The share of reinvested earnings in total FDI income
With the rising significance of foreign direct investment (FDI) in the Czech Republic, the income on this investment increased gradually from the late 1990s onwards (see Chart 1), peaking in 2007 at almost CZK 310 billion. Following an initial phase in which reinvestment predominated, the shares of dividends and reinvested earnings were approximately equal as from 2003. When the financial crisis broke out in 2008, the absolute volume of FDI income decreased, but above all there was a sizeable decline in the share of reinvested earnings in favour of repatriated dividends (see Chart 2). This trend was visible not only in the Czech Republic, but also in other monitored countries. It was related to a general lack of liquidity in foreign parent companies, which led to transfers of liquidity from subsidiaries, and to limited investment opportunities. The share of reinvestment in total FDI income has recovered in the following years, but at around 30% it is still below the pre-crisis level. This fall in reinvestment was probably one of the key factors reducing estimated potential growth of the economy (see section III.3.4).
In the case of the Czech Republic, moreover, it should be noted that the potential for further privatisation FDI inflows or large greenfield FDI projects was largely exhausted a few years ago, and reinvested earnings have been the predominant source of FDI inflows into the economy approximately since 2006. Since the onset of the financial crisis, reinvested earnings have dominated the overall FDI inflow into the Czech Republic (over 90% in 2011; preliminary balance of payments data indicate the figure of 87% between January and July 2012). 1
Reinvestment can be expected to continue to play a pivotal role in the inflow of FDI and will therefore be one of the main sources of growth in the potential of the Czech economy. It will be affected by the changing time structure (ageing) of the current FDI stock and its impact on the share of reinvested earnings in total FDI income. This is because the older is the investment, the higher is the share of repatriated dividends that can be expected at the expense of reinvested earnings (see the FDI life cycle theory). 2 Novotný and Podpiera (2008) 3 estimate the total life cycle of an initial direct investment at roughly 15 years, with FDI profitability peaking in the sixth year. Given the current time structure of the FDI stock in the Czech Republic, even given a pessimistic assumption of zero FDI inflows, we can expect – ceteris paribus – FDI income of over EUR 10 billion a year over the next four or five years. Given a slightly optimistic assumption of the reinvestment ratio returning to 50% as the euro area crisis dissipates, this would mean an FDI inflow to the Czech economy in the form of reinvestment of around EUR 5 billion a year, although probably beyond the horizon of the current forecast. At the same time, productivity growth would rise gradually from its current low levels.
Chart 1 (BOX) FDI income: debit side
Total FDI income in the Czech Republic increased almost linearly until 2010
(CZK billions)
Chart 2 (BOX) Share of reinvested income in total FDI earnings
The onset of the financial crisis accelerated the outflow of dividends from the Czech Republic and from the other monitored countries
(percentages; source: CNB, Eurostat)
1 However, reinvested earnings can take the form of only temporarily undistributed funds without representing actual investment.
2 Brada and Tomšík (2003) Reinvested Earnings Bias, The “Five Percent” Rule and the Interpretation of the Balance of Payments – With an Application to Transition Economies. William Davidson Institute WP No. 543.
3 Novotný and Podpiera (2008) The Profitability Life-Cycle of Direct Investment: An International Panel Study. Economic Change & Restructuring 41(2).