Business Environment of Gulf Cooperation Council for Foreign Direct Investment - Research Paper Example

Running head: Business Environment Assessing Business Environment for Foreign Direct Investment in the GCC Insert Insert Grade Insert Tutor’s Name 20 July 2012 Background The Gulf Cooperation Council (GCC) is part of the Arabian Peninsula consisting of countries such as Saudi Arabia, Kuwait, Bahrain, Qatar, The United Arab Emirates (UAE) and The Sultan of Oman but excluding the Republic of Yemen, which is in the Arabian Peninsula. The GCC was founded on 26th May 1981 with an aim to promote coordination between member states in all fields including internal and international trade and economic activity in order to achieve unity. To understand traded relationships between the rest of the world and GCC, we need to explain some concepts such as FDI1, which is the acquisition of ownership of assets by a foreign country in another country with the intention of having direct control over manufacture, distribution and sales of a firm in the host country. Foreign investment basically means the gap in a country’s requirement for investment and its savings rate (Yuang, 1998 p.63). The host country for FDI stands to benefit in a number of ways in terms of capital formation, export diversification, technology import, management system improvement, and enhanced market competition, infrastructure development to support economic activity, financial sector growth and markets development (OECD, 2001 p.13). FDI is a powerful engine in helping to achieve country objectives such as those about poverty reduction, development and international integration, and it is perceived to be an international investment route that most developed economies have embraced. Low income countries in Africa, for example, have not taken this advantage and are thus being excluded from the globalization benefits of FDI. This research paper seeks to explain general aspects of international trade and economic blocs as well as critically evaluate the economic environment for FDI in the United Arab Emirates focusing on business risk for a firm keen on investing in UAE and considering key aspects of the international business environment such as culture, ethical practices, legal systems, purchasing power, income, consumption patterns, taxes, infrastructure, economic prospects and stability in general among others. Picking on a specific product or service, the paper will explain distribution and marketing strategies and provide guidance on the extent to which the firm’s performance may be put at risk based on last five years. International Trade International trade deals with the dynamics around movement of goods and services including intellectual property across country borders and it affects not only a country’s economic, social and political wellbeing but also the effect on the global situation. At country level, international trade causes changes on the currency value thus exposure to forex risks; the balance of payments position i.e. exports and imports level, growth of the financial sector among others. The effects of international trade can also be assessed at country and global levels. The most recent of the worldwide negative effects of cross border business was the global financial crunch, which was a result of careless securitization of sub-prime mortgage contracts in the USA. Favorable international trade would ordinarily lead to improved economic performance, job creation and improved standards of living. Exchange rate, which determines a country’s relative level of trade internationally, is an economic measure of one country’s currency value relative to the value of the coinage of another nation. The level of currency exchange rate fluctuates because of a combination of several factors such as differentials in inflation and interest rates, deficits in the country’s current account, political stability, economic performance, public debt and terms of trade. Countries that experience high inflation and interest rates will normally deal with a depreciated currency relative to currencies of their partners in international trade that results in expensive imports and cheap exports, and negatively affects economic growth. The impact of a depreciated currency is a deficit in the country’s current account, which implies that the country needs more foreign currency than it gets through its exports or it is spending more on foreign trade that it is earning resulting in cheap domestic goods and services for foreign traders. Increased political and economic risk in a particular country as perceived by international investors reduces the attractive of its currency and appetite for trade resulting in divestment to more stable economies with a promising future. International trade has resulted in regional trade or economic blocs across the globe. There are about five levels of economic integration, which are Free Trade Area (FTA), Custom Union (CU), Common Market (CM), Economic Union (EU) and Political Union also called political federation. For FTA, tariffs between members are abolished or significantly reduced to develop economies of scale and increase comparative advantage. A custom union aims to put in place same tariffs to third parties for countries that are members, usually to minimize re-export issues. Common market is where factors of production are free to move within member countries while Economic union involves harmonization of monetary and fiscal policies for countries in the region. Political integration entails the formation of a common government for the region. An example of this is the European Union (EU), which has been part of many trade arrangements across the globe. The European Commission (EC) is a regional financial and political bloc that integrates about 27 countries in Europe and aimed to foster economic cooperation, promote independence among trading partners. The EC has maintained preferential trade arrangements with most developing countries under the Generalized System of Preferences (GSP) and through the Cotonou Agreement, which succeeded the Lome’ Convention for the less developed countries. Trade arrangements between the EU and developed economies have included the European Economic Area (EEA), Free Trade Areas (FTAs) and the Euro-Mediterranean partnership. The ACP2 is a trade arrangement between EU and countries in Africa, Caribbean and the Pacific (Bhagwati et al, 1998, p.1128-1148). In simple terms, EU’s integration may be classified in three categories consisting of the core EU which carries with it a common external tariff as well as a single market, the free trade area arrangement containing reciprocal trade preferences. Thirdly, there are the one-way trade preferences exclusively for the developing countries. The ACP preference is another set of trade arrangements by the EU where it provides one way trade preferences for more than seventy countries in Africa, Caribbean and Pacific. These preferences are, however, not available to all developed countries in these regions and do not also apply to only least developed economies, for example; thus, contravene the provision of the WTO regarding discriminatory practices, equity, and fairness (Purdey, 2011, p. 60). FDI in Developing Economies China is the largest beneficiary of FDI among emerging countries. An article by the Dow Jones in 2011 on India’s Foreign Investment Approach in Retail Industry stated that India holds great potential for the retail market which is largely unorganized thus providing opportunities growth unlike the case with the saturated developed markets. Foreign single brand retailers are allowed to make up to 51% direct investment in India, but there are considerations to open it up to 100% and encourage such investments to decentralized locations in the country. FDI growth particularly through mergers and acquisitions has benefited China in terms of the good outcome of large current account surpluses that allow the country to have claims on foreigners (The Economist, 2011 p.5). A country that acquires renowned and established companies through FDI gets the advantage of introducing already marketed brands in its markets as opposed to nurturing its own brands, which could take many years and substantial financial input. FDI from countries whose economies are developed is usually cheaper and provides a reliable source of financing. With a deep industry economy from various FDI projects, countries such as India and China have benefited from a growing workforce hence minimizing the problem of unemployment. China, for example, has gained a speedier access to emerging markets like India through the merger and acquisition strategy and is Jaguar Landover Range (JLR’s) fastest growing market where it manufactures the parts and ships them to India for assembly. This makes the cars in India cheaper because minimal import duty is imposed and creates job opportunities for the Indian economy (The Economist, 2011 p.3). FDI in UAE, particularly Dubai, has been on an upward trend in the recent past with 50% increase in applications from many European nations. Most foreign companies have a positive perception about the business environment in the Emirates region. Dubai alone had estimated that FDI will increase by at least 10 per cent to Dh 27 billion at the end of 2011. The realized FDI in 2010 was Dh 23 billion. The high demand by European countries foreign investment in Dubai is an indication that firms operating in the European markets, which were severely affected by the global financial crisis, are looking to diversify in the more stable and profitable markets in the UAE (Sadik and Bolbol, 2001, p.2116). Saudi Arabia has been ranked the highest FDI recipient among the GCC followed by the UAE but among the top ten countries among the Arab countries followed by Egypt, Qatar and Lebanon, which command bigger shares than even the UAE. It has also been observed that developing countries including the Arab economies have been more resilient during the recent economic crisis in terms of economic growth and FDI accumulation compared to the developed countries (UNCTD, 2011). Arab world countries have witnessed a major increase in the level of FDI inflows over the past decade with the GCC countries being the highest receiver in the Arab region. Increased FDI is a strong signal for sustained economic stability, growing confidence among investors, proper governance and social structures and improvement of the economic situation in the GCC region. Various information sources including the World Bank through its reports on doing business have shown that Arab world has a favorable business environment particularly for foreign investors compared with other countries outside Arab region. This phenomenon has been attributed to various reasons such as domestic laws in Arab countries actually promote to a large extent local investments by foreign companies. Business performance and economic performance of GCC countries has been on an upward trend with new policy and regulation increasing the attractiveness of the FDI towards Arab countries particularly from European firms. The UAE particularly Dubai enjoys key strengths and/or incentives in terms of attracting FDI which include its proximity to emerging markets and advanced country infrastructure with very flexible economic legislation. Dubai has put immense support to companies setting FDI in areas such as petrochemicals, precious stones, metals, soft commodities, heavy equipment, oil and gas, shipping, financial services, healthcare, information technology and sports. The enhanced investor confidence and investment has been made possible also by formalization of strategic partnerships with specialized firms outside the UAE. This is one of the reasons that the number of foreign firms wishing to set up shop in Dubai increased by over 50%, indicating commendable progress in attracting FDI inflows. The other favorable factor for the increase in FDI interest in Dubai is its strategic location, which connects it to the leading business capitals of the world and acting as an ideal access point for businesses to critical resources as well as key consumer markets. Firms that seek to set up business in the emirate hub receive adequate strategic as well as first-hand information and assistance. UAE is committed to its goals of economic diversification that enables businesses to find and exploit opportunities, engage in networking and translate these outcomes to growth (SAGIA, 2010 p.73). The Dubai FDI, an agency that is in charge of management of FDI in the UAE through the PPP3 initiative, has continued to promote efforts to pull in more capital and entrepreneurs with an aim to achieve growth and expansion by providing the requisite environment for business to succeed. Dubai has embraced competitive trade policies with innovative public and private sector partnerships, encouraging and friendly environment for business to thrive, incentives that are contributing features of economic and market situation in UAE, which have attracted external investments in the form of FDI raising the star for Dubai as a strongly and fast emerging market. Companies that have participated in world trade through Dubai have reaped the benefits of unique operational efficiencies and unlimited access to other emerging world markets. These firms have also gained from significant opportunities available in Dubai for expansion, growth and financing. FDI growth in the UAE has also been attributed to mergers and acquisitions across borders (Mohamed, 2008, p. 20). There have been rising business relationships between the UAE and Australia in the recent past with increasing business opportunities in areas of building materials, environmental products and services, security equipment and services and skin care, beauty and Spa products. The building and construction industry is the third biggest sectors of the UAE economy valued at much more than USD 221 billion, after oil and trade. Demand for building materials is instigated by the need for construction of diversified commercial, residential and institutional buildings, houses, hotels, beach resorts, hospitals, schools, roads, public parks, shopping malls, and major airport expansion. For a foreign firm such as one from Australia wishing to export building materials to the UAE, the business environment is favorable and requirements flexible enough because the Abu Dhabi government promotes expansion and growth (Skotnicki, 2005, p. 50). An Australian company seeking to set up business in the real sector has the following important information to assess: The UAE is ranked Australia’s second biggest market in the gulf, with sound economy, youthful population, well established and managed banking system, excellent infrastructure and sophisticated business community familiar with western practices. The developed engineering and building services from Australia are ideal for the large infrastructure projects in the UAE. Government’s continued investment in infrastructure presents opportunities for Australian companies. Business opportunities are more in the social infrastructure subsector particularly transport projects than in the residential and commercial areas. In terms of product specification, there is demand for a variety of building materials including green building and sustainable infrastructure solutions. There is five per cent tariff on all goods and services imported into UAE but steel and cement is currently exempt from this tariff. To ensure quality, building and construction standards developed by the UAE, which also apply to building materials, must be strictly adhered to. British standards have also been used as UAE ones are being finalized. Building products must also be tested, approved and certified by the municipal governments even though they meet the set standards described above. This process can also be undertaken by local companies engaged in distributing the product. In terms of regulation, Austrade 4 provides information about agency and distribution franchise regulations including information on the different commercial opportunities available to Australian companies. In terms of country risk analysis and specifically on political risk, the UAE is ranked behind Qatar which is regarded as the least corrupt country in the Middle East and North Africa (MENA) region. A minimum of five years is the jail term for public servants convicted of embezzlement if the crime is one that relates to counterfeiting. If anyone is convicted for accepting a bribe, the jail term is one year while offence to attempt to bribe by a public servant is punishable by imprisonment for up to five years. International trade regulation is in form of restrictive agency, sponsorship, and distribution requirements. Foreign investment in land and stocks is restricted (UAE country report, 2012 p.11). If intending to undertake business outside the designated free zones, a foreign investor such as the Australian building and construction material company under review in this write up must have a UAE national sponsor, agent or distributor. UAEG5 has, however, opened up its trade sectors since 2011 in compliance with the obligations issued by the World Trade Organization and has taken positive measures to reduce restrictions for foreign investment through new laws that encourage international business to thrive by improving transparency for investors (Redemeyer, 2012, p.8). The trade liberalization law provided for a hundred per cent foreign ownership in sectors such as education, health, professional services, computer-related services and technology transfer. The key laws affecting foreign investment and which have been seen as obstacles to FDI in the UAE include the Federal Companies Law, Commercial Agencies Law, Federal Industry Law and the Government Tenders Law. Foreign businesses with continued presence in the UAE must be licensed, and the range of licenses include trade license, industrial license, service license, professional license and construction license, the latter of which the Australian company seeking to export building materials to the UAE needs to acquire. On mutual consent, arbitration may commence by petition to the UAE federal courts. In regulating trade, the UAE maintains non-tariff barriers to investment. The Federal Customs Authority is responsible for harmonizing UAE customs rules, regulations, procedures and documentation. There are no duties on exports, but various restrictions exist regarding importation of certain products such as alcohol, tobacco, firearms and pork and related products. This is because of the regions strict religious and cultural beliefs. Delays in custom clearance are strictly minimized, and documentation requirements adhere to international standards. The prerequisite for new companies to participate in government tenders is first to be registered, and for a company to bid for federal projects, it must be wholly owned by UAE nationals or if foreign, at least 51 per cent of shareholding owned by UAE nationals. Assessment of infrastructural muscle of the UAE shows that there is fairly well developed and modern infrastructure with land transport dominated by road networks to major cities. All emirates have modern airports but rail system is underdeveloped or inexistent completely. All seaports are modern. The port of Jebel Ali in Dubai is the biggest (man-made port) in the globe. Goods are imported by sea and distributed by road within the UAE and to nearby locations in the GCC countries. UAE practices Islam as the official religion with citizens being Muslims. Non-Muslims are free to practice their religions, but not preach openly. Foreign workers constitute a majority of the population predominantly from India, Pakistan, Jordan, Egypt, and Iran. Expatriates from industrialized countries are in much demand and enjoy a high standard of living (UN, 2010). Nepalese expatriates are popular for low incidence of crime hence preferred. As a member of the United Nations and the Arab League, the UAE has diplomatic relations with 60 countries, including most of western European nations. The U.A.E. has no political parties but has strengthened its federal institutions with each emirate enjoying independence. The political and leadership system is dynastic and based on tribal consensus (TI, 2010, p.6). Marketing Strategy for New Business in the UAE It would be of interest for a new Australian firm looking to export business materials to UAE to note that Australians have been leaders in the construction management with a wide range of opportunities as elaborated above. The company will need the introduction to an agent who will ensure that the products are pre-qualified with the relevant consultants and can leverage the strong networks between UAE and Australia in the construction industry (Roscow, 2011, p.15). The firm needs to know the following to effectively penetrate the market: Most building materials are imported through Dubai. Importers set up warehouse facilities to store the product. Firm will have to enter into the well-developed distribution network at three major Emirates i.e. Abu Dhabi, Dubai, and Sharjah. To compete competitively with suppliers from India and China, the product should be improved to enhance value addition with distinct value. To sell to government, a foreign company will need to have foreign representation. Companies aspiring to succeed need the commitment and resources to maintain relationships with partners or establish an office. Through Austrade, the firm can use experienced Australian staff including business development managers as members of business sector business groups to get into the market. These are highly connected with key business people and have the capability to open doors for new companies from Australia. Austrade can arrange business delegations to the UAE and appointment programs. There are key trade exhibitions each year which are organized by Austrade and which the firm may take advantage of and participate to market its products. Bibliography Bhagwati et al., 1998. Trading Preferentially: Theory and Policy. Economic Journal, p.1128-1148 Mohamed A.H., 2008. Most FDI in the UAE comes from non-Arab nations, Emirates Business 24/7. 23 OECD. 2001. New Horizons for Foreign Direct Investment. France: OECD Publications Service. Purdey, D., 2011. Legal Migration in the Relationship between the European Union and ACP Countries: The Absence of a True Global Approach Continues. European Journal of Migration & Law; Vol. 13 Issue 1, p53-94 Rademeyer, E., 2012. UAE Costs to Rise Marginally in 2013. MEED: Middle East Economic Digest; 5/18/2012 Supplement, p7-9. Roscow, A., 2011. ANALYSIS UAE Construction Slowdown Pushes Material Prices Down. MEED: Middle East Economic Digest Vol. 55 Issue 45, p15-15 Sadik, A. T. and Bolbol, A. A., 2001. Capital Flows, FDI, and Technology Spillovers: Evidence from Arab Countries. Elsevier, vol. 29(12), pages 2111-2125 Saudi Arabia General Investment Authority (SAGIA), 2010. Annual Report of FDI into Saudi Arabia, National Competitiveness Center. Skotnicki, T., 2005. Gateway to the Gulf. BRW, Vol. 27 Issue 26, p48-51 The Economist, 2011 & 2012. Role Reversal & foreign Direct Investment Transparency International, 2010. UAE: Risk Summary. Middle East Monitor: The Gulf; Vol. 20 Issue 1, p6-6 UAE country report, 2012. Country conditions. Political Risk Yearbook: UAE Country Report; Special section p1-15 United Nations (Department of Economic and Social Affairs, population division), 2010. World Population Prospects: The 2010 Revision. New York and Geneva: United Nations. United Nations Conference on Trade and Development (UNCTAD), 2011. World Investment Report 2011; Non-Equity Modes of International Production and Development. New York and Geneva: United Nations. Yuang, Y., 1998. FDI China: An Asian Perspective. Singapore: Institute of Southern Asian Studies. Read More