The life cycle of foreign direct investment and its impact on the balance of payments

In the late 1990s the Czech Republic adopted a policy aimed, among other things, at boosting the inflow of foreign direct investment (FDI), which until then had been fairly insignificant. The following text describes the three phases of FDI flows recorded to date. These are also the three main phases of the FDI life cycle in the Czech Republic. The description focuses on the amount and structure of the capital inflows and the distribution of earnings into reinvestment and dividends.

The first phase (1998–2002) saw a strong inflow of capital from abroad (see Chart 1). Most of the newly generated FDI earnings were reinvested in the Czech Republic. In this period the capital inflow was strongly supported by sales of state-owned property to non-residents and the average annual FDI inflow reached 8.8% of GDP. In the second phase (2003–2 007), the investment structure changed gradually. In particular, the amount of earnings generated and reinvested in the Czech Republic increased. The Czech Republic’s attractiveness to foreign investors in the Central European region started to decline somewhat in this period. In addition, sales of state-owned property ceased to play an important role. Nevertheless, capital continued to flow into the Czech economy at a significant annual average level of 5% of GDP. As for the distribution of FDI income, the ratio of dividends to reinvestment was initially roughly one-to-one, but by the end of this phase dividends had started to exceed reinvestment (see Chart 2).

Chart 1 (BOX) Structure of FDI in the Czech Republic
The FDI inflow structure has gradually changed in favour of reinvested earnings
(CZK billions)

Chart 2 (BOX) FDI earnings – debit side
The ratio of dividends to reinvested earnings went up considerably during the economic crisis
(CZK billions)

In the third phase (2008–2013), the outbreak of the economic and financial crisis caused a major change in the external conditions and the average annual FDI inflow fell to 2.5% of GDP. Foreign parent companies often got into trouble and used retained and newly generated earnings to fund either themselves or their other subsidiaries in third countries. The privatisation process ground almost to a halt and some foreign firms sold off their assets in the Czech Republic for various reasons. The value of FDI earnings generated by foreign firms in the domestic economy declined. This was reflected in a fall in reinvested earnings as firms struggled to maintain or increase their dividend payments (see Chart 2). The overall FDI inflow decreased significantly in this period owing to a sizeable decrease in investment in equity.

In the first phase, the value of dividends paid to non-residents was negligible (only 0.6% of GDP on average), but in the second phase it rose to 2.9% of GDP and during the economic crisis it reached 5.3% of GDP while maintaining an upward trend.¹ The return on investment² increased steadily from about 8.4% in 1999 to 13.5% in 2004. Since then it has been flat or falling very slightly. Looking at other Central European countries (see Table 1), the pre-crisis return on direct investment in the Czech Republic and Slovakia was much higher
(3–5 percentage points) than in Hungary, Poland and Slovenia (Eurostat data; euro as reference currency). After 2008, the difference compared to other countries increased as a result of a sharper decline in returns in other Central European countries than in the Czech Republic. The FDI return in the Czech Republic was 3–4 percentage points higher on average than that in Poland, Slovakia and Hungary. Compared to Slovenia, which was hit hard by the crisis, the FDI return was roughly four times higher. The different investment returns across countries were due to different investment structures, life cycle phases and depths and sectoral impacts of the crisis in the various countries.³

Table 1 (BOX) International comparison of FDI returns
FDI returns were higher in the Czech Republic than in neighbouring countries
(percentages; average for period; source: Eurostat, CNB calculations)

¹The most recent value for 2013 was 5.8% of GDP.

²Return on investment = total FDI earnings / FDI stock in previous year

³The proportion of non-resident firms in sectors with above-average earnings, such as banking, utilities and telecommunications, is much lower in Poland and Slovenia than it is in the Czech Republic. The massive investment inflow phase started earlier in Hungary and later in Slovakia than it did in the Czech Republic.