Hande Dülger is a Central Bank Specialist at the CBRT.
Cihangül Özgüler is a Central Bank Specialist at the CBRT.
Burcu Taşdemir is a Chief at the CBRT.
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Direct investments, which are defined as one of the main elements of financial globalization, constitute an increasingly important capital item in the financing of the current account deficit. In addition to being a long-term financial instrument for a country, these investments are important since they encourage the use of new technologies in production instead of old ones and thus urge an increase in productivity and the opening up of companies to new external markets.
Conceptually, direct investment is defined as a cross-border investment associated with a resident investor in a country to have a long-term relationship with an enterprise that is resident in other country. That the direct investor holds at least 10 percent of the enterprise’s equity capital or has a voice in its management is the fundamental issue in this investment frame.
The inward direct investment stock in Turkey is shown as a Direct Investment item under the Liability side of the International Investment Position (IIP). This item is composed of non-residents’ equity capital investments in Turkey and other capital items. Other capital refers to investments associated with the loans extended by the non-resident enterprise to the resident enterprise covered by a direct investment relationship.
According to IIP data, the stock value of Turkey’s direct investment liabilities was USD 141.6 billion at the end of 2016. Equity capital liabilities, having the largest share in this item, stood at USD 131.0 billion. An analysis of these equity capital investments by sectors reveals that the investments were concentrated in finance and insurance. Wholesale and retail trade, and manufacturing and distribution of electricity, gas, steam and air conditioning supply were the other sectors with a significant share.
How is the geographical distribution classified?
In line with financial globalization, the increase in cross-border capital mobility has caused the emergence of complicated investment relationships between direct investors and direct investment enterprises. In this context, international institutions have defined some set of standards for a better understanding of direct investment relationships, namely the direct investment chain, and for an accurate geographical classification of direct investment statistics. The Benchmark Definition of Foreign Direct Investment, which is adopted by the OECD and sets the ground for international standards for direct investments, includes two approaches for geographical classification: the classification based on the country of “immediate investor” as the last link in the investment chain and the classification based on the country of “ultimate investor” at the top of that chain.
Let us simply explain the direct investment chain through an example including enterprises A, B and C as residents of three different countries (Figure 1). Assume that Enterprise C in Country 1 has a minimum share of 50 percent in the equity capital of Enterprise B in Country 2, and Enterprise B makes an investment in Enterprise A in Country 3 at an amount corresponding to minimum 10 percent of its equity capital. Consequently, according to international standards, Enterprise C at the top of the investment chain is the ultimate investor as it has a voice in the management of Enterprise B with a share of 50 percent and more while Country 1 is the ultimate investing country. Enterprise B is defined as the immediate investor since it is the closest enterprise in the direct investment chain investing in Enterprise A while Country 2 is defined as the immediate investing country. In real life examples, direct investment chains can include far more comprehensive and complicated structures. There may be different reasons for an enterprise residing in a country to make a chain investment in an enterprise residing in another country, such as increased competition conditions due to global economic developments or the desire to benefit from some commercial and financial advantages offered by other countries.
In compliance with the international methodology, direct investment data released as a part of Balance of Payments and International Investment Position Statistics are compiled and disseminated based on the immediate investing country. Moreover, in the framework of the “Direct Investment Survey” conducted by the Central Bank of Turkey, inward equity capital investments are also classified based on the ultimate investing country.
Accordingly, an analysis on the stock of equity capital investment in Turkey for the years 2015 and 2016 based on the immediate investing country reveals that the largest direct investor country is the Netherlands. This is because the Netherlands provides convenience for the establishment of companies called “Special Purpose Entities” that act as intermediaries for the arrival of direct investment in that country and its departure to another country. Due to this feature, the Netherlands is not generally an ultimate investing country but it rather acts as an intermediary for international direct investments. Likewise, there are similar companies in countries like Ireland, Luxembourg and the United Arab Emirates that act as intermediaries in the transfer of direct investment from one country to another.
Analyzing 2016 year-end stocks for these four countries, we see that the direct investments where the Netherlands is classified in the IIP as the immediate investing country decrease by 32.3 percent, approximately USD 7.6 billion, according to the ultimate investing country classification (Table 1). The ultimate investing country of 49 percent of these investments is the United Kingdom, 10 percent is South Korea and 7 percent is Switzerland (Chart 1).
Similarly, an analysis of the ultimate investing country of direct investments where the immediate investing country is Luxembourg reveals that the investments made from this country decreased by 38.4 percent with Germany having an 81-percent share in this decrease.
Ireland is another country where the differentiation between immediate investor and ultimate investor is significant. The country of approximately 88 percent of investments, where the immediate investing country is classified as Ireland, changes when the classification is based on ultimate investor. The largest share in this change belongs to the United Kingdom with 83 percent.
Another significant difference can be seen in the United Arab Emirates. The ultimate investors of 77.5 percent of investments from this country reside in other countries. Saudi Arabia has the leading share in this change with 96 percent.
To sum up, the country as the last link of the investment chain is the basis in current geographical classification of the direct investment statistics. However, from an economic point of view, classifications based on the country of ultimate investor should also be taken into account when analyzing the country breakdown of direct investment statistics. Such data are significant in terms of making sounder cross-country evaluations and policy recommendations regarding direct investments.