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Determinants of FDI in emerging markets: evidence from BrazilClaudio Felisoni de AngeloFEA (School of Economics and Administration), Universidade de Sao Paulo, Sao Paulo, Brazil

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Rangamohan V. EunniWilliamson College of Business Administration, Youngstown State University, Youngstown, Ohio, USA, and

Nuno Manoel Martins Dias FoutoFEA (School of Economics and Administration), Universidade de Sao Paulo, Sao Paulo, BrazilAbstractPurpose The paper aims to evaluate the relative importance of various factors that inuenced the ow of foreign direct investment (FDI) into Brazil in recent years. Analysis of empirical data indicates that evolution of the consumer market and strength of consumer sales are more important in explaining capital movements into Brazil than other frequently offered explanations such as exchange rates and country risk. Design/methodology/approach The paper uses two-stage least squares regression to estimate the coefcients of a system of simultaneous equations relating FDI ows into Brazil to various inuential factors. Findings The results indicate that internal market growth represented by aggregate consumer sales was a signicant determinant of FDI into Brazil. Increase in interest rate on consumer nancing was negatively related and the attractiveness of the Brazilian market had no impact on FDI ows during the captioned period. Research limitations/implications While factors such as ination and exchange rates might be more important for smaller, less stable markets, in the case of larger emerging markets such as Brazil, multi-national rms might be less concerned with short-term uctuations and more guided by internal market growth that affords greater opportunities to achieve economies of scale and scope. Practical implications The ndings suggest that policy planners in big emerging markets should try to stimulate their internal markets rather than tweak scal and monetary policies to attract FDI. Originality/value The paper extends and expands the knowledge of international capital ows and provides a more nuanced understanding of the importance of internal market dynamism in attracting FDI into emerging markets. Keywords International investments, Direct investment, Emerging markets, Sales, Brazil Paper type Research paper

Introduction The Brazilian economy has gone through profound changes over the past 13 years, since the introduction in 1994 of Plano Real, an economic stabilization program that successfully brought the erstwhile hyperination under control. The annual rate of ination, which was 5,150 percent at the threshold of Plano Real, was brought down to about 10 percent at the end of the program (IMF Financial Statistics). Curbing ination was an important achievement, which opened the door for opportunities in different areas of the economy.

International Journal of Commerce and Management Vol. 20 No. 3, 2010 pp. 203-216 q Emerald Group Publishing Limited 1056-9219 DOI 10.1108/10569211011076901

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In particular, internally, the reduction in the ination rate contributed to diminishing the price volatility. Relative price stability provided consumers with a clearer value perception making them more demanding, and the market became far more competitive. Externally, Brazil came to be perceived as an attractive market for foreign direct investment (FDI). For instance, the World Economic Forum 2007 reported that Brazil was the second most attractive country in Latin America for FDI. FDI inows and stocks of certain emerging markets including Brazil, Argentina, Chile, Mexico, China, and India and their proportion to gross xed capital formation are presented in Tables I and II. According to the FDI UNCTADs, 2008, Brazil was the fourth developing country in FDI inow during 2007, behind China, Hong Kong (China), and Russia. This is not really a surprising assessment, considering the countrys large population and the relatively stable macroeconomic conditions that had emerged in recent years. Clearly, in order to sustain economic growth over the next several years Brazil depends crucially on FDI. The issue of FDI and its ows, especially in the context of large developing economies, is an eminently worthy area of research. Being part of the Brazil, Russia, India, and China (BRIC) nations and given its importance in Latin America, unraveling the factors that inuence FDI ows in Brazil would be of interest to academics and policy planners alike. The purpose of this paper is to evaluate the relative importance of various factors in determining the ow of FDI into Brazil. In particular, based up on an analysis of empirical data of recent years (2000-2007), we argue that evolution of the consumerAs a percentage of gross xed capital formation 1990-2000a 2004 2005 2006 9.8 15.2 20.7 12.2 11.0 1.8 10.7 13.4 27.9 12.3 7.7 3.0 10.6 10.1 25.8 9.8 6.4 6.6 15.0 9.0 42.9 13.3 5.9 5.8

FDI inows Brazil Argentina Chile Mexico China India

1990-2000a 12,000 7,141 3,393 9,368 30,104 1,705

2004 18,146 4,125 7,173 22,883 60,630 5,771

2005 15,066 5,265 6,984 20,945 72,406 7,606

2006 18,822 5,037 7,358 19,291 72,715 19,662

2007 34,585 5,720 14,457 2,685 83,521 22,950

Table I. FDI ows into select emerging markets

Notes: aAnnual average; Millions of dollors Source: UNCTAD (2008)

FDI stocks Brazil Argentina Chile Mexico China India

1990 37,143 7,751 16,107 22,424 20,691 1,657

1995 47,887 25,463 24,437 41,130 101,098 5,641

2000 122,250 67,601 45,753 97,170 193,348 17,517

2006 236,186 59,753 80,501 241,050 292,559 52,369

2007 328,455 66, 015 105,558 265,736 327,087 76,226

As a percentage of GDP 1990 1995 2000 2006 8.5 5.5 48.1 8.5 5.1 0.5 19.0 23.8 60.8 16.7 16.2 3.7 22.0 27.9 55.0 25.5 10.5 5.7 25.0 25.2 64.4 29.7 10.1 6.7

Table II. FDI stocks of select emerging markets

Note: Millions of dollors Source: UNCTAD (2008)

market and strength of consumer sales are a more important factor in capital movements into Brazil than other frequently offered explanations such as exchange rates and country risk. The rest of this paper is organized as follows. In the next section, we carry out a review of the relevant literature, followed by a formulation of the research problem. We then outline the model and the methodology employed to test the hypotheses. The results are presented in the penultimate section, and the nal section contains a discussion of the ndings and conclusions. Literature review FDI in emerging markets: review of recent research In recent years, there have been a large volume of studies focusing on the factors that inuence ow of foreign capital into industrialized and emerging markets. While some studies focused on socio-political factors, such as the opacity index of recipient countries (Hooper and Kim, 2007), others related transparency and institutional factors to FDI. For instance, Egger and Winner (2005) showed a positive relation between corruption and FDI in a sample of 73 developed and underdeveloped nations from 1995 through 1999. Asiedu (2001) found that the determinants of FDI are not the same in different world regions. By comparing the FDI ows into developing countries in Sub-Saharan Africa, she found factors such as return on capital and better infrastructure to have a positive effect on FDI in developing countries, while they had no signicant effect in other African countries. Similarly, greater openness to trade had a greater impact on FDI into developing economies than it did in Africa. Another group of studies sought to identify variables related to market size and dynamics, such as GDP, exports, phone density index, and country risk (Moosa and Cardak, 2006), taking into consideration the direct impact on recipient countries or the indirect impact on countries that, in principle, compete for FDI volume (Garcia-Herrero and Santabarbara, 2007). Studies along similar lines, Frenkel et al. (2004) also included factors relating to both the investing countries and target countries in order to identify the determinants of wealthy countries FDI in emerging markets. Hsiao and Hsiao (2006), using data from 1984 to 2004, tested the causality between GDP and exports for Taiwan, South Korea, China, Malaysia, Singapore, Hong Kong, the Philippines, and Thailand and the FDI received by these countries. Combining both the above-mentioned lines of research, Bengoa and Sanches-Robles (2003) use panel data from 18 Latin American economies from 1970 to 1999 to show that economic freedom is a determining factor of FDI to the recipient countries and that economic growth is also directly inuenced by FDI. Trevino and Mixon (2004) compared the macroeconomic and institutional differences between Latin American countries to explain multi-national corporations FDI in these countries from 1988 through 1999 and identied a dominance of the effects of the institutional environment on FDI in Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela. Some studies are characterized by a greater theoretical focus, thereby contributing to the development of an economic theory of FDI. Employing concepts from behavioral economics, Hosseini (2005) explores the importance of FDI on the economic development of nations, and how modeling of the FDI could be investigates. Basu and Guariglia (2007) empirically and theoretically studied the relationships between FDI, inequality and economic growth, using a panel of 119 developing nations, and showed that FDI promotes both inequality and growth, and tends to reduce the importance of

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agriculture to the GDP of the recipient country. Along the behavioral line of research, the essentially empirical work of Galan and Gonzales-Benito (2006) analyzes the decisions of 103 Spanish multinationals to make FDI in Latin American countries, showing variance in the determinants of FDI in countries outside Latin America, with evidence of a cultural afnity bias. Important obstacles in the econometric identication of FDI determinants are dealt with in studies such as Li and Liu (2005), which employs panel data from 84 countries for the period 1970-1999 and applies simple and simultaneous equation techniques to reveal evidence of an endogenous relationship between FDI and economic growth from the mid-1980s onwards. This study shows that the endogenous nature of FDI and economic growth should always be kept in view, as FDI tends to cause growth in the host country market, which in turn becomes more attractive to FDI as the internal market grows. Russ (2007) shows that, when exchange rate and projected sales for the recipient country are jointly determined by macroeconomic variables, FDI regressions to exchange rates and exchange rate volatility are subject to bias. The companys response to interest rate volatility would differ, depending up on whether volatility is the result of disturbances in the companys home country or the FDI recipient. In contrast to the large number of comparative studies of FDI recipient countries, studies such as the one by Sun et al. (2002) focus on internal determinants of a specic country to identify the determinants of FDI. In that study, the spatial and temporal variation in the determinants of FDI across several regions of China were investigated, and the ndings revealed a negative effect of FDI ows and accumulated FDI on domestic investment. Our study attempts to identify variables related to the market size to explain the inow of FDI in developing countries. However, but rather than using aggregate variables such as the GDP, market size is represented by the families consumption market and its dynamic, employing factors that explain the retail sales volume like real income, seasonal factors, the level of households debt, interest rates, and nancing to the consumer. We do realize that there could be pitfalls in data when FDI gures reported by different countries are used to carry out comparative studies. For instance, some countries such as Brazil require companies to report all nancial inows and outows across its borders, while others like Argentina do not. There are also differences in what ows are considered as FDI, reinvestment, etc. and the minimum transaction volume and the size of the companies subject to such reporting requirements. Nevertheless, the data compiled by UNCTAD are based on information gathered from central banks, the World Bank and research institutions in different countries and therefore are invested with greater reliability for comparisons across countries. Trends in foreign investment in Brazil in the 1990s After several attempts at controlling and stabilizing ination throughout the 1980s and 1990s, the so-called Plano Real which came into effect in July 1994 was eventually successful in reducing the annual ination rate from approximately 5,150 percent ( June 1994) to around 10 percent in December 2001. The program, however, left two anks exposed: (1) Growing external imbalance brought about by a massive increase in imports without a corresponding growth in exports.

(2) A severe scal crisis, characterized by a primary decit in the established public sector; a nominal public decit averaging 7 percent of the GDP in 1995-1998, and growing public debt. A progressive deterioration of the cambial anchor as a basic instrument of economic policy followed. Over the rst ve years of Plano Real, the global nancial markets went through three serious crises the Mexican crisis of 1994, the Asian u of 1997, and the Russian crisis of 1998. Each of these affected inward FDI into emerging markets such as Brazil through the so-called contagion effect (Giambiasi, 2005). Over this period, despite successful curbing of ination, economic growth stagnated at 2.8 percent a year, similar to that of the lost decade of 1980s (Ferrari-Filho and de Paula, 2003). This is in sharp contrast to the average annual growth index of 7 percent for the period 1940-1980 (Bacha and Bonelli, 2005). Until the deployment of the Plano Real in 1994, short-term or portfolio investment, which seeks to take advantage of the differences in interest and exchange rates between developed and emerging markets, accounted for 60 percent of the foreign investment in Brazil. After Plano Real; however, portfolio investment declined to 10 percent, and even reached negative gures in 1998, while FDI grew considerably from the mid-1990s (Baumann, 2001; Baer and Rangel, 2001). In the 1990s, FDI underwent a striking change, following the adoption of macroeconomic and institutional stabilization measures, predominantly intended to attract FDI. As part of Plano Real, from 1995 through 2002, several important reform measures were carried out in Brazil: privatization, end of the state monopoly in oil and communications sectors, restructuring of the nancial system, social security reform, renegotiation of state debt; enactment of the scal responsibility law, creation of regulatory agencies for public utilities, control of ination as the central focus of economic policy (Giambiasi, 2005). Implementation of the Mercosur/Mercosul led to inow of FDI, especially from Spain, into several sectors such as utilities (power, gas, and water), transportation, communications, nancial, banking, and insurance services (Trevino and Mixon, 2004). Prior to 2000, absence of scal tightening, coupled with the need to generate surpluses in order to pay off external debt and replenish foreign exchange reserves, in the midst of a rapid surge in imports and international crises, led to increased short-term interest rates. This, in turn, had an adverse impact on the average family income and consumer market growth in Brazil. In the post-2000 period, however; with greater availability of personal credit and more comfortable foreign exchange reserves, the Brazilian consumer market began to come into its own; and with ination under control, growth had returned to more acceptable levels. With the initial post-Plano Real adjustments behind, the period of 2000-2007 offers a setting that is more appropriate for analyzing the inuence of the consumer market and the dynamics of retail sales in the determination of FDI in Brazil. The research question and hypotheses The objective of this study is to examine the extent to which internal market changes could explain the movement of FDI into Brazil. The study thus focuses on the determinants of FDI from the perspective of the internal market of a single country Brazil, more specically, the dynamics of the Brazilian consumer market. In order to do so, we also investigate the factors that explain retail sales volume, such as real income, seasonal factors, and the level of debt, interest rate for consumer nancing.

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It is widely recognized that host market characteristics are a signicant determinant of FDI ows. As the size of a market increases, the opportunities for efcient use of resources and leveraging economies of scale and scope via FDI increase too. In the past, several studies have shown the positive relationship between FDI ow and market size (Chakraborty, 2001). The larger the market, the greater would be the level of consumer sales. It is thus possible to relate FDI ow to the host countrys consumer market represented by its retail sales: H1. FDI in Brazil is positively related to the aggregate consumer retail sales. We, however, capture the dynamics of the internal market by introducing factors that have an impact on the level of consumer retail sales namely, real income, debt, and seasonal factors. The level of debt, in turn, is relatable to real income, interest rate for consumer nancing, and duration of repayment period to nance consumption. We will deal with these circular relationships by employing a system of simultaneous equations. Besides internal market evolution, it is possible to hypothesize that FDI depends on the investors perception of country risk, which in turn captures several other factors such as political and institutional stability, and the countrys capacity for enforcing contracts and property rights. Where a host country environment is perceived more risky, Buckley and Cassons (1981, 1999) internalization theory predicts that multi-national rms would tend to substitute arms length modes to penetrate foreign markets such as exporting and licensing instead of direct foreign investment. Portfolio investment by foreign rms in the pre-Plano Real period is a manifestation of this approach. In other words, the higher the perceived risk of a host country, the lower would be the inow of FDI. In this paper, the exchange rate will be considered as a proxy variable to the investors risk perception. In fact, exchange rate can produce two different and opposite effects over FDI. In the long run, as a consequence of turning the assets cheaper, the currency depreciation implies growth of FDI (Scott-Green and Clegg, 1999). However, in the short run the currency depreciation, standing for risk perception, should impact negatively. Based on this line of reasoning, we propose that: H2. FDI in Brazil is negatively related to the perceived country risk. The relationship between FDI ow and the exchange rate of the host countrys ` currency rate is widely studied. Depreciation in the host countrys currency vis-a-vis other countries should increase the FDI inow as foreign currency denominated assets become cheaper (Scott-Green and Clegg, 1999). Thus, we can formulate the following hypothesis: H3. FDI in Brazil is positively related to the relative depreciation of its currency ` vis-a-vis the US$. In order to keep ination under control, during the years 2000-2007, Brazilian economic authorities have maintained a policy of elevated interest rates to nance consumption. Although this has had a positive effect on stabilization of the economy, one possible negative consequence concerns the impact of high-interest rates on retail sales. This impact could be transmitted to FDI, mainly for companies already established in Brazil. Based on this logic, we propose as follows: H4. FDI in Brazil is negatively related to increase in internal interest rate.

Finally, greater openness of a host country to foreign investment is likely to encourage inow of FDI by making it more attractive as compared to other countries with less so (Chakraborty, 2001). Since the mid-1990s, Brazil embarked up on an aggressive policy of liberalization and opening up of the economy to foreign multinationals. The general improvement in Brazils macroeconomic environment, growth of foreign reserves, and control of ination rate in recent years is in part a result of the policies favoring economic liberalization leading to increased ow of FDI. We therefore formulate the following hypothesis concerning the increased attractiveness of the Brazilian market as a result of stability and openness of the economy to FDI inows: H5. FDI in Brazil is positively related to the increasing overall attractiveness of the Brazilian economy during the study period, 2000-2007. The model The research question dened by the ve hypotheses derived in the preceding section could be expressed as a set of equations a simultaneous equations system that relates the dependent and independent variables. In order to identify the internal market factors that had an impact on FDI in Brazil, the research problem was mathematically represented as follows: Internal market salest FReal income21; Debt21; Seasonal factors Debtt GReal income21; Consumer interest rate21; II Period of payment in financing consumption21 FDIt H Internal market sales; Exchange rate III I

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Equation (I) postulates that the retail sales over the period t depend on real income for the period t 2 1, the total volume of debt in the economy for t 2 1 relative to the total wages paid, and seasonal variations over the course of the year. Equation (II) proposes that the total volume of debt relative to total wages for the period t as an expression of real income for t 2 1, the interest rate for t1, and the payment period in t1. Equation (III) explains FDI using as arguments internal market sales and the exchange rate. In this system of equations, the dependent and independent variables are considered simultaneously. Although equation (III) includes three explanatory variables, Brazil country risk was excluded from the estimation process, due to a strong correlation between exchange rate and country risk. This was so because Brazilian monetary authorities, while carrying out economic reforms, tried to incorporate changes in the risk index into the exchange rate management (selling and buying foreign currency). After a brief qualitative analysis carried out through interviews with international trade experts, we chose to retain exchange rate rather than Brazil country risk as a variable. Experts suggested that changes in country risk were captured in changes in exchange rate. Lags in explanatory variables were settled based on logic and statistical reasons. Equation (III) was also studied considering different lags; however, the best adjustment resulted from taking all the variables in the same period of time. The reason for this is probably related to the way that FDI decisions are made: companies that are already established in Brazil consider sales volumes when deciding to reinvest its earnings

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or send them back to their headquarters. According to the World Investment Report (UNCTADs, 2008), 30 percent of all FDI inows in 2007 were due to reinvested earnings generated by increased prots of foreign afliates in developing countries. Another noteworthy feature of these equations is that sales and volume of total debt are at the same time explanatory as well as explained variables in this system. This is a problem typical to the simultaneous equation estimation process. Once the coefcients of the explanatory variables are determined, they could be used to analyze the importance of internal market movements to the inux of FDI. Data and methodology Two-stage least squares (TSLS) regression was employed to estimate the coefcients of the system of simultaneous equations. The equations used for estimation are as follows: logser01 a b2 :logser0221 b4 logser0421 b1 ser07 b1 :ser08 b1 :ser09 b1 :ser10 b1 :ser11 1 I Instrument variables: ser02, ser05, ser06, ser07, ser08, ser09, ser10, ser11: logser04 F m1 logser0221m2 logser0521 m3 logser0621 j II logser13 t g1 :logser01 g14 :logser14 l III

Instrument variables: ser02, ser05, ser06, ser07, ser08, ser09, ser10, ser11. Table III contains a description of the variables and the data sources. Functions (I) and (III) were estimated using TSLS because it is a biased simultaneous equation wherein independent variables are also dependent variables. Function (II) was estimated by ordinary least squares as all the explanatory variables are exogenous to the system. Finally, in the equations system, the variables retail sales, average real income, andDescription Real sales Real average income (A) Total volume of borrowings (B) Total volume of borrowings/average real income (B/A) Annual real interest rate for consumption nancing Average payment period Dummy rst quarter (1 for rst quarter; 0 for other quarters) Dummy second quarter (1 for second quarter; 0 for other quarters) Dummy third quarter (1 for third quarter; 0 for other quarters) Christmas (1 for December; 0 for other months) Mothers day (1 for May; 0 for other months) FDI Exchange ratea e , j and l disturbance terms Table III. Description of variables and data sources Variable ser01 ser02 ser03 ser04 ser05 ser06 ser07 ser08 ser09 ser10 ser11 ser13 ser14 Data source IPEA IPEA BC BC BC

IPEA IPEA

Notes: aExchange rate corrected by the USA and Brazil ination (R$/US$)(IUS/IBR): where R$/US$ is nominal exchange rate, and IUS and IBR are, respectively, US and Brazilian ination; IPEA Instituto de Pesquisa Economica Aplicada; BC Banco Central do Brasil

exchange rate are transformed into natural logarithms; apart from being widely used in studies such as ours, the log specication makes it easy to interpret the results because the coefcients of the variables represent the elasticity of the sales in relation to each of them. For instance, b2 means that an 1 percent change in the average real income, sales will change by (b2). (1 percent) (equation (I)). This change, in turn, would impact FDI by (g1) (b2). (1 percent). Results The hypotheses were tested employing monthly data on consumer sales, economic indicators and FDI ows for the period from June 2000 to June 2007. The results related to the three equations estimated are presented in Tables IV-VI. H1 states FDI in Brazil is positively related to the aggregate consumer retail sales. From Table VI, it could be seen that 1 percent of changes in sales over the period t-1 implies an increase of 1.75 percent in FDI and the value of the coefcient is signicant. As mentioned earlier, country risk was excluded from the explanatory variables in preference to exchange rate. H3 states that FDI in Brazil is positively related to the relative ` depreciation of its currency vis-a-vis the US$. From Table VI, it could be seen that the elasticity of FDI to exchange rate is 20.71. In other words, an 1 percent devaluation of Brazilian currency relative to the US$ has a 20.71 percent impact on FDI. We may incidentally mention that when the ratio of the Brazilian government rate and the US government rate (risk) was also estimated, the sign of the coefcient was also negative but the value is less than 0.71. This provides conrmation that the effect of risk perception on FDI is likely to be less than that of exchange rate uctuations. Retail sales movements in the internal market therefore seem more relevant than changes in risk level. This probably reects the Brazilian economys level of maturity. H4 concerns the impact of interest rate charged on consumer nancing operations and FDI. In order to test this hypothesis, it is also necessary to consider the data in Tables IV and V. An 1 percent increase in the interest rate would elevate the consumer volume of debt relative to total wages paid by 0.84 percent (Table V). Such an increaseCoefcient C(1) C(2) C(4) C(7) C(8) C(9) C(10) C(11) R2 Adjusted R 2 SE of regression Durbin-Watson stat. 20.724775 0.668435 20.567619 20.050177 20.031664 20.025355 0.315149 0.051246 0.927151 0.919760 0.037681 1.886993 SE 0.475821 0.091025 0.032758 0.014227 0.015737 0.014293 0.018238 0.018620 Mean-dependent var. SD-dependent var. Sum-squared resid. t-statistic 2 1.523207 7.343456 2 17.32756 2 3.526901 2 2.012044 2 1.773944 17.28008 2.752216 Prob. 0.1323 0.0000 0.0000 0.0008 0.0481 0.0805 0.0000 0.0076 4.692828 0.133023 0.097969

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Notes: Dependent variable log(ser01); method TSLS; sample (adjusted) 2000:07 2006:11; included observations 77 after adjusting endpoints; logser01 C1 C2* logser0221 C4* logser0421 C7* ser07 C8* ser08 C9* ser09 C10* ser10 C11* ser11; instrument list: ser02, ser05, ser06, ser07, ser08, ser09, ser10, ser11

Table IV. Sales equation: equation (I)

IJCOMA 20,3C(1) C(2) C(3) C(4) R2 Adjusted R 2 SE of regression Durbin-Watson stat.

Coefcient 213.32000 1.767759 0.836853 20.362780 0.882783 0.877966 0.060748 0.469927

SE 0.558259 0.181065 0.060024 0.118983 Mean-dependent var. SD-dependent var. Sum-squared resid.

t-statistic 223.85991 9.763110 13.94189 23.048994

Prob. 0.0000 0.0000 0.0000 0.0032 2 4.827350 0.173897 0.269394

212Table V. Debt equation: equation (II)

Notes: Dependent variable log(ser04); method TSLS; sample (adjusted) 2000:07; 2006:11; included observations 77 after adjusting endpoints; logser04 C1 C2*logser0221 C3*logser05 21 C4*logser0621; instrument list: ser02, ser05, ser06, ser07, ser08, ser09, ser10, ser11

Coefcient C(1) C(2) C(3) R2 Adjusted R 2 SE of regression Durbin-Watson stat. Table VI. FDI equation: equation (III) 2.824097 2 0.710851 1.748921 0.516600 0.503356 0.283546 1.611026

SE 2.380196 0.316617 0.280222 Mean-dependent var. SD-dependent var. Sum-squared resid.

t-statistic 1.186498 22.245148 6.241192

Prob. 0.2393 0.0278 0.0000 7.670803 0.402348 5.869098

Notes: Dependent variable log(ser13); method TSLS; sample (adjusted) 2000:08; 2006:11; included observations 76 after adjusting endpoints; logser13 C1 C2*logser1422 C3*logser01; instrument list ser02, ser05, ser06, ser07, ser08, ser09, ser10, ser11

would impact internal sales by 2 0.48 percent or (0.8369).(2 0.57) (Table IV). Consequently, a 0.48 percent reduction would imply a 2 0.84 percent or (1.75 percent). (2 0.48 percent) decrease in FDI (Table VI). The inuence of consumer nancing interest rate on FDI was also found to be signicant. H5 concerns the relationship between FDI in Brazil and the increasing overall attractiveness of the Brazilian economy during the study period, 2000-2007. To test this hypothesis, the study period was divided into two sections, one ranging from June 2000 to December 2003 and the other from January 2004 to June 2007. This was done to take into account the different macroeconomic conditions that prevailed in the two periods. While Brazils economy was characterized by high-interest rates and low-GDP rate in the earlier period, while it experienced decreasing interest rates and increasing GDP growth in the latter period. Model III was therefore estimated for these two periods separately. The results are presented in Tables VII and VIII. The models parameters were tested by breakpoint Chow. The test revealed that the differences were not signicant. Hence, this hypothesis should be rejected, implying that there was no evidence of changes in the ow of foreign capital to Brazil over the study period, which could be interpreted as a result of increased attractiveness of the market.

Coefcient C(1) C(2) C(3) R2 Adjusted R 2 SE of regression Durbin-Watson stat. 3.581909 2 1.161827 2.065047 0.503878 0.477766 0.262926 2.050384

SE 2.534478 0.376496 0.382896 Mean-dependent var. SD-dependent var. Sum-squared resid.

t-statistic 1.413273 23.085894 5.393239

Prob. 0.1657 0.0038 0.0000 7.594670 0.363832 2.626935

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213Table VII. FDI in Brazil and attractiveness of Brazilian economy (2000-2003)

Notes: Dependent variable log(ser13); method TSLS; sample (adjusted) 2000:08; 2003:12; included observations 41 after adjusting endpoints; logser13 C1 C2*logser1422 C3* logser01; instrument list ser02, ser05, ser06, ser07, ser08, ser09, ser10, ser11

Coefcient C(1) C(2) C(3) R2 Adjusted R 2 SE of regression Durbin-Watson stat. 4.534647 2 1.242195 1.894167 0.574542 0.547951 0.290112 1.549838

SE 4.370874 0.603585 0.472651 Mean-dependent var. SD-dependent var. Sum-squared resid.

t-statistic 1.037469 22.058028 4.007543

Prob. 0.3073 0.0478 0.0003 7.759988 0.431492 2.693285

Notes: Dependent variable log(ser13); method TSLS; sample (adjusted): 2004:01; 2006:11; included observations 35 after adjusting endpoints; logser13 C1 C2*logser1422 C3* logser01; instrument list ser02, ser05, ser06, ser07, ser08, ser09, ser10, ser11

Table VIII. FDI in Brazil and attractiveness of Brazilian economy (2004-2006)

In all, of the ve hypotheses proposed, H1-H4 were conrmed and H5 was found to be not supported by the data. The evolution of the consumer market is important for FDI and it is more relevant than changes in exchange rate, which incorporate, and therefore account for, country risk variation. Discussion In this study, we attempted to explain the FDI in Brazil in terms of internal market dynamics, particularly consumer sales. The research carried out was against the backdrop of the Plano Real, which ushered in a new era of economic stability and growth in Brazil. Allowing for a period of maturation for the effects of the Plano Real to play out, we chose the period of 2000-2007 to account for the inow of FDI into Brazil. Based on a review of extant research on FDI in emerging markets, we identied a subset of factors which were found to inuence inward FDI in such markets. In the context of Brazil, we attempted to isolate the determinants of FDI ows from among aggregate retail sales, exchange rate, interest rate for consumer nancing, and attractiveness of the Brazilian market. Our study stems from certain assumptions (hypotheses) derived from literature. The rst is that internal market growth is an important factor for the expansion of FDI. The second and the third propose that expansion motivated by changes in the internal market is more important in explaining the ow of investment than the inhibiting effect

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of the risks associated with such endeavors in Brazil, represented by the Brazilian exchange rate. The fourth hypothesis postulates that uctuation in the interest rate on consumer nancing is an important element in determining the ow of FDI. The nal hypothesis assumes that interest in the Brazilian market has changed for the better over time making it more attractive for drawing FDI. The interrelationships among these factors were modeled in a system of three simultaneous equations, which were estimated using monthly data of the most recent years (June 2000 to June 2007). The results showed that internal market growth represented by aggregate consumer sales was indeed a signicant determinant in explaining FDI into Brazil. This sensitivity to internal sales proved stronger than that to exchange rate uctuations, which stands for variations in country risk. Increase in interest rate on consumer nancing was found to be negatively related to FDI. Finally, contrary to popular notions, there is no evidence to suggest that the overall attractiveness of the Brazilian market made any difference to the ow of FDI over the study period. In testing the attractiveness of the market, the size of the market was represented by the real sales series. Arguably, variables such as population size and growth could also be considered in future studies. Our study has implications for both academic research to understand FDI ows as well as policy to promote increased inward ows in emerging markets. Academic research on FDI to date tended to focus on macroeconomic factors such as market size measured by GDP, ination, interest and exchange rates in host countries, and corresponding variables in home countries. In this study, we included both macroeconomic variables as well as internal market dynamism measured by consumer sales. While factors such as exchange rates did emerge signicant to explain FDI inows into Brazil during the captioned period, aggregate retail sales appear to bear a greater correlation to FDI. This nding might be explained by the large size of the Brazilian market but provides a more nuanced understanding of the importance of internal market dynamism in attracting FDI. It is quite possible that while factors such as ination and exchange rates might be considered more important for smaller, less stable markets, in the case of larger emerging markets such as the BRIC countries, multi-national rms might be less concerned with short-term uctuations in these variables and more guided by the internal market growth that affords greater opportunities for a more intensive use of their resources to achieve economies of scale and scope. Policy planners in the big emerging markets may try to stimulate their internal markets by undertaking efforts to reduce the transaction costs such as the tax rates that are typically high, rather than tweak their scal and monetary policies to attract FDI. For instance, the Brazilian internal market was stimulated by a policy that allowed companies to deduct debt payments from the employees paychecks. We do recognize that the ndings our study cannot be generalized unless they are validated in other emerging markets with similar market characteristics. Our study also underscores the need to differentiate emerging and developed markets as well as variations within the emerging markets themselves in isolating the determinants of FDI.References Asiedu, E. (2001), On the determinants of foreign direct investment to developing countries: is Africa different?, World Development, Vol. 30 No. 1, pp. 107-19. Bacha, E.L. and Bonelli, R. (2005), Uma interpretacao das causas da desaceleracao economica do Brasil, Revista de Economia Poltica, Vol. 25 No. 3(99), pp. 163-89.

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Sun, Q., Tong, W. and Yu, Q. (2002), Determinants of foreign direct investment across China, Journal of International Money and Finance, Vol. 21, pp. 79-113. o, L.J. and Mixon, F.G. Jr (2004), Strategic factors affecting foreign direct investment Trevin decisions by multi-national enterprises in Latin America, Journal of World Business, Vol. 39, pp. 233-43. UNCTAD (2008), World Investment Report, available at: www.unctad.org/wir Corresponding author Rangamohan V. Eunni can be contacted at: rveunni@ysu.edu

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