in several South highest levels of brain drain in a set of Asian countries, the public sector continues to comparator countries. In Afghanistan, the skills dominate the banking sector. In Sri Lanka, the shortage caused by war is exacerbated by the commercial banking sector is still dominated barriers to educating girls and employing women by the two state banks, accounting for about in most jobs outside the home. In Bhutan, the percent of total banking assets. In addition, skilled labor shortage is the result of the persistent budget deficits have led the government's absorption of most skilled and government to borrow heavily from the educated workers. banking sector, driving up interest rates and South Asian firms do not innovate much or make much crowding out private sector access to financial use rif modern systems rif commlmication, which serVlCes. strongly undermine their competitiveness in The efficien~y rif the land market, both as a factor rif the context of a globalized and knowledge- production and an asset that can be mortgaged, is not based system of production. For example, cited as a major obstacle in most South Asian lCAs. Bangladesh spends less on research and Fewer firms in South Asia than in China or development (R&D) as a share of GDP than Brazil report access to land and registering do most other developing countries in East and land as major deficiencies in the investment South Asia. The low level of R&D spending in climate. An exception is Afghanistan, where it Bangladesh is reflected in relatively low levels is exceptionally difficult for businesses to for other measures of innovation (such as the clear title to new land, espeCIally serviced land. number of granted U.S. patents per capita). Sri The fact that in the rest of South Asia access Lanka is doing relatively better, with levels of to land is not cited as a major constraint is R&D investment close to those observed in more a statement of the relative importance of similar industries in developing countries such other constraints than an indication of well- as China and India. Internet use is also low in functioning land markets in the region. South Asia. In India, there is relatively greater use of the Internet, but Internet connectivity x CUfvl!l.TE iN SOUTH ASIA vanes across states. Only 30 percent of Corruption is a major problem in ma'!)! South Asian businesses in Pakistan normally communicate countries and can be traced to the discretionary power if with their customers or suppliers using the government officials. Corruption is particularly Internet-far fewer than the 71 percent of firms serious in Afghanistan, where it has recently that do so in China. In Afghanistan, business shot up in the list of constraints cited by firms, use of Internet is nearly nonexistent and in Bangladesh, where corruption has been outside of a few of the largest cities. In a problem for many years. Bangladesh ranks Maldives, however, the penetration of the lowest (158th) in the 2005 Transparency telecommunications is very high among the International Corruption Perception Index; business community compared to that in the more than half of all surveyed firms reported other South Asian countries. corruption as either a major or very severe obstacle to their growth. Firms also complain South Asian firms bear a heary regulatory burden: about corruption in India, Nepal, and Pakistan. starting a business can be a hassle; but runninp, it is Two South Asian countries fare relatively better even more so. Surveys of the business climate in on this front: Sri Lanka and Bhutan. Bhutan South Asian countries all point to heavy contrasts starkly with its other neighbors. Its regulation and government unpredictability as a government is genuinely concerned with key constraint on private sector performance. proper administration, and officials are seen as An indicator of this constraint is the time being honest and helpful. senior managers spend dealing with officials of regulating and the frequency with South Asian firms hat1e little faith in the judiciary and which officials inspect factory premises. The tend to ~ypass it. Bangladesh exemplifies the burden of regulation is, on average, smaller in South Asian case-here a third of the firms India, at 7.4 visits a year for a typical business, surveyed reported that courts were never or than in China (26.7 visits a year). However, seldom fair or honest. An exception is Sri paradoxically, senior managers of small Lanka, where more than half of rural nonfarm businesses in India typically spend a greater enterprises and urban manufacturing firms share of their time dealing with regulations reported that the legal system is not a major (11.9 percent) than do their Chinese (7.8 constraint. The deficiencies in the judicial percent) or Brazilian (7.2 percent) counterparts. system render contract enforcement a big Moreover, Indian industry suffers from more problem in most South Asian countries. Even cumbersome and costly entry and exit in Sri Lanka, despite the overall positive regulations compared to not only China and perception of the legal system, enforcement of Brazil but also other large-economy contracts still poses an obstacle to many comparators, such as JYIexico and the Russian businesses. It is thus common for South Asian Federation. Tax and customs administration is businesses to bypass the judicial system. In widely cited in South Asia as a major source of Bhutan, only around 5 percent of firms in the regulatory hassle. In Pakistan, tax and customs survey reported hiring a la,\"yer or threatening administration is the leading obstacle to a to take a client to court for nonpayment. In conducive investment climate, and 60 percent Afghanistan, businesses do not rely on the of business contacts with government officials formal judicial system but on informal are the result of visits by tax agents. An mechanisms to resolve disputes. exception to South Asian pattern of Security is an actual problem in some S outb Asian regulatory hassle is Sri Lanka, where businesses countries; it is looming in others. In Afghanistan, suffer much less from regulatory burdens. XI THE INVESTMENT CLIMATE IN SOUTH ASIA the investment climate survey carried out in The Costs of a Deficient Investment 2005 reveals that insecurity figures relatively Climate low in the list of complaints. While counterintuitive, this is explained by the The third chapter highlights the costs imposed I?Y improvements in the security situation in the deficiencies in the investment climate. Pouler problems major cities covered by the survey and by the impose real costs on firms; thry lower production and tie mechanisms developed by firms to cope with tip scarce capitaL The typical business in Pakistan insecurity, though at high cost. In Pakistan, estimates that it loses about 5 percent of businesses report being exposed to crime, annual sales to power outages. The problem is ranging from petty theft to organized violence. worse in India, where the average manufacturer In contrast, in India the incidence of crime loses 8.4 percent a year in sales, and extreme in seems to be low on the list of problems for Afghanistan, where 18 percent of merchandise private firms. value is lost because of power disruptions. The figure is less than 2 percent for the average A1uch has been accomplished in South Asia in recent manufacturer in China or Brazil. The use of years with regard to trade policy, but problems remain. generators to deal with unreliable power supply Most non tariff barriers have been removed, ties up scarce capital. Poor transportation creates tariff rates across stages of production have marketing problems and often leads to spoilage. In Sri become more uniform, and average levels are Lanka, urban firms report losing 7 percent of coming down. In particular, the process of sales because of transport problems, and slow trade liberalization in India and Sri Lanka has speeds spoil 40 percent of agricultural produce been critical in fostering the restructuring of before it reaches market. In Afghanistan, firms the export base from primary products to reported losing 5 percent of their domestic manufacturing. However, onerous customs merchandise value during transit because of clearance procedures is one of the most breakage or spoilage and losing only 0.6 commonly cited problems in South Asia. In percent to theft. In Bhutan, the high costs and Afghanistan, Bangladesh, and Pakistan, poor reliability of road transport make it customs procedures are a serious problem, with almost impossible for industries heavily more than 30 percent of firms citing them as a dependent on transport to be competitive major constraint on doing business. At the except in the border areas. other end of the spectrum are Bhutan and Nepal, where less than 5 percent of all Poor access to finance limits gro1J!th opportunities. surveyed firms cite customs procedures as a Regression exercises show that, in Bangladesh, major concern. The average shipment of firms with better access to formal credit grow imported inputs takes 17 days to pass through more quickly than firms that rely more on customs in Pakistan. In Afghanistan, retained earnings, even after controlling for importing requires 10 documents and 57 firm and industry characteristics. Regulatory separate signatures. Maldives requires fewer hassles add to the cost of doing business. The documents (12 for importing), fewer signatures number of inspections and visits by officials (four for importing), and shorter processing imposes a financial and nonfinancial (that is, time for both exporting and importing than do time) cost on managers and dampens firms' most countries in South Asia. Sri Lanka's ports performance. Regression analysis for and customs are also more efficient than those Bangladesh shows that the number of of some of its competitors. inspections per employee has a significant negative correlation with investment and XII THE iNVESTMENT CLIMATE IN SOUTH ASIA productivity. Similar exercises for India also reported undertaking any significant staff show that the time that management spends on training. Most firms in Nepal provide little addressing regulations is negatively associated trammg, preferring to hire already trained with business profitability. workers or to rely on technologies that do not demand highly skilled workers. Inflexible labor markets add to CMt and discourage aqjustments-and thry do not necessari!J help the poor. Firms in Sri Lanka try to avoid restrictive labor What to Do? regulations by hiring temporary workers, but The analysis in the leAs suggests a strong this practice has its costs: survey results show relationship between the investment climate in that productivity falls with an increase in the South Asian countries and their economic share of temporary workers in a firm's performance. On the basis of the theoretically employment. In Nepal, restrictive labor laws sound and empirically supported relationship have caused many older firms to be overstaffed between a good investment climate, on the one and unable to reorganize by hiring people with hand, and higher productivity and firm growth, skills that better match their current needs. on the other, potentially significant gains can Training raises productivity; yet, most jirm,r do not be achieved by policies and programs that invest in training. In Sri Lanka, firms whose address the constraints highlighted by the managers hold a tertiary or professional degree leAs. The fourth chapter reviews the policy tend to be more productive. In Bangladesh, recommendations proposed by the various leA regression analysis shows that firms that ran surveys for the different dimensions identified: training programs or sent employees to outside infrastructure (power, transportation), factors training programs saw higher sales growth, of production (finance, labor market and skills, profitability, and investment. However, only 26 technology), regulatory burden and corruption, percent of Sri Lankan firms benefit from and risk and uncertainty (policy predictability, external training. In Bhutan, although they judicial reforms, security). complain about lack of skills, virtually no firms XIII THE INVESTMENT CLIMATE IN SOUTH ASIA Chapter I SOUTH ASIAN INVESTrvlENT CLIMATE IN INTERNATIONAL PERSPECTIVE The poverty reduction strategies for South eight South Asian countries and selected Asian countries emphasize private investment comparators: Brazil, China, Indonesia, South as a vehicle for creating productive jobs. Africa, Turkey, and Vietnam. These Policymakers in South Asia are also concerned comparators were selected on the basis of their about the relatively low integration of their geographical position (at least one country in economies with the global economy despite the each region: Latin America, East Asia, Africa, considerable macroeconomic reform effort and Europe) and on their economlC that has been underway in the region in recent performance. years. Export and import orientation is low, The ICAs are based on a survey of a inflows of foreign direct investment are representative sample of private firms that seeks modest (in fact negligible in most countries), to shed light on impediments to daily business and supply linkages with leading multinational through quantification and comparison. The companies are weak. Since a dynamic survey assesses conditions facing factor markets, enterprise sector is important for creating jobs product markets, infrastructure services, and and exploiting the benefits of globalization, firm performance. The use of a standardized, there is a need to take a hard look at the rigorous methodology to measure the principal investment climate in these countries. determinants of the investment climate makes it The investment climate of a country, province, possible to benchmark countries or regions or region describes the policy, regulatory, against comparators. institutional and governance environment, both However, comparisons of subjective ratings by present and expected, that influences firms across countries, regions, and of entrepreneurship, supports well-functioning firms require caution, as these comparisons markets, and affects the returns and risk involve the evaluation of distinct conditions by associated with investment. Investment Climate different observers at different times. The Assessments (lCA) have been carried out for all ranking of a particular deficiency over another countries in the South Asia region.: This report does not necessarily mean that the cost of that summarizes the findings of these assessments. It deficiency, in terms of lost productivity and compares South Asian countries to countries in sales growth, is higher. In addition, there are other regions, analyzes similarities and natural limitations in the cross-country differences within the region, and identifies the comparisons, as ICA reports themselves are way forward in improving the investment structured to reflect specific country climate. Key data from the South Asian ICAs conditions and emphasize differing factors of were used to draw comparisons between the 2 These countries are Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka. THE INVESTMENT CLIMATE I~j SOUTH ASIA particular relevance. 3 Moreover, the South Asian ICAs are based on firm surveys that were carried out over a period of years, starting with the first India survey and the Nepal survey in 2000, and ending with the Afghanistan and Maldives surveys in 2005.' Similarly, the surveys underlying the ICAs for the comparator countries span several years. As a result, the data presented might not be representative of the current situation in many countries. In addition, questions were asked slightly differently across the surveys the annex to chapter one). These caveats should be kept in mind in exceptions are Bhutan, Maldives, and India. reading through the assessment of how South The situation is much better in the comparator Asia compares with the selected comparator countries. In Turkey and South Africa, barely economies and how South Asian countries 10 percent of firms rate electricity supply as a compare among themselves. major constraint. Only in China is the figure nearly 30 percent. A. South Asian Performance in an A comparison of China with India, one of the International Perspective better performers in South Asia, is instructive. In the 2003 survey, Indian firms reported that In a number of areas, South Asian countries it took them an average of 68 days to get an appear to be doing significantly worse than the electricity connection, compared to only 10.4 comparator countries. Electricity is the most days in China. In the year preceding the survey, striking area: in five of the eight South Asian Indian firms reported 154 days of power countries, more than 30 percent of firms outage, which cost them 8 percent of sales. By identify electricity as a major constraint for the comparison, Chinese firms reported 4.9 days operation and growth of their businesses. In without power the year before the survey, with Afghanistan and Bangladesh, this figure is a loss of 1.9 percent of their sales. As chapter more than 60 percent (figure 1). The only three shows, inadequate and poor-quality 3 Therefore, the lCA methodology and reporting tool should not interpreted as objective but rather as a lead to inferences about the priorities within a specific group of private-sector firms to provide a guide to policymakers. 4 The second India survey was carried out in 2003; much of the India-specific information in this report is based on this survey. A third survey is currently under way. Surveys for the second lCAs in Bangladesh and Pakistan are about to be launched. 5 Cheap, reliable electricity is among Bhutan's biggest competitive advantages over other countries in South Asia. The total power output of Bhutan is 457 megawatts (in with a total domestic consumption of about 105 megawatts. Bhutan's hydro-electricity power potential is estimated at more than 30,000 megawatts. However, Bhutan's power situation is unique; therefore, it is difftcult to transpose lessons from Bhutan to other South Asian countries. 2 THE INVESTMENT CLlMJl:fE IN SOUTH ASIA electricity imposes substantial costs on South Asian firms, putting them at a disadvantage relative to their competitors. Access to finance is another area where South Asia does not perform as well as the comparator countries. However, the difference between South Asia and the comparator countries is less striking than with electricity. For four South Asian countries (Afghanistan, Bangladesh, Maldives, and Pakistan), more than 35 percent of firms identify access to finance as a major respectively 15 percent and 30 percent (figure constraint. Among the comparators, only in 3). In no comparator countries is more than 60 Brazil do more than 35 percent of the firms percent of firm investment financed by express a similar concern (figure 2). internal funds. This perception ranking is confirmed by the Corruption is another area where the pattern of investment financing: for five South performance of South Asia is a cause of Asian countries (Afghanistan, Bangladesh, concern. For four countries (Afghanistan, Bhutan, Maldives, and Nepal), more than 60 Bangladesh, Maldives, and Pakistan), percent of firms' investments are financed by corruption is a major constraint for more internal funds (no data are available for India). than 40 percent of the firms. In the By contrast, in China and Vietnam the share of comparator countries, only in Brazil and investment financed by internal funds is Indonesia do firms complain widely about corruption, with 67 Figure 3 percent and 42 Patterns 01 investment financing percent, respectively, Percent of investments financed by: saying that it is a major constraint IndoneSial!!!=I§§=~~§!~~~ii~:il~~~~ Vietnam (figure 4). The poor South Africa Brazil performance of Turkey most South Asian China countries in terms of corruption is Maldives confirmed by the Bangladesh Pakistan 2005 Transparency Bhutan International Corru- India ...'1 Nepal ption Perception Sri Lanka Index, which ranks 0% 20% 40% 60% 80% 100% Bangladesh the ~ Internal Funds ~ Banks D Leasing Informal Sources ~ Trade Credits [] Other Sources 0 lowest (158th 3 THE INVESTMENT CLIMATE IN SOUTH AS!A (such as Bangladesh, India, Pakistan, and Maldives) less than 10 percent of firms had overdue payments from buyers/ suppliers/ customers, while for most of the comparator countries, more than 50 percent of firms report having overdue payments (figure 6). However, this apparent good performance in South Asia might hide a less positive reality. For example, in Bangladesh most firms offer supplier finance to very few clients because they do position), followed by Pakistan (144th), Nepal not trust their suppliers or do not believe the and Afghanistan (117th), India (88th), and Sri court system will enforce contract and property Lanka (78th). rights. 6 This is how firms manage to have low South Asian firms appear much less inclined to overdue payments. However, in Maldives offer formal training to their employees than overdue payments are low despite the wide use those in the comparator countries. In four of supplier credit (63 percent of small countries (Afghanistan, Bhutan, India, and enterprises and 95 percent of large enterprises Pakistan), less than 20 percent of firms offer report receiving input credits). formal training to their employees. In the comparator countries (with the exception of Indonesia), more than 50 percent of the firms offer formal training (figure 5). In other areas-such as, transport, labor (regulations and availability of skilled labor), innovation, and technology-the average South Asia performance is comparable to comparator countries. In one area, South Asia is actually doing significantly better than the comparator countries. In a number of South Asian countries 6 In Bangladesh, only 17 percent of firms expressed confidence in the system to enforce contract and/ or property disputes, while in India 71 percent of the firms expressed confidence in the system. 4 THE INVESTMENT CLIMATE IN SOUTH ASIA B. Performance Diversity fijJura6<:',~; -, _, '", -C""':::: "'" 0 across South Asian PercentalJeof.irm$Vlif"Q~mll'.Ym~'_ Countries from supplierslbuyers/customers The common features in South Asia are one part of the story. There are wide divergences too. Even if South Asia, as a whole, 1S doing better than the comparator economies only on a few fronts, individual South Asian countries are good performers on several dimensions of the investment climate. Comparing the countries of the region is a a major constraint. By contrast, in Sri Lanka, difficult exercise, considering their diversity. Nepal, India, and Bhutan, the proportion is less Afghanistan is just emerging from a long than 20 percent. Firms in Afghanistan are period of conflict and instability, which has particularly credit constrained-not surprising destroyed its economy. Countries such as considering its recent history. For 56 percent Bhutan and Maldives have unique economies, of firms in Afghanistan, access to finance is a and it might be difficult to transpose their major constraint, and 79 percent of firms' experiences to other countries. Nepal and investments are financed by internal funds. Bhutan are relatively small economies in Bank lending is virtually nonexistent (0.2 comparison with India, Pakistan, and percent). Bangladesh, and they have also been affected Labor market conditions vary even more. In by conflict in recent years. In addition, the data two countries, Bhutan and Sri Lanka, labor on Bhutan and Nepal need to be used with regulations are a big problem (figure 7). In caution as these are the oldest surveys (2000 Bhutan, labor regulations are cited as the for Nepal, 2001 for Bhutan). The survey second most important constraint and, in Sri instruments have since then changed and Lanka, as the fifth most problematic factor. Nepal, in particular, has been through much About a third of the Bhutanese firms, and a turmoil since the survey. Nonetheless, the quarter of Sri Lankan firms, consider labor analysis of divergence is instructive. With the regulations a major or severe constraint. above caveats in mind, one can still ask: If Maldives presents an interesting case. Here, some South Asian countries can do well, why while 28 percent of the firms consider labor not others? regulations a major or severe constraint, it is Conditions in the factor markets differ not cited as one of the top constraints by the widely within South Asia. firms (it ranked as the 12th constraint). At the other end of the spectrum is Bangladesh, An example of how South Asian countries where less than 10 percent of firms consider differ is access to finance. In Afghanistan, labor regulations to be a major or severe Bangladesh, Maldives, and Pakistan, more than constraint. 30 percent of firms consider access to finance 5 THE INVESTMENT CLlf,1;'l,TE IN ASifl problem by providing ·:jjUl"ti._.. formal training to ic:Qllllra,qts • their employees. The proportion of firms doing so is 66 percent, lower than in China (85 percent) but quite high by South Asian standards. Other South Asian countries doing relatively well on this front include Sri Lanka and Nepal, with 33 -1lf,1~~~l,ab()r~IlllS as~MI\lOrCo.nstfalllt percent and 45 percent, ~firm!l~~~IJ:.eWI a8:lit.l1aJor GUll$trllint respectively, offering formal training. Shortage of skilled workers is a major However, in Bhutan, despite the complaints problem in Bhutan and Maldives, but much less about skill shortages, barely 3 percent of firms' of a headache in India and Pakistan. In employees had received training in the 12 Bhutan, every other firm (i.e., 49 percent) months preceding the survey. Even some of considers skilled labor shortage a major the larger countries are no better. In India, constraint, and in Maldives, the proportion is only 18 percent of firms offered formal 43 (figure 7).7 But in India and Pakistan, only 13 training; in Pakistan, only 11 percent did so. percent of businesses lack of skilled workers as a major constraint. Interestingly the proportion is Rgure 8 the same in Afghanistan (13 The hidden eoats of government regurations percent). However, 111 25 Afghanistan, firms are facing numerous pressing challenges, 20 and they might not consider 15 availability of skilled workers as one of their most 10 urgent challenges at present. In the rest of South Asia, the 5 proportion of firms complaining about lack of skilled workers is between 15 and 21 percent. D Senior Management Time Dealing with Government Regulations In Maldives, firms are trying to D TIme Spent in Tax Inspection Meetings (Oays/Year) address the skill shortage 7 In Bhutan, where most educated people have a strong preference for working in the public sector, much of the skilled and educated workforce has been absorbed in government. 6 THE INVESTMENT CLIMATE IN SOUTH ASIA Corruption and regulations In Afghanistan, nearly 20 percent of senior management time is spent on dealing with Corruption is a problem in South Asia but not equally in all countries. Bangladesh and Sri government regulations. This figure is only 4 percent Sri Lanka and Bangladesh (figure 8). Lanka offer contrasts. In Bangladesh, corruption is the 2nd most important The experience of firms with customs and constraint, with 58 percent of firms identifying trade regulations also varies widely within it as a major constraint. In Sri Lanka it is the South Asia. In three countries-Afghanistan, 10th most important constraint, with only 17 Bangladesh, and Pakistan-these types of percent of firms complaining strongly. These regulations are a serious problem, with more firm-level perceptions are confirmed by the than 30 of firms citing this issue as a 2005 Transparency International Corruption major constraint on doing business (figure 9).8 Perception Index, which ranks Bangladesh at At the other end of the spectrum are Bhutan bottom in terms of corruption (158th) and and Nepal, where less than 5 percent of all Sri Lanka at 78th. Although corruption is surveyed firms cite customs and trade admittedly a lesser problem in Sri Lanka regulations as a major concern. compared to other South Asian countries, the country IS far from being a best-practice While only 34 percent of firms in Pakistan example. communicate with their customers or suppliers by e-mail.this figure stands at 62 percent in 8 This is consistent V,1th country rankings on the World Bank's Doing BusineH Ilidicator 011 Trading aCross Borders where and Pakistan rank at the 125th, 123rd, and 103rd position, respectively. See World Bank, Doillg 7 THE INVESTMENT CLlM.ATE IN SOUTH ASiA a wide spectrum of the country. In both India and Pakistan, lagging states are associated with . t20,..-------'-------------------, weaker investment climates. too There are also some surprising results; in India, the cost of business regulation particularly for labor- as well as corruption issues are in fact more severe in what businesspeople would typically rate as "better climate" states like Andhra Pradesh and Gujarat. On the other hand, the quality, availability, and cost of infrastructure is perceived to be India and 97 percent in Maldives (figure 10). superior in better climate states. In India, on The low rate in Pakistan might be due to the average, managers reported spending 13 low level of demand for such type of percent of their time dealing with government communication, rather than the lack of access regulations. This nationwide average hides to e-mail services. It may also be symptomatic huge discrepancies between states: Gujarat and of a telecommunications sector that lacks the Kerala (the worst performers with 24 percent capacity to provide a sufficient range of and 21 percent, respectively) compared to services and has a shortage of fixed telephone Madhya Pradesh (the best performer with 7 lines. As the Maldives economy is highly reliant percent). on the international tourism industry and has therefore developed a high-quality In Bangladesh there are considerable communications system, the high rate of e-mail differences in the key factors affecting the use is not surprising. investment climate in Dhaka from those cited as important for Chittagong. In Pakistan, firms in the less developed North West Frontier C. Differences within Countries Province (NWFP) are more concerned with Regional differences electricity and corruption, and even though An important finding of many of the ICA there are not statistically significant differences surveys is the noteworthy differences in the in the burden of regulation across provinces, investment climates of specific regions within both Punjab and NWFP have much higher South Asian countries. Some provinces or frequency of regulatory inspections than Sindh states are lagging the rest of the country in has. The survey in Sri Lanka identified the top 9 terms of development. These observations are constraints for urban firms as electricity, important for ensuring that the benefits from government policy issues (including an improved business climate are shared across macroeconomic policy), and labor issues, while 9 For example, in India the income per difference between states is often greater than the income per for India and China as a whole. 8 THE INVESTMENT CLIMATE IN SOUTH ASIA the top constraints for their rural counterparts and 2005. As a result, ';~~If~C are transport, access to finance, and electricity. the situation in a The factors causing variations in the number of countries AfQhalllstari·· Baflfll~de$b investment climate within a particular country may have evolved point to the need to (i) distinguish between since the surveys were federal and provincial aspects regarding completed. regulatory burden and (ii) assess causes for A number of caveats different degrees of infrastructure services need to be within a country. underlined. First, the above analysis Size differences compares countries m4Q11~$ia The well-known sentiment that smaller firms across different years; Soo1lrAfjjea are affected more adversely by deficiencies in for example, ~ epal T~.<· the investment climate because of their more (with data from 2000) vietna.m . 2005 limited access to factors of production and is compared with smaller cost structures is confirmed through Maldives (with data the ICA surveys in South Asia, though there from 2005). are important differences between factors Second, the surveys used for these ICAs have faced by small firms and those faced by large changed over time. In some instances, firms. Certainly, in all countries, access to land, questions are therefore asked differently, which labor, and finance are more binding constraints affects the comparison across countries (see to business for smaller firms. However, in example next page). Three surveys varied ~epal bureaucratic burdens and labor significantly from the others: Nepal and regulations seem to be more of a concern for Bhutan (which follow the same model) and larger firms, possibly because SMEs often India (which is unique). operate in an informal regime. Similarly, in Pakistan tax administration and other Third, the survey in Maldives has specificities. regulatory visits are much more frequent for The survey focused on four sectors: tourism large than for small firms. In contrast, in accommodation, manufacturing, tour operators Bangladesh SMEs face a heavier burden of and travel agents, and transport logistics, with a regulation, with more government visits and a total sample size of 147. higher share of total costs going to bribes than larger firms spend. On the other hand, poor A fourth caveat is the relativity of the infrastructure services seem to hamper smaller indicators, with firms in certain countries being firms more than larger firms, in large part more vocal regarding their constraints than in because of greater access to the power grid for other countries. For example, in Bangladesh larger firms and the ability of larger firms to the top constraint (electricity) is expressed by produce their own electricity in-house. about 75 percent of the firms (that is, about 75 percent of the firms consider electricity a major constraint). Similarly, in Maldives the Annex to Chapter I: top constraint (access to finance) is expressed Data Caveats by 71 percent of the firms. For Brazil, the top constraint (tax rates) is expressed by 85 percent The ICAs for the 14 countries under of the firms. By contrast, in India the top consideration were undertaken between 2000 9 THE iNVESTMENT CLIMATE IN SOUTH ASIA constraint (telecommunications) is quoted by problem in Maldives is more severe than the 37 percent of the firms and in Sri Lanka, the telecommunications problem in India, for top constraint (electricity) is cited by 42 example, but that firms in Maldives are more percent. However, the different percentages vocal in expressing their concerns. might not mean that the access to finance ,,' ":, , .",:," ,- -,', -,<,:,,:'" , " Formostoftbe9tt1ertqllntrie&, the~III!~OIl~'asKOOasfOI~.:..i~" ..... ~ . . . . . . < .'. ptea• ...,lJUS"if8ftJllftb~~~~~r.a{ll'GIJI.~~~I)~l'ntlpar.ot:JCHl"~l!Ii.,...11 an ~~. 'D$I&II profJII1Q1,ptease iIHIoe it$~" .. an .-ele lP'fijijr·,04Id~._"IiiNoo_l,e~~"'i".lI.81~e, 2If=MIld8ratel!li$tacfa;a.ft1aflJr' v_cte,and 4='''l:,u~re,G~cl.~ "" ;.,",--' ,--->-- '-':> ',,:' -;':,,-'-- .-- -". t Telecommrmications ··10.Ob1ail1ingOf~eWjngp¢r_ 2, Bectricity.11.~ecll$s ttltinailcj~o ·(ll,g:· ,QQliat&ral) 10 INVESTMENT CLIMATE IN SOUTH ASIA Chapter 2 THE MANY DIMENSIONS OF THE SOUTH ASIAN INVESTMENT CLIMATE A. Macroeconomic Environment and characteristics of the input and output markets. Technologically advanced enterprises Though macroeconomic factors are often might be more vulnerable to infrastructure considered to be short-term and cyclical, the problems than less advanced ones and thus be credibility and sustainability of the fiscal and more likely to rate infrastructure as a significant monetary framework has an important problem. In other words, the extent to which influence on business confidence, investment firms complain may not always reflect the state decisions, and even daily transactions. of infrastructure but rather may be conditioned Macroeconomic instability and policy by their own requirements. This makes cross- uncertainty is generally not a major concern to country comparisons difficult. private sector firms in Pakistan, Bangladesh, and India, because of recent success in maintaining macroeconomic stability as a Electricity centerpiece of the development framework. Electriciry is a mqjor problem in most South Asian Fiscal constraints have, however, limited countries. government's role in improving infrastructure services. In Nepal, recent turmoil has led to a With the exception of Bhutan, businesses recessionary period without macroeconomic throughout South Asia cite electricity as a pressures but with insufficient demand. major constraint. The problem has many Macroeconomic policy, and more generally, dimensions. There are large areas in South Asia economic policy uncertainty, is however cited that are not covered by the national grid. as a major obstacle and the second most Where there is coverage, enterprises often face important constraint for a significant long delays in obtaining connection. Once percentage of firms (predominantly urban connected, businesses have to endure poor- ones) in Sri Lanka. quality supply, including frequent outages, and low and fluctuating voltages. B. Infrastructure The two polar cases in South Asia are Afghanistan and Bhutan. In Afghanistan, In ahnost all South Asian countries, businesses grossly insufficient generation, transmission, cite electricity as a major problem. They and distribution capacities have led firms to cite complain less about transport, power as the number one constraint to doing telecommunications, and water supply. This business. Even though 76 percent of the firms does not mean that these are not problematic are connected to the power grid, they get very areas. They do constrain business, although little power from the grid and have to rely on not as seriously as electricity, and may become generators instead. In one city, Jalalabad, 97 binding constraints as the economies develop. percent of surveyed firms rely on generators. Demand for infrastructural services depend on By contrast, cheap, reliable electricity is among the production technology used by the firm 11 Bhutan's biggest competitive advantages over Province grossly underserved. Less than 70 other countries in South j\sia. Indeed, several percent of rural enterprises use electricitv from firms, including Bhutan Carbide and Chemicals the national grid. . and Bhutan Ferro Alloys, were established in Getting connections are not easy. In India, it Bhutan because of this advantage. Electricity takes 65 days for a small business start-up to prices in Bhutan are less than half those of its get connected to the public grid; 26 days for closest competitor in South Asia and only a fifth prices in other important locatio~s in the businesses located in one of the metropolitan of areas and 54 days for start-ups based in one of region. Electricity prices in Bhutan are the smaller cities. A business start-up in subsidized. If subsidies are removed the profitability of power-intensive industri~s in Pakistan can expect a 40-day waiting period before getting an electrical connection-double Bhutan will be reduced, but Bhutan's electricity the wait in China. Their Chinese counterpart prices will still remain well below regional levels. needs only 21 days overall-32 days if in a Maldives is not doing badly either. Only about metropolitan area, and just 15 days in a 20 percent of firms in manufacturinb o . think that medium-sized city. Brazil's figures are electricity is a major constraint, while the comparable to China's. Maldives stands out proportions are and 10 percent in the among the South Asian countries-it takes only transport-logistics and tourism sectors, days to get connected. respectively. By 2005, all Maldivian islands had access to electricity and only three islands had The quality of the power supply is another fewer than six hours of power supply. problem. In some areas of Nepal, firms reported power outages of more than 30 times Other countries fall in between, but firms in per month. Such power outages are often these countries report electricity as a major, if unscheduled and erratic, thus preventing firms not the top, problem. In Kathmandu, Nepal, from planning adequately for outages. In about 40 percent of firms identified electricity Bangladesh, firms reported experiencing power as their biggest problem; in some places i~ outages and surges about 250 days a year on Nepal the proportion was 90 percent. In average-and many reported outages and surges Bangladesh, only 4 percent of enterprises every day they operate. For the average reported that electricity posed no obstacle, and business in India, power outages occur almost in Pakistan 21 percent considered it no every other day, compared to once every two obstacle. By comparison, in China 37 percent weeks in China and once a week in Brazil. In of enterprises reported that it was no obstacle. Maldives, on average, the frequency of power In Sri Lanka, many urban and rural outages is 2.8 days compared to 6 davs in the entrepreneurs viewed electricity supply as the Philippines and 14.5 days in Pakistan: Power most serious impediment to investment and fluctuations affect some sectors more than growth-because of poor access, high cost, and others. I" Thus, often poor-quality electricity unreliability. Access to electricity is heavilv supply discourages investment in particular concentrated in urban areas such as \X:rester~ activities even if they are otherwise viable. Province, leaving rural areas such as uva 10 Electricity is not as large a relative problem for all sectors. In Nepal, the fraction of firms that reported electricity as their bIggest problem ranges from more than three-fourths for chemicals and metals to about a thIrd for nonmetals and carpets. TIllS difference reflects the technologies used in these industries. 12 THE INVESTMENT CLIMATE IN SOUTH ASIA Inadequate and unreliable supply has led South Insufficient cost recovery but high tariffs for industry. Asian firms to resort to the more costly option In India, underinvestment in the power sector of generators. The proportion of firms can be traced to government-owned generators is highest in Afghanistan (76 monopoly of enterprises operating under state percent) followed by Sri Lanka (75 percent for electricity boards (SEBs)-at least until the early urban manufacturing firms), Bangladesh (72 1990s. Many of the SEBs adopted a deliberate percent), Maldives (64 percent), India (61 and long-standing policy of underpricing the percent ll), and Pakistan (42 percent). The supply of electricity to households and farms. comparable figures for China and Brazil are 27 Industry bore the burden by paying tariffs that and 17 percent, respectively. In India, were excessive by international standards. generators account in many cases for as much as Average tariffs for industrial use, at the time of 30 percent of a business's power consumption. the ICA survey, were about US$0.08 per kilowatt-hour in India compared with US$0.05 }yfany factors are responsible for inadequate and poor- in Southeast Asia. There are significant qualit)' pOJver suppjy. interstate variations, ranging from Rs 6.64 per Inadequate generation capacity and deficiencies kilowatt-hour in Uttar Pradesh to Rs 3.00 per in transmission and distribution are serious kilowatt-hour in Punjab. problems in many South Asian countries. Sri The failure of the SEBs to protect transmission Lanka and Bangladesh have far less generating and collect payments has produced significant capacity capita than most of their regional financial shortfalls, leaving maintenance and competitors (0.03 kilowatts of capacity per additional capacity wanting. In Sri Lanka, capita). In Sri Lanka, this situation can be although low-cost hydro sources produce more attributed in part to environmental concerns and than 70 percent of electricity, repeated interest groups working against power projects droughts and rapidly growing demand met by 1n locations. India has 0.10, Pakistan expensive emergency power generation have 0.12, and China 0.21 kilowatts of capacity per led to some of the highest commercial power capita. In some countries, the problem is more tariffs in the region. However, despite charging in transmission and distribution than in high prices to industries and businesses to generation. For example, serious cross-subsidize residential customers, the state- underinvestment over the years in transmission owned power company was able to recover and distribution infrastructure is at the root of only about 78 percent of its costs in 2002, the power supply problem in India. In leaving a huge shortfall to be covered by Afghanistan, in addition to grossly insufficient taxpayers. Selling electricity below the cost of generation capacity, there is inadequate supply provides a strong disincentive for the transmission and distribution capacity. Most of company to expand access to the grid or the equipment in the Afghan power sector is off-grid services for villages. old, dilapidated, and failing, and backup equipment is rare. Inadequate investment in Weak public sector capacity. In Afghanistan, a generation, transmission, and generation is the state-owned power utility, Da Afghanistan result of many factors, discussed below. Breshna Moassesa (DAHM), is in charge of generation, transmission, and distribution of 11 These are ligures from the 2003 survey and show a 10 percentage reduction in the proportion of businesses that on self-generated pov.;er compared to the 2000 survey. This change reflects some recem progress in the power sector in India. 13 THE iNVESTMENT CLIMATE IN SOUTH ASIA electricity. Its several regional electricity Sri has a dense road network by regional departments are responsible for running standards, but the quality of its roads is poor electricity facilities in different parts of the relative to its Asian competitors. As much as country. Weak capacity in the Ministry of 90 percent of the country's paved road network Water and Power and DABM remains a huge is in poor condition because of lack of challenge to the implementation of the maintenance. In Bhutan, where transport is investment program. DABM has neither an the only infrastructure dimension that firms appropriate governance structure nor financial complain about, roads are in poor condition resources to improve electricity services. and are often cut off by landslides. These circumstances make transport costly and Inadequate regulator} jrameJJ!ork to attract pn'vate unreliable; for example, the cost of imJestment. Several South Asian countries have transporting timber can exceed the value of the tried to attract private capital to the power wood. India currently has no interstate sector. However, an inadequate regulatory expressways linking its major economic centers, framework has discouraged large-scale private and only 3,000 kilometers of four-lane investment. India has tried recently to attract highways (while China has built 25,000 private investment in generation and kilometers of four- to six-lane, access- distribution and has sought to unbundle SEBs controlled expressways in the past 10 years). into independent commercial The average speed of trucks and buses on specializing in generation, transmission, or highways in India is 30-40 kilometers an hour, distribution only. However, most states have about half the expected average. not developed a regulatory framework in which potential investors have confidence. Transport services are also problematic. the efforts have not borne much fruit. Because the freight transport system is unreliable, firms are forced to carry more stock Transport that otherwise needed, to deal with uncertain supply. The average small business in Indian Poor-quality roads) inifficient ports) and inadequate industry has approximately a one-month transport services are common features in J outh Asia. inventory of its major inputs when it orders Road transport. To be effective, entrepreneurs fresh supplies. For metropolitan area need a quick and easy way to their goods to businesses this figure drops to 24 days, but rises market. Many South Asian firms do not have to a staggering 37.5 days for businesses based this. In Sri Lanka, 20 percent of urban in one of the smaller cities. manufacturing firms, and 40 percent of rural Complaints about transport services vary firms, indicated that transport was a major or depending on firm characteristics. In Nepal, severe constraint. Urban firms complained where a quarter of firms reported problems that absenteeism due to the unavailability of with obtaining trucking services, complaints transport was 'a cause of low productivity. came more from the larger exporting firms that Rural firms considered road quality as the need to ship goods expeditiously.12 In Sri biggest problem followed by access to roads Lanka, large firms with a larger market area and lack of available transport services. depend more on the road network and trucking 12 In Nepal, firms are also unhappy that they are not able to choose their own trucking operator and instead have to use the truck that is first in queue. 14 THE INVESTMENT CLlM.ATE IrJ SOUTH ASLA services than smaller firms, and hence exports, five days. Although this performance complain more about the services. The same is compares well with Pakistan's, it falls short of true for Maldives. In Nepal, exporting firms that in India and China. The average wait for were concerned about the major highways as imports to clear customs in Bangladesh was well as the road network in India where they nearly 12 days, while the average longest wait export to. But nonexporters were concerned was 23 days. For exports the average wait was primarily with the local road network. In nearly 9 days, and the average longest wait 14 Maldives, transportation problems seem to be days. These problems, compounded by a bottleneck only for tourism (23 percent) and inefficient customs procedures below), transport-logistics sectors (32 percent). In hamper export growth and investment. Afghanistan, a relatively small proportion of Railwqys. Railways used to be an important firms (25 percent) reported transport as a mode of transportation, but their use has gone major or very severe problem. However, it is down with declining efficiency. India noteworthy that when asked about factors exemplifies this trend. With a network of constraining exports, a larger proportion (39 63,028 kilometers, the Indian Railways is the percent) identified lack of roads, au second-largest rail network in the world and connection, railroads, and other infrastructure one of the country's mal or national as a major constraint. In fact, this was the institutions. However, congestion on main second most important factor inhibiting lines is steadily increasing long-haul delivery exports after lack of trade finance. 13 times, and the rapidly deteriorating quality of Ports. Inefficiency in ports is another problem. rolling stock has led to declining safety This is particularly felt in Bangladesh, where standards. As a result, the Indian Railways is it has been said that the inefficiencies of the becoming unattractive as a transport provider. Chittagong Port have given Bangladesh all the Long-haul goods traffic is steadily moving away characteristics of a landlocked country. One of from rail to roads. For instance, in 1991-92, the the most inefficient and costly ports in Asia, Indian Railways transported 57 percent of the Chittagong is plagued by labor problems, poor cement produced in India. By 2002, the figure management, and lack of equipment. The had dropped to 43 percent. The volume of container terminal in Chittagong handles about iron steel transported by rail has dropped from 100-105 lifts per berth a day, well below the percent to 34 percent over the same period. productivity standard of 230 lifts a day Cross-subsidization of passenger fares, one of suggested by the United Nations Conference the highest in the world, has produced high on Trade and Development (UNCTAD). Ship cargo tariffs.14 turnaround time is five to six days, compared The poor performance of railways spills over with about one day in more efficient ports, and into other sectors. In Pakistan, for example, the port faces serious congestion. The median because of poor quality and unreliability of rail time required for imports to clear ports and services, only about a quarter of businesses use customs in Bangladesh is seven days and for 13 The rirst statistic may thus reflect the limited horizons of many private firms that operate mainly within a localized economy and may fmd the poor-quality transport infrastructure adequate for their needs. 14 In a situation of zero cross-subsidization, the ratio of passenger earning per passenger kilometer to freight earning per metric ton of freight kilometer should be 1. For India it is O.3-compared 'W;'th 0.65 in Thailand, 0.85 in Malaysia, 1.1 in China, and 1.4 in the Republic of Korea. 15 THE INVESTMENT CLIMATE IN SOUTH ASIA rail for freight transport, far fewer than the 87 infrastructure sectors. In Maldives, where the percent of firms in Punjab and 99 percent in telecom sector appears to be one of the high- NWFP that use roads. With most demand for growth sectors in the economy, only 4 percent freight transport having been channeled to the of manufacturing firms thought it was a major trucking industry, the use of roads exceeds constraint (the corresponding proportions are what the current system can replace and 27 percent for transport and logistics, and 18 maintain. As a result, 70 percent of the percent for tourism).16 In Afghanistan, 26 national road network is in fair to poor percent of the surveyed firms mention condition, and provincial networks are in even telecommunications as a major or very severe worse shape. For example, 90 percent of the problem. provincial network in Punjab is rated in fair to There have been significant improvements in poor condition. telecommunications in South Asia in recent years. Sri Lanka began reforming the sector Telecommunications in 1980 well before its neighbors. The reforms The spread of mobile telephones has been impressive in started with the separation of posts and South Asia ... telecommunications service provision, with successive reforms leading to greater private The quality of telecommunications servlCes participation, competition, and investment. draws fewer complaints from the business Since privatization in 1996, teledensity in the community in South Asia than does power or fixed-line sector has more than tripled, while in transportation. In Sri Lanka, only 15 percent the mobile sector, always subject to private of urban manufacturing firms and 8 percent of competition, it has increased from less than 0.1 rural enterprises cited telecommunications as a to more than 5. Sri Lanka ranks ahead of India major or severe constraint. 15 These results are in terms of Internet hosts per million people, not surprising since Sri Lanka fares well in despite the latter's big successes in technology comparison with competitor countries in exports, but is far behind Malaysia, the providing telecommunications services-its Philippines, and other fast-growing countries in combined fixed and mobile teledensity East Asia.17 (telephones per 100 people) exceeds that of countries in South Asia and even fast-growing The number of fixed-line telephones per 100 Vietnam. Enterprises in Bangladesh rated people in Bangladesh rose significantly in the telecommunications a smaller constraint on past two decades despite relatively rapid enterprise operations and growth than do other population growth-from 0.11 in 1980 to 0.39 in 15 Urban and rural enterprises in the south (Uva, Sabaragamuwa, and Southern Provinces) were more likely than firms elsewhere to report problems with telecommunications. Interestingly, relatively few rural enterprises in North Eastern Province identified telecommunications as a problem, despite low connection rates. The reason may be that telecommunications are less important for their businesses-since rural enterprises in this area are significantly less likely to engage in trading or services-and thus are not perceived as a problem. 16 However, things can be better. For example, regarding combined fixed and mobile phone penetration rate, as well as the use of the Internet, Maldives ranks far behind other countries in East Asia (i.e., Singapore), even though it is performing better than its South Asian counterparts. 17 There is tremendous untapped potential for commercial use of the Internet, especially in rural areas, where less than 2 percent of firms reported using a computer and only 0.05 percent the Internet. The situation is more promising in urban areas, where more than 65 percent of firms reported using the Internet. 16 THE INVESTMENT CLIMATE IN SOUTH ASIA 2001. But the most dramatic change has been fixed-line telecommunications remams an m mobile telephony, driven by private important agenda in South Asia. investment. Introduced only in the 1990s, Getting a fixed phone-line connection can be an mobile phones surpassed fixed-line phones by arduous process in most South Asian countries. 2001. In 2005, Bangladesh was served by The average business in Sri Lanka waits 61 900,000 fixed lines and had approximately 3.5 days, and in Pakistan 42 days before getting a million cellular service customers. 18 In new telephone connection-three times as long as Pakistan too, recent deregulation measures in China, Malaysia, and the Philippines. The have led to rapid growth in mobile phone use waiting list per 1,000 people Sri Lanka is for business purposes. Ninety percent of large among the worst in Asia, with a wait for formal firms and 67 percent of small firms rely on fixed-line connection of more than a quarter- mobile phones to conduct their business. million people. In Bangladesh, enterprises that There has been progress in the smaller South obtained a telephone connection within the Asian economies as well. Even in previous two years reported an wait of Afghanistan, the telecommunications sector 126 days, far longer than the 22 days in Pakistan has been developing very rapidly. Driven by a and 7 days in China. A shortage of new fixed- competitive market and US$200 million in line connections is an important reason for private investment, the mobile footprint covers delays in getting connected. In Pakistan, for as much as 50 to 60 percent of the country's example, new fixed-line connections currently population, providing services in 23 provinces. stand at a mere 0.5-0.6 million a year for· the In Maldives, the rapid progress of whole country. communication, especially the introduction of Access costs in Pakistan are also high-they are mobile phones in 1997, has proved to be a more than six times as high as in Malaysia and backbone for socioeconomic development and four times as high as in India. Getting new has lessened the insular nature of the islands, fixed-line telephone connections is significantly opened up new economic opportunities, and more difficult for small businesses than for contributed toward growth and expansion of larger companies. The "speed money" that business activities. 19 With the introduction of needs to be paid to obtain a connection also mobile telephones in 1997, the accessibility of consumes a far greater proportion of the the outer islands improved significantly. resources of small businesses . ... but thry can't fullY make tip for deficient fixed lines. Although difficult to assess accurately, the Greater access to mobile phones can substitute quality of service also appears to be a problem for fixed-line connections only up to a point, in many South Asian countries. Bangladesh although advances in technology are enhancing had 208 faults for every 100 mainlines in 2002, the versatility of mobile telephony. Improving according to the International 18 Bangladesh still lags behind other countries in both fixed-line and cellular telephony. In 2003, in Bangladesh was still the lowest in South Asia, according to the statistics of the International Telecommunication Union: only 1.56 among 100 people had access to telecoms faciliry. 19 About 150,000 mobile phones are available, while fixed lines total about 60,000. In Male, the of Maldives, two-thirds of the population have a regular phone at home and more than three-fourths have a mobile In the atolls where fixed lines have been installed, one in six people has a in the house. Mobile have spread wider: one-half of the population has at least one. 17 THE INVESTMENT CLIMATE IN SOUTH AS!A Telecommunication Union. In companson, availability of water is not a problem, its quality there were 203 faults per 100 mainlines in often is affected by high arsenic content, both in India, 99 in Pakistan, 38 in Malaysia, 29 in large cities where industrial pollution is not the Philippines, 1S in Sri Lanka, and 13 in controlled and in rural areas. Indonesia. In Maldives, nearly a third of the Although adequate for basic communication, manufacturing firms surveyed complained mobile phones cannot provide the about the quality of water used in production, infrastructure for full-fledged Internet while in Nepal, nearly a third of the firms connectivity essential to a modern business. In indicated that they have problems with the Pakistan and Bangladesh, to give just two supply of water. In Kathmandu, many firms examples, the of fixed-line received service for only one hour per day, and connections has impeded the development of at an unscheduled time during the day. In Sri the information technology and software Lanka, enterprises did not identify water as a industries. In Pakistan, only 30 percent of major constraint to doing business, but still firms report use of the Internet in Pakistan as nearly a third of firms in both rural and urban compared to 4S percent in India and 71 areas complained about their water supply. The percent in China. industries most affected by the unavailability of water produce carpets, garments, and textiles, Water Supply all of which require water in their washing and dyeing processes. In water; as in eiectricity) poor supplY from the national tYJtem forces firms to find their own Jources. Firms have thus had to invest in alternative sources of water. In India, businesses have While India is making progress in developing its developed costly "substitutes" (individual, urban and rural water supply and sanitation boreholes, pumping stations, storage tanks, and infrastructure, service provided is highly purification equipment). A recent survey of unreliable: water is typically distributed a few 10,000 households and businesses in Delhi- hours per day-regardless of its quality-and is not where water is seldom distributed more than safe for drinking. It is unlikely that the situation six hours a day-shows that they spend an can be improved without addressing the average Rs 150 on substitutes while they spend inadequate policies, outdated institutional Rs 100 on their official water bilL In 0Jepal, arrangements, and perverse incentives in the many firms have either invested in wells or sector. In Pakistan, the situation is fairly purchased water brought in by private tankers. similar to that of India, although In Sri Lanka, most firms have their own supply decentralization of the decision-making process of water: 70 percent of urban firms and nearly that took place a few years ago may make water 60 percent of rural enterprises have their own and sanitary providers more responsive well or share one, while only 27 percent of to the needs of customers. Afghan cities have urban firms and 21 percent of rural enterprises one of the lowest connection ratios in the world. reported using water from the 0Jational Water External financing has been made available ro Supply Development Board. Complaints about extend the service and set the basis for sound water problems are most common among institutions and policies. A challenge in Kabul is those without their own supply. to protect the limited groundwater resources against industrial pollution and potential over In urban areas of Sri Lanka, greater private extraction by industries. In Bangladesh, while participation in the water sector is being 18 THE INVESTMENT CLIMATE IN SOUTH ASIA encouraged to ensure universal access to a AcceJJ to and JOurceJ 0/ finance. Access to finance piped water supply, which should reduce is the most serious constraint affecting the businesses' water supply problems. In rural investment climate in Maldives. In Sri areas, lack of autonomy in human resources Lanka, finance is one of the top three and financial decisions, and the central constraints to doing business, especially in the government's continued involvement in rural areas: 60 percent of rural firms cited "devolved" responsibilities, have until recently finance as a constraint. In Bhutan, firms cited undermined the local governments' finance as their fourth biggest business performance in many areas, including water problem, and about 43 percent of firms supply. Moreover, competition for water reported being credit constrained, that is, among domestic, agricultural, industrial, and wanting to borrow more at current interest commercial users is increasing. rates. In Nepal, although the vast majority of manufacturing firms (77 percent) have access to at least some external finance, large collateral C. Factors of Production requirements and other factors prevent firms Finance from obtaining as much finance as they need. An inadequate financial S]Jtem makeJ .south AJian In Bangladesh, 40 percent of firms reported firmJ reliant on internal JourceJ forfunding. that poor access to finance was a major constraint, although 66 percent of firms Capital is a key input into any business, and an reported having an overdraft facility or line of efficient financial system, able to allocate credit. 20 The situation is relatively better in financial resources quickly and cheaply to their India, where 27 percent of firms rate access to most productive uses, is an essential part of a finance as a major-to-severe obstacle to sound investment climate. Many countries in business operations or growth. the South Asia region are undergoing structural reforms in their financial sectors, characterized Most finance available is short term. In Nepal, by a shift from public to private ownership, despite the presence of a wide variety of commercial principles for the remaining public lending institutions, the majority of fmance is banks, and higher levels of discipline in risk short-term bank credit, and most firms are management being enforced by supervisory unable to access long-term credit. Less than 28 authorities. In the medium term, well- percent of the sample had outstanding loans functioning financial systems may become a with a term length greater than a year. No strong characteristic of the investment climate commercial banks in Afghanistan offer long- in South Asian countries. Currently, however, term finance: the maximum tenure of financing in most South Asian countries firms cite poor is three years. Most focus on opening access to finance, especially term finance, and commerdalletters of credit (see box on access the high cost of finance as major factors to finance in Afghanistan, below). In Pakistan, constraining investment. as a result of the short-term nature of the funds borrowed, there is a mismatch of 20 This could be explained by the fact that banks in Bangladesh, especially the nationalized commercial banks, make extensive use of overdraft facilities, which are typically fully drawn by tirms. For example, 60 percent of tirms had exhausted their overdraft facility. Thus, many firms with an overdraft facility may still feel credit constrained. This is true for other regions as well. For example, in Brazil 60 percent of firms consider access to tinance as a major constraint even though 74 percent of firms have an overdraft or a line of credit. 19 THE INVES1MEfn CLiIliMTE IN SOUTH ASIA matuntles, with short-term loans being rolled investment (15 percent) and declines markedly over to finance longer-term projects. with enterprise size. More than 75 percent of the respondents had not applied for a bank Because of the poor access to external finance, loan. In Bangladesh, on average, around 55 many South Asian firms rely on retained percent of working capital and nearly 60 earnings and equity as their most important percent of investment capital comes from sources of working capital. At one extreme is retained earnings, while only 30 percent of Maldives, where only 11 percent of working working and investment' capital comes from capital requirements and 17 percent of banks. In Bhutan, about 30 percent have no investment capital come from domestic bank credit. commercial banks. The contribution of international banks is even lower, 3 percent and Inadequate access to bank credit is an 5 percent, respectively. In Sri Lanka, retained important impediment to starting or expanding earnings account for 44 percent of working a business in Pakistan. More businesses have capital for urban manufacturing firms, followed access to overdraft facilities in Pakistan (22 by bank lending (23 percent) and trade finance percent) than in China (17 percent), but ~ewer (9 percent).21 Bank lending is even less for new Pakistani businesses have outstanding bank Access to finance in Afghanistan In Afghanistan, although 12 commercial banks are now licensed to operate, most are concentrated in Kabul and provide services primarily to international donors and businesses, foreign nongovernmental organizations (NGOs), and foreign government agencies. No commercial banks in Afghanistan offer long-term finance. The maximum tenure of financing is three years. Most focus on opening commercial letters of credit. Transactions are very secure because the importer has to deposit the total imported costs of goods in the bank before opening the letters of credit or a secured contract, such as for construction or other awarded contracts, which are financed by donor agencies. A small but increasing number of nonbank financial institutions, including one credit union and 11 microfinance institutions provide limited services and small amounts of credit. In addition, a new leasing organization has just become active in Kabul and other areas. However, these institutions are nascent and able to provide only a fraction of what is needed. Thus, they are augmented by a wide variety of informal money lenders and other credit sources. There are no credit bureaus or credit rating agencies. Because the financial system is so underdeveloped, Afghan firms are almost entirely reliant on internal funds and money from friends and family to fund their operations. Only three firms in the Investment climate survey sample reported having bank credit, and on average nearly 94 percent of new investment by firms was funded by either Internal funds or money from family and friends. Remittances are also important, and on average funds from family and friends outside of Afghanistan financed 3 percent of investment. Informal sources play an important part in supporting Afghan businesses. Many businesses rely on informal funds transfer systems generally known as hawala to make payments and transfer funds. Only 30 percent of the $ample reported having a bank account. The hawaladars also provide short-term loans to finance working capital needs. Nearly 21 percent of firms responding to the survey reported having a loan from a hawaladar with an average term of 3.8 months. Currently, the financial system provides little or no access to financial products and services for small urban or rural enterprises. Instead, an extensive array of informal money exchange dealers and some NGOs support urban and rural microenterprises with limited financial services.22 As the reconstruction effort progresses, there is a pressing need to address the burgeoning requirements of such enterprises, along with the needs of more formal enterprises and those of international investors. 21 However, the experience of South Africa and Vietnam suggests that the indicator "percentage of investment financed by internal funds," by itself, may not be a good indicator to assess whether firms are credit constrained. In South Africa, only 13 percent of firms consider access to finance as a major constraint, but 58 percent of investments by firm"s are financed by internal funds and only 16 percent by bank financing. By contrast, in Vietnam only 30 percent of investments are internally funded and yet access to finance is identified as the top constraint by firms (with 40 percent of firms considering access to finance as a major constraint). 22 The development of rural financial markets is hindered by several factors: (i) dispersed populations and poor transport and communications facilities; (ii) high risks associated with rain-fed agriculture; (iii) absence of physical collateral and land- tenure systems that minimize the value and use of land as collateral; and (iv) past history of state involvement and subsidized lending, which led to low recovery rates. These problems, some of which may affect urban microenterprise finance, tend to be more acute in rural areas. 20 THE INVESTMENT CLlMIl.TE !r~ SOUTH ASIA loans (20 percent 43 percent in the categories (in terms of employment) use some China sample; however, China's financial sector form of credit. This differential access is even is not the best even by emerging market more pronounced for long-term credit. Close standards, given its large levels of to 30 percent of the firms in the two largest- nonperforming loans). As indicated above, the size categories have access to long-term credit, situation is better in India, where 54 percent of while only 17 percent of firms in the two small businesses have bank credit lines or smallest-size categories do. In Sri Lanka, overdraft facilities. This figure is much higher small firms are forced to rely more on internal than that for China, suggesting that India's financing, leasing, and informal and family investment climate is clearly better in this sources. In Pakistan, 18 percent of small respect. But the India figure is lower than firms and 50 percent of all large firms have Brazil's by about 50 percent. A greater access to overdrafts. Fifty-seven percent of proportion of small businesses might thus have new investment by SMEs and 67 percent of been rationed out of formal credit markets in working capital finance comes from internal India than could otherwise be the case even by finance or retained earnings; only about 7 emerging market standards. percent of funds for new investment or working capital come from banks or other Within countries, access to formal finance financial institutions. varies by regions and sectors. Thus, in Sri Lanka, new investments in rural enterprises Collateral requirements are typically high (see are financed largely from internal sources (43 figure 11). However, the analysis of the data percent) and family and friends (35 percent), on collateral-more specifically, the value of respectively. In Bhutan, companies in the collateral as a percentage of loan value-can be service sector were more likely than misleading. A lower value does not necessarily manufacturing companies to be credit mean a more efficient banking sector or an constrained, and fewer had bank credit. easier access to credit. Conservative banks Access to credit is also highly correlated with have a strong preference for real estate size; a much greater proportion of large firms collateral and will therefore exclude many than small firms have access to external potential borrowers, in particular SMEs, which finance. In Nepal, for example, about 60 often cannot provide such collateral. More percent of firms with fewer than 50 workers dynamic banks will accept a wide of had access to credit, while 84 percent and 93 collateral, such as machinery, inventory, percent respectively of the largest two vehicles, and consumer durables, but the 23 Even during their initial Indian SMEs have relied much more on debt financing-from banks and nonbank financial institutions (NBFls)-than their counterparts elsewhere. But the shtinkage of the NBFl sector in response to policy and regulatory changes since 1997 has meant that SMEs no have access to finance from this source. And bank credit to SMEs has also dropped since 1997. The limited debt finanCIng available to Indian SMEs is of a short maturity (less than one and is v,1th options available to their counterparts in other countries. 24 This difference may arise because service have fewer physical assets to pledge for collateral-or because lenders are less comfortable in the risks of such service as tour operators, transport firms, and computer training schools. 25 Higher interest rates and the lower share of loans extended to SMEs are not necessarily evidence of market failure. Smaller firms have a higher turnover rate than firms, them riskier to lend to. Given the fixed overhead costs per loan, the smaller size of loans extended to smaller firms also makes lending to them less profitable for banks. Small firms also often have less collateral and less of a proven track record, making it harder for banks to assess their creditworthiness. 21 distressed value 2(' of such Figure 11 collateral is usually low. Such Patterns of lending alJdbofflJVliQt.· banks will therefore cover their 180 risks in taking a wide range of 160 assets, which will translate to a 140 • • higher value of collateral as a • • 120 • • • percentage of a loan (for 100 • example, this value stands at • 134 percent in Ireland and 124 60 percent in South Africa). 40 20 Cost of finance. While access to O+-~~~~~JL.~~~~ finance is most commonly cited as a problem, in a few countries the cost of finance is ~~ofCollateraljll!~ of lJ)aI'! Vl)I~ . a problem too. For example, in If. ~()t FltnIi w\1fl ~dfQffOr ~inetlf Credit ... Sri Lanka, almost a third of urban firms and rural Corporation of Bhutan provided loans to a businesses cited cost of finance as a major private entity based on work orders. However, constraint. Urban firms in Sri Lanka did not this practice does not appear to be common. mention access to finance as a major problem Other services that are missing include leasing but reported that the cost of finance is the finance, private debt markets, electronic banking, fourth biggest constraint to expanding or automated teller machines, venture capital (or operating their businesses. The problem is risk capital) for start-up enterprises, and even more serious for small firms and rural firms. credit or debit card facilities. Small urban manufacturing firms reported paying significantly higher average interest rates A IJariety 0/ factors limit actess to finance for South (18 percent) than did large ones (12 percent). Asian firms. Within the rural enterprises surveyed, 60 The factors constraining SME finance in India percent identified high interest rates on loans, provide a glimpse of the root causes of the and nearly 50 percent identified tedious loan problem. A variety of credit market procedures as major or severe constraints. In imperfections result in high transactions costs Bhutan, high nominal and real interest rates and default risk. Specific problems include the were a major concern for firms. Real interest following: (i) problems in using land as rates ranged between 7 percent and 10 percent collateral, lenders' nonrecognition of other at the time of the survey. types of collateral, and difficulty in collateral Lark rj innovatil1e financial instruments. In Bhutan, enforcement and loan recovery; ell) insufficient for example, the banking system provides few credit information on SMEs; (iii) poor SME innovative lending instruments. The survey team credit-assessment practices and poor lending came across only one example of factoring technologies, such as inadequate use of credit serVIces, In which the Royal Insurance scoring/ rating tools; and (iv) a bankruptcy 26 The likely value of the asset if sold by the bank in case of the borrower's nonrepayment of the loan. 22 TliE INVESTMENT CLIMATE iN SOUTH ASIA framework that prevents easy exits for troubled South Asian state-owned commercial banks, firms. fifth possible contributor is the and a branch of a widely known international degree of confidence lenders have in the bank. contract enforcement mechanisms of the Public sector dominance. In some South Asian courts. These problems recur in other parts of countries, the public sector continues to South Asia. dominate the banking sector. In Sri Lanka, Heazy reliance on collateral. Collateral plays a vital the commercial banking sector is still role in the availability of finance, and lack of dominated by the two state banks, the Bank of collateral is thus a major constraining factor. In Ceylon and People's Bank, accounting for Sri Lanka, being more productive does not about 45 percent of although this help a firm obtain a loan. Banks are unable to proportion represents an important decline discriminate on the basis of performance and compared to that in the early 1980s. The instead rely heavily on the value of collateral significant level of nonperforming loans and when considering a loan application. For rural inefficiencies of state banks contribute to high enterprises, land is important as collateral. intermediation costs. This in turn results in Almost a quarter of loans to rural enterprises high cost of funding for banking sector as in Sri Lanka required collateral, and land was a whole as the more efficient private banks are offered in 75 percent of transactions. able to operate with similar lending rates while However, high levels of public landownership, enjoying high profits. In Bangladesh, at the unclear ownership records, and widespread time of the investment climate survey, 40 restrictions on the use and transfer of land percent of industrial loans were make it difficult to use land as collateral, nonperforming. In Bhutan, high interest rates limiting access to external finance. High are also blamed on the relatively large share of collateral requirements were cited as reasons nonperforming assets in the banking system for not applying for loans by nearly all (interviews suggest that it is about 15 percent), respondents in the Pakistan survey who which has further increased banking costs. needed a loan but did not apply for one. Crowding-out ~ffect of government borrowing. Shallow financial [ystem. The financial system in Another cause for the high costs of finance is most South Asian countries is shallow. the crowding-out effect government Although Sri Lanka's financial sector has borrowing. In Sri Lanka, where high cost of developed and expanded over past two capital is cited as a major constraint, persistent decades, private sector credit amounts to about budget deficits have led government to borrow 38 percent of GDP, compared to 1 percent heavily from the banking driving up in China. The ratio is even less in other South interest rates. Asian countries-27 percent of GDP in Deficiencies in setting interest rates. Banks in South Bangladesh, 28 percent in Pakistan, and 29 Asia often set interest rates based on the percent in India. Capitalization of equity borrower's sector rather than its risk profile. markets in India is 30 percent but only 15 Training bank credit officers to properly assess percent in Sri Lanka, compared to about 40 risk is an important step in moving banks away percent in China. The financial sector of from using simplistic and less relevant criteria Maldives is very narrow and dominated by the in determining interest rates-al1d in moving banking sector, which consists of one locally toward market-determined rates. owned commercial bank, branches of three 23 THE INVESTMENT GUM"" TE iN Weak information and enforcement. Bhutan Money is fungible and it is difficult for banks to exemplifies the case of weak information and monitor how their loans are used. Once enforcement, but the problem is widespread in contracts are written the legal mechanisms for South Asia. In Bhutan, banks attribute their enforcmg them are so that they cannot be reluctance to lend to two factors. The first is relied upon. For these and other reasons, banks lack of information and of mechanisms to restrict the length of loans and demand high collect information, which makes it difficult to levels of collateral and personal guarantees. identify profitable projects in a risky Lack if insurance is a particularly serious environment. Most firms do not keep accurate, problem in Afghanistan. Afghan firms are transparent financial accounts, and Bhutan has faced with an almost complete absence of no credit rating agencies or other institutions msurance. Many managers and potential providing information on borrowers. Bhutan's investors have cited the lack of insurance as a small, thin market, where few firms are major reason that they are hesitating to invest. diversified, is particularly vulnerable to shocks, The insurance sector in Afghanistan is in dire and predicting earnings is difficult. Moreover, straits. The sole insurance company, the because banks lack information and well- Afghan National Insurance Company, is trained loan officers, they are unable to substantially undercapitalized and in a weak adequately monitor the use of borrowed funds. financial pOS1tlOn. The Afghanistan The second factor is inability to enforce Investment Guarantee Facility has been contracts. In Bhutan, the legal code is established to mitigate political risk and not life improving rapidly and many new laws have been and nonlife commercial risks. But until there is passed, but financial institutions still find it a new insurance law, it is unlikely that there will difficult to enforce agreements or seize be any new providers of normal business collateral. \vhile the laws may be adequate, they insurance. The existing insurance law is more are not enforced. Courts are extremely slow and than 40 years old (1962) and therefore requires inefficient, and seizing the assets of borrowers substantial modifications or indeed who default is almost impossible unless the replacement by a new law to be consistent with property is directly attached to the loan. Thus all the new commercial environment. banks demand high collateral, specifically tied to a loan, so that it can be seized to offset the cost Land of long court proceedings. That the courts are considered a very inefficient way to resolve The efficiency of the land market, both as a disputes is evidenced by the fact that only about factor of production as well as an asset that can 5 percent of firms in the Bhutan survey be leveraged into capital through registration reported hiring a lawyer or threatening to take a and mortgage, is not cited as a major obstacle client to court for nonpayment. in most South Asia leAs. The subject of land issues is treated sporadically in the South Asia In Nepal, the vast majority of external credit ICAs, as apart from Bangladesh, fewer firms comes from commercial banks, and for various in South Asia than in China or Brazil report reasons banks face enormous difficulties access to land and registering land as a major obtaining information on clients, assessing their deficiency in the investment climate. This risk, and enforcing contracts. The way that the result is more a statement of the relative tax laws are enforced discourages firms from importance than an indication of a well- keeping accurate books that banks can rely on. functioning land market in South Asia. 24 THE INVESTMErH CLIMATE IN SOUTH ASIA An exception is Afghanistan, where it is systems are dominated by cases over disputes exceptionally difficult for businesses to get involving land issues. For the other country for clear title to new land, especially serviced land which land issues were addressed, Sri Lanka, (see box below). The lack of certainty in land land is a bigger issue for urban than rural firms, tenure discourages existing businesses from with 10 percent of urban businesses citing making large new investments and effectively access as a major problem compared to only 2 prohibits new investors, especially foreign percent in rural areas. investors, from entering the market. The difficulty of obtaining new land is borne out by Labor Markets and Skills the survey. Nearly 56 percent of the firms who had tried to acquire new land in the past three The two major labor issues in South Asia are years were unsuccessful. the rigidity of labor markets in several countries and the shortage of skilled labor in The World Bank's Doing Business indicators most countries. show that registering property in Pakistan, India, and Sri Lanka takes longer and costs Labor regulations vary across South Asia. more than in China or Brazil. 27 In particular, although in India access to land is not Labor regulations are a key constraint for firms considered as urgent as power supply, there is in many South Asian countries, while they tend evidence that regulatory distortions and unclear to be less of an issue for some of their property rights in the land market have caused neighbors. Regulations impinge mostly on the the cost of land to account for a higher firing side and are relatively more flexible on proportion of business costs in India than the hiring side. According to the Doing Business elsewhere in South and East Asia. Anecdotal study, the region has the lowest hiring cost in evidence from Pakistan indicates that court the world and also scores low on the index of Voices of Afghatrentrepteneurs: The challenge o,getting . tand 'Obtainlngl8nd has been the main pftlblerli for us. The former Ministry of Ught Industf'ieshad aflocateda pIotot land far Us intooj>iJl·e,;Char~hi area of Kabul. However, we are yetta gel this gOVllmmentiand and we arenot sure wellVllf wilL We have applied for II plot of/and to AtSA [the Afghanistan Jhvestment Support Agencylbut bave not got IIresPOnse. yet.AlSA has promised to ~.el.pbut wedo not knowif the.yhave the CClpacity to altocate land. Wet\lusreptedabouse in Kabul in Ma!ch2OQ2andi!l.sta\ledmy maphlnel}', We pay aremof.US$1,2.69mtr month for the bouse. It has limited space and, being located in aresljlentiaf area, It Is riot good for the local environment. t.ackof land Is cori$fralning me in many wayS. !lYle bad the. land we would constructamooemmedlci!l!~produGtion·factolY withmodetnsystelll$use~ln ~ti(ope:afl!1Nortb America; .expandemploymentfr!)mtl'lecuf(eIlt ·of3lUo 150 ·byexpamlngproductiOrillapactt}l;mal'ketingnetWoik,aadtatesvOfume:.andhelp reducetne country's dependentfJ onimportedmeoicineantf perhaps even1iXport tolOO nelgfiboring C{S[tommattwealtll bf Independent States} countries;' -Pbarmaceuticatcompany . .. . . . .. . .. .,'.. ....' . . ... .., 'We approlchedtheMirustryof AlJriculturela o~taln ia,nd•.. Wlt.dld. ~tanaflocation from the:Mill1stry a,nd,it~ ~greSd ~t Qllrproi~etwlirbe. a loinfventvre w.ith the. Govem/JIent:withtt!eMjni~ryo~njnganper~pf l)Uh~~I'e$.. While.itwasrelatiWly_to .ge~ 1httaff!lCatiOntetter from theMWstty,wearena. . . ." ..' . . . CttmrlJd. Jt 1st!· ... to. ' .. .., .... , ..... ' several ,offlC(l$ til_air . . . .. .. ... .. . . .lIrinl(;:mereis;a( ....... ..... ..... . .. . ..... ...... ~rtI(jltlarly difficult hasbeentlleMunic.pa»tY:ij\~Mi~d,f;Urand,QtII'J, 3ndth8lfIl!J!P~~.witby(1urdOc~.w.~.:Vi()~~t ~~tyq~~IOO.pUi~,we.lJ@ to pay I!ribebliftlletearesomewilere wehlilttiJlay'a.~ am()t,liltJ'j~y,welJottfle!~It.~er®,.g.r:·;i fJo~tJ;YfaI;llIi .. . 27 World Bank, Doing Business in 2006; Creating Jobs. 25 THE INVESTMENT CLIMATE IN SOUTH ASIA rigidity of hours worked. 28 However, as holidays and leave than 1n almost any other described in detail below, there is much less country in the world. flexibility ",'ith regard to firing workers and, In Bhutan, the labor market is segmented with even on other aspects where the region on an estimated 50 percent of formal wage average does well, some countries have onerous employment accounted for by non-nationals, regulations. The absence of a well-functioning mostly Indians. Recruitment of foreign labor market can offset the benefits of a well- workers is subject to stringent restrictions and, educated workforce. This is evident, to some when permitted, entails time-consuming extent, in Sri Lanka and India. procedures. These factors may explain why a Sri Lanka's labor regulations are ranked large proportion of firms in Bhutan (more than among the top five obstacles in the investment 30 percent) cite labor regulations as a major or climate by urban manufacturing firms. severe constraint. Rules regarding employment Inflexible and arbitrary, these regulations create of national workers are less stringent and are uncertainty about the costs of hiring and firing not well enforced; firms report some flexibility workers, thus discouraging investment. An in hiring and firing employees, and in setting example is the mandated payments for wages without any influence of organized redundancy, which are many times those labor.30 legislated in other Asian countries. 29 The In India, 17 percent of firms identified labor Termination of Employment of Workers Act regulation as an impediment to growth. (TEWA) of 1971 makes it very difficult for Regulations make it virtually impossible to fire firms to fire or layoff workers. Employers are a worker. India scores 90 out of 100 on the most concerned about the discretionary and Doing Btlsiness Difficulty-of-firing Index, relative opaque administrative process for obtaining to 43 on average in South Asia, 23 in East Asia, authorization to layoff workers. The and 27 in Organisation for Economic Co- government may refuse authorization, creating operation and Development (OECD) member uncertainty about the ability to layoff workers. countries. Firms must pay 79 weeks of salary Lengthy procedures add to the uncertainty: in notice, severance, and penalties to dismiss a many cases drag on for years while employers worker-compared with a regional average of 75 must explain their financial performance and weeks, and East Asia and 0 ECD averages of business plans to justify the layoff. Labor 44 weeks and 35 weeks, respectively. Thirty regulations in Sri Lanka also mandate more 28 The cost to hire a new worker accounts for only 5.1 percent of a worker's salary. The rigidity-of-hours index for South Asia is also low, at 35 on a scale from 0 to 100 100 is the highest rigidity), ret1ecting relatively few restrictions on overtime and annual vacation. This level even surpasses that of OECD countries (an average of 50) and trails only East i\sia. 29 In 2004 Sri Lanka increased the maximum severance payments for workers with 20 years of service from 36 months of wages to 48, it (he most expensive in the world after Sierra Leone to dismiss workers. 30 There have been some reform initiatives after the Bhutan ICA was wrinen. The government has prepared a draft Labor and Employment Act to balance the legitimate needs of workers \1;1th the promotion of activity. Once effective, this act will (i) allow Bhutanese, particularly youths, to be employed in a wider spectrum of economic activities; allow for more-t1exible working hours; (iii) allow night work in industries requiring a round-the-clock-work schedule; and (iv) help streamline processes and reduce the time required for recruiting foreign workers. The act is expected to be submitted to the Committee of the Council of Ministers before the end of 2006. A range of reforms to streamline the process for recruiting toreign workers were implemented recently. In particular, an online recruitment system has cut the time to obtain foreign worker permits from three months to three weeks. And a one-stop sen'ice center was established, allowing applicants to complete all the formalities required for worker recruitment in one 26 THE INVESTMENT CLIMATE IN SOUTH ASIA percent of firms reported that they would firms to make all employees permanent after employ fewer workers if they were free to working 240 days. After they become choose their employment levels. Of those permanent, workers cannot be laid off or fired reporting excess labor, 30 percent attributed without the consent of the labor department, a overstaffing to laws and regulations that limit process that can take months or sometimes firing of workers; 17 percent reported pressure years. Market needs are not considered from unions; and 13 percent reported sufficient grounds for such consent. government or political pressure. Absenteeism Conversely, few firms in Bangladesh believe is also a problem, imposing costs on that labor issues impede their growth; than production and the potential profitability of 10 percent of firms consider labor regulations to enterprises. India's labor regulations are also be a major constraint (see box below). When unusually complex. There are 47 central asked what ideal staffing levels would be if government laws and 157 state regulations that hiring and firing were costless, the median firm directly affect labor markets. These laws are in the investment climate survey reported that often inconsistent and at times overlapping. As its current staffing level was ideaL Afghanistan a result, it is almost impossible for either firms has made significant progress with regard to or workers to be aware of their rights and labor regulation (Afghanistan now ranks 25th in obligations, or for enforcement authorities to the 2005 Doing Business Index on Hiring and ensure compliance with regulations. Firing). Regulations governing hiring, firing, and Labor regulation in Pakistan is excessive by working hours all give Afghan firms significant international standards, as can be seen from flexibility. In Maldives, although 28 percent of data on a number of indicators of labor market the firms consider labor regulations as a major flexibility. According to the Doing Business or severe constraint, it is not cited by the firms indicators Pakistan's overall indicator for as one of the top constraints (it ranked as the restrictiveness of employment laws is the 12th constraint). According to the Doing Business highest in the South Asia region, and is much indicators, Maldives ranks fifth in the world on higher than indicators for the East Asian the ease of hiring and firing-and is by far the countries, including Malaysia and Singapore. best-performing South Asian country on this Since the employment regulations are most indicator. The cost of hiring is zero-there are no applicable for permanent workers, Pakistani social security taxes or payroll taxes associated firms have resorted to large-scale hiring of with recruiting a worker. There are minimal temporary workers. According to the 2002 restrictions on work conditions. Employees are investment climate survey, the proportion of prohibited from working more than 10 hours in temporary workers in Pakistani businesses is a day, but there are no restrictions on night or one of the highest by any international holiday work and no mandated annual leave. standard, standing at about 36 percent Firing is more costly. Employers must pay 20 compared to, for example, 15 percent in India weeks of wages in severance, penalties, and and 3 percent in Bangladesh. notice to dismiss workers. In Nepal, the most problematic regulation for Matry South Asian firms face a shortage of skilled firms is the retrenchment provisions for workers. permanent labor. Twelve percent of firms Shortage of skilled labor affects South Asian identified it as the one of top three countries at various levels. Firms in Maldives, business problems. Labor regulations require Bhutan, and Nepal complain the most about 27 THE INVESTMENT CLIMATE IN SOUTH ASIA workers, those with the best opportunities abroad, fled. Consequently, qualified management, skilled technicians, and educated professionals are scarcely available to today's enterprises. However, it is understandable that Afghan firms face many other challenges and might not yet consider skills shortage as their most pressing constraint. As is the case with transportation, the way firms responded to questions about skills shortages depended on the industrial structure. This pattern is illustrated by the case of India, where a typical firm reported filling a skilled vacancy within three days, as opposed to six in shortage of skilled labor. Asked about their BraziL This comparison may suggest that skill biggest business problem, firms in all sectors shortages are not as ubiquitous or biting a and locations in Bhutan overwhelmingly cited problem in Indian industry as they appear to be the lack of skilled labor. Managers report that in Brazil. However, this does not necessarily the skills provided by most schools and training mean that India has a larger pool of skilled institutions do not match the skills needed by workers than BraziL It means only that there industry. So while a growing number of school are more skill shortages in Brazil, possibly leavers cannot find jobs, firms feel that their because the demand for skills in those biggest problem is a shortage of skilled and countries is greater, which would also be experienced labor. Despite some consistent with their higher investment rates in improvements, inadequacy of local skilled more skill-intensive industries. That India labor continues to be a major problem in apparently faces fewer skill shortages than Maldives, where 45 percent of firms cited this Brazil is not therefore necessarily a plus for the inadequacy as a major or severe constraint. In current investment climate in India. Nepal, firms ranked shortage of skilled labor The shortage of a skilled labor force has a as their fourth main constraint. variety of origins. In Bangladesh, illiteracy Sri Lanka's labor force is well educated remains high despite recent improvements in compared with those in other lower-middle- school enrollment. This high incidence of income countries. Yet the demand for illiteracy reflects the poor education results in technical, managerial, and computer skills still the 1970s and 1980s and the difficulty of quickly outpaces supply. In India and Pakistan, one reducing illiteracy among adults. In addition, in eight businesses identified skill shortages as there has been a "brain drain" of skilled workers. a major obstacle to the expansion of their Brain Drain has also been the case in Sri business; in Bangladesh, the proportion is 19 Lanka. A ranking by the World Economic percent. Similarly, firms in Afghanistan do Forum in 2003 shows that Sri Lanka has among not express concerns about a shortage of the highest levels of brain drain in a set of skilled labor, despite high illiteracy and poor comparator countries. In Afghanistan, the education. During the two-decade long skills shortage caused by war is exacerbated by conflict many of Afghanistan's best-qualified the barriers to educating girls and employing 28 THE INVESTMErH ClIMATE IN SOUTH ASIA women in most iobs outside the home. In relatively low levels for other measures of Bhutan, the skilled labor shortage is due to the innovation. For example, companies and government's absorption of most skilled and individuals in Bangladesh were granted fewer educated workers, which is compounded by the U.S. patents per capita than were those in other fact that most educated Bhutanese have a strong developing countries in East and South Asia. preference for working in the public rather than Similarly, basic research appears to be weaker in the private sector. However, this situation is Bangladesh than in other countries in slowly changing as the government absorbs region: authors from Bangladesh published fewer and fewer schoolleavers and graduates. fewer scientific articles per capita than did those from any of the comparator countries in Innovation and Technology and South Asia except Indonesia. Sri Lanka is doing relatively better, but even there Technology is another important factor firms tend to invest little in R&D: 0.11 percent affecting firm-level performance, especially in of sales, on average. However, levels of R&D the present context of a highly globalized and investment are close to those observed in knowledge-based system of production. To similar industries in developing countries such enter world markets and compete successfully as China and India. Technology use in Sri with imports, firms must improve their Lanka, as measured by the share of firms using productivity. That means not only upgrading e-mail and computers, is also close to that in their human capital but also adopting China. South Asian also face many appropriate new technology. Technology is a difficulties in searching for, acquiring, and general term covering a wide range of areas. absorbing technology box). Those most relevant to South Asia include management knowledge, market knowledge, South Asian firms do not make much UJe if modern production technology, design and product {ystems qf communication. development, information technology, and Internet use is low in South Asia. This is management and quality systems. Use of the symptomatic of a telecommunications sector Internet is another dimension. The Internet that suffers from shortage of fixed telephone has become one of the most efficient ways for lines and lacks the capacity to provide a firms to communicate and to conduct business sufficient range of services. In India, there is with distant clients. relatively greater use of the Internet but with South Asian firms do not innovate much and face variations in Internet connectivity across states. dijjiculties in acquiring technology. Forty-seven percent of SMEs in the good- climate states use the Internet to conduct Bangladesh exemplifies the typical South business, while only 27 percent of SMEs in Asian pattern of firms' low investment in poor-climate states do so. Only 30 percent of research and development (R&D). Bangladesh businesses in Pakistan normally communicate spends less on R&D as a share of GDP than with their customers or suppliers using the do most other developing countries in East and Internet-far fewer than the 71 percent of firms South Asia for which data are available. R&D that do so in China. In Afghanistan, business spending totaled about 0.03 percent of GDP in use of the Internet is nearly nonexistent Bangladesh compared to about 0.2 percent in outside of a few of the largest cities. On the Philippines and Malaysia and about 0.7 average, 15 percent of the surveyed firms percent in China and India. The low level of regularly use e-mail in interactions with their R&D spending in Bangladesh is reflected in 29 THE INVESTMENT Cl.!MATE IN SOUTH ASIA Diffllulties faced in searching for, acquiring, and absorbing technology Searching for technokJgy. I..arge firms generally rely on their equipment suppliers and buyers to identify sources of technology, but many recognize that they need more advanced technology that they cannot easily identify. Small companies often' use guesswork to estimate their technology needs, which frequently leads to costly mistakes. Acquiring technology. Acquiring technology is less problematic, though still time consuming, if companies use reliable suppliers who commls.siont/Je equipment and provide training for operators. Firms acquiring used equipment, however, often fInd that it is incorrect or defective. Hiring consultants can also be problematic, since many may be inappropriate unless recommended by a supplier or buyer. Absorbing technology. Absorbing-or internalizing-technology poses significant challenges. Once production technology is acquired, it often has to be adapted to meet orders from customers. Some firms reported that such absorption problems can increase the costs of technology transfer by one-third. Maintenance and spare parts add further difficulties. clients and suppliers and 9 percent use Web . .. bllt tb~y would bettifit if tb~y did so. pages. In Maldives, however, the penetration Evidence from South Asia confirms that of telecommunications is very high among the innovation and use of modern technology has business community compared to the other a positive impact on firm performance. In South Asian countries. The percentage of firms that use e-mail regularly to interact with Nepal, the weaknesses in technology transfer mechanisms contribute to low enterprise and clients stands at 98 percent in the tourism worker productivity. Firms in Nepal that do sector, 96 percent in the manufacturing sector, have access to technology transfer or "learning and 84 percent in the transport and logistics mechanisms," such as trammg, foreign sector. ownership, foreign licensing, and technical Firms do not innovate because tb~y bm'e little incentive agreements have significantly higher or capacity to do so . .. productivity than other enterprises. In Bhutan, the low investment in improving Bhutan is a case in point. In Bhutan, the production techniques, combined with the lack preferential access to the Indian market, India's Of worker training, has led to low productivity high tariffs, and the natural protection provided and a lack of competitiveness for most by Bhutan's remote location have led to little Bhutanese products, both globally and within domestic competition and created few South Asia. In Maldives, the proxy measure incentives for firms to innovate and seek employed for technology (that is, regular use of productivity improvements. Few resources are e-mail and Web sites in business operations) devoted to improving production processes or was positive and significant as a determinant of introducing new products. Investment is low productivity and sales growth. Foreign and directed mainly at increasing production or competition and use of e-mail and Web sites replacing worn machinery with eXlstmg for business actlvwes emerge as key technology, mostly from India. In Nepal, determinants of enterprise performance. many of the "learning" mechanisms are weak or missing: direct foreign investment is low, few firms train workers, business and technical D. Regulatory Burden and Corruption training institutions are underdeveloped, local Regulatory Burden technical consulting serv1ces are weak (although there is some opportunity to bring in Starting a bllsiness can be a hassle; mnning it even technical experts from India), and in many more so. industries, buyers and suppliers are not visiting In many countries bureaucratic red tape can Nepal on a regular basis, which limits slow the creation and growth of formal-sector possibilities for technology transfer. businesses or drive them into the informal 30 THE I~JVESTMENT CLIMATE IN SOUTH ASIA economy. Generally, the regulatory burden routine visits to business premises; they have the faced by private sector firms consists of tax and power to suspend plant operations if required for customs administration, regulatory inspections, inspection purposes. The inspections enforce labor regulations, and other administrative many rules and regulations that are not interventions affecting the running of a business necessarily much different from those in on a day-to-day basis. In addition to its role in developed economies. However, in India, as in the regulation of business start-up, closure, and much of the developing world, government provision of industrial incentives, government officers have too much discretion in deciding intervention manifests itself though customs which rules to enforce, on whom, when, and how. inspections, visits by tax officials, and other The burden of regulation is, on average, inspections to enforce a variety of health, safety, smaller in India, at 7.4 visits a year for a typical and environmental standards. business, than in China (26.7 visits a year).31 While these inspections are not in themselves However, paradoxically, senior managers of different in South Asia than in the rest of the small businesses in India typically spend a world, the issue for most of the countries is that greater share of their time dealing with of discretion in enforcement as well as the regulations (11.9 percent) than do their Chinese frequent and arbitrary nature of the visits. (7.8 percent) or Brazilian (7.2 percent) Bureaucratic procedures required to do business counterparts. Moreover, Indian industry does are often seen as rent-seeking opportunities by suffer from more cumbersome and costly entry corrupt public servants. As a result, such and exit regulation compared not only to China procedures can quickly mushroom, stifling even and Brazil, but also to other large-economy the most entrepreneurial individuals. Surveys of comparators such as Mexico and the Russian the business climate in South Asian countries, Federation. including Bhutan, India, Nepal, and Firms in Pakistan reported that a large Pakistan, all point to heavy regulation and amount of time and energy is lost on government unpredictability as a key constraint regulation, as senior managers spend an to private sector performance. average of 10 percent of their time dealing Once started, firms bear a regulatory burden on with regulatory agencies. This is compared their operations. An indicator of this burden is with less than half that amount of time for the time senior managers spend dealing with firms in Bangladesh (4.3 percent) and three officials of regulating agencies and the frequency quarters of the time in China (7.5 percent). with which officials pay inspection visits to Tax and customs administration is widely cited factory premises. A case in point is India. Here, in South Asia as a major source of regulatory most laws that regulate the private sector are hassle. In Pakistan, tax and customs federal. However, their administration is mainly administration is the leading obstacle to a the responsibility of state governments, which conducive investment climate, and 60 percent have considerable discretion in enforcement. of business contact with government officials State inspectors are the chief enforcers through 31 Things have improved over time. The average number of inspections per year for the 2003 India-wide sample (7.4) represents an improvement over 2000 (11.7). 31 THE INVESTMENT CLIMATE IN SOUTH ASIA is because of visits by tax agents. In India, tax It is relatively easy to start a business in and customs issues are not as burdensome as Sri Lanka for firms in China, Brazil, and other countries Starting a business in Sri Lanka involves relatively little red tape. of South Asia, and in fact have improved Nearly 74 percent of urban manufacturing firms reported that obtaining a business license or operating permit was not a problem, during the past three years with fewer compared with 37 percent in India, 41 percent in China, and 51 inspections and fewer days to clear customs. percern in the Philippines. Less than 6 percent of urban manufacturing firms and 4 percent of rural nonfarm enterprises cited the procedure as it major or severe obstacle. An exception to the South Asian pattern of The administrative burden for start-ups in Sri Lanka has become heavy regulatory burden is Sri Lanka, where lighter only in recent years. In 2002, entrepreneurs wishing to businesses do not appear to suffer from these register a limited liabitity. company had to undertake eight procedures taking at least 73 days and costing $127, equivalent to problems. In sharp contrast with neighboring 15 percent of per capita gross national income (GNt). In the past countries, Sri Lanka has made big strides in year the process was simplified, reducing the number of procedures to seven, the average time to 50 days, and the cost to just under 11 reducing red tape, and it has improved the percent of GNI. Even so, Sri Lanka still trails behind more-dynamic governance framework to the point where it no East Asian economies in the time it takes to open a bUSiness. Further efficiency gains are likely, however, with the government longer poses a significant obstacle to doing planning to automate the company registry. business. Procedures for registering a new firm are simple-and, unusually, more than half of Corruption is endemic in Afghanistan and rural enterprises are registered. Today it is not adds to the uncertainty facing businesspeople. only easy to start a business (see box below), It is especially threatening to foreign investors but also relatively easy to run a business once or Afghans returning from overseas who do started. Less than 8 percent of all firms in Sri not have powerful patrons or understand the Lanka cited licensing and operating permits as system. In the 2005 Transparency a constraint to doing business. Less than 15 International Corruption Perception Index, percent complained of being constrained by Afghanistan ranks 117th, which places it tax administration, crime, customs regulations, among the world's most corrupt countries. or corruption. Nearly 58 percent of the sample covered by investment climate survey cited corruption as a Corruption major or severe problem, which ranks Corruption is a mqjor problem z'Jt ma~' S o14th Asia corruption just behind access to land and C014ntrieJ and can be traced to the diJcretionary potJler electricity. Afghan firms report that on average got!ernment ojficials. they pay an amount in bribes equivalent to more than 8 percent of sales, which is more Corruption is associated with a heavy regulatory than four times the average reported in burden although the latter has other costs as well. neighboring Pakistan. In addition, when Gathering reliable information on corruption is Afghan firms obtain a government contract, difficult, understandably, since firms may be they have to pay almost 8 percent of the reluctant to prov-ide detailed answers on contract value in bribes. unofficial payments. Corruption is particularly serious in Afghanistan, where it has recently Corruption is also a key issue in Bangladesh, shot up in the list of constraints cited by firms, which ranks the lowest (158th) on the 2005 and Bangladesh, where it has been a problem Transparency International Corruption for a while. Firms in India, Nepal, and Perception Index. More than half of all firms Pakistan also complain about corruption. Two in the sample reported that corruption was South Asian countries fare relatively better on either a major or very severe obstacle to their this front: Sri Lanka and Bhu tan. growth. The incidence of corruption varies 32 THE INVESTMENT CLIMATE IN SOUTH ASIA between agencies. The customs and tax Measures of perceived corruption from agencies top the list, both in the frequency with Transparency International show that Sri which firms reported making payments to Lanka has a much smaller problem of them and in the payments required. While a corruption than its South Asian neighbors, in relatively small number of firms reported keeping with its lower regulatory burden. making unofficial payments to the gas company Among urban firms in Sri Lanka, more than half for connections, the payments were very large, reported that corruption was no problem, averaging close to 100,000 taka for a compared with 21 percent in India. Around 11 connection.32 percent of rural enterprises that dealt with government agencies for registration, and 8 A high proportion of businesses in India find percent that dealt with agencies for licensing, corruption to be a major or severe obstacle to reported making unofficial payments. These business success. Corruption is often greater payments were equivalent to 5-6 percent of the where the system of regulation under which official licensing or registration fee. Rural businesses operate is complex, lending greater entrepreneurs also reported that laws and room for discretion to functionaries who deal regulations are occasionally misinterpreted or with enforcement. Individual government manipulated by officials as a result of a lack of officers seem to have too much discretion in knowledge among officials or because of ethnic, deciding which rules to enforce, on whom, social, or income biases. Thus, while less of a when, and sometimes, how. In many cases problem than in its South Asian neighbors, inspection visits are arbitrary or excessive, and corruption nevertheless exists in Sri Lanka. are viewed by business owners as punitive, or as a veiled demand for bribes. In Nepal, firms Bhutan contrasts starkly with its other report that corruption is pervasive and exists neighbors. The government is genuinely throughout the government. It is rampant in concerned with proper administration, and places where public officials have discretion to officials are seen as being honest and helpful. interpret unclear laws. Firms noted that the But Bhutan has reached a critical point where it introduction of new laws, such as the value could easily lose this advantage. Many added tax (VAT) and environmental laws, have important government decisions hav~ been created new opportunities for corruption. 33 made case by case, such as issuing a business Transparency International ranks Pakistan at license, determining allowable tax deductions, 144th rank on its 2005 Corruption Perception issuing permits for foreign workers, and Index. A third of firms in Pakistan reported approving applications for foreign direct having made unofficial payments. Tax and investment. Laws and regulations have not labor officials are far more likely than other been clearly publicized or consistently officials in the country to seek such payments. implemented. The discretion that the system 32 Obtaining a connection to a gas service is a rare event. Thus the small share of flrms reporting payments for connections probably reflects the fact that most Hrms in the sample already have connections, not that unoffIcial payments for connections are rare. 33 However, most Hrms report that for many services, the "corruption mechanism" operates smoothly. The level of the bribe is flXed; red tape and delays are minimal. As a result, flrms often consider the cost of corruption in a similar manner to a user fee imposed by the government. The difference is that corrupt offIcials the revenues instead of the government. 33 THE INVESTMENT CLIMATE IN SOUTH ASIA allows could open the door to corruption and judicial system to enforce their property rights certainly to the appearance of favoritism. in business disputes. Only 37 percent indicated While this system has served Bhutan that the interpretations of the rules were reasonably well, it will become a growing predictable or consistent. In Afghanistan, the obstacle as the economy expands. formal court system barely functions and suffers from a lack of qualified legal professionals, no method to hold judges E. Risk and Uncertainty accountable, and reportedly endemic Courts and the Justice System corruption. Entrepreneurs and other investors want Because of the deficiencies in the judicial assurances that contracts will be honored, that system, contract enforcement is a big problem disputes will be handled fairly and quickly by in most South Asian countries. Even in Sri the legal system, and that its decisions will be Lanka, despite the overall positive perception enforced. Thus a country's legal system can of the legal system, enforcement of contracts support investment-or seriously undermine still poses an obstacle to many businesses. Justice delqyed isjustice denied: South Asian jimu have While the number of procedures and the costs little faith in the judicia1Y and tend to ~ypaJ'S it. involved in resolving a contract dispute in Sri Lanka are comparable to those in OECD In most South Asian countries, businesses countries, the process takes more than twice as typically have little faith in the judiciary. An long. In Bhutan, while the legal code is exception is Sri Lanka, where more than half improving rapidly and many new laws have of rural nonfarm enterprises and urban been passed, Hnancial institutions still find it manufacturing firms reported that the legal difficult to enforce agreements or seize system was not a major constraint. By contrast, collateral. Laws may be adequate but are not in Bangladesh a third of the surveyed Hrms enforced. 34 reported that courts were never or seldom fair or honest. More strikingly, nearly 70 percent of It is thus common for South Asian businesses Hrms involved in legal cases in court in the to bypass the judicial system. In Bhutan, previous three years reported that the courts where courts are extremely slow or inefficient, were never or seldom quick. In India, only about 5 percent of Hrms in the survey although 75 percent of the firms were reported hiring a la\vyer or threatening to take conHdent that the legal system would uphold a client to court for nonpayment. In their property rights, 88 percent of Hrms Afghanistan, which lacks formal alternative responded that courts were "never," "seldom," dispute resolution mechanisms such as or only "sometimes" quick. Courts were also arbitration or mediation, businesses do not rely not ranked highly for their affordability, on the formal judicial system but on informal enforceability, and consistency. In Maldives, dispute resolution mechanisms. The approximately 40 percent of the Hrms surveyed investment climate survey also revealed that in indicated that they lacked confidence in the Afghanistan fewer than half the incidents of 34 Banks reported, for example, that passing checks with insufficient funds is a violation of the criminal code, but no one has ever tried to enforce the law. As a result, even government agencies are reluctant to take checks. Courts are extremely slow and inefficient, and seizing pledged assets of borrowers who default is extremely difficult. 34 THE INVESTMENT CLIMATE IN SOUTH ASIA crime or theft were reported to police and less significant characteristic of commercial than 30 percent of those reported were solved. systems in South Asia. In Nepal, firms do not normally use the court In Afghanistan, until recently, firms cited system or go to the police to solve poor security as the most important constraint disputes. They resolve conflicts by threatening to doing business. The investment climate to cut off relations with their customers either survey carried out in the summer of 2005 in the same business or in other businesses reveals a different picture, with insecurity through quid-pro-quo deals made with other figuring much lower in the list of complaints. firms. Most small firms are unable to collect It is counterintuitive that most managers in from their clients when they have a conflict and survey did not rank crime and disorder as a have to bear the losses themselves. major or severe constraint. But this result can A slow judiciary compounds cumbersome be explained. There have been real regulatory procedures to make exit difficult. In improvements in the security situation in the India, for example, bankruptcy procedures major cities covered by the survey. At the same involve outdated and ineffective laws that have time, eXlstlOg firms have developed led to large-scale inefficiencies in the system, mechanisms to cope with insecurity, though at often resulting in high costs of credit and high high cost. The surveyed firms reported accumulation of nonperforming assets. Recent spending 15 percent of sales for security estimates show that it is entirely common fur infrastructure, significantly more than did firms proceedings to take more than two years, and in neighboring countries. Many firms have more than 60 percent of liquidation cases formed close ties with powerful elements in before the High Courts have been in process society, including warlords and government for more than 10 years. According to the officials, to obtain protection in addition to World Bank's Doing Business indicators it resources. Security is thus a lesser concern for typically takes 10 years in India to close a them. However, new entrants and potential business compared to 1.5 years in OECD investors who do not have established contacts countries. There is also no proper formal and with powerful figures find the environment informal rehabilitation mechanism for much more daunting and are often discouraged financially troubled companies. Lack of formal from investing. and informal workout mechanisms leads to inefficient use of assets and usually to an In Pakistan, businesses report being exposed to crime, ranging from petty theft to organized increase in the cost of lending or winding-up violence. One in three managers is concerned process. about extortion or intimidation of the company's employees, a somewhat higher Security percentage is concerned about arson, and more Security is an actual problem in some South Asian than three-quarters theft. One in five countrie.r; it is looming in others. respondents reports that its business was the target of at least one crime during 2000-2002. Although security is not cited as a leading The share is highest in NWFP, where one in concern for private sector firms in South Asia, three businesses report having been victimized it represents a real cost burden and a deficiency by crime. In response, businesses in NWFP because of the need for firms to provide in- spend 4.5 percent of their revenue on security, house security services. Though considered with firms in Sindh and Punjab spending 1-2 longer-term objectives, security concerns are a 35 THE INVESTMENT CLIMATE Ir~ SOUTH ASIA percent. In Nepal, security was not cited as a more uniform, and average tariff levels are major concern in the 2000 survey, but it is coming down. In particular, the process of trade clearly a bigger headache now. liberalization in India and Sri Lanka has been critical in fostering the restructuring of the export In contrast, in India law enforcement and base from primary products to manufacturing. crime seemed to be low on the list of priorities There do remain some concerns on the part of for private firms. In Sri Lanka, only 14 business in particular countries. In Pakistan, percent of urban firms identified crime, theft, some binding import restrictions remain and and disorder as major constraints while rural exports have stagnated relative to those of enterprises, apart from those in the north and neighboring countries, raising questions regarding east, for the most part did not face law and international competitiveness. Firms in Nepal order problems. cited negative effective protection for manufacturing and a general bias toward trading F. Trade over manufacturing in the trade regime as severe obstacles to business. In Afghanistan, External trade regimes that foster competition, manufacturers argued that the tariff structure is efficient import substitution, and production for such that they often pay more duty on imported export playa key role in supporting a country's inputs than traders do on imports of the finished investment climate. Import competition, access goods. Bangladesh's average tariffs remained to globally traded goods, and a neutral incentives higher than those in many other developing regime promote higher factor productivity and countries in Asia. improved competitiveness. In addition, with globalization many countries of the South Asia Illegal trade is also a problem. For example, region are seeking to integrate into production Afghan manufacturing firms complain about chains led by large multinational firms, which the unfair competition from smaller informal themselves seek firms that are able to compete firms that can smuggle goods into the country on a global level. and do not pay taxes. In Nepal, many firms are concerned about the lax enforcement of The extent to which firms may reap the benefits customs, which encourages smuggling of international trade depends on a number of operations by traders. factors including, in particular, the nature of the trade policy regime, trade-related infrastructure (especially port infrastructure), and customs Customs Administration administration. Port-related infrastructure has Onerous customs clearance procedures are one been discussed above. This section discusses of the most commonly cited problems in South trade policy issues and customs administration. Asia. However, as mentioned in chapter one, the experience of firms with customs and trade Trade Policy regulations also varies widely within South Asia. In Afghanistan, Bangladesh, and Pakistan Much has been accomplished in South Asia in customs procedures are a serious problem, with recent years \V'ith regard to the tariff regime. more than 30 percent of firms citing them as a Most nontariff barriers have been removed, tariff major constraint on doing business. At the rates across stages of production have become 35 This result is consistent with the ranking of these countries on the Doing Business Indicator on Trading Across Borders. Afghanistan, Bangladesh, and Pakistan rank respectively at the 125th, 123rd, and 103rd position 011 this indicator. 36 THE INVESTMENT ClIrl-1ATE IN SOUTH ASIA other end of the spectrum are Bhutan and continue to use wide discretion on the Nepal, where less than 5 percent of all surveyed valuation and inspection procedures, which firms cited the clearance process as a major leads to corruption and delays. Customs concern. 3" procedures in Afghanistan are significantly slower than among its neighbors, which further In Bangladesh, 43 percent of firms involved in erode the competitiveness of products. trading identified customs and trade On average it took firms nearly 10 days to clear regulations as a major constraint (which exports last year and about 11 days to clear represents the sixth most important constraint imports. for Bangladesh) Firms reported that it took on average 11 days to claim imports from customs. Two countries fare better. Maldives requires The World Bank Document Doing Btlsiness fewer documents (12 for importing), fewer reports that a firm needs 16 documents and 38 signatures (four for importing), and shorter signatures to import a good. In Afghanistan, processing time for both exporting and 39 percent of firms identified customs and importing than do most countries in South trade regulations as a major constraint (which Asia and compared to other small-island represents the sixth major constraint for economies and the OECD countries. It is Afghan firms). It takes on average 11 days to ranked at the 52nd position by Doing claim imports from customs. Pakistan needs Business Indicator on Trading across Borders 12 documents and 15 signatures to import. and is the best-performing South Asian country on this front. Broadly speaking, Sri The average shipment of imported inputs Lanka's ports and customs are more efficient 17 days to pass through customs in Pakistan, than those of some of its competitors. In a 11 in Bangladesh, 7 in India/7 and 7 in China. World Economic Forum survey of port quality, Delays on imports are greater than those on Sri Lanka's ports outperformed of but export delays hurt firms more. China, India, and the Philippines, though they buyers with many suppliers to choose ranked below those of Malaysia and Thailand. from put a premium on reliable delivery. The relatively high efficiency of Sri Lanka's Delays m customs can mean that a ports is due in part to reforms that introduced consignment literally mIsses the boat, competition in the Colombo port in the mid- jeopardizing the export contract. In 19905 by allowing the private sector to build Afghanistan, importing reqUlres 10 and operate a new terminal, the South Asia documents and 57 separate signatures. Gateway Terminal. The rankings of port Businesses reported that customs officials 36 The apparent discrepancy between the TCA data on "percent of ftrms that trade customs and trade regulations as a major constraint" and the Doing Business Indicator on Across Borders has several potential explanations. The and Bhutan TCA surveys asked the question on constraint differently than the other surveys: these surveys asked mms to assess whether the "import regime" (and not customs and trade regulations) is one of the three main constraints. In addition, the Bhutan survey was undertaken in 2000 and the Nepal survey in 2001. The Doing Business data are from 2005. 37 Clearing customs has shown improvements over time: the average number of days needed for a shipment of inputs to clear customs was 10.3 days in 2000. For small businesses in low-tech industries in lYh,lmbai, this ftgure fell from 16.5 in the 2000 to 13.6 in 2003. Similar changes were reported for "maximum delays" in customs clearance. In international LUllll."ll"'.lVC terms, India's national average for customs clearance dropped below China's in 2003. 37 THE INVESTMENT CLIMATE IN ASIA quality are broadly consistent with the results under-invoicing, custom officials do not use of investment climate surveys that show that the actual invoice value, but rather a "reference clearing imports through ports and customs value"); (iv) difficulties with the duty drawback takes 3.5 days in Sri Lanka. However, port scheme (delays and rigidity of the scheme); (v) tariffs remain high, resulting in burdensome lack of enforcement; and (vi) smuggling (which shipping costs, and moves per hour could be creates unfair competition). significantly increased (Sri Lankan ports average 25 moves per hour, compared with 100 Trade Facilitation Services in Singapore). Sri Lanka is ranked 92nd on the Doing Btlsimss Indicator on Trading across Lack of trade facilitation services is another Borders. important constraint. Afghan exporters, for example, identified the lack of trade finance, Typically, South Asian firms face the following insurance, and lack of cold storage and other problems in clearing goods through customs: storage infrastructure, along with inefficient (i) procedural delays and red tape (clearing customs and clearance procedures, as the customs is a time-consuming process); (ii) biggest impediments to increasing exports. inaccurate classification of goods (the tariff Moreover, no independent agencies ensure rates on some imported goods can vary based standards or certify quality. The high cost of on how the good is classified under the shipping is another impediment to trade in different headings of the harmonized codes, Afghanistan. Responsibility for inspecting which provide opportunities for arbitrary shipments beyond the border is not delineated decisions, delays, and corruption); (iii) among different agencies, causing shippers inaccurate valuation of goods (for fear of delays and raising costs. 38 THE it~VESTfv~ElvT CliMATE IN SOUTH ASIA Chapter 3 THE COSTS OF A DEFICIENT INVESTMENT CLIMATE Power problems impose real costs on firms; thry lower The use of generators to deal with unreliable production and tie up scarce capital. power supply ties up scarce capital. In India, Pakistan, and Sri Lanka, tied-up capital Inadequate and poor-quality electricity supply represents 11-12 percent of fixed assets for imposes real costs on firms, seriously businesses that run generators. This is one constraining business operations and growth. reason Pakistani firms use more capital but Power disruptions often cause damage to produce less output than Chinese firms. The materials in process-materials that cannot be heavy reliance on generators in Bangladesh used when power is restored and production means that the reported losses seriously resumes. Power disruptions also damage understate the true costs of the poorly equipment, adding maintenance and repair costs performing electricity grid. Generators are that are directly attributable to the outages. costly to buy and run. In Bangladesh, while Revenues are forgone because of the power from the grid costs about four taka per downtime forced by outages. The typical kilowatt-hour, it costs more than six taka per business in Pakistan estimates that it loses kilowatt-hour for businesses to use their own about 5 percent of annual sales to power generators. In some countries, the relative cost outages. For Bangladesh, regression results of generators is higher. show that, even when industry and firm Poor transportation creates marketing problems and characteristics are controlled for, sales and often leads to spoilage investment both suffer as the number of power disruptions increases. Firms reported Poor transportation has its costs. For rural losing more than 3 percent of production on firms in Sri Lanka, the poor quality of roads average as a result of problems in the and lack of transport services create electricity grid. The problem is worse in marketing problems and raise transport costs, India, where the average manufacturer loses reducing productivity. Urban firms report 8.4 percent a year in sales, and extreme in losing 7 percent of sales due to transport Afghanistan where 18 percent of problems. Slow speeds spoil 40 percent of merchandise value is lost because of power agricultural produce before it reaches market. disruptions (30 percent in the city of In Afghanistan, firms reported losing 5 Kandahar). The figure is less than 2 percent percent of their domestic merchandise value for the average manufacturer in China or during transit because of breakage or spoilage Brazil. In Sri Lanka, lack of reliable and losing only 0.6 percent to theft. The electricity reduces the productivity of urban proportions are not much different for manufacturing firms by almost half, while international shipments from Afghanistan: among rural firms the productivity of those 4.6 percent (breakage or spoilage) and 0.9 without connections to the grid is 25 percent percent (theft). Firms rarely receive any lower than those with connections. compensation for such losses; only 2 percent 39 THE INVESTMErH CLIMATE I~J SOUTH ASIA said they were ever compensated by the air transport is among the main obstacles to transport operators. 3~ penetrating markets beyond India and developing service industries (such as In Pakistan, most urban centers of industrial information technology) and niche export concentration are located far from the coast. markets (such as fresh mushrooms). Thus, high transport costs lower competitiveness of most firms. Dependence Poor acceH to Jinance limits gro1J/fh opportunities. on a poorly maintained and thin road network With inadequate access to external finance, as the primary mode of transport only adds to firms have limited opportunities for growth. this cost. High freight handling costs at the Reliance on their own funds limits ports of Karachi and Qasim-estimated to be specialization, adoption of better technology, several times higher than those of comparable growth in productivity, and thus economic ports in region-also raise the cost of growth and development. For example, Pakistani goods. W A recent review of trade in regression exercises show that in Bangladesh, selected commodities estimates that Pakistan with better access to formal credit grow could save up to 16.5 percent of the value of more quickly than firms that rely more on exports by improving its trade and transport retained earnings, even after controlling for logistics systems. Inefficiency in transport firm and industry characteristics. In Maldives, alone is estimated to cost the economy Rs. 320 poor access to finance is associated with low billion a year. In Bhutan, the high costs and labor productivity, while cost of finance is a poor reliability of road transport make it significant negative determinant of labor almost impossible for industries heavily productivity and investment rates. In Sri dependent on transport to be competitive except in border areas. 40 Lanka, empirical analysis for rural firms indicates that greater access to informal finance The waits at the port can also be costly to and location in communities with more firms. Bangladesh, regression analysis efficient financial sectors (as measured by the controlling for industry and firm characteristics time taken to clear a check) are associated with suggests that each day that exports are delayed higher productivity. in customs is associated with a 0.3 percentage Regulatory hassles add to the cost f!l doing busineH. point reduction in investment and a 0.2 percentage point reduction in sales and In Bangladesh, firms about 17 visits a employment growth. In Bhutan, deficiencies year from all government agencies. The most in airline transport affect the ability of frequent visits come from the customs agency companies to ship raw materials and finished (7.5 a year) and the tax agency (2.7). Dealing products a timely way. High-cost, unreliable with these visits can be costly, not only in fees 38 In Nepal, a ftrm in the beverage industry indicated that the ftrm incurs losses of 2 to 3 percent as a result of breakage in bottles when they are transported to and from retail outlets. Similarly, a carpet manufacturer in Kathmandu reports that because of the poor quality of the local the ftrm has to repair one of its vehicles every week and spends Rs.100,OOO per year on maintenance. 39 One estimate puts these costs at 1.5 times those in Bombay and 4.5 those in Colombo. 40 The road network can make a great difference in their ability to compete. Firms that are competitive in the border areas (because they export to India) might not be competitive in the center of the country. Most enterprises import raw materials from India, send ftnished products to that country, or borh. As a result, the road network creates a big cosr disadvantage for producing goods anywhere except the border. 40 THE INVESTMErff CLlfv1A"fE IN SOUTH ASLA and payments but also in the resources firms business locations across Indian clt1es. Cities must expend to satisfy inspections. 41 In where firms in general face lower regulatory Pakistan, firms reported spending 10 percent burdens are likely to more investment of management time dealing with government and have higher shares of manufacturing officials. Businesses in Pakistan receive an activity. average of 36 inspection visits per year, also Inj7exible labor markets add to costs and discourage above levels in Bangladesh or India. Slightly atfjustments-but they do not necessarify help the poor. more than 60 of the contact that businesses in Pakistan have with government Firms in Sri Lanka try to avoid restrictive officials is with of the Central Board of labor regulations by hiring temporary workers, Revenue, the responsible for assessing but this practice has its costs: survey results and collecting all inland revenue and customs show that productivity falls with an increase in duties. Forty percent of small businesses and the share of temporary workers in a firm's more than 70 percent of large businesses in the employment. In addition, workers are paid a survey sample claimed to have been audited by salary that takes into account the high costs of tax authorities at least once within the previous retrenchment. As a result, Sri Lankan workers three years. are paid much less than at the same skill level in other parts of South Asia, despite The number of inspections and vIslts by the country's relatively high per capita GDP. oHicials imposes a financial and nonfinancial Besides, contrary to public opinion, TEWA (time) cost on managers, and dampens firms' does not protect the poor, since they work performance. Regression analysis for mainly in the informal sector and as casual Bangladesh shows that the number of laborers in agriculture or on plantations and are inspections per employee has a significant not covered by the law. negative correlation with investment and productivity. Similar for India also In Nepal, restrictive labor laws have caused show that the time that management spends on many older firms to be overstaffed and unable addressing regulations is associated to reorganize by hiring people with skills that "\\dth business profitability, thereby having an better match their current needs. have adverse effect on location of economic activity. devised many ways to overcome these In many cases inspection visits are arbitrary or restrictions, including adopting capital- excessive, and business owners view them as intensive production methods, casual punitive or as a veiled demand for bribes. But labor, subcontracting their production, or firms often pay up because the costs of not splitting their production between various sites doing so can be high. Inspections may be more (to reduce the risk of labor disputes spreading). frequent or more intrusive, leading to All these raise costs and lower productivity. disruptions to production plans or loss of valuable staff time. Regulations and Excess regulation of industrial relations is a corruption are important determinants of major drag on the international 41 Managers reported spending 5 percent of their time on average dealing with regulatory matters. With a reported average compensation for managers of around 1 million taka, the management cost alone amounts to close to 50,000 taka annually. More than a third of firms facilitators to help with regulatory issues, at an average annual cost of more than 600,000 taka. 41 THE INVESTfvlENT CLIMATE IN SOUTH ASIA competitiveness of many of India's labor- industry has already adjusted itself beyond the intensive industries. Labor market rigidity has reach of the law through its choice of lines of not only kept the growth rate of exports low, actiVity and scales of operation. The but may also account for the "shockingly low" respondents to the India investment climate share of formal-sector employment in India's survey indicated that, on average, their staffing economy. Only 8.5 percent of India's labor levels exceeded the desired levels by 11 force, or 27 million people, are in formal-sector percent. 42 This proportion compares with 19 employment, of whom 70 percent work for percent for China, suggesting that India's government agencies. industrial labor market could be significantly more flexible than China's in allowing firms to Labor market restrictions also reinforce exit adjust their workforce to changes in market barriers. For example, the Industrial Disputes conditions. However, India's labor market also Act of 1947 requires establishments with more seems to be far less flexible than Brazil's on the than 100 workers to secure state government same criterion. permission before plant closure or a retrenchment of workers. This permission is The usefulness of labor market flexibility is rarely granted, thus adding to protracted borne out by experience in Bangladesh. insolvency procedures. Labor regulations, Regressions controlling for industry and firm including but not limited to the Industrial characteristics show that the share of a Disputes Act, also reduce the flexibility of company's labor that is temporary (rather than firms to respond to changes in market permanent) is positively correlated with sales conditions. The Industrial Employment Act and employment growth. That is, firms that has made it difficult for businesses to shift can adjust their staffing levels more quickly workers not only between plants and locations, seem to grow more quickly.43 but also between different jobs in the same Training raisesprodtlctivity; 'yet, most firms do not plant. Indian labor laws firms significantly imJest in training. less control over their hiring and firing decisions than China's labor code provides. In Sri Lanka, firms whose managers hold a tertiary or professional degree tend to be more It is interesting then that only about 17 percent productive. A manager's prior experience in of the Indian sample identified labor regulation exporting firms also raises productivity. The as an impediment to growth, which is survey also shows that the type of training comparable to the percentage reported for matters: external training increases a firm's Chinese businesses but much smaller than that productivity, while formal in-house training for Brazil. This could mean much of Indian 42 Not all the overstaffing is to be involuntary on the part of firms. Employers normally retain workers in excess of current needs if anticipate an upturn in their sales in the near future and if the combined cost of training that would be involved in adjusting manpower through the market to a particular of the business exceeds the cost of retaining some workers at wages exceeding their marginal product. Indeed, more than 60 percent of respondents who reported overstaffing at the time of the survey cited anticipated growth in demand as a reason for their decision to retain workers in excess of their current needs. However, there is also clear indication that a substantial part of the reported overstaftlng has been forced on employers by existing labor laws as shown by the fact that 29 percent of overstaffed businesses cite labor laws to be the reason ther at(· retaining more workers than they need. 43 However, causality here is difficult: it mal' be that firms hire temporary labor because they are so quickly, not that firms grow more quickly because use temporary labor. 42 does not. In Bangladesh, regression analysis their workforce, this has come with a price. shows that firms that ran training programs or Both employees and employers are deprived of sent employees to outside training programs the benefits of stable and longer-term saw higher sales growth, profitability, and employment relationships, such as the constant investment. upgrading of skills needed to remain competitive. Heavy reliance on temporary However, only 26 percent of Sri Lankan firms employment undermines the incentives of benefit from external training. In Bhutan, workers and firms to participate in, or sponsor, although they complained about lack of skills, on-the-job skill formation. Thus, although a virtually no firms reported undertaking any far higher proportion of Pakistan firms reports significant staff training (only 3 percent of skill shortages, only 15 percent of them firms' employees had received training in the 12 sponsor on-the-job training. This is very low, months preceding the survey).44 Most firms in even by developing country standards. This Nepal provide little training, preferring to hire low proportion is particularly worrisome already trained workers or to rely on because with low average levels of schooling, technologies that do not demand highly skilled on-the-job training is important for alleviating workers. In Pakistan, while the high skill shortages. proportion of "temporary" workers may have given businesses greater flexibility to adjust 44 Contrary to firms did not cite labor turnover as an important reason for not extending formal training to workers. Large enterprises and those based in Colombo are much more likely than others to offer formal, external training. For managers and public institutes are the primary sources of external while for skilled workers institutes and industry associations are the main sources. Firms that use outside rated private institutes as more effective than public institutes or industry associations. 43 THE iNVESTMENT CUMfi.TE iN SOUTH Chapter 4 WHAT TO DO? POLICY RECOMMENDATIONS The previous chapters suggest a strong Bangladesh has sufficient energy resources relationship between the investment climate in (mainly natural gas) that can be converted into South Asian countries and their economIC electricity more competitively than many of its performance. Based on the theoretically sound neighbors and peers can generate. But this and empirically supported relationship between a requires reforming the power sector. In India, good investment climate on one hand and higher the enactment of the Electricity Act (2003) is a productivity and firm growth on the other, positive development, but much more policies and programs that address the constraints needs to be done to make the enabling legal analyzed by the ICAs can achieve potentially and structural environment work. In Sri Lanka, significant gains (see box below). This chapter although the Electricity Reform Act 2002 provides a rich flavor of the recommendations provides for the restructuring of the Ceylon contained in the various ICAs.45 Electricity Board and Lanka Electricity Company, implementation of these reforms Gains from improvlngthe.ib.'JllJmeot t;Umate has been pending since October 2003."6 A • 1JIIooi~..iH$ estimated than }O P6l:CflIltagllJ!Qirtt r,ed!lclio~lIIjndiOators regulatory agency, the Public Utilities of..ooftclencyinpower supply. IIIX and ClI~oma .ad!Jlin~f$tI!ln•. and imllro.ve6 faGtM mad(~ts will lead Iii) all joot:ease lnfimHew/ Commission, has been established and staffed Ilfodlil;tiliitYandsales .growth faiellaf 1~ Il&fG.!lrltand41 percent, and it has prepared licenses and regulations; !llSp~. '. . .,... '.' ." ". • hI PalIj~tlle IC4elltlma,es .t"""lng IlpPa~~lIll's indiPaiQrs in however, to date it has no legal mandate to lIlfrastful:t~rll; el)S!omS,lIlld finance to tltQS6 ill Cbilluift raise sales and emlllQYmllnt gro.wtl1b18.5 /lnd3.1perc~ ,\lintS, respectively. regulate the power sector. • In l!rjtanlm..for riwl firms.havil)ga«:ed$talll1d using eilldricity from tlte gtidIs allSQIliaJel:! with· total f$mfpro.ducti);lty (lfP) 25 percent These are just three examples of an issue that flIQllerlhiJn that QffirrnsllOlllOflilettell to 1Jl!! grid, ~Ing llP!)!)ne or ~flatcess to, fIlll~!!lIlt Iil!ll1lCial ..selVitlel! .is~ciated wltll a. is a regional challenge. In general, radical and higher'i'I'P .~. 33cpercent anq 6 per~nt. r!l$Pe5l1vely.Qn the Oth9( systematic restructuring of the power sector is hand, jIOOf r~liII~ttyr,edUCed the l\I\IeI (lITFP by 44Pareallt . needed in most South Asian countries in order to reduce inefficiencies in the public sector and encourage private investment. As indicated in A. Infrastructure the leAs and as summarized below (see box), Power this restructuring will require work in a number Some South Asian countries have an advantage of areas (see also box on power sector reforms that their neighbors do not. For example, in Pakistan, below). The relevance, relative 45 This chapter does not discuss trade policy. A rich set of recommendations for trade policy reforms in South Asia is in World Bank, South Asia Region PREM; Trade Po/ides in South Aria: An 0lJeniew, 2004. 46 The objective of the proposed reforms to introduce competition and managerial focus. The Ceylon Electricity Board is to be restructured into a holding company with the following subsidiaries: one generation company, one transmission company (and single buyer), and two or more distribution companies. The current government (elected November 2005) has made a commitment to implement rhe reform and has tabled amendments to the Electricity Reform Act in Parliament. 44 THE lNVESTMENT CLIMATE jN SOUTH ASjt~ Power sector reforms for South Asia: Illustrative examples Define a vision and strategy • Further clarify the government's vision of the power sector, including Its strategy regarding tariffs, investments, and private sector participation (Afghanistan). • Develop a rural energy strategy to bring electricity to rural areas (in Afghanistan, in the medium term). Invest in the power sector • Invest in transmission and distribution systems to improve the quality and reliability of the power supply (Sri lanka). • Minimize delays in implementing a plan for expanding least-cost generation capacity (Sri lanka). Improve sector and public enterprise governance • Reduce transmission and distribution losses arising from theft and leakages (India). • Commercialize the sector and strengthen its financial and operational performance; phase out capital and operation subsidies to reduce the sector's fiscal burden (Sri lanka). Restructure public sector entities • Undertake financial restructuring (Bangladesh). • Corporatize the power utility, Da Afghanistan Breshna Moassesa; strengthen its managerial, technical, and financial capacity; and restructure it in the form of regional business units (Afghanistan). • Undertake organizational and financial reform of the state electricity boards (India). Carry out tariff reforms • Rationalize power tariffs, depotitlcize tariff setting, and implement a phased reduction in cross-subsidies that operate against Industrial customers (India). • Embark on a relatively ambitious power tariff reform program (Afghanistan in the medium term as the quality of power supply is improved and the power network is expanded) • Introduce transparent and efficient subsidy mechanisms to help expand access to electricity in rural areas (Sri lanka). Establish a good regulatory framework • Introduce independent regulation (Bangladesh). • Establish truly independent, teChnically competent, and fully professional state-level electricity regulatory commissions (India). • Provide open access toSEB grids (India). • Enable the Public Utilities Commission to implement sector regulations, especially the tariff regulations aimed at achieving cost recovery (Sri lanka). Phase in competition and private entry • Attract private sector involvement in utility operations to help improve efficiency (Sri lanka). Develop alternative energy sources • Prepare a policy to promote the development of small-scale distributed renewable energy in rufalareas (Sri Lanka) • Promote renewable energy sources SUCh as solar, hydro, biomass, and wind as part of the national energy strategy (Sri lanka). Power sector reforms in Pakistan Pakistan needs to .invest heavilyindislributionand transmission capacity, buttbatlnvestment will not bfl forthcolllirlgWith9Ut ~ s~ssful restructuri[l!J of '!fie Water and Power{)evelopmenl Authority,a~1 opening oBbe sector to privjltecapftill, .an'.raS$igl1l1!ent0t~st!Jnificant role for the market jtrtariff~termiflatiOn; Reform of the pOWer sector must open dlsfributiOn andtransmmskmbuslpesstlS;¥weltas ijeneratiOl'l, to private .capltal. '. There isa~d tQ~en'gth~thegovernment's policy (I6Velwmenland lmp!ementatiQR tlI!Pacity. ·$.UOO.~OfltlS.!1ave been on '. the governlT!&nt's agenda fOr ~.on1lltlme; what seflrnslacking Isthe political c()mmitmenUo .' . 'Som~ important reformsJlaVe taken place. sueltaslt}epriVafgmio/l of t~e Karachi ElectriC Supply Corpora .... ...... '.' . .U\I}Jtlooam~ goa! ofimpr~Vfrl:fl~ffipitmcYin,~e$8Qtf)f.. However,llW{8.needs tribe(lQne,Th~prial!ofcolltlfWeti . ;~ .Il()t .. j!tni~ tolf)~s.in industri~tprgdl,ll:ti\fjty:f8l1~te.c.ou1d also create another. fiscal. cris/s,ool/en by the. fl~n(;iflg tle~s of a' DII'Il.:PitOffJllliflfjslatej,oWlJed utilities;' . .' . .... c. 45 THE INVESTMENT CliMATE IN SOUTH ASIA priorities, pacing, and sequencing of the ferry goods and passengers into and around various measures are not the same across the Bhutan. countries, and the various countries indicated in parentheses are to illustrate a point rather Telecommunications than to say that a particular point is most The public sector will continue to play an important for that country or only to that important role, especially in providing country. line services in many South Asian countries and of course, in regulating the sector. Hence, Transport strengthening the public sector entities is an important item in the reform agenda. The An important agenda is reducing the state's role Bangladesh ICA, for example, recommended in transport or at least ensuring a level playing the corporatization of the Bangladesh field. For Afghanistan, where private transport Telegraph and Telephone Board (BTTB) into a companies (both freight and passenger) have public limited company, with professional expanded rapidly since the end of the conflict, management and a more independent board of the ICA expressed concern about the possible directors. In Afghanistan, where the public distorting effects of the state's involvement as sector telecom company, Afghan Tel, had an operator in the sector. It said, for example, recently been corporatized, the ICA argued for "though the government has licensed a number its strengthening. of private airlines, any government favoritism to Ariana (the state-ol1med airline COlJlPatry) will While it is important to strengthen the public undoubtedly impede the development of sector entities, there are limits to how much can private airlines and competition in the air be achieved through public sector reforms. For transport sector. II Bangladesh, the ICA notes that while the proposed corporatization of BTTB will Some countries face unique challenges. For improve the company's operational flexibility, it example, Bhutan's physical characteristics pose may not fully isolate the company from such a constraint on road transport that the political influence. That suggests a need to country faces a choice between investing consider privatization for the medium term. heavily in roads and focusing the development International experience over the past t\VO of transport-dependent industries solely in the decades has proved the importance of border areas. Choosing the second option competitive markets and broad private would mean that only niche industries relying participation for successful expansion of little on transport could be profitably telecommunications services. That lesson has developed in the center of the country. In the been borne out in Bangladesh and in other short to medium term, while industries relying South Asian countries, where private heavily on transport are likely to be profitably investment has driven the rapid expansion of developed only along the border with India, the mobile phones. development plan for the center of Bhutan will probably need to focus on niche-type industries The next challenge IS to attract private with less need for cheap, reliable transport. At investment into fixed-line telephony while the same time, there is need to think II outside continuing to improve the environment, the box," such as using private charter airlines especially the regulatory environment, for from India and Nepal to bring tourists into private investment in mobile telephony. The Bhutan and developing helicopter services to Pakistan ICA, for example, talks about: the need 46 THE INVESTMENT CliMATE iN SOUTH ASIA for an adequate regulatory framework for the a proven track record, making it harder for telecom sector, including licensing regime and banks to assess their creditworthiness. radio frequency management, to generate Increase competition. Encouraging competition private sector investment. The Afghanistan and innovation would help improve the cost leA recommends the strengthening of the and efficiency of banking services. Lack of regulator, the Telecommunications Regulatory competition as well as innovation and creativity Authority. reduces market orientation in the banking system. The two are linked. Thus, increasing B. Factors of Production competition for depositor funds and lending Finance opportunities is likely to be the best way to promote innovation, creativity, and market Although South Asian countries have made orientation. In small, underdeveloped banking important strides in developing their financial systems the most competition often systems, in most countries the system still falls comes from nonbank sources-such as leasing far short of what the private sector needs to companies, insurance companies, venture become internationally competitive. The capital, and private debt instruments (see financial systems' weaknesses will become even below). more evident as the private sector grows and especially as foreign investors enter and local Introduce a wider range of products. An example of firms attempt to break into world markets. The a new product is leasing, a potentially powerful leAs recommend a set of actions to promote yet relatively simple financial service that is access to finance. These are the following: increasingly offered in the developing world. Leasing has several important advantages for ImprOl)e credit information. Establishing credit SMEs. Most important, the leased equipment information bureaus, or expanding them to (such as a vehicle or machinery) belongs to the incorporate positive information and smaller finance company throughout the lease period, firms, could go a long way toward reducing so repossession in the case of nonpayment is information asymmetries and thus lowering the simple and requires no long legal process. risk premia applied to small borrowers. In this ' Indeed, the leased equipment usually forms the context higher interest rates do not necessarily collateral for the transaction, doing away with indicate market failure, but they may reflect the need for the "borrower" to provide large greater risks or costs. Banks often charge amounts of security.47 In many countries higher interest rates from smaller firms for a leasing companies have provided not only variety of reasons: (i) small firms have a higher important new financial instruments but also turnover rate than larger firms, making them effective competition for commercial banks. In riskier to lend to; (ii) given the fixed overhead Maldives, the government has supported costs per loan, the smaller size of loans creation of a leasing finance and a housing extended to smaller firms also makes lending to finance institution, which has somewhat them less profitable for banks; and (iii) small deepened the market. 48 firms also often have less collateral and less of 47 These two advantages are particularly powerful in environments such as Bhutan's. 48 With the entry of the .Maldives Finance Leasing Company C:V1FLC) in 2002, have access to medium- and long- term equipment finance for various economic sectors, This was one of the government's initiatives to strengthen and introduce more sophistication and depth into the financial sector. 47 THE INVESTMENT CLIMATE IN SOUTH ASIA Develop private debt markets and intercompatry a drawn-out process that requires government borrowing. Another potentially effective way to persistence and strong political will. increase competition for banks is to develop private debt markets, allowing companies with Labor Market and Skillft9 sound financials to issue their own debt in the The Sri Lankan government has taken some domestic market. Like a government debt early steps to increase flexibility in the labor market, a private debt market provides funding market, though the effects have yet to become directly to an enterprise without channeling apparent. Some stroke-of-the pen reforms can funds through the banking system. be accomplished quickly if the government has Commercial banks receive fewer deposits as a the political will to do so. These measures result (reducing excess liquidity). Furthermore, include reducing mandated severance payments because the intermediation mechanism in line with international best practice and squeezes interest margins more effectively than abolishing the need to obtain approval of the intermediation through a commercial bank, commissioner of labor every time a company savers benefit through higher rates while seeks to fire an employee. The procedures for borrowers benefit through lower ones. worker separation can also be streamlined. Reduce discrimination against small plqyers. Policies Pakistan has embarked on some labor market or practices that discriminate against small reforms. At the federal level, the government firms should be tackled. A relatively simple but is revising the labor code to increase flexibility effective step would be to develop credit rating in the labor market and lower the cost of agencies to help firms build records of their employer compliance. The reforms are credit histories in order to break the cycle of expected to improve considerably the flexibility not being able to obtain credit because they of hours as well as the rigidity of hiring. The have no record of having handled it well in the available number of hours for workers, past. particularly for females, will be increased. Term limits for contracts will also be Improve the legal !)stem. Successfully making lengthened. At provincial levels, enforcement finance available for firms requires an effective of the new legislation will be enhanced through legal and regulatory framework that instills more professional and less intrusive inspection confidence in the rights of lenders and methods. Labor disputes, clogged in the high borrowers and facilitates efficient and verifiable courts at the appellate level, will find a new financial transactions. Improving and appeal venue in the Labor Appellate Tribunal. streamlining the laws governing the corporate However, Pakistan can do more. It can remove sector and enhancing the effectiveness and the requirements to retrain or replace workers efficiency of an enforcement mechanism for before a dismissal. Severance pay, currently creditors' rights (including the judicial system) one month per year of service, can be cut to at would help improve access to capital and least be in line with more flexible regional probably also lower its cost. Further, benchmarks; for example, Bangladesh and improving the legal system would also facilitate India require only a half-month's severance per trade by encouraging firms to extend more year of service. trade credit. Legal and regulatory reforms are 49 The section on labor regulations is largely based on World Bank, Doing Business in South Asia in 2006. 48 THE INVESTMENT CLIMATE iN SOUTH ASIA India needs to simplify regulations, with special ActtORSfoJllljJfO.jlbOtttlaikjffl~J.i"i1itfi. emphasis on improving industrial relations, ·SouUtASia . smoothening dispute resolutions, and removing ambiguity. It also needs to reduce the rigidities in labor markets. Specifically, four main reforms are needed: (i) consolidating and simplifymg labor laws from the current 47 laws to about 4 covering the main areas of dispute resolution, conditions of work and welfare, wages and benefits, and social security; (li) modernizing the Industrial Disputes Act to reduce the bias toward adjudication in disputes and to increase flexibility for employers in hiring and firing in a way that also protects workers' rights; (iii) resolving ambiguities concerning the Contract Labor (Regulation and Abolition) Act to introduce greater flexibility; and (iv) improving the labor law enforcement and inspection system. Regarding the shortage of skilled labor, South Asian countries will need a better supply of educated workers as they to move up the technological ladder and diversify into new economic sectors. In Bangladesh, despite significant progress in enrollment ratios over the Technology past decade, illiteracy remains relatively high: at As discussed in chapter two, South Asian firms 58 percent, the rate is higher than that in any of face many difficulties in searching for, acquiring, the comparator countries in East and South Asia and absorbing technology. These countries thus and slightly higher than the average for low- need to improve the efficiency of technology income countries (46 percent). Bhutan needs to transfer mechanisms. This effort would include recognize the considerable advantages offered by programs to increase direct foreign investment, the country's ready access to a large pool of make work permits for expatriate experts easier skilled, experienced, and relatively low-cost to obtain, raise the level of manager and worker workers in India. Mandating reductions in the training, improve firms' access to technical use of non-national labor is an ineffective way to consultancy services, and assist managers to visit promote the private sector or to generate the suppliers and buyers. employment for which Bhutanese are most suited. Instead, policies should focus on C. Regulatory Burden and Corruption increasing the productivity of Bhutanese workers through a mix of management training, worker A variety of initiatives are needed to reduce the training, and technology transfer. regulatory burden and address the problem of corruption: In reforming its labor markets, South Asian countries can look to other countries for Improve investment facilitation services. In guidance box). Afghanistan, the Afghanistan Investment Support Agency has helped many investors 49 THE INVESTME~iT negotiate the regulatory maze without paying Asia but one that needs to be addressed as a bribes, but this function is still limited in scope. priority. This is a multidimensional agenda, For Nepal, the ICA identified the need to including more and better training for tax improve the working of the one window officials, improvements to the system for service. Suggested actions include first limiting resolving tax disputes, and improvements to its scope and sharpening its focus to deal with customs administration (see box). The a limited group, such as exporters in Pakistan ICA listed reforms of the inspection Kathmandu, and then expanding its scope to regime of the Central Board of Revenue as a include other types of firms and extending its priority to reduce the overall regulatory burden reach outside Kathmandu. In all countries, an on industry. important implementation issue is to foster A1ake exit easier. Reducing barriers is an coordination of all ministries in making the important agenda, particularly in India. one window service operate effectively. Bankruptcy procedures take much longer in Simplify regulations. There are many short-term India than in countries whose regulatory opportunities for streamlining regulations, environment is otherwise not much different eliminating unnecessary ones, and reducing the from India's. barriers in India's industries scope for informal payments. Procedures for are strongly reinforced by the excessive the entry of new firms could be simplified, for regulation of industrial relations (Industrial example, reducing unnecessary costs and delays Disputes Act of 1947). Very little progress has and encouraging informal firms to enhance been made at amending any part of the law at their legal status and thus improve their access the federal or state levels, probably because of to finance. The benefits of simplifying the constraints imposed by electoral politics. regulations are evident from the Indian Implement broader public administration riforms. At experience, where the cost to industry of entry the end of the day, many fundamental reforms and exit regulation has come down will be required in public administration. This considerably as a result of policy reforms is exemplified by the case of Bangladesh, where implemented since 1991. Early reforms the ICA argued that "broader public included the removal of a policy reserving administration reform will be required to create certain industries for the public sector and the a new governance framework, which includes abolition of licensing requirements for private rationalizing cadres and revising the skill mix investment in many industries. However, the while introducing better compensation long-standing policy of reserving many labor- packages and performance-based salaries." intensive industries to small-scale operators has yet to end. It also takes significantly longer in India to obtain approval for a new business D. Risk and Uncertainty than in comparable economies. The Pakistan Policy Predictability ICA recommended decreasing the discretion of inspectors and tax collectors and moving to I t is important to make policies predictable and greater automation of processes to help speed easy to understand. Access to clear and concise procedures and reduce unnecessary regulatory policy information could also playa crucial role. hassles and corruption. For Nepal, the ICA argued for stability in tariff rates and currency regulations so that firms Improve the tax administration. Improving the tax could effectively plan and said that changes administration is a major challenge in South should be made with adequate notice and 50 THE INVESTMENT CLIMATE IN SOUTH ASIA consultation. Business aCtlvlt1es in a country lower its cost. For Nepal, the ICA argued for such as Nepal are already risky and uncertain, strengthening the court and legal system so that and there is no reason that government actions contracts can be adequately enforced at· a should add to the level of uncertainty. reasonable cost. In India, the company law is being amended to establish a bankruptcy Judicial Reforms tribunal. Reforms undertaken in Maldives and Sri Lanka provide additional examples of what All South Asian countries need to strengthen can be done (see box below). their judicial system. The Bangladesh ICA, for example, recommended the forceful pursuit of the Supreme Court's mandate to ensure separation of powers between the executive and the judiciary, arguing that this separation would do much to lessen corruption and delays in the lower courts. It also recommended decentralizing the lower judiciary, simplifying procedures, and introducing effective mechanisms to ensure transparency and accountability. Afghanistan needs to develop an effective judicial system that enforces decisions and helps resolve disputes so that recourse to informal means of dispute resolution is reduced, which is particularly important in the current context where investors often fall back on the informal connections and relationships to help settle Security disputes. In Bhutan, improving and In Pakistan, tackling the law-and-order streamlining the legal system would help problem quickly and decisively is essential for improve access to capital and probably also boosting investor confidence. Doing so 51 THE INVESTMENT CLIMATE IN SOUTH ASIA requires reforming enforcement institutions. administration of the courts by streamlining The government has already initiated some recordkeeping, traInIng judges, and measures, such as the Police Act of 2002. The disseminating information. However, progress act provides for more democratic control over in implementing both police and judicial the police and their insulation from political reforms remains slow. Urgent and aggressive interference. The government has also action is required to persuade investors that initiated grassroots reforms in the judicial enough is being done to restore law and order. system, with the aim of improving the 52 THE INVESTMHJT CLIMATE IN SOUTH ASIA ANNEX: COUNTRY PROFILES (South Asia) AFGHANISTAN Summary of Enterprise Survey Indicators Small MedIum large Arghanlstaln (1-111 (»99 (100+ SOuthAsia ~ IImp1oy_> ~) IImploy_) Infrastructure Indicators % of Firms Identifying Tf1lI'ISpOftatIo as a Major 28.6 j(}.6 25.6 28.6 1S.8 11•.6 Constraint % of Firms Identifying Eledlicity as a Major 64.6 60.8 71.7 57.1 39.3 34.8 Constraint Oa:ys/Yf!ilf of Insuffldent Water Supply 3M 35.4 28.4 J3.3 8.0 23.9 Delays In ObtaIning Electricity Connec:tlons 43.9 3!U 50.6 38.2 55.2 39.7 (Days/Year) Delays in Obtaining Telephone Connec:tlOns 30.5 35.9 28.2 11.0 65.0 54.8 (DaysfYear) Finance Indicators % of firms Identifying Access to FIII~ as a 56.2 56.8 56.7 5O.(J 28.1 35.5 MajOr COnstraint % of Firms identifying Cost of Finance as a 56.8 55.6 6J.l 44.4 34.6 +1.1 Major Constraint % of Investments Financed by Internal Funds 78.6 66.7 61.S 68.8 53.1 63.9 % of Invesl:mef1ts financed by Banks 0.2 24.0 (J.(J 0.0 18.0 16.5 % of Investments financed by leasing 0.1 21.0 3.1 1.2 2.9 1.1 % of ill' of Contract) % of Firms flfeslS'or,als (as % of Total 14.0 18.7 1M 10.1 13.5 23.7 of which: % Female 2.1 2.8 1.9 0.4 2.5 4.1 Noo-production W~rs (as % of Total 31.5 25.3 35.5 36.1 15.7 12.8 of which: % Female 17.6 25.0 14.2 14.0 13.6 18.9 21.7 26.8 16.3 21.0 31.5 34.1 6.6 9.0 6.1 2.0 25.4 1'1.0 Production Workers (as % of Total 32.8 29.3 36.9 31.8 28.7 26.3 of wh 1Ch: % Fentale 19.0 as 26.1 16.0 26.0 20.6 hllp:,~1rru.lvorldb<1l1k. org/EnterpliseSurverS ES Country Profile: BHUTAN 2001 57 % of Firms Resolving Disputes through Court 21.4 12.5 8.3 5(1,{) 3.0 9.2 Action Innovation and Technology Indicators % of Firms Undertaking Innovation 58.S 43.6 68.8 68.2 79.3 72.6 % of Firms Acquiring Technological 100.0 10{)'o 100.(} 100.0 3"1.9 53.1 InllOvations by Purchasing New Mi!chil\t!ry or %cit Firms USing E'mail to Interact with 76.3 70.6 68,(} 95'; 62.1 49,9 BuyerS/Suppliers/Customers % of Firms Using Website to Interact with 18.8 23.5 12,(1 19.1 26.7 26.1 Buyers/SuPplIerS/Customers Trade Indicators % of Firms That Trade Identifying Customs 8< 8.3 5.0 5.3 11.1 28.3 28.9 Trade Regulations as a Major Constraint Days on Average to Claim Imports From 4.7 (/,(} 8.5 8.0 Customs http//fTI,J,wolldl:>ank,org/Enterpr ise5ufvevs E,) Country Profile: BHUTAN 200] 58 THE INVESTMENT CLIMATE IN SOUTH ASIA INDIA Summary of Enterprise Survey Indicators Small Medium urge Inc&a (1-19 (20H99 (~ Finns Identifying Tl1Insport;ttion as a Major Constraint 0/0 of Firms Identifying E\e(:trldty as a MaJor 28.9 ZlI.l 31.0 29.0 383 34.8 Constraint Days/year of Power Outages 154.1 159.5 157.6 111.8 90.9 52.6 % of Sales Lost tc Power OUtages 8.2 8.6 8.4 4.7 5.4 4.6 Days/Year of InsuffiCient Water Supply 24.7 26.7 25.8 9.1 lo.a 24.0 Delays in Obtaining Electricity Connections 67.7 6s.J 73.4 72.5 55.2 39.7 (Days/Year) Delays in Obtaining Telephone Connections 63.3 70.1 51.8 49.9 65.0 54.8 (Days/Year) Finance Indicators % of Firms Identifying Access to Finance as a 18.2 J1.8 20.6 14.3 28.1 35.5 Major Constraint % of Finns Identifying Cost of Finana! as II Major 20.0 19.1 21.5 17.6 34.6 +1.1 Constl1llnt % financing by Banks, Working capital 42.1 6!iA 76.9 83.4 NA NA % financing by Banks 8. OAs. Term loans 56.pfesef'tt av~s 01 responding lirms that are not conSidered to be ollttiers, Outliers are defiflOO as firms with ""lves greater than the _ pillS 3 times the stIlIndlird deviation or Ie$$ than the mea... minus J limes the standard devlatoon for that partlCuiar indK:ato<. Reqlonal lind ,n(ome group indicators are calculated as _ages of (ountty·level IndlClltorS In the respectM! reqlon and income groups. EX Coufllrl' Pmfile' INDIA 2(J(}3 60 THE iNVESTMENT CLilV1iUE IN SOUTH /\S!!~ MALDIVES Summary of Enterprise Survey Indicators Small Medium large Maldives (1-19 (20-99 (100+ South Asia Identifying Electricity ~s ~ Major 21A 22.2 25.0 12.0 383 19.6 1.8 0.8 2.8 2.4 75.1 73.3 IUa'f5/Y'e"r of Insuffident Water Supply 3.4 3.8 2.9 0.0 8.0 89.4 Finance Indicators % of Firms Identifying Access to Finance as a Major 69.3 66.7 69.8 72.2 28.1 26A Constraint % of Firms IdentIfying Cost of Finance as a Major 66.7 58.0 725 70.3 34.6 33.2 Constraint % of Investments Financed by Inte~1 Funds 64.3 65.2 72.2 52.3 53.1 63.9 % of Investments Financed by Bcnks 22.7 13.9 19.5 37.0 18.0 165 % of Investments Financed by leasing 4.3 3.9 7.7 0.0 2.9 1.1 % of Investments Financed by Informal Sources 1.0 2.4 0.0 0.7 5.2 4.7 % of Investments Financed by Trade Credits 2.2 5.0 0.6 1.4 1.9 1.6 % of Investments financed by Other Sources 5.5 9.7 0.0 8.6 18.8 12.3 % of Firms With Bank Loans/Overdraft Accounts 43,2 38.2 33.3 64.1 48.7 22.5 Value of Collateral (% of loan Value) 126.6 88.8 JJ?.l 81.3 108.9 143.4 Labor Market Indicators % of Firms Identifying Labor Regulations as a Major 25.9 20.8 30.8 26.3 16.4 14.6 on straint % of Firms Identifylng Labor Skill Level as a Major 43.5 30.9 50.0 52.6 16.5 17.4 onstraint % of Firms Offering Formal Training 66.3 48.6 78.0 76.5 26.9 55.9 % of Skilled Workers Offered Formal Training 62.5 79.0 58.9 52.1 33.2 26.0 Managers/Professionals (as % of Total Workforce) 20.2 27.9 13.3 19.1 13.5 26,1 of which: % Female lOA 3.7 9.9 26.7 2.5 1.7 killed Production Workers (as % of Total Work· 46.3 43.8 4?.2 48.8 31.5 40.6 force) of which: % Femak! 16.2 11.4 19.8 17.8 25.4 12.5 nskilled Production Workefs (as % of Total Work- 35.7 29.3 40.8 37.7 28.7 22.7 orcel of which: % Female 12.0 ll.? 9.4 9.4 26.0 19.1 ES Country Prt~file: MALDIVES 2005 61 THE INVESTMENT CLIMATE IN SOUTH ASIA as a Major COnstraint Identifying Oime, Theft and Disorder as 26.1 20.8 40.4 13.5 22.6 24.1 COnstraint with Overdue Payments from 9.7 8.4 1.6 19.8 16.2 58.4 26.8 27.0 33.3 .20.0 3.0 20.1 Innovation and Technology Indicators % ti Firms Undertaking Innovation 58.8 49./ 70.4 56.4 19.3 70.1 % of Arms lden!:ifvlng Foreign COmpetition as 42.9 25.0 57.1 50.0 35.8 ImPQftant Inliuence in lowering Production Costs or DevelopIng Products % of Firms Identifying Domestic Competition as 19.0 67.6 85.7 83.9 63.3 Impoltant Influence In lowering Production Costs or Developing Products % of Firms Acquiring Technologl<:allnnovations by 90.9 66.7 100.0 few oils 34.9 63.7 n:haslng New Machiner; or Equipment Firms Acquiring Technologlcallnnovatiorls by 16.0 13.3 19.2 11.1 13.4 B.B Hirinq Kev Personnel % of Firms Acquiring Tech nologicallnnovatklns by 4.0 6.7 3.8 0.0 5.0 2A LiceIlsinq % ti FIrmS Acquiring TechnoIogiaIl Innovations by 18.0 20.0 11.5 33.3 30A 11.6 Developing Internal or with Others % of Arms Acquiring Technologl<:al In novatiOns by 22.0 20.0 19.2 33.3 16.4 7.6 OIh.... W/tv. % of Firms Using E--mall to Interact with 97.1 94.3 97.3 100.0 62.1 58.2 Buyer$fSuppliet$/CUsto/l1et'S % of FInns Using Website to Interact with 68.9 51.4 73.0 83.9 26.7 +1.4 Buyers{SuppliersfCUstomet'S Trade Indicators Days on Average to Oalm Imports From CUstoms 0.0 0.0 0.0 0.0 0.0 0.0 % of FIrmS That ImpOrt Directly 0.0 0.0 0.0 OJ) 0.0 0.0 % of Inputs WhIdI Firms Import Directly Z5.0 57.1 50.0 35.8 % ti Arms Expected to GIve Gifts to Obtain Import 0.0 0.0 0.0 0.0 0.0 0.0 licenses ES Country Profile: .MALDiVES 2005 62 THE INVESTMENT CLIMATE IN SOUTH ASIA NEPAL Summary of Enterprise Survey Indicators small Medium t..'trtIe Nepal (1-19 (20-99 (100+ South AU % of Firms ldentll'ying Electricity 11$ d Firms Ex\leded 1:0 GIve Gifts to Obtain 1m- NA NA NA IVA 9,4 16.9 port lJcenSle$ IIt1m; ~ lndIcatoo; of Sales) 06 0,4 09 0,9 08 1,5 lOSl!ieS due to Clime (% of sales} OS as os 0.6 0,) 0.4 Innovation and Technology Indicators R&D Expeo(jitum; ('II> of sales) 0.0 0.1 0.0 0.0 0.5 U % of Films Acquiring Technologk:i!\1 Inno\(atIons by 54.2 46.9 48.2 5(;'9 30.5 !lto Purcnaslng New Machinery 01 Equipment % d FIrms Acquiring TechnologiCal Inno\(lOOns by 1.2 9.4 6.4 78 H.S 97 Hmog Key Persol)nel % of FIm'IS Acquiring TechllOlogltallnnovllOOns by 3.9 9.4 S.l 2.1 S2 2.6 UWliing % of FIrms Acquiring Technological Innovations by IS.6 25.0 11.1 16.1 331 24.6 OeW'Ioplng InI:emlIl or wll:l1 Others % of Firms Acquiring TecMo!ogicallMovaOOns by 16.2 9,4 18,4 17,{J 16.4 12.1 Other Ways % 01 Arms USing E-mail to Interact witt1 68.2 17.8 55,6 84.S 5tH 61.3 ~SuppfierslCustomers % oIl'lrms Using Website to llll:etlKt with 29.3 JU 14.6 41.2 29,7 43,) lluyers;SupPliets/Customers Trade Indicators % of Arms That Trade Identifying CUstoms & 16.5 15.4 15.3 17.8 28.0 25A Trade Regulations as a Major Constraint Days on Average to Claim Imports from CUstoms 3.6 0,0 4.1 J,4 8.7 6.9 OIlY'S on Average to Clear Customs for Exports 3.1 2.8 .l..1 3.6 6.2 4.1 % of Ftrms That Import Directly 42.6 4,4 25.8 59.4 34.1 35.5 % 01 Arms Expected to Give Gifts to Obtain 1m· 18.8 (J.O 2]./ 11.8 16.1 12.$ port I.ia!nses Note; Country-level indicators denotJll9 percentage 01 firms use as denominators tile number of firms for which data for tile m;pedlve question Is available. Country-leltel IndIQtors dend:ing quantiles (i.e. the number of days, percentage 01 saies, percentage 0I1o.1n value, etc.) represent ~ of respooding firms \hat ale not consldefed to Ill! outliers. Outliers are defined as firms wltll vaIlIes greater than tile mean plus ) limes the standard deviation or less than the mean minus 3 times the ~ deviation for the!: partlcula: iI'ldlCator. ~ and Inmme gtOIJI) ~s are c:aIcuIeted lIS ~ of country-lew!! ,ndk:lltors in the ~ regiOn and income groups. 1::.....' Country Profile. SRI LANKA 1004 68 THE CLIMATE IN SOUTH ASIA COUNTRY PROFILES (Comparator Countries) BRAZIL Summary of Investment Climate Indicators Small Medium Large ti . Lower amil (1-49 (so.149 (250+ La n Amenca Middle Constraint % of Firms Identifying Electricity as a Major 20,3 20S /9./ 2:1S 25.6 19.6 Constraint Days/year of Power Outages 3.5 3/1 3.7 3.7 11.7 16.9 % of Sales lost to Power Outages 2.5 2.7 2.3 2J 3.9 4.5 Days/year of Insufficient Water Supply 0.7 OJ OJ 02 13.4 13,9 Delays in Obtaining EIec:triCity Connections 20,6 20.0 2G.6 22,4 25.6 25.0 (DaysJYear) Delays in Obtaining Water Connections (Days/Year) 10,7 9.8 10,6 16.8 39.S 30.2 Delays in Obtaining Telephone Connections 12,6 12.8 13.:1 8.3 64,S 3],S (Days/Year) I Finance Indicators % of Firms Identifying Access to Finance as a 59.5 61.0 59.7 51.1 43,9 26.4 Major COn straint % of Firms Identifying Cost of Finance as a Major 82,3 82.9 82.3 79.4 53,6 33,2 Constraint % of Investments Financed by Internal Funds 56.3 59.0 54.7 49.6 54,5 &1.0 % of Investments Rnanced by Banks 14.3 HO 14.2 15.2 22.9 15.6 % of Investments Financed by leasing 3,1 2,0 4.:1 4.4 1.7 1.7 % of Investments Financed by Informal Sources 2,3 3.2 1.S O.S 5,1 5.7 % at Investments FInanced by Trade Credits 8.7 10.7 6.7 6.9 8.2 3.7 % of Investments Rnanced by other Sources 15,) 11.1 18.7 23.'1 7.7 8.7 % of FIrms with Bank Loa ns/Overdr of Arms 1"hat Trade kIentifyIng Customs ,. 45,,2 41,2 49..1 41.8 25.2 22.7 Tr.tde ResluIIItlons as it Major Constraint Days on Average to ClaIm Imports From CUIltoms 1VI /1.3 11.2 no 8.3 6.4 Days on Average to Oe¥ customs for Exports 7.8 1.9 0,:/ 6.9 3.4 3.7 'II> of Firms 1"hat Import 0Ir«t1y 15.1 f).a 21.6 44.4 37.1 37,4 % of Firms Expeded to GiYe GIfts to Obtain 1m. S.O 3.7 6.8 Z,6 7.7 \6.0 port I.icenses NtJt.e; ~ indic:ators denoting JlC!I'Q!ntaIIe of fimls use as denornIIlators tile number of ftmI$ for which data for tile respective avallebk!- CounI:ry-leveI indic:ators ckmoting quantities (I.e. tile number 01 elm. peIO!I'ItIge 01 sales. percentage of loan QUI:lSlIOll 15 Vltlue. etc,) ~ iIVII1IgIlS of respondiftg firms tMt ani IIOt CIlIISi!:feI'ed to be outJiI!B. OUtliers alt! defined as firm5 with values flmlIter tNn tile me;m plus 1 timeS tile standard deYIidloo or Ie$$ tNn tile me/Nl minus 1 times tile staIIdanI deYiIIiaIl for that 1IIdIcator. RegIonal and inCome group indicators lilt! talculBted as ~ d OlUntIy-hM!I indicators In tile respedlve It!gIon and In<:tlme groups. hrtp://l1u. worfdbank. org/lnV('stmefltClimak Ie'S COUIIl", Profile: BRAZIL 2003 70 THE INVESTMENT CLIMATE iN SOUTH ASIA CHINA Summary of Investment Climate Indicators Small Medium large Lower China (:1.-4$1 {50-249 (250+ Ea. Alia Middle E'mpIoyeeI) Em"~} Emplov-) • Pacific Income Infrastructure Indicators % of Firms Identifying TransllOl'llltion as a Major 19.1 15.0 15.6 25.8 15.4 9.9 Constraint % of Arms Identifying Electricity as a MajOr 29.7 26..1 293 32.5 24.5 19.6 Constraint Days/Yeaf of Power Outages 4.9 4.3 5.6 4.8 4.5 16.9 % of sales Lost to Power Outages 1.9 2.1 2.1 LS 4.0 4.S Delays In Obtaining Electricity Confli!d:lons 10.4 7.4 7.3 J4.8 9.0 25.0 (Days/Year) Delays in Obtaining Telephone Connections 6.0 6.0 6.2 5.9 9.4 37.S (Dilys/Year) Finance Indicators % of Firms Identifying Access to Finance as a 22.S lU, 20.5 29.0 15.3 26.4 Major Constraint % of Firms Identifying Cost of finance as a Major 21.8 18.1 17.7 28.8 20.5 33.2 Constraint % of Investments Financed bV Internal Fund!; 15.2 14.4 1(H 15.2 33.8 64.0 % of Investments financed bV Banks 20.4 12.4 1~3 31.1 B.2 lS.6 % of Investments Financed bV leasing n.iI a.a n.a n.it 1.3 1.7 % of Investments Financed bV Informal SOUrces 7.7 10.8 8.2 3.5 17.4 5.7 % of Investments A naneed bV Trade Credits 1.0 1.0 OJ 1.S 3.3 3.7 % of Investments Fioanced by Other Sources 55.6 6104 55.4 48.7 3],2 9.3 % of FII'mS with Bank LoansjCNerdraft Accounts 23.3 10.1 23.3 39.4 19.6 22,5 Value of COllateral ('Yo of Loan Value) 80.S 8.3.8 81.6 78.9 76.3 143.4 labor Market Indicators % of Firms Identifying labor RegulatiOns as a 20.7 15.S 20.J 25.1 19.3 14.6 Major Constraint % of Rrms ldentifylng labor Sldll Level as a Major 30.7 28.8 3J.4 31.4 11.0 17.4 Con$traint % of firms Offering Formal Training 84,8 82.0 85,1 81:5 38.2 55.9 % of Skilled Workefs Offered Formal Training 47.7 47.0 48.6 47.2 46.2 25.5 Managel's/Professlonals (as % of Total World'orce) 59.2 $9.8 58.0 60.1 33.4 26.1 Non-productIOn Workers {as % of Total Workforce} 9.2 11.9 7.5 7.9 9.4 10.7 Skilled ProductiOn Workers (as % of Total Work· force) 3.9 3.0 4.1 4.8 34.0 40.6 Unsk!Ued ProductiOn Workers (!IS % of Total Work· force) 27.7 15.3 3tH 27.2 23.2 22.7 http://rru.worldbank:org/investmentOimate lCS Country Profile: CHINA lOO} 71 THE INVESTMENT IN SOUTH ConstRlint UIlOffltial Payments to Get Things Done (% of 1.9 2.5 Ui 1.7 2,] B sales) % of AmIs Expected to Give Gifts in Meetings with 38] 41,9 37.0 3$,0 29.9 23.1 Tax Inspectors % of Firms Expected to Give Gifts to Regi5tef Their 7.6 6] 8.3 8.0 7.6 7.6 Business % ot Arms Expected to Give Gifts to Obtain Import 16.9 17.9 20.(5 14.3 13.8 16.0 licen5e'S % Senior M;magernent TIme Oeafing with 19.6 20.7 19.3 18,5 1l.2 83 Government RegulationS Tune Spent 10 Tax Inspection Meeti!lgs (DarilYearJ 12.0 10.7 123 13.4 5,8 3.8 Courts and Crime Indicators % of FIrms ldentlf\llng Crime, Theft and 0Is0tder as 20.0 24.4 19.4 17.5 27.4 24,1 II Major ConstraInt % of rlmlS with OVerdue Payments from 73.4 71.9 75.3 72.5 66.5 58.4 Buyers,(Supplier.i/Customers % of Arms Resolving Disputes through Court 21.7 11.8 22,0 ]4.(5 11.0 213 Action % of Firms with Confidence in Legal System to 82,5 82.3 83,3 81,6 61,7 55.6 Enforce ~ RighI!; In Disputes Costs of Security (% of Sales) 0,5 0,6 0.5 0.5 4,5 1.6 Losses due to Crime (% of Sales) 0,1 0.1 0.1 0.1 0] U Innovation and Technologv Indicators • , % d I'irm$ Undertakillg Innovation 47.7 33.2 5112 62.4 73.1 70.1 R&D Expenditures {'II, d sales} 25 2.0 2.8 2.6 3.0 0.9 % of Arms Aajuiring Some Tedmoioglcallnno- 43.0 26.3 37.3 53.7 65.4 7O,] vatIoos by P\lrcha5ing New Machlnery or Equipment % d FIrmS Acquiring Some TechnologkallllllO- 15.1 7(J J78 J5.6 43.9 21.0 lliltions by Hiring Key Pet:sonnel % of Firms Acquiring Some TechnoIogkaI Inno- 67.0 56.1 64.9 72.7 72,1 37.S wtions by Developing Internallv or with others % of Firms USing Internet to Communicate for 47.7 37.2 50-I 57.5 47.0 62.9 BuSiness I't.Irposes % d firms Whose Employees Use iI PC Regularly 38.0 46.2 .kif 30.0 25.1 22.3 Trade Indicators % oIAm1s That Trade IdenlfVlll9 Customs &. 29.7 Z5.0 25.0 34.1 2],; 22.7 Trade Regulations as II Malor Constraint Gays 011 Average to Claim ImportS From Customs ],6 9.0 8.0 6..$ 6.S 64 Gays 011 Average to Clear Customs for Exports 6.2 7.4 67 4.9 5.0 3.7 % of FfflM That Import 2L7 9.2 :H9 37.2 35,0 5'1,7 % d F'1ml$ Expected to GNe Gifts to Obtain 1m- 16,9 17.9 10,6 }4,) 13.8 16.0 port Lil:en5e'S 1IItJtlI: COIJfItry-level itIdkators denoting pen;entllge of firms use /IS denomiMtors the number of firms for whICh data for the question is available. COIJfItry-ie'ie1 indiCators denoting qlJlllltities (i.e. the lIumber 01 days, pertefltage of sales, pel'c:enJtagtn value, etc.) represent _ages of responding firms that are not considered to be OIIt1iers. Outfiers are defined /IS FImlS witI'! IIiIlUes greater than the mean plus 3 time5 the standard de'IIiatlon or less than the mean minus 3 times the standard devetion for ttlat partiCUlal Indkator. Regionlli and il\Q)me group indicators are c:alculilted /IS _ages of CQIJ{Itty-1eltei indkators In the respecti\le region and mcome !JfllUP$. http://rru,worldtJank.org/investmentClimate ICS County), Profile: CHINA 2003 72 fHE iN SOUTH ASI", INDONESIA Summary of Investment Climate Indicators Small Medium I.!Irge East A$ia .. Lower Indonesia (1-49 (50-249 (250+ PIIdfic Middle employees> employees) employ_l Income Infrastructure Indicators % of Arms Identifying Transportation as a Major Constraint 16.4 1!L2 15.6 18.3 15.4 10.11 % of Firms Identifying Electricity as a Major Constraint 22.3 11.5 25.4 29.B 24.5 19.5 % of F'rms Identifying Telecommunications as a Major Constraint 9.1 4.5 12.7 10.3 11.8 9.4 Days of Power Outages 3.5 3,7 3.4 3.4 4,3 9.9 % of ~Ies Lost to Power Outages 3.3 3,4 3.7 2.8 3.1 3.3 Delavs in Obtaining Electridty Connections (Days) 12.2 11.7 11.4 13.5 9.0 19.0 Delays in Obtaining Water Connections (Days) 11.4 8.5 14.7 11.4 7.9 25.3 Delays in Obtaining Telephone Con nedions (Days) 19.2 17.7 10.8 21.0 9.3 31.9 Finance Indicators % of Firms Identifying Access to Finance as a Major Constraint 17.5 16.0 16.6 19.5 15.3 28.1 % of Investments Financed by internal Funds 41.9 38,4 36.7 49.4 33.9 66.1 % of investments Financed by Informal Sources 24.5 43.3 22.S 10.1 23.0 4.9 0", of Investments Financed by Trade Credit 2.8 3.1 1.9 3.2 3.1 4.7 % of Investments financed by Commercial Banks 16.3 8.0 9.8 29.1 8.9 12,4 % of Investments financed by Leasing VI 1.1 2.9 3.1 1.2 V % of Investments Ananced by Other Sources 12.1 6.1 26.1 5.1 29.9 9.3 % of Firms with Bank LoanS/Overdraft Accounts 19.2 6.6 26.3 25,6 2:0.2 22.9 Value of Collater;sl (~ of loan Value) 116,3 92.9 142.S 107.5 77.1 123.6 labor Market Indicators 0/. of FIrms Identifying labor Regulations as a Major Constraint 25.9 11.9 29.S 35.5 19.3 16,0 ~ of Arms Offering Forma! Training 23.8 $,2 27,9 38.5 46.5 48.0 Managers/Professionals (as % of Total 5.1 9.4 8,4 4.8 12.3 18.3 Workforce) of which: % Female 15.0 14.7 16.4 14.0 21.3 10.0 Non-production Wor1