Thursday, October 22, 2009

Direct Investment, the Balance of Payments, and the International Investment Position

It’s no secret that capital has been leaving the country, even as the trade balance generates a continuous surplus. Breaking down the financial account of the balance of payments (BOP), here’s what Malaysia has experienced over the past ten years or so (1999-2008, RM Millions):

While FDI has been increasing, it doesn’t even begin to cover outward investment or the (negative) “other” investment. Portfolio investment has ebbed and flowed depending on the vagaries of the stock market, except for last year with a flight to safety from all emerging markets prompting a sell down of equities and other assets in favour of (paradoxically) USD assets. That spike has partially reversed in 2009.

The cumulative numbers are staggering: negative RM156.6 billion in outward direct investment, RM257.0 billion in other investment, and RM52.8 billion in portfolio investment, for a total outflow as at end of 2008 of RM 466.5 billion.

That’s right, nearly half a trillion Ringgit, or half of current M3.

The question is: is this outward flow occurring because foreigners are abandoning Malaysia as an investment destination, or is this Malaysian companies investing abroad? The former is downright bad for obvious reasons, while the latter is only somewhat good as it can be counterbalanced by subsequent inward income flows. Anecdotal evidence favours the latter, as there’s plenty of news of domestic corporations making big bets on other emerging markets – such as Maybank in Indonesia, and Maxis in India.

However, there is an inherent flaw in using BOP data to figure out where investment is actually going, because it is a flow measurement, not a stock measurement. With BOP data, we’re completely ignoring the possibility of reinvestment of profits and earnings. This doesn’t turn up in financial flows, and it’s difficult to judge private sector investment attitudes towards Malaysia based on BOP data alone.

It is more than possible that the outward flow of investment is due not only to Malaysian firms investing overseas, but also to foreign-owned firms redirecting investment overseas from retained profits generated locally. That in itself is not great news, but it’s certainly more palatable than foreign firms pulling up stakes and leaving. What we need is to get a view of foreign and domestic holdings of investment stock, not just flows as in the BOP, to get a better idea of what’s going on.

Luckily, we do actually have such a report – the International Investment Position. This is a relatively new set of statistical information (as such things go), and data availability is still very patchy for many countries. Malaysia’s for instance, only goes back to 2001 and was first published in 2005. Prior to the IIP, figuring out a country’s investment stock position (more commonly known as the net foreign asset position) was a matter of guesstimation and to be honest it still is, even with the IIP – you’re depending on accurate reporting to compile the statistics and there are many offshore money centers, some with dubious legal enforcement.

Be that as it may, the IIP makes for interesting reading. I’ve posted on Malaysia’s net foreign asset position, and the IIP (with some discrepancies) confirms the notion that Malaysia is now a net creditor nation (RM Millions):

Since we’re at the moment interested in the direct investment position, here’s both the asset and liabilities side (RM millions):

External Direct Investment Assets

External Direct Investment Liabilities

So we are primarily looking at Malaysians investing abroad, with a very small pullback in foreign inward investment in 2008, which is understandable given economic conditions over the past two years. The numbers don’t quite reconcile with the BOP data, mainly due to slightly different categorization as well as the element of reinvested earnings involved.

And of course, the net portfolio position is still sharply negative (RM millions):

But on the whole, we’re in a better than decent position here (assuming the positive IIP holds). Even though investment and capital are leaving the country, this is counterbalanced by an increase in future potential earnings from abroad, as well as less pressure to keep reserves high. This also puts upward pressure on the exchange rate.

Technical Notes
1. BOP data from BNM's Monthly Statistical Bulletin
2. The International Investment Position Reports available from DOS


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  3. Dear Sir,
    Thanks once again for devoting your time to answer my query. I had to summarize my earlier comments so that its easy to follow (getting a long winded comment can sometimes drive a blogger up the wall :)
    I humbly feel there is an element missing which is the Income portion on the Balance of Payments (BOP). Perhaps this short example would illustrate my understanding of the scenario.
    Year 1:
    (i)Intel Penang sells $100 of Pentium V. Intel keeps the money in Penang. Assume 0 imports, (the silicon was made using our fine Golden sand, it was cut and assembled all in Penang)
    (ii) WNPOC (Petronas Sudan) makes a profit of $100. Petronas keeps the money in Sudan.

    Is this how the BOP should look like.
    Current Account
    Xports = +100
    Imports = 0
    ---> Intel_____ = -100
    ---> Petronas__ = +100
    Financial Account
    -->Outflows = -100 (Petronas)
    -->Inflows = +100 (Penang)
    Change in Reserves = Sum everything
    = Net Current Account + Net Financial Account
    =Change in BNM Reserves

    Would appreciate if you could clarify up to this point.
    Thanks, its always a deep honour to be able to interact with intellectuals and professionals like yourself, and a welcome change from the Zero sum game played out on our national discourse

    Hidup KJ

  4. Ah, I see the problem you're having. The BOP only records actual cross-border transactions. You can read the manual (under revision) here. LOL, no I haven't read it either!

    I do know however that BNM collects its BOP data from fx transaction reports through the commercial banks. Net errors and ommissions reconciles the change in reserves with the data actually collected. Since we have a negative figure for net errors, money is probably still leaving the country unrecorded (probably in suitcases to Singapore, I shouldn't wonder).

    Under your example, the only transaction recorded under the BOP would be X=+100 (adding it to income amounts to double-counting).

    Since Intel and Petronas have both retained their profits in-country, their income is not recorded in the BOP (it hasn't crossed borders yet), but is recorded in the IIP as +100 in external liabilities under "equity capital and retained earnings" in both Malaysia and Sudan. That is, assuming Sudan actually collects IIP data!

    Change in reserves would be =< 100, because BNM might not fully sterilise the inflow, which could be another factor in raising net errors and omissions.

    Reconciling the BOP and IIP goes something like this:

    net Income account less employee compensation (BOP) + net Financial account (BOP) = - change in net IIP

    Does this help?

  5. Thanks sir, I learnt a lot from this discourse. I am very grateful to you for taking the time to explain.

  6. "288. Reinvested (undistributed) earnings of branches and other unincorporated direct investment enterprises and direct investors’ shares of earnings, which are not formally distributed, of incorporated direct investment enterprises are deemed to provide additional capital to the enterprises and to increase the value of an economy’s stock of foreign assets and liabilities. When such earnings are recorded in the balance of payments, therefore, entries should be made both for direct investment income and for direct investment capital. For example, reinvested earnings attributable to a resident direct investor of a direct investment subsidiary or of a branch should be entered as a credit in the current account under direct
    investment income (income on equity) and as a debit in the financial account under direct investment abroad (reinvested earnings).
    Portfolio investors’ shares in earnings, which are not formally distributed, of incorporated direct investment enterprises should not be entered in the balance of payments."

    Balance of Payments Manual
    Chapter XIV Page 73

    Wenger was right but he was not his usual pompous self. Perhaps the setiakawans are targeting to recruit u to their cause.
    Beware...they are quite fishy

  7. anon, thank you, but which version of the manual are you looking at? In BPM6, Chapter 14 is on "Selected Issues", and there doesn't appear to be a Chapter 14 in the revised BPM5.

    I did find the relevant passages in Chapter 8 (pg197) and especially Chapter 11 (pg 280-284) of BPM6.

    Cool, I didn't know that, thanks.

    Wenger, your first post was right. My apologies, looks like I'm the student now!

  8. Hi, thank you for the insightful article. If I'm not mistaken, the Investment Position report is no longer available?

    1. Hi Debbie,

      Gosh, this is a really old post. Since then, DOS has reorganised their website, so many old links no longer work.

      The latest report is available here.