Lewis University

Celebration of Scholarship

The Effect of Foreign Direct Investment on Uganda, with a

Comparison to Kenya and Tanzania

By

Patricia J. Kaira

International Finance-MBA Student

College of Business

A.

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A. Abstract

Uganda, Kenya, and Tanzania currently hold together the East African

economy with Rwanda and Burundi and are encouraging other countries

like Sudan, and Congo to add to its strength. The aim of this research is to

analyze if foreign direct investment has a similar effect on the Tanzanian

and Kenyan economies as it has on the Ugandan economy.

Hence, the scope of the research will be comparing different economies

so as to come up with viable data to encourage foreign trade and

investment in Uganda and East Africa. This data will be analyzed using a

mixed-method approach of quantitative and qualitative methods. The

quantitative methodology analyses balance of payments for Uganda, Kenya,

and Tanzania and statistical data from the United Nations Conference on

Trade and Development (UNCTAD), International Monetary Fund (IMF),

and World Bank showing a comparative analysis of these countries’

economies. The qualitative methodology reviews academic journals on the

effects foreign direct Investment has on the economy of a country, its

contribution to economic growth, and its contribution to trade policy

decisions concerning regional blocks like the East African Community

(EAC).

The results of the analysis will whether foreign direct investment is

having a similar impact on Uganda, Tanzania, and Kenya, and if it is

fostering cooperation and integration among economies and financial

markets of the three countries.

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A greater understanding of the impacts of foreign direct investment

will contribute to the on-going discussion of whether an East African

Monetary Union (EAMU) can be successfully formed among the three

countries.

Keywords: East African Community (EAC), East African Monetary Union

(EAMU), Foreign Direct Investment (FDI), United Nations Conference on

Trade and Development (UNCTAD), OLI (Ownership, Location,

Internalization) Paradigm, and International Monetary Fund (IMF).

B. Introduction

FDI is an important aspect of globalization not only for multinational

enterprises (MNE), but for countries too. Uganda has realized that foreign

aid and foreign investment has contributed to its economical growth in the

region. The East African region is changing rapidly since oil and natural gas

were found in Uganda and off the cost of the United Republic of Tanzania.

Hence, the goal of the East African Community (EAC) is to transform the

regional economy through industrialization by 2032. Uganda has a current

growth rate of 5.6%, which has slowed down from 6.5% in the early 2000s;

currently Tanzania’s has medium-term growth prospect at around 7%

(AFDB, 2013). Ugandan government stabilized its economy in 2012 where

inflation fell from 18.7% in 2011 to 14.6% (AFDB, 2013). Foreign direct

investment (FDI) is very important to Uganda because it encourages trade

and domestic investment from remittance, export and import, and sector

growth; The research done will show that FDI is not only important to

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Uganda, but also to Kenya, Tanzania and the whole East African region

using the framework of the OLI paradigm.

C. Literature Review

OLI Paradigm

This theoretical framework explains why multinational enterprises

(MNEs) choose foreign direct investment than alternative modes like

licensing, joint ventures, strategic alliances, management contracts, and

exporting. This theoretical framework was developed by John Dunning in

1977, where a firm must have competitive advantage in its home market

that it can transfer abroad for it to be successful in foreign direct

investment (Eiteman, Stonehill, & Moffett, 2013). The “O” in OLI stands for

owner-specific advantages; hence, firm’s has to have competitive

advantages in its home market. Therefore, the advantages must be firm

specific, not easily copied and in a form that allows the firm to transfer

these advantages to its foreign subsidiaries (Eiteman, Stonehill, & Moffett,

2013).

The “L” stands for location-specific advantages. These factors are

typically market imperfections or genuine comparative advantages that

affect FDI to particular locations (Eiteman, Stonehill, & Moffett, 2013);

hence, Uganda, Kenya, and Tanzania. Deepak’s colleagues explain that FDI

trends would indicate MNEs often invest in a particular country not

withstanding idiosyncratic variations in individual investment decisions.

Therefore, the shifts in FDI destinations over time can therefore be

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analyzed at a country level development (Deepak, Guisinger, Phelan, &

Berg, 2003).

The “I” on OLI stands for internalization. The key ingredient for

maintaining a firm-specific competitive advantage is possession of

proprietary information and control of the human capital that can generate

new information through expertise in research (Eiteman, Stonehill, &

Moffett, 2013).

Uganda’s Economy and FDI

Uganda received independence in 1962 with the help of Milton Obote

who later became Uganda’s first president. In 1971, Obote was ousted by

Idi Amin Dada who was ousted by Tanzanian forces in 1979 leading to the

reinstatement of Obote as president. In 1986, insurgent leader Yoweri

Museveni took power in a military coup. In 2005, Museveni established a

multi-party government where he went on to win a third term in 2006 and a

fourth in 2011. Limited market reforms have produced more than a decade

of relatively strong economic growth. Uganda has substantial natural

resources, but agriculture and fishing employ over 80% of the workforce

(THF, 2014).

Uganda’s average tariff rate is 7.3 percent; hence, the Ugandan

government does not generally discriminate against foreign investors, but

the legal and regulatory systems may be difficult to navigate. The financial

system is dominated by banking which is relatively open to competition but

still subjected to government influence. Lending to the private sector has

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gradually increased; however, capital markets are still relatively small and

underdeveloped (THF, 2014).

Uganda has always been open to foreign investment where it provides

tax incentives for medium and long-term foreign investors. According to

The Heritage Foundation (THF), Uganda’s economic freedom score is 59.9

which is below the world average, making it the 91st freest economy in the

2014 Index out of 165 countries. Its score is 1.2 points lower than last year

due primarily to deteriorations in financial freedom, monetary freedom, and

business freedom. Uganda is ranked 10th out of 46 countries in the Sub-

Saharan Africa region (THF, 2014).

Foreign direct investment does face political risk because of location and

internalization. In the case of Uganda, firms will be facing country specific

risk which is cultural and institutional risks rising for the current

controversial laws passed by the Ugandan government concerning

homosexuals and women. Currently, it cannot be determined how passing

these laws will affect Uganda’s economy and its relationship with the World.

Kenya’s Economy and FDI

Kenya has a long history of economic leadership in East Africa as the

largest and most advanced economy in the region. However, ethnically-

charged post-election violence in January-February 2008 left about 1,200

dead and 600,000 displaced, caused many to reassess Kenya’s investment

climate. Since then, the economy has rebounded; serious concerns

regarding corruption and governance have slowed Kenya’s economic

growth, while some neighboring countries have maintained higher growth

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rates and more political stability. Economic growth in 2012 was projected

by the World Bank to have been 4.3 percent, lower than earlier projections

of 5 to 6 percent growth (U.S Department of State, 2013). The World Bank

changed its projections because Kenya’s long term flows which are mainly

project loans that include defense loans increased from $527 million in

2010 to $1, 449 million in 2012 (World Bank, 2013). The new growth rate

projections changed to 5.0 percent in 2013 and 5.1 percent in 2014.

Overall GDP growth has been negatively affected by global-specific risk

like high interest rates, heightened insecurity due to al-Shabaab terrorist

attacks and the emergence of youth gangs, election uncertainty, and

depressed global demand due to the Euro-zone debt crisis. Tourism and

horticulture have been most affected by the slowdown in Europe. An

increase in consumption expenditure in construction and trade sectors as a

result of improved access to credit brought by falling interest rates; hence,

would accelerate overall growth (U.S Department of State, 2013).

The East African Community (EAC) currently relies on Kenya’s economy

because it is the largest in the region and is much more dynamic than those

of other member countries. Kenya has a stable economy which is better

linked to the other economies in terms of investment flows and trade.

Thanks to its more advanced human capital base, its more diversified

economy, and its role as a leader in the information communication

revolution in the region, Kenya's economy is expected to remain strong,

creating salutary benefits to the other member countries (Kimenyi & Kibe,

2014). The prospects for a strong economy are boosted by recent

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institutional reforms that have culminated in the adoption of a new

constitution that provides for devolved governance. Kenya has always had

relatively market-friendly policies for most of the post-independence era,

relative political stability, and lack of dramatic ideological shifts which have

helped Kenya keep its position (Kimenyi & Kibe, 2014). Hence, the other

members of the East African Community have had rather turbulent political

histories.

Tanzania’s Economy and FDI

Tanzania is one of the poorest economies in term of per capita

income. Tanzania started liberalizing its credit allocation in the 1980s, but

this was not realized until liberalization of the financial sector in the 1990s.

According to The Heritage Foundation, Tanzania’s economic expansion in

recent years has been facilitated by open-market policies related to global

commerce. However, private-property rights are weakly protected and

poorly defined, deterring sustainable investment (THF, 2014).

Tanzania liberalized the financial sector by passing the National

Investment (Promotion and Protection) Act in the April of 1990.This act

provides the fundamental definition of investment implying also to foreign

direct investment (FDI). According to this act FDI and foreign capital are

described as follows “….foreign investment means contribution of foreign

capital by a foreign national (i.e. a person who is not a citizen of the United

Republic and, or a company or other body corporated outside the United

Republic of Tanzania).” Foreign capital, thereafter, is defined to include

plant, machinery, buildings, spare parts, raw material, and other business

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assets obtained by the expenditure of foreign convertible currency or

negotiable instruments demonstrated in foreign convertible currency and

retained earnings as well as unremitted dividends (UNCTAD, 2006).”

The National Investment Act has led to the establishment of the

Tanzanian Investment Act of 1997. The Tanzania’s capital account regime

restricts the free flow of capital in and out of the country. Non-citizens

cannot buy bonds and other debt securities in the domestic market.

Through the Tanzanian Investment Center (TIC), Tanzania assist investors,

screens foreign investments, and facilitates project start-ups. The TIC has

been given authority to manage Public Private Partnerships (PPPs) for

foreign companies under the 2010 PPP legislation that sets a framework for

Build-Operate-Transfer arrangements with private companies. Filing with

TIC is not mandatory, but offers incentives for joint ventures with

Tanzanians and wholly owned foreign projects above USD 300,000 (U.S

Department of State, 2012). Tanzania’s foreign direct investment increased

from $1.2 billion in 2011 to 1.7 billion in 2012. This shows that the

legislations and regulations that Tanzania has establishes although seeming

restrictive have helped increase FDI.

D. Methodology

Foreign direct investment of a particular country cannot be analyzed on

its own without analyzing the foreign direct investment of its neighboring

countries so as to come up with a viable understanding of how it affects

these countries’ economies. As was stated before the scope of this research

is to compare these three economies to come up with viable data to

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encourage more foreign direct investment in Uganda and East Africa. Also,

is foreign direct investment fostering cooperation and integration their

economies and financial markets.

How has FDI contributed to the Uganda, Kenya, and Tanzanian economies?

The qualitative aspect of this research tries to answer the question

above by reviewing journal articles, business articles, and literary research

done by renowned organizations like UNCTAD, World Bank, The Heritage

Foundation, and the respective agencies in Uganda, Kenya, and Tanzania.

This literature will show the contributions FDI has on economical growth,

contribution to regional trade policies, and how government policies have

affected its decline or increase in past years.

Has FDI played a similar role in Kenya and Tanzania?

The quantitative aspect shows how FDI has affected these economies

by analyzing FDI inflows in relationship to each country’s balance of

payment (BOP). GDP per capita is also important when analyzing FDI,

because it provides information on what percentage of GDP growth comes

from FDI. Another economic statistic being analyzed is the counties current

accounts. The current account transactions in the balance of payment

shows the net flow of trade, goods, services, and unilateral transactions

(including FDI) between country and all foreign countries. The statistical

data comprising all the areas discussed above will come from the World

Bank, International Monetary Fund (IMF), Trading Economics, and Knoema.

E. Analysis

Government regulations and legislation

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As stated in the literature review multinational enterprises (MNEs) will be

facing country-specific risk in East Africa, if they decided to invest.

Currently, Uganda is in favor of trying to level the playing field for all

investors. In 2012, Uganda made some significant changes to its 2011 tax

code to include the introduction of transfer pricing regulations and the

elimination of the "investment trader status," which previously allowed

monthly recouping of Value Added Tax (VAT) on all imports and services

related to the initial construction of an investment in order to boost

domestic revenues (U.S. Department of State, 2012).

Kenya has experienced difficulty seizing opportunities generated by

trade liberalization in developed markets to export manufactured

commodities. In 2012, Kenya created a legal framework for FDI which

comprise of the Companies Ordinance, the Partnership Act, the Foreign

Investment Protection Act, and the Investment Promotion Act of 2004. To

attract investment, the Kenyan government enacted several reforms,

including abolishing export and import licensing except for a few items

listed in the Imports, Exports and Essential Supplies Act; rationalizing and

reducing import tariffs; revoking all export duties and current account

restrictions; freeing the Kenya shilling's exchange rate; allowing residents

and non-residents to open foreign currency accounts with domestic banks;

and removing restrictions on borrowing by foreign as well as domestic

companies (U.S Department of State, 2012).

As stated before, Tanzania established the National Investment Act

which led to the Tanzanian Investment Act of 1997. Its capital account

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regime is restrictive to the free flow of capital in and out of the country.

Non-citizens cannot buy bonds and other debt securities in the domestic

market. Hence, through the Tanzanian Investment Center (TIC), Tanzania

assist investors, screens foreign investments, and facilitates project start-

ups.

The economical effect of FDI

In 2012, Uganda’s foreign direct investment (FDI) net inflow was 4.74%

of GDP according to the World Bank (TradiningEconomics.com, 2012).

However, Uganda’s GDP was $19.88 billion and FDI was $1.7212 billion

which increased by about 4 points to 8.66% of GDP (Google, Inc, 2014).

The Chart below shows how FDI net flows as a percentage of GDP. The

chart below shows that Uganda relies more on FDI than Tanzania and

Kenya. Hence, Uganda’s FDI has increased steadily for 16 years since

President Museveni was democratically elected president in 1989.

Chart 1: Foreign direct investment, net inflows (% of GDP)

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However in 2012, Kenya FDI remains subdued because it only received

$ 164 million compared to Uganda that received $3.9 billion. Kenya’s FDI

inflow was 0.8% of GDP compared to Uganda at 8.66%. Uganda’s FDI

climbed in 2010 to 2012 because it had reached an agreement with the

countries that use the Nile River (Sudan, Egypt, and Ethiopia) to build a

new dam. Also during that time it was rumored that Uganda had a high

reserve of natural gas and oil; hence, this was confirmed in 2013.

Even though, Kenya is the most stable economy in the region, it has not

been an attractive destination for foreign direct investment because of

infrastructure and political unrest. Currently, Kenya does not have the

proper infrastructure to facilitate the production activities and sales of

goods and services (World Bank, 2013). Even though Kenya’s FDI is 0.8% of

GDP its GDP per capita is much higher than its neighbor Uganda.

Source: World Bank via Google World Development Index

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Chart 2: FDI Flows (As a % of fixed Capital across 16 years)

Kenya and Tanzania may have less FDI than Uganda, but they have a higher

GDP per capita than Uganda.

F. Results

The results indicate that Uganda, Kenya, and Tanzania know the benefits

of foreign direct investment (FDI); hence, they have regulation and

legislation to increase their private sector. According to The Heritage

Foundation, Uganda, Tanzania, and Kenya’s trade and investments have

increased by 7 and 6 points as described in the 2013 Economic Index

Report.

Currently, Kenya and Tanzania have very low FDI which economically is

not good. Looking at their GDP’s of 2013; hence, they both had a GDP of

$79 billion which was higher than Uganda by $25.6 billion. This shows that

Kenya and Tanzania economics are not determined by the amount of FDI

Source: World Bank *Kenya is used as the mean because it has the most stable economy and political climate.

Kenya

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they have but by the political stability, which Uganda has not had in the

past. Uganda went through eight years of war and it is still trying to catch

up to its neighbors economically.

As stated in the analysis the factor encouraging FDI in the region is

the legal framework created to increase growth in the private sector.

Relating to the OLI paradigm, this legal framework encourages MNE’s to

partner with their local counterpart and increase trade. Uganda, Tanzania,

and Kenya have a location specific advantage for MNE’s because of the

Great Rift Valley which is the most fertile and resource rich are in Africa.

The factors that discourage FDI are country-specific risk and

infrastructure. Country-specific risk being political instability and unrest in

the region; hence, which affects bilateral trade in the region and with the

world. Concerning infrastructure, there still some areas that are still

underdeveloped; however, more investment is going to those areas like the

Northern Uganda which has been devastated by 20 years of war.

G. Implications

Kenya and Tanzania need to increase their FDI inflows if they want to

compete on the international stage. Currently, their economies are striving

but for how long because FDI is becoming an important aspect of

globalization because it encourages multinational enterprises to invest.

Therefore, Kenya and Tanzania have aligned their economies to the East

Africa Community (EAC) with Uganda which is the sixth fastest growing

economy according to the United Nations Development Program (UNDP).

The other member countries of the EAC are Rwanda and Burundi.

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Before the EAC was established, Uganda, Tanzania, and Kenya have

always trade with each other. The electricity that Tanzania and Kenya use

comes from Uganda via Lake Victoria. Uganda is landlocked; therefore, it

exports its goods through Kenya via Mombasa and Tanzania via Dar-es-

Salaam.

Hence, the EAC increased the commitment to transform the regional

economy through industrialization; hence, its overriding objective is to

create a modern, competitive and dynamic industrial sector, fully integrated

into the global economy. The East African Community has provided free

movement of trade and investment across the region; hence, future

consideration of merging stock exchanges and integration of a single

currency are being considered. At the end of 2013 in Kampala, Uganda,

heads of state in East Africa on Saturday signed a monetary-union deal,

setting the clock on a 10-year timeline for the establishment of a regional

single currency. Bariyo states “The deal marks an important touchstone in

the region's transition from a collection of conflict zones to one of the

world's most promising destinations for investment (Bariyo, 2013).” This

deal will lead the way in the creation the East African Monetary Union

(EAMU) similar to the European Union. Therefore, Kenya and Tanzania are

working towards increasing their FDI so as to enhance investment not only

in their countries but in the region.

H. References

AFDB. (2013). Tanzania Economic Outlook. Abidjan, Côte d'Ivoire: African Development Bank (AFDB).

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AFDB. (2013). Uganda Economic Outlook. Abidjan, Côte d'Ivoire: African Development Bank (AFDB).

Bariyo, N. (2013, November 30). East Africa Takes Step Towards Single Currency. Retrieved March 5, 2014, from The Wall Street Journal: http://online.wsj.com/news/articles/SB10001424052702303332904579230004056818752

Deepak, S., Guisinger, S. E., Phelan, S. E., & Berg, D. M. (2003). Trends in Foreign Direct Investment Flows: A Theoretical and Empirical Analysis. Journal of International Business Studies , 34 (4), pp. 315-326.

Eiteman, D. K., Stonehill, A. I., & Moffett, M. H. (2013). Foreign Direct Investment and Political Risk. In International Business Finance (13 ed., pp. 460-477). Upper Saddle River, New Jersey, U.S.A: Pearson Education, Inc. .

Google, Inc. (2014, Janurary 10). Google Public Data Explorer- Foreign direct investment, net inflows (BoP, current US$). Retrieved March 08, 2014, from World Development Indicators: https://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&met_y=ny_gdp_mktp_cd&hl=en&dl=en&idim=country:UGA:KEN:TZA#!ctype=l&strail=false&bcs=d&nselm=h&met_y=bx_klt_dinv_cd_wd&scale_y=lin&ind_y=false&rdim=region&idim=country:UGA:KEN:TZA&ifdim=region&hl=

Kimenyi, M. S., & Kibe, J. (2014, Janurary 6). Africa's Powerhouse. (The Brookings Institute) Retrieved March 5, 2014, from Brookings: http://www.brookings.edu/research/opinions/2013/12/30-kenya-economy-kimenyi

THF. (2014). Index of Economic Freedom-Uganda. Washington, DC: The Heritage Foundation (THF).

THF. (2014). Tanzania-Economic Freedom Score. (The Heritage Foundation) Retrieved March 22, 2014, from 2014 Index of Economic Freedom: http://www.heritage.org/index/pdf/2014/countries/tanzania.pdf

TradiningEconomics.com. (2012). FOREIGN DIRECT INVESTMENT - NET INFLOWS (% OF GDP) IN UGANDA. Trading Economics . Retrieved Febuary 15, 2014, from http://www.tradingeconomics.com/uganda/foreign-direct-investment-net-inflows-percent-of-gdp-wb-data.html

U.S Department of State. (2012, June). 2012 Investment Climate Statement-Kenya. Retrieved March 23, 2014, from U.S. Department of State: http://www.state.gov/e/eb/rls/othr/ics/2012/191175.htm

U.S Department of State. (2012, June). 2012 Investment Climate Statement-Tanzania. (Bureau of Economic and Business Affairs) Retrieved March 22, 2014, from U.S Department of State: http://www.state.gov/e/eb/rls/othr/ics/2012/191247.htm

U.S Department of State. (2013, April). U.S. Department of State. Retrieved March 15, 2014, from 2013 Investment Climate Statement-Kenya: http://www.state.gov/e/eb/rls/othr/ics/2013/204669.htm

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U.S. Department of State. (2012, June). 2012 Investment Climate Statement - Uganda. Retrieved March 22, 2014, from U.S. Department of State: http://www.state.gov/e/eb/rls/othr/ics/2012/191256.htm

UNCTAD. (2006). United Republic of Tanzania. United Nations Conference on Trade and Development.

World Bank. (2013). Time to Shift Gears. Povery Production and Economic Managment Unit Africa region. Nairobi, Kenya: UNCTAD.