Repatriation: the Destructive Storm Inside the FDI Cloud

Gross domestic savings are generally very low in least developed countries such as Ethiopia. That paved the way for foreign investment to emerge as an alternative source of bridging the gap between savings and the required investment after 1992. Since foreign firms bring not only financial capital but also managerial techniques as well as entrepreneurial and technological skills, foreign direct investment (FDI) is regarded as one of the major components of Ethiopia’s economic growth over the past decade. However, it’s not all been rosy. Although initial investment by foreign firms improves the current and capital accounts of the host country, in the long run, repatriation of profit, interest, royalties and management fees may harm its foreign exchange position. This is exactly what is happening in Ethiopia. A minimum of USD1 billion is requested by locally operating foreign companies that repatriate profits annually. However, a fraction of this amount is availed by commercial banks operating in the country. This phenomenon traps foreign companies, forcing them either to wait for a long time to repatriate their profits or reinvest it as EBR’s Ashenafi Endale found out.

Drawing foreign investment has become one of the most notable strategies used by developing countries to foster development. One of the most successful African countries in attracting foreign investment, Ethiopia makes a good example in this regard. Over the last decade, the county has been listed as one of the top five foreign direct investment (FDI) destinations in Africa. Although FDI inflow to Ethiopia contracted by 18Pct in 2018 to USD3.3 billion, according to a report by the United Nations Conference on Trade and Development, the country is still the biggest FDI recipient in East Africa.

Information from the Ethiopian Investment Commission (EIC) indicates that a total of 2,643 foreign investment projects with a combined capital of ETB104.7 billion became operational in the country in the last two decades. Out of the total, 60Pct of the investment projects are in the manufacturing sector while 20Pct are in real estate and rental businesses. In addition, 14Pct of the projects operate in construction including water drilling while four percent are in agriculture.

As business people exploring options across the globe to make more profits, foreign investors work hard to advance their interests. Although repatriating the hard earned profit sounds simpler than making the profit itself, for foreign companies operating in Ethiopia, repatriating profit back home is way harder than making profit as hard currency reserves are always thin.

For foreign investments such as beer companies like Heineken Ethiopia, Toyota exclusive dealer The Motor & Engineering Company of Ethiopia (MOENCO), foreign hotel chains and airlines flying into the country, repatriating profit from Ethiopia is almost an impossible task.

“We have invested ETB22 billion so far and we have huge money at hand in local currency,” explains Fekadu Beshah, communication and marketing manager of Heineken beer. “We know it is difficult to repatriate in foreign currency; that is why we do not ask for repatriation but reinvest it to expand our operation,” he notes.

Foreign investments with huge annual sales such as Diageo, Coca Cola, and National Tobacco Enterprise as well as relatively medium businesses like Chinese owned Tecno Mobile, along with many others across all sectors, are forced to wait for a long period of time to repatriate profits. The delay in profit repatriation can last up to three years.
“When we invested in Ethiopia, we knew profit repatriation would be very difficult,” says Girum Tsegaye, CEO of Ethio Capital Lease – a company engaged in equipment leasing and asset-backed lending.

Yenehassab Tadesse, Director of Foreign Exchange Monitoring and Reserve Management at the National Bank of Ethiopia (NBE), says the inabilities of the central bank are not to blame for the delay. “If the required tax is paid and other legal documents are fulfilled, the NBE immediately approves repatriation requests. But the local bank, where the repatriating foreign company has an account, might not have enough foreign currency,” explains Yenehassab. The Director indicated that the lack of foreign currency at commercial banks, in turn, extends the time required to repatriate profits.

According to insiders, a minimum of USD1 billion is requested annually by foreign companies that repatriate profits. Commercial Bank of Ethiopia (CBE), Dashen Bank and Awash International Bank are the banks with the biggest repatriation requests as they have better foreign currency mobilization capacity and business relationship with many foreign companies operating in the country. “The maximum foreign currency CBE allocates for repatriation is USD100 million,” says Muluneh Aboye, Vice President for Credit Management at CBE. However, he stated, the request is in billions.

Fantasy than reality
In Ethiopia, repatriation of profits is guaranteed by law in accordance with the investment proclamation as well as through bilateral agreements Ethiopia has signed with other countries. Ethiopia’s investment proclamation guarantees not only repatriation of profits but also principal and interest payments on external loans, payments related to technology transfer agreements and proceeds from the sale or liquidation of an enterprise, among others.
Based on the 2017 directive governing foreign currency allocation, transactions carried out by foreign currency are grouped into two: commercial and legal transactions. Transactions related to the import of goods and services involving Letter of Credit (LC) are grouped under commercial transaction. Since the government needs to wisely spend the limited forex resources it has, allocation of funds for commercial transactions is subjected to national priorities.

The first top nine foreign currency allocation priorities are occupied by imports of essential goods including fuel and capital goods. Ethiopian commercial banks are obliged to allocate at least 50Pct of their foreign currency stock for essential imports prioritized by the government. On the other hand, foreign currency allocations for non-essential lists are made on first-come-first-served basis.

Repatriation of profit is regarded as legal transaction with guaranteed priority over commercial transactions involving LC. However, along with transfer of excess sales of foreign airlines, sales from share and liquidation of companies by FDI, repatriation of profit is listed after the ninth priority goods-import-category, which is against the trend observed worldwide.

The second guarantee for profit repatriation comes in the form of bilateral agreements specifically designed to protect foreign investment. Until 2018, Ethiopia signed 34 of these bilateral agreements.

Based on the mechanism of regulating foreign capital outflow, bilateral agreements can be categorized as agreements that fully liberalize foreign capital outflow and those that allow transfer of foreign capital on the fulfilment of certain criteria. Bilateral agreements signed by Ethiopia, for instance, with United Kingdom, France, Israeli and Brazil allow full liberalization of capital outflow for investors from those countries. However, it turns out even these bilateral agreements could not guarantee capital repatriation. As a result, many foreign investors are forced to stall the repatriation of their profits for a long time or reinvest it locally.

“I know many foreign companies that divert their profit and reinvest it in Ethiopia instead of waiting for a long time to repatriate it,” says Muluneh.

Dangote Cement is among giant foreign companies operating in Ethiopia that reinvested their profit. Dangote launched a packaging factory with its reinvested profit. After starting operation in 2015 with an investment of USD550 million, Dangote Cement was able to repatriate USD70 million from its birr account in Ethiopia to Nigeria in 2018. But after 2018, the company has not repatriated any profit. “Repatriation of profit is very difficult as there aren’t enough hard currency reserves at commercial banks operating in Ethiopia,” says an official at Dangote who spoke with EBR on the condition of anonymity.

The same is true for MOENCO, which reinvested its profit in a mining company. Access to foreign currency by businesses is forecasted to get tighter due to further depletion of reserve under COVID-19. Remittance, tourism, export, FDI and other foreign currency sources are declining dramatically.

The dilemma
In Ethiopia, FDI started to receive attention as an alternative source of capital formation and catalyst for economic growth in the beginning of the 1990s. During that time, policy makers believed that in developing countries like Ethiopia where gross domestic savings are too low, FDI can fill the gap between savings and the required investment. It would, thus, in effect foster economic development. On top of creating massive employment opportunities, policy makers further noted that FDI can boost the competitiveness of countries through manufacturing of export products. The foreign exchange earnings generated would help improve the balance of payment deficit over time.

FDI certainly improves the current and capital accounts of a country. However, some scholars disagree with this notion as they point out that it depicts only the initial effects of FDI. Instead argue these experts, repatriation of profit, interest, royalties and management fees as well as substantial import of intermediate and capital goods ends up negatively affecting the foreign exchange position of the host country in the long run. According to Alemayehu Geda, Professor of Economics at Addis Ababa University, it is obvious repatriation depletes a country’s foreign currency reserves unless FDI inflow increases exponentially. “Profit and capital repatriation can even exceed the external loan interest and other external expenses at some point. Reinvestment of profits also piles up the profit that should be repatriated later. This puts the country in a vicious circle of failing to serve repatriation,” explained Alemayehu.

In his recent book entitled ‘The Economy of Developing Countries’, which he adopted from the notable Economist from The Great Depression era – Michael Kaleck, Alemayehu argues that repatriating two-thirds of the profit of foreign companies and reinvesting one third would still significantly hurt Ethiopia.

Repatriating profit is difficult not only for Sub-Saharan African countries but also Asian giants like China, where strict controls are imposed on profit repatriation. Foreign enterprises in China are allowed to repatriate profit only once a year, after investing all their subscribed capital within the time limit.

But in a country like Ethiopia where weak regulatory capacity exists, this can lead to unwanted trade practices in the form of under-invoicing of export prices and over-invoicing import prices.

Foreign companies that fail to repatriate profit legally might use various informal mechanisms like trade mis-invoicing. By increasing import prices and reducing export prices, they can stash away the marginal amount abroad. In fact, under-invoicing of export prices and over-invoicing import prices, which is also the major mechanism of sending out profits, dividends and capital, is becoming common trade practice in Ethiopia.

According to the 2015 Global Financial Intelligence report, USD19.7 billion left Ethiopia through trade mis-invoicing by importers, out of the total USD26 billion illicit financial flow that left the country between 2004 and 2013.
Alemayehu says foreign companies do not bring their entire registered capital to Ethiopia in foreign currency. “This is because they know they cannot repatriate it back later. Therefore, they bring limited amount of investment capital to Ethiopia. The capital stashed abroad will be their compensation for their inability to repatriate in the future.”

According to Tan Jian, Chinese Ambassador to Ethiopia, profit repatriation from Africa particularly Ethiopia is difficult mainly because Ethiopia has a wide foreign currency imbalance. “Ethiopia’s need for foreign currency escalates because the country mainly trades countries outside of Africa. African countries need to boost intra-Africa investment and trade under single currency in order to balance the high need for foreign currency” he argues.
In the book, Alemayehu suggested developing countries like Ethiopia should take three steps to benefit from FDI.

The first is creating a strong private sector in order to reduce the country’s dependency on FDI while the second move is conducting strict auditing on foreign companies in order to control over-invoicing and under-invoicing. The last step involves prohibiting repatriation of profit from reinvested capital.

Founder and director of Ibex Frontier, an investment consultancy company with offices in Addis Ababa Ethiopia, London UK and Washington DC USA, Zakaria Amsalu says not to bother taking these steps. He pointed out: “investors are looking beyond the current forex issues and putting their faith in the idea that this temporary foreign currency hiccup will adjust in the future.”

However, Alemayehu stressed that this is not a temporary problem. In fact, he says the ongoing partial and full privatization of public enterprises might accelerate the problem even further. Alemayehu cited ethio telecom, a public enterprise destined to be privatized partly next year, to substantiate his argument. “ethio-telecom collected USD746 million in the first half of 2019/20 alone, and USD1.3 billion during the 2018/9 fiscal year. Its profit margin is 66Pct,” he explains. “If the coming foreign partner repatriates even half of the profit annually, it will significantly affect Ethiopia’s foreign currency reserve. The government should learn from the damages caused by profit repatriation in Nigeria after privatizing the Nigerian telecom,” warns Alemayehu. EBR

9th Year • May.16 – Jun.15 2020 • No. 86