Determinants of foreign direct investment in the mining sector in Asia: A comparison between China and India

Resources Policy 36 (2011) 49–59

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Determinants of foreign direct investment in the mining sector in Asia: A comparison between China and India Vlado Vivoda n,1 School of Communication, International Studies and Languages, University of South Australia, A1-03, Magill Campus, GPO Box 2471, Adelaide SA 5001, Australia

a r t i c l e in fo

abstract

Article history: Received 3 May 2010 Received in revised form 17 July 2010 Accepted 18 August 2010 Available online 15 September 2010

The aim of this paper is to assess the conditions that influence foreign direct investment in the mineral industries of China and India. The paper first surveys literature on the determinants of foreign direct investment to identify key conditions, under which host countries attract mining FDI. It then builds an evaluative framework which allows for comparative analysis. The paper then comparatively evaluates the performance of foreign investment regimes that govern mineral industries in China and India. Its findings show that the overall conditions for foreign mining investment in China and India are not favourable and that substantial policy, regulatory and other changes in both countries need to be made if more investment is to flow. & 2010 Elsevier Ltd. All rights reserved.

JEL Classification: D81 F23 Q38 Keywords: China India Mining sector FDI determinants

Introduction In the early 1990s, China and India opened up their non-fuel mineral industries to foreign investment. Since, both countries have made changes to their regulatory regimes, intending to improve the investment climate for foreign mining companies. In the case of India, this has led to a complete redrafting of the existing mining laws, making India comparable to any liberal mineral producing regime. Meanwhile, China undertook more piecemeal changes to its mining legislation, promoting foreign investment in its highly prospective western provinces (Table 1). Yet, despite favourable regulatory reforms, both China and India have struggled to attract the desired levels of FDI into their non-fuel mineral industries. For example, in India, there is only a small presence of foreign mining firms and foreign mining

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Tel.: + 61 8 830 24874; fax: + 61 8 830 24745. E-mail address: [email protected] 1 Vlado Vivoda, Ph.D., is a Research Fellow at the School of International Studies, University of South Australia. He teaches undergraduate courses in International Relations and International Political Economy. In 2008, he published a book on bargaining in the contemporary oil industry. He specialises on energy security and mining regulation for foreign investment in Asia. He has published on energy and mining-related issues in Energy Policy, New Political Economy, International Journal of Global Energy Issues, Minerals and Energy and The Australian Journal of International Affairs. 0301-4207/$ - see front matter & 2010 Elsevier Ltd. All rights reserved. doi:10.1016/j.resourpol.2010.08.005

investment represents less than 1% of foreign direct capital stock in India (Athreye and Kapur, 2001). The country did not reach the US$22.37 billion investment target for 2007–2009 (Business Monitor International, 2008; O’Callaghan and Vivoda, 2010). Most mining majors have also steered clear of China, where the lack of transparency and uncertainty plague the investment environment (Suxun and Chenjunnan, 2008). In 2007, the sector attracted 1% of total FDI across all sectors in China (NBS, 2008). Although China improved foreign investment conditions between 2004 and 2006, resulting in a surge of foreign investment into the sector, many of these investments have not been realised, with some being stalled or stopped altogether. This has led to a feeling of uncertainty by some foreign enterprises towards China as a destination for exploration, mining and metals investment (CIMG, 2009). Only 10–15% of metal mining production in China and India was produced by foreign mining companies in 2005 (UNCTAD, 2007). Consequently, the aim of this paper is to assess the conditions that impact on the level of foreign direct investment in the mineral industries of China and India. The focus is on China and India because they have been the two fastest growing economies in the region and the largest FDI recipients among developing Asian states. The paper is organised as follows. ‘‘Introduction’’ surveys literature on the determinants of foreign direct investment to identify key conditions, under which host countries attract FDI in the mining sector. ‘‘Conditions that facilitate foreign

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Table 1 Recent changes in mineral rules and regulations in China and India. China

2008

2007

2006

2006

2005

2004

2003 2000

1996 1993 India

2008 2008 2006 2000 1997 1994 1993

Ministry of Commerce and MOLAR jointly promulgated the ‘‘Measures for the Administration of the Foreign-invested Mineral Exploration,’’ which consolidated existing rules governing the establishment and operation of foreign-invested exploration enterprises The Foreign Investment Guidance Catalogue was revised and the number of minerals classified as ‘encouraged’ reduced MOLAR announced its intention to amend the provisions of the Mineral Resources Law to create a more attractive investment environment for foreign investors MOLAR issued the ‘‘Notice of Further Regulating the Administration of the Grant of Mineral Rights,’’ to standardise procedures for the grant of exploration and mining rights State Council Directive ‘‘Notice Concerning the Comprehensive Rectification and Standardisation of the Regulation for Mineral Resource Development’’ Projects that do not require government financing and that fall into the ’permitted’ and ’encouraged’ categories will be approved automatically The State Council issues ‘China’s Policy on Mineral Resources’ that encourages foreign investment China issued the ’’Opinion on Further Encouraging Foreign Businesses to Make Investment in Exploring and Exploiting Mineral Resources Other Than Oil and Gas’’ Mineral Resources Law revised, the legal framework surrounding the mineral sector strengthened China allows foreign investment in prospecting and mining The Government gave its approval to the new National Mineral Policy 2008 Government allows 100% foreign-owned FDI in mining and mining-related industries Investment policy liberalised New foreign investment guidelines issued presenting new opportunities for mining investors FDI policy in the mining sector further liberalised to incorporate ’’automatic approval’’ Legislative changes consequent to National Mineral Policy National Mineral Policy revised: non-fuel and nonatomic minerals covered by the Act

direct investment in mineral industries’’ comparatively evaluates the performance of foreign investment regimes that govern mineral industries in China and India based on the evaluative criteria set up in ‘‘Introduction’’. This includes a discussion of key political, regulatory, fiscal, monetary, environmental, social and many other issues that impact on the levels of foreign investment in the mineral sectors of China and India. Finally, ‘‘Assessing the performance of China and India’’ summarises the main findings. The existing literature on foreign mining investment in China and India has some limitations. Region-wide and/or other comparative studies are either dated (Naito et al., 1998, 1999, 2001; Naito and Remy, 2001) or focus on a single country (China—Andrews-Speed et al., 2003; Tse, 2003; Penney et al., 2007; Suxun and Chenjunnan, 2008; India—Jhingran, 1997; Chatterjee, 2002; Singh and Kalirajan, 2003; Sames, 2006; Jain, 2008). This paper builds on previous theoretical work on determinants of FDI in the mineral sector to develop an evaluative framework, which allows for comparative analysis. The paper also has broader relevance, as the same evaluative framework developed here can be applied to a region-wide study, or comparatively to evaluate the attractiveness of any number of foreign investment destinations in the mining sector.

Conditions that facilitate foreign direct investment in mineral industries By and large, although some determinants of FDI (for example, the quality of formal institutions or tax policies) are important in the location of manufacturing and services as well as resource industries (mining and petroleum), most are industry specific (Imbun, 2006). The mineral sector has a certain combination of characteristics that can hardly be found in any other industry. According to Andrews-Speed (1996) and Saidu (2007), these include:

        

High capital intensity. Low labour intensity. Long lead time. High-risk. Non-renewable resource. Finite life. Volatile markets. Many failures. Late payback.

As a result of these unique characteristics, the determinants of FDI in the minerals sector are substantially different than those in other sectors. Otto (2006) argues that not only are determinants of FDI industry specific, they are also firm specific. The criteria that any one company will apply, in deciding whether to invest in a particular mineral-rich nation, will be unique to that company and time. Some companies, particularly risk-taking juniors that aim to establish a foothold in the industry, will target countries with good prospectivity regardless of risk, but most mining companies will balance prospectivity against risk criteria, when making investment decisions. Mining companies have many countries from which to select when deciding exploration and development budgets. In an ideal world, investment would flow to nations that have the most abundant and richest deposits. In reality, many other factors besides geological endowment influence investment decisions. Consequently, prior to investment, foreign mining companies require as much assurance as possible as to the security of the investment. This is particularly so given that mining investments involve large sunk costs that are irreversible. Due to the nature of the industry, mining companies are immobile for a period of time, and as such, their investments are typically of high-risk. The greatest risk is usually at the prospecting and exploration stage, and capital outlay increases over time as a project proceeds. It is in the commercial interests of any mining investor to undertake due diligence when considering any new major investment, and risk assessment should be part of any due diligence effort. One of the most convenient ways to measure geological potential and country-specific risk is by survey. The three best-known annual surveys of exploration investment are those conducted by the Metals Economics Group (MEG), Behre Dolbear and the Fraser Institute. The MEG survey provides general information on the sources and destinations of investment by various commodities, but does not provide much information on the reasons behind the direction of investment flows. The Behre Dolbear ‘Ranking of Countries for Mining Investment,’ which has been compiled since 1999, ranks twenty five countries that are host to major exploration or mineral development efforts and/or mining operations on seven criteria. The rankings in this annual survey are based on qualitative opinions gathered from company professionals and research from various public and confidential sources (Behre Dolbear, 2010). While the survey undoubtedly has some value, it provides no detailed explanatory notes on why the countries have been assigned a particular score for

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each of the seven criteria. The scores are based on the ‘‘collective experiences’’ gained by company professionals, who according to the company ‘‘have had the unique opportunity to travel widely and experience many different cultures’’ (Behre Dolbear, 2010). While their staff’s expertise is certainly extensive, and the survey has some value, their country ranking method lacks scientific rigour. The Fraser Institute survey, which commenced in 1997, is of slightly more use with regards to the determinants of mining FDI. It ranks, among other things, policy potential, mineral potential and investment attractiveness of a growing number of jurisdictions worldwide. Respondents include both junior and major mining companies, but also regulators, government officials, NGOs and many other groups and individuals involved in the mining industry.2 Whereas most mining companies will be interested in surveys such as those prepared by the MEG, Behre Dolbear and the Fraser Institute, inhouse assessments are the norm for guiding actual investment decisions. These vary from ad hoc decision-making in junior firms, to a classic Delphi-type approach or a guided uniform criteria assessment system (GUCAS) in major firms (Otto, 2006). Countries rich in natural resources attract more FDI than those not well endowed. Indeed, the geological potential of a country is the single most important factor in determining the attractiveness of that country to foreign mineral investment (Johnson, 1990; Eggert, 1992). Yet, some resource-rich countries have attracted more foreign investment than others. For instance, Australia and Canada have attracted more foreign mining investment than China and Russia. After analysing the main criteria to which mining companies refer in making investment decisions, Morgan (2002) found that a significant proportion reflect perceptions of a country’s administrative procedures and government agency functions. He argues that the perception of security of tenure is of paramount importance to foreign mining investment. Morisset (1999) examined determinants of an FDI in Africa’s resource-rich countries. He argued that the implementation of a few visible actions is essential in the strategy of attracting FDI:

     

opening the economy through a trade liberalisation reform; launching an attractive privatization programme; modernizing mining and investment codes; adopting international agreements related to FDI; developing a few priority projects that have a multiplier effects on other investment projects; and mounting an image-building effort with the participation of high political figures, including the President.

A study by Kasatuka and Minnitt (2006) found that noncommercial risk (NCR) deters foreign investment in mineral rich countries. Non-commercial risk includes government instability, poor socio-economic conditions, conflict, corruption, political terrorism, civil war, quality of bureaucracy, racial and nationality tensions, religious tensions and other issues. More recently, Tole and Koop (2010) examined firm location decisions by the world’s major gold mining firms using a dataset of political, economic, regulatory, infrastructural and investment risk variables observed since 1975. They found that firms prefer not to venture far away from their home offices, are strongly attracted to countries that 2 While liaising with government departments and non-for-profit organisations involved in the minerals industry, the author has been informed that many of these organisations are asked to fill out the Fraser Institute survey on an annual basis and they confirmed that they regularly respond to it. It is therefore unclear whether the survey represents responses only from the mining companies (as the company claim). In any case, allowing regulating agencies to respond to a survey that ranks mining jurisdictions adds a degree of bias to the results and makes it less objective.

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Table 2 key foreign investment criteria in the mining industry. Sources: Johnson, 1990; Otto, 1992b; Morisset, 1999; Naito, et al., 2001; Morgan, 2002; Kasatuka and Minnitt, 2006; Tienhaara, 2006; Penney et al., 2007; Tole and Koop, 2010. Category

Specific criteria

Geological

Geologic potential for target minerals Ability to apply geological assessment techniques Quality of mineral titles system (cadastre) Consistent and constant mineral policy National security and political stability Internal and external conflicts High level of transparency Low level of corruption Adoption of international agreements related to mining Trade liberalisation Privatization programme Image-building effort to attract investment Import-export policies Existence of prior priority projects Stability of exploration/mining terms (security of tenure) Modern mineral legislation Efficient regulatory institutions/administrative procedures Ability to predetermine tax liability (predictability) Stability of fiscal regime Method and level of tax levies Ability to repatriate profits Realistic foreign exchange regulations Ability to raise external financing Permitted external accounts Ability to predetermine environment-related obligations Stringent environmental regulations Ability to gain the support of local stakeholders Majority management control held by investor Right to transfer ownership Quality of infrastructure Projected measures of profitability (IRR, NPV, pay-back)

Political

Investment Promotion

Regulatory

Fiscal

Financial

Environmental and Social

Operational

Profit

have low levels of corruption, are attracted to fairly developed economies that provide a good business environment characterised by predictability, efficient institutions, transparent laws and advantageous tax codes. They also found that stringent environmental regulations attract firms. However, the most comprehensive study to date on determinants of an FDI in the mineral sector is that by Otto (1992a). He identified over 60 factors that may influence a mining company’s decision to invest in one country over another. He divided the investment criteria into nine principal categories: geological, political, regulatory, marketing, fiscal, monetary, environmental and social, operational and profit. In an effort to establish the relative importance of each individual criterion, Otto (1992b) surveyed 39 internationally active junior and major mining companies. Surveys by Johnson (1990) and Naito et al. (2001) have yielded similar results. The criteria ranking results for the most important determinants of investment are shown in Table 2 and are listed under Otto’s nine principal categories. Table 2 also includes additional criteria as identified by Morisset (1999), Morgan (2002), Kasatuka and Minnitt (2006), Penney et al. (2007) and Tole and Koop (2010). These key criteria in Table 2 provide a sufficiently broad basis for a meaningful cross-country comparison between China and India in ‘‘Conditions that facilitate foreign direct investment in mineral industries’’, though they do not include comparison according to projected measures of profitability (i.e. IRR, NPV, pay-back), which are commercially sensitive.

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Assessing the performance of China and India Geological Geological prospectivity has a major influence on the level of exploration activity as it defines the likelihood that a mining company will discover an economic deposit. The geological prospectivity of a region is determined by its geology and known mineral endowment. Both China and India have high geological prospectivity and a wide variety of non-fuel minerals have been commercially produced in both countries. China has substantial commercial reserves of bauxite, copper, gold, iron ore, lead, manganese, mercury, nickel, silver, tin, tungsten, zinc and various rare earth metals. India has substantial commercial reserves of bauxite, iron ore, manganese, zinc and many other minerals (Fong-Sam et al., 2007). The availability of a credible and publicly accessible geological database is an essential element to increasing the transparency of minerals-related information. A lack of adequate geological information can result in a downgrading of assessments of a region’s or a country’s potential to host exploration and mine development investment. Transparent information facilitates and promotes mineral exploration by reducing the costs and associated risks (PMSEIC, 2001). In the 2008/09 Fraser Institute’s Annual Survey of Mining Companies, quality of geological database (including quality and scale of maps, ease of access to information, etc.) was an investment deterrent to as many as 77% of survey respondents in China and 83% in India (Fraser Institute, 2009). China’s and India’s geological information is not of the same breadth or quality as that which exists in Australia or Canada. India does not have an established and easily accessible mineral titles system (cadastre) to provide adequate transparency, while choosing areas for mineral concessions. The Geographical Information System (GIS) is inadequate and antiquated and is not linked to geological databases. As a result, it becomes a daunting task for an investor to find out which area is open and which is not. Moreover the Geological Survey of India (GSI) has been spending much of its scarce resources on coal, while a vast amount of work remains to be done in the area of regional exploration for other major minerals. GSI data have been deemed inadequate for the exploration stage of mining operations (Planning Commission, 2006). In China, a lack of relevant legislation, an underdeveloped national database, and a reluctance to disclose geological information for national security reasons have all affected the provision of detailed geological information resources to foreign investors (CIMG, 2006). Previously collected geological information is often considered state secret and access to it by foreign companies is strictly limited and costly. According to Ward et al. (2003), provincial bureaus are also reluctant to release local data into the central database and the purchase and pricing of geological maps and reports is unclear.

Political An important purpose of a national mineral policy is to communicate investment conditions to potential investors and thereby improve competitiveness. In order to attract foreign mining investment, the national mineral policy should be consistent, clear and concise (Otto, 2006). Both China and India have published mineral policy documents. However, there has been a lack of consistency in the application of these policies. In both countries, some government officials are suspicious of foreign investors and often assume that they will exploit the national mineral endowment with little or no benefit to civil society. Yet, other officials realise that to attract investors, reforms

must be instituted that address investor requirements. Policy inconsistencies are a direct consequence of a high degree of decentralisation in both countries. In China, according to a president of an exploration company with operations in the country, ‘‘despite favourable policies espoused by the central government, there is a disconnect with how those [policies] are interpreted and acted upon in the provinces’’ (Fraser Institute, 2008). Some writers have even suggested that China targets foreign mining investment solely with the aim of transferring technology and superior management experience (Morrison and Foerster, 2008). In India, the decentralisation process has diluted central government authority and empowered the local level government units. State government agencies have a high degree of decisionmaking power and, at times when they have conflicting policies or objectives with the central government, they have not been shy to exercise that power (Limaye, 1998). Generally, in India, lower level government units have substantial power over decisions regarding mining investment in their jurisdictions, in a similar way to Indonesia and the Philippines (Vivoda, 2008; O’Callaghan, 2009, 2010; O’Callaghan and Vivoda, 2010). The reluctance of certain local governments to consent to mining projects is an evidence of divergence from the pro-mining policy pursued by the national government. The leading role in promotion of foreign mining investment has been played by the state of Rajasthan. In 2000, Rajasthan passed a policy with a focus on clarity of investment procedures, transparency and accountability (Singh and Kalirajan, 2003). Few other states have followed in the Rajasthan’s footsteps. In addition, despite liberalisation of the India’s investment restrictions in the mining sector and the proinvestment policy, the Indian government continues to have a strong preference for domestic natural resources companies over their Western counterparts (Bailey, 2007). Political stability and the absence of conflict and tension are also important determinants of foreign investment in the mineral sector. Mining companies are unlikely to invest in a country, if they perceive a significant possibility that the government will be destabilised or overthrown by unconstitutional or violent means, or there is a high degree of political or ethnic violence. A stable political environment reduces the risk of regulation changes and licences being revoked without warning. In unstable and/or conflict-ridden countries, companies will be concerned with the safety of their employees, equipment and tenements. Where violence is common, companies need to increase their spending on security measures for land holdings, mining equipment and staff, which increases operating costs (Penney et al., 2007). A report by Kaufmann et al. (2009) indicates that in 2008, the political stability and absence of violence in China and India stood at 33.5% and 16.7%, respectively.3 Both countries were in fact outperformed by Cambodia, Laos, Malaysia, Mongolia and Vietnam. The security situation has recently been worrying in India, where Naxalites, the left-wing Maoist guerrillas, are engaged in a violent struggle against what they regard as social injustice and economic inequality, especially in rural areas. They are a disparate collection of various groups and have targeted mining interests, large firms and infrastructure in resource-rich states of Orissa, Andhra Pradesh and Jharkand (Ford, 2007; EFIC, 2008).

3 The percentile rank of political stability and absence of violence criteria compared to all other countries included in the survey. The value is derived by ‘‘capturing perceptions of the likelihood that the government will be destabilised or overthrown by unconstitutional or violent means, including politically motivated violence and terrorism’’. The best performing country was Luxembourg, at 100%, and the worst Iraq, at 0% (Kaufmann et al., 2009).

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Regardless of government’s policies and regulations, it is important that information on these is transparent. Transparency reduces uncertainty and increases commercial confidence. Increased transparency allows companies to make an informed judgment on conducting exploration. In particular, the ability to access relevant information can make investors more willing to undertake exploration. If companies cannot determine what the relevant regulations and policies are, they are unlikely to invest in mineral exploration. Penney et al. (2007) found that there is a lack of investor certainty and administrative transparency in China, particularly at the provincial level. Suxun and Chenjunnan (2008) argue that there is no transparent procedure for ensuring the transfer from exploration to mining licence in China. The court trial of four executives of Rio Tinto, a mining major, in early 2010 also highlighted a lack of transparency in the Chinese judicial system (Kent, 2010). Administrative transparency is also an issue for mining investors in India. Particularly worrying is the lack of procedural transparency in the distribution of licence/lease, environment clearances, exit-policies and incentives (Singh and Kalirajan, 2003). This is unsurprising, given that India has previously expressed opposition to administrative transparency obligations on an investment in previous rounds of WTO and other multilateral negotiations (Sauve´, 2006). As previously mentioned, the access to geological information for foreign mining companies in both China and India is extremely difficult and geological data is often considered a state secret. Corruption, or the extent to which public power is exercised for private gain and capture, is one of the key deterrents to foreign investment. A report by Kaufmann et al. (2009) indicates that in 2008, the control of corruption in China and India stood at 41.1% and 44.4%, respectively.4 In Transparency International’s Corruption Perceptions Index (2009), China scored 3.6 out of 10 and India 3.4 out of 105. When their performance is put in perspective, they show that corruption is a serious issue in both China and India. While the level of corruption in the two countries is not as worrying as in some other Asian states, such as the Philippines, Myanmar or Laos, who score lower on both indicators, it is far from acceptable to foreign investors. A manager of an exploration company active in China stated that ‘‘China’s [suffers from] corruption at every level [and needs to] develops a stable democratic government’’ (Fraser Institute, 2007). In India, corruption is also widespread as regulating agencies lack independence from sectional influence and capture. The payment of bribes by mining companies to avoid bureaucratic red tape is commonplace (Planning Commission, 2006). The prospects in the anti-corruption battle in both countries are not promising. In analysing anti-corruption strategies in Asia, Quah (2006) was highly critical of China and India, arguing that their strategies show signs of inadequate anti-corruption measures and weak political will. Mining is a risky activity and mineral investors seek to reduce the risks by gaining legal protection for their investments. Mineral-rich countries, which adopt international agreements related to mining, are likely to attract more foreign investment (Tienhaara, 2006). These international agreements include bilateral investment treaties (BITs) between the home and the host

4 The percentile rank of the control of corruption criteria compared to all other countries included in the survey. The value is derived by ‘‘capturing perceptions of the extent to which public power is exercised for private gain, including both petty and grand forms of corruption, as well as capture of the state by elites and private interests’’. The best performing country was Singapore, at 100%, and the worst Somalia, at 0% (Kaufmann et al., 2009). 5 In comparison, the best performing country was New Zealand, at 9.4, and the worst performing Somalia at 1.1 (Transparency International, 2009).

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country, which give mining companies from home countries access to international arbitration and prohibit expropriation without compensation in host countries. China is, and India is not, a member of the International Centre for the Settlement of Investment Disputes (ICSID). China and India have not implemented or shown support for the Extractive Industries Transparency Initiative (EITI). With regards to bilateral investment treaties (BITs) between China and India and the home countries of the major mining companies, both countries have a BIT with Australia, Switzerland and the UK, but not with Canada, South Africa and the US (UNCTAD, 2010). Finally, neither China nor India uses the Committee for Mineral Reserves International Reporting Standards’ (CRIRSCO) International Reporting Template (IRT) as a template in the process of developing or revising their reporting documents (CRIRSCO, 2010). This shows that both China and India have failed to adopt most of the international agreements related to mining and this acts as a deterrent to foreign investment in the sector. Investment promotion Increasingly, governments are taking the role of investment promoter. The methods available to promote investment are both indirect, such as reforms of the underlying legal system and institutions, as well as direct, such as advertising and promotion of pro-investment policy. Naito and Remy (2001) argue that longterm success in attracting private investment in mineral exploration is affected not only by favourable natural endowment, but also effective implementation and promotion of policies. According to Naito et al. (2001) national governments focus their mining sector policies on how they can attract investments. Otto (2006) argues that the key to successful promotion is to first bring the mineral potential to the attention of investors, and second, to assure them that investment risks are low or manageable. In this context, a mineral-rich country wishing to attract mining FDI should publicise its mineral policy and the mining-related international agreements it had signed. More importantly, the mineral policy should be combined with broader sectoral reforms, which include the establishment of a competitive investment climate for private sector participation, including privatization and trade liberalisation. The mineral industry is trade focused, and as such, general trade restrictions that affect the sector will impede investment in mineral exploration and extraction. For example, any trade restrictions on the import of capital equipment required for mineral exploration are likely to affect exploration expenditure. Finally, if there is an evidence of few prior successful priority projects in the country by large international mining companies; this will attract potential mining investors. Both China and India have an official policy on mineral resources. ‘China’s Policy on Mineral Resources’ was issued in December 2003 by the Information Office of the State Council. India’s 2008 ‘National Mineral Policy,’ issued by the Ministry of Mines, is based on the recommendations of the government’s high level committee report, which sets up the policy in much detail (Planning Commission, 2006). China’s mineral policy devotes considerable attention to measures aimed at attracting foreign mining investment. The policy states that ‘‘China implements the policy of encouraging foreign businesses to invest in mineral resources prospecting and exploitation in the country,’’ and that it aims to ‘‘improve the investment environment, encourage and attract foreign investors to prospect for and exploit mineral resources in China’’. The policy also outlines in some detail the new rules and regulations for foreign investment (Information Office of the State Council of the People’s Republic of China, 2003).

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India’s mineral policy is also aimed at attracting foreign investment: ‘‘induction of foreign technology and foreign participation in exploration and mining for high value and scarce minerals shall be pursued. Foreign equity investment in joint ventures for exploration and mining promoted by Indian Companies will be encouraged’’ (Ministry of Mines, 2008). However, there is no elaboration on the details of new rules and regulations for foreign mining investment. Both China and India’s mineral policies briefly outline the new rules and regulation for mining investment in general, and improvements in the governance and management of the sector, in particular. At the same time, there is no explicit assurance for foreign investors that investment risks are low or manageable and of what measures are to be taken by the respective governments to make those risks low and/or manageable. In addition, there have been no signs of broader proinvestment sectoral reforms in the two countries that should accompany investor-friendly mineral policies, and this is a deterrent to foreign mining investment. In India, the government still has a firm grip on the mineral industry, and 80% of the total value of mineral production is claimed by the public sector (Sames, 2006). In China, mining activities also continue to be largely under the control of the central government or regional or local public authorities. Foreign participation in the industry is limited and insignificant in the context of the overall number of participants in the sector (CIMG, 2009). With regards to import–export trade restrictions, in China and India, it is required that production of various minerals is consumed or used domestically and export of certain minerals is prohibited. For example, China prohibits the export of gold and India prohibits the export of coal. Moreover China and India serve as rare examples of countries that levy an export tax on minerals. China levies the export tax rate for aluminium, copper and nickel at 15%, while India levies 7% tax on iron ore exports (Davis, 2010). Trade restrictions and export taxes are not promoting China and India as attractive destinations for foreign mining investment. Finally, given the short timeframe within which mineral industries in China and India have been open to foreign investment, there is still no evidence of successful completion of previous priority projects by foreign mining investors. While some majors established their operations in both countries, their projects are small scale in international standards and cannot be regarded as ‘priority’.

Regulatory Foreign investment is likely to increase when regulations and procedures are clear, efficient and transparent and when all levels of government are consistent and effective in their application of regulations. The overall government effectiveness is affected by perceptions of the quality of public provision, quality of bureaucracy, competence of civil servants and their independence from political pressure and the credibility of government decisions (Jalilian et al., 2007). Ineffective governance structures and poor governance infrastructure, and in particular, excessively complex administrative and/or regulatory procedures required to establish and operate a business, discourage inflows of foreign mining investment (Globerman and Shapiro, 2002). Conversely, a high level of cooperation between government departments or the existence of a ‘one stop shop’ to manage the regulatory process can reduce the time required and cost of obtaining approvals, which may encourage mineral exploration in a jurisdiction (Penney et al., 2007). In addition, mining laws in most nations provide a two-step process in which a company gains, first, a right to explore and then should an economic deposit be discovered, a

right to mine. The strength of the linkage between the right to explore and the right to mine is a measure of the company’s security of tenure (Otto, 2006). If the company perceives that it will have high security of tenure, the more likely it is that it will invest in a particular country. In the 2008/09 Fraser Institute Annual Survey of Mining Companies, uncertainty concerning the administration, interpretation and enforcement of existing regulations was an investment deterrent to 67% of survey respondents in China and 74% in India. Similarly, regulatory duplication and inconsistencies (federal/ provincial, federal/state and interdepartmental overlap) was an investment deterrent to 72% of respondents in China and 80% in India (Fraser Institute, 2009).

China The regulatory framework for the minerals sector is complex in China. The framework manifests itself both in terms of a complex approvals process and inconsistent regulations and policy between central, provincial and local levels of government (Penney et al., 2007). China’s legal system is also highly complex and regulations are subject to frequent revision and changing interpretation (Morrison and Foerster, 2008). Obtaining an exploration licence in China requires dealing with a number of ministries and levels of government. The process is more complex for foreign investors as there are more stringent conditions on investment structures, foreign equipment and expertise, and the type of minerals that may be targeted (Penney et al., 2007). The process for acquisition of a mining licence after the mineral reserves has been verified as neither automatic nor transparent. In most cases, the authority to grant exploration and mining rights is transferred to provincial and local governments. As a result, there is a high degree of duplicity and complexity in the approval process (O’Callaghan and Vivoda, 2010). For example, two levels of government can issue exploration licences and four levels of government can issue mining licences (Ward et al., 2003). Local government agencies, at times, present a different regulatory and policy focus from that at central government level. Local governments set up their own standards for the acquisition and cancellation of mineral rights, and China’s Mineral Resources Law does not provide mineral rights holders with sufficient safeguards against the intrusion of local government (Suxun and Chenjunnan, 2008). Consequently, as a project moves through various stages (exploration, feasibility, construction, development and operation) investors are often required to comply with standards that overlap, are unclear, and may be subject to a degree of administrative discretion at the provincial and local level (Suxun and Chenjunnan, 2008). This undermines investor confidence in the security of tenure and adds uncertainty in investment in China’s mining sector. Moreover the structure of government bureaucracy in China is in a state of flux, resulting in unclear lines of authority regarding the regulation of foreign mining investment. There is significant regulatory confusion and overlap between various departments, including the Ministry of Land and Resources (MOLAR), the Ministry of Commerce, the State Environmental Protection Administration (SEPA) and the State Development and Reform Commission (SDRC) with regards to the mining licence approval process. In particular, although MOLAR may issue its approval in a timely fashion, the Ministry of Commerce, the environmental agencies and the SDRC approvals may take longer (O’Callaghan and Vivoda, 2010). Unsurprisingly, investors’ perceptions of China’s regulatory and legal system in the mining sector are mainly negative. According to a president of an exploration company with operations in China, ‘‘in China, title and laws mean nothing. The

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law is what the emperor says it is at any given time—and the emperor is an amorphous political party. After spending $10 million on exploration in China, we were stonewalled by Beijing for four years as a means to deny us the final production permit’’ (Fraser Institute, 2009). In particular, many foreign investors find ventures with local partners and security of tenure to be of particular problems in China. According to an exploration company consultant: ‘‘China’s [suffers from] uncertainty of land tenure because of the necessity to partner with government entities who prove untrustworthy. After giving our partner in China $300,000 + in cash, land covering the joint venture (JV) area was never transferred into the name of the JV: delay after delay. Finally, we gave up on the property and moved out of China. This scenario has been repeated time and time again in China—word is travelling in investment circles that everyone who works in China is getting ‘‘ripped off’’ (Fraser Institute, 2008). China also has restrictive licensing conditions. The Foreign Investment Guidance Catalogue categorises various minerals as ‘encouraged,’ ‘permitted,’ ‘restricted’ or ‘prohibited’ and determines the type of investment structure permitted for exploration and extraction. The most recent revision to the catalogue came into force in late 2007 and, for the most part, it imposed further restrictions on foreign investment in minerals exploration and development activities (Morrison and Foerster, 2008). Thus, at present, a number of minerals is opened to foreign companies (iron ore, copper, lead, zinc and bauxite), but the strategic minerals, such as gold, silver, platinum, tin, radioactive minerals and rare earth metals are restricted or prohibited. In addition, known deposits that are low grade or technically challenging are offered via bidding or other approaches and mines that are offered to investors are generally those that are losing money. For example, foreign investors are permitted to exploit ‘‘gold deposits that are of low grade and hard to extract’’ (Suxun and Chenjunnan, 2008). Investors are also expected to bear the costs of the social obligations typical of socialist mining communities (worker housing, roads, schools and hospitals). India According to a survey conducted by Naito and Remy (2001), as part of a larger World Bank project, India had one of the lowest scores on various regulatory parameters of interest to investors compared to other resource-rich countries in the region. Nonuniformity of rules and regulations across the country characterises Indian mining laws. The states hold the sole licensing authority for most minerals, except for iron ore and uranium, which require prior consent from the central government. States can also create their own qualifying conditions and most of them hold discretionary powers to terminate a mining lease, or to take ownership of a mine on grounds of non-performance, or environmental or labour-related reasons (Research and Markets, 2009). In India, a prospecting company starts with a reconnaissance permit (RP). This allows them to conduct preliminary studies on and above the ground through aerial and geophysical surveys. The next stage, for which they need a prospecting licence (PL), is when they can drill the ground and locate specific deposits. The mining lease (ML) follows these two stages. The RP is given for a maximum area of 10,000 km2. Then, in two years, an RP area is halved. In the third year, it is reduced to just 25 km2. While the sequence is in tune with global norms, some investors argue that the actual area over which an RP is first allowed is too small: the global norm is for awarding 50,000 km2. While the reconnaissance is based on some geological data, the probability of finding metals increases when the area is larger. Some investors also

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argue that the final area should be 500 km2, as it is around the world (Planning Commission, 2006). Bureaucratic delays in the mining licensing and approval process are common in India. Some investors claim that it takes as long as 6–7 years to move from an RP to a PL (stages 1–2). According to Indian government mining policy review, getting permissions to move from the reconnaissance stage to mining takes 5–7 years. The global norm for moving from an RP to an ML is about 18 months (Planning Commission, 2006). There is also regulatory confusion from jurisdictional overlap between the Ministry of Environment & Forests (MoEF) and the Indian Bureau of Mines (IBM) regarding the approval of environmental permits for mining operations (Planning Commission, 2006). A long-standing discord between conservation of forest resources and exploitation of mineral resources seems to be a formidable obstacle to speedy development of the mineral resources (O’Callaghan and Vivoda, 2010). As a result of regulatory confusion, there is an uncertainty about who has the final say over the assets—the centre or the states. While the states issue the different permits, the permissions come from the centre. This takes time, since files keep moving between the states and Delhi during RP, PL and ML application stages. According to a recent study, the number of clearances for a typical mining project is 37 at the central government and 47 at the state government level (Planning Commission, 2006). Given that state governments are empowered to design and regulate their own FDI policies, the division of mining project approval mechanisms between the central and state governments often undermines FDI promotion efforts by the central government (Singh and Kalirajan, 2003; Bloodgood, 2007). The regulatory burden on foreign investors tends to be higher at the state level, where application and approval procedures vary widely. FDI projects already approved at the central government level tend to bottleneck as they proceed, since nearly 70% of the approvals and applications needed for an FDI project implementation are obtained from state governments. State-level impediments to an FDI can be severe, and companies have abandoned projects mid-way through implementation, due to issues such as onerous zoning, land-use and environmental regulations (Planning Commission, 2006). Finally, inadequate financial and human resources have been an endemic problem both in China and India. This is a broader problem in developing economies more generally. Regulating agencies do not have the adequate administrative machinery to deal with their responsibilities. The problem has been exacerbated at the provincial/ state level following decentralisation efforts which have transferred more powers to lower level governments without simultaneously providing them with additional human and/or financial resources. There is a chronic shortage of adequately trained compliance and enforcement officers, many of whom find employment in the private industry far more rewarding. In China, when the government promoted the National Environmental Protection Administration (NEPA) to the ministry level, and renamed State Environmental Protection Administration (SEPA), it reduced its staff from 600 to 300. This compared with the 6000 in the US Environmental Protection Agency (O’Callaghan and Vivoda, 2010). Even if regulatory mechanisms to ensure mining operation compliance are used, they are often ineffective. In China, SEPA often sends their compliance officers to the mines and regularly issue them with fines for non-compliance. However, administrative penalties are not severe enough to ensure environmental compliance (Stokoe and Gasne, 2009/10). Given that the penalties are small and/or not properly enforced, the violators often get a ‘get-out-of-jail-free’ card, simply because the government prioritises development over environmental issues (Economy, 2007). The cost of an environmental breach has recently been described to be ‘‘less expensive than compliance itself ’’ (Stokoe and Gasne, 2009/10).

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Fiscal Mineral exploration is a high cost activity and the profitability of a project can be significantly influenced by a government’s fiscal regime. Generally, foreign mining investment is likely to be enhanced by mineral taxation regimes that are simple, stable, predictable, transparent, equitable, efficient and competitive (Saidu, 2007). For mining companies, the overall level of tax, including royalties and tax incentives (e.g. tax holiday) influences incentives to explore and develop. Higher taxation levels are likely to reduce incentives to invest in a particular jurisdiction. All other things being equal, companies will prefer to invest in lowtax jurisdictions (Otto et al., 2006). Moreover when deciding where to invest, mining companies consider the perceived stability of a fiscal regime over time, and this requirement is probably the most important for companies, due to the long timeframe of most mining projects (Andrews-Speed, 1996). Mining investors look for predictable fiscal regimes, as transparent and clear tax regulations allow companies to predetermine their tax liability. Different types and levels of taxes imposed on mining companies also have a direct bearing on the rates of return, and thus also influence investment behaviour (Saidu, 2007). For instance, taxes or royalties based on units of production irrespective of profitability may create economic inefficiencies by discouraging the exploitation of lower grade ore and shortening the life span of some mines. This makes this type of royalties regressive tax instruments, which can contribute to inefficient resource exploitation and premature mine closures with a negative impact on investments (Andrews-Speed, 1996; Otto et al., 2006). Taxes on corporate profits (and to a lesser degree incomes) are more efficient and recognise the inherent risks in mining operations, particularly wide fluctuations in international minerals prices and the difficulty of anticipating all geological, technical, financial and political factors over a mine’s lifetime (Mitchell, 2009). Overall, China’s tax and royalty regime have been classed as complicated and insufficiently developed to deal with complex mining projects (Cornelius et al., 2008). Some analysts have even suggested that China has the harshest tax regime in the AsiaPacific region (Anderson, 2009). In India, royalty rates for various minerals have regressive features and are higher than those of other countries (Jain, 2008). According to the Federation of Indian Mineral Industries (2010), India has the most heavily taxed minerals industry in the world and a highly complex and unpredictable tax system. Moreover China and India’s federal systems allow taxes and royalties to be taken at multiple levels of government. Thus, both countries’ fiscal systems have the complication of multiple levels of government competing for their share of the take. This leads to an excessive tax burden for mining companies, a tax regime in which profit-related taxes form a small part and to excessive administration costs for the companies.

Financial In China, the freedom to repatriate profits and capital to the home country depends largely on the investment structure utilised by the foreign investor. Wholly foreign owned enterprises (WFOE), which are rare, are free to convert profits earned in Chinese currency to US dollars, therefore enabling to be remitted abroad to the parent company. The majority of foreign-invested entities, structured as joint ventures with domestic mining companies (over 97%) face restrictions on repatriation of profits (UNCTAD, 2007). Constraints are imposed on the timing and

magnitude of transactions to repatriate foreign investors’ profits. This places a discriminatory burden on foreign investors and discourages investment (Penney et al., 2007). India allows full repatriability of their investment capital and the income/dividend generated therefrom, once all the local and central (tax) liabilities are met (Federation of Indian Mineral Industries, 2010). Foreign nationals who are not permanently a resident in both China and India can establish bank accounts (external accounts) in China and India, respectively. Mineral exploration is a risky and capital intensive activity. Large capital investments are usually required to find a mineral deposit, which can be viably mined. However, the risk that an economically viable deposit will not be found is high enough that companies often find it difficult to raise funds through debt financing (Penney et al., 2007). The majority of funds used for mineral exploration are raised on the Australian, London, Toronto or Johannesburg stock exchanges from the sale of shares. Although some countries limit the ability of mining companies to raise external financing, this is not the case with China or India.

Environmental and social Hilson and Haselip (2004) argued that the desperation of many developing country governments to promote foreign mining investment has provided little incentive for mining multinationals to engage in environmental best practice. Consequently, they argue that few of the mining multinationals operating in the developing world have embraced environmental management in its entirety. This, indeed, may have been the case in the 1980s and 1990s with the Ok Tedi, Grasberg and Marcopper environmental disasters in PNG, Indonesia and the Philippines, respectively. A recent empirical study, however, has shown a positive change in environmental management practices among multinational mining firms operating in the developing world. Tole and Koop (2010) found that stringent environmental regulations either have no effect in forming investment location decisions by mining firms, or in more cases, that stringent environmental regulations attract mining firms. Regardless of any short-term cost savings from lower environmental standards, most multinational mining firms now view their presence in environmentally ‘dirty’ parts of the world as potentially damaging of their corporate reputation, even though they may adopt international best practice standards. Similar to mining regulation, environmental regulation in China and India is complex and inconsistent, resulting in regulatory overlap. Given regulatory overlap and complexity in China and India, mining companies are unable to predetermine environment-related obligations. More broadly, the environmental record of both China and India has been poor. According to Yale University 2010 Environmental Performance Index (EPI), which ranks 163 countries on 25 performance indicators tracked across ten policy categories covering both environmental public health and ecosystem vitality, China is ranked 121st and India 123rd, respectively. Since both countries have poor environmental standards, and even though foreign mining investors adopt best environmental standards in the operations, they face potential risks to their corporate reputation if they choose to establish and/or maintain operations in the two countries. There are numerous examples where local stakeholders rejected mining, and consequently, discovered deposits were not brought into production. Local communities have the power to influence the security of tenure between exploration and mining. The key to a community accepting or fighting exploration and mining often depends on the extent to which the community and its members will directly or indirectly benefit from mining (e.g.

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through taxation, employment, infrastructure, gifts, etc.) balanced against the perceived harm (e.g. environmental costs) it may cause. The importance of gaining the support of local stakeholders can be critical to the ultimate success of an exploration project. Hence, the ease with which their support, or ‘social licence,’ can be gained in the target country is one of the key determinants of mining investment (Otto, 2006). Countries that have recognised that communities have a role to play in the mining investment process and that have actively addressed key issues will be more attractive to potential investors than countries where these problems are left solely for the company. In the 2008/09 Fraser Institute’s Annual Survey of Mining Companies, socioeconomic agreements and community development conditions (including local purchasing, processing requirements, or supplying social infrastructure such as schools or hospitals, etc.) posed an investment deterrent to 46% of survey respondents in China and 75% in India (Fraser Institute, 2009). This is an issue in other developing nations and not exclusive to China and India. Mines are usually located in remote areas, populated by rural poor and with inadequate social and other infrastructure. Therefore, foreign mining investors are often de facto social infrastructure providers in China and particularly in India. To gain local government approval, they will be obliged to employ local workers, who often lack the required skills, as well as build hospitals, schools and other social infrastructure. This has presented a strong deterrent for investing in China and particularly India.

Operational Foreign mining investment is likely to increase when countries allow investors operational flexibility, so that they can form corporate structures to suit the operating environment. The ability of mining investors to invest in exploration activities is impeded when they cannot alter the operating structure of their business to suit their changing needs (i.e. joint ventures to share risk). China currently imposes equity requirements or requirements on foreign investors to take a local joint venture partner. This acts as an impediment to potential FDI and limits the level of interest from foreign companies in establishing operations. For foreign mining companies, joint ventures are the primary pathway to enter the Chinese mineral sector and government prevents the outright acquisition of Chinese mining companies. In contrast, in India, foreign equity holdings of up to 100% are allowed for most minerals and there is no difference in caps on foreign equity holdings, during the exploration and mining stages. Regarding ownership transfer, in China, the transfer of exploration and mining rights between entities can occur one year after the issuing of the original rights or once mineral resources are discovered (Penney et al., 2007). India also allows the transfer of ownership of mining leases, and most transfers do not require central government approval (Federation of Indian Mineral Industries, 2010). The existing infrastructure of a particular economy or region, such as access to water and electricity and the quality of roads, influences the level of foreign investment. Minerals are often found in remote or regional locations, which cannot support a workforce. These areas generally have limited access to hospitals, schools, roads, airstrips and other infrastructure. Inadequate infrastructure will typically increase the cost of developing a deposit and, therefore, reduce the expected profitability of the mine development, particularly if the full development costs of transport, water, power and housing are borne by the investor. Similarly, a lack of basic infrastructure can impede access to

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exploration areas and increase the cost of conducting exploration (Penney et al., 2007). In the 2008/09 Fraser Institute’s Annual Survey of Mining Companies, the quality of infrastructure (including access to roads, power availability, etc.) was an investment deterrent to 53% of survey respondents in China and 85% in India (Fraser Institute, 2009). In India, infrastructure, such as ports, airports, power stations and water supply are less developed than in developed and many developing economies. While both China and India have undertaken significant spending to improve the quality of infrastructure, India has been lagging significantly behind China.

Conclusions The existence and extractability of minerals is the most important determinant of where mining companies invest in exploration and extraction. While the presence of mineral deposits is a necessary requirement to attract mining investment, it is not a sufficient condition. Many countries that are endowed with minerals have traditionally been unable to attract an FDI. In the past two decades, many governments have become increasingly aware that mining companies are selective in their choices and that, in order to attract investors, they need to implement regulatory and legal reforms, and establish effective regulatory structures. Countries can improve the likelihood of mineral sector investment by taking steps to satisfy investor decision criteria through informed policies and regulations. Over the past two decades, more than 110 countries have revised their mining and related rules and regulations or made major amendments to them (Otto, 2006). While China and India are among those countries, as the previous section has shown, policy and regulatory changes did not lead to a lowering of most risks for foreign mining investors. Improved regulation per se does not automatically attract more foreign investment. Despite the high geological potential, the combination of various issues places China and India in an unfavourable position in the global market for foreign mining investment. The low level of foreign investment in China and India’s mining industry is a direct result of inadequate and ineffective fiscal and regulatory regimes governing foreign mining investment, inconsistent and unclear policy towards foreign investment, the lack of geological information, unfavourable political environment, a host of environmental and social issues, the low quality of infrastructure, and several other issues concerning profitability, geography and socio-economic development. It is also a direct result of strong and competitive domestic mining industry that is largely protected from foreign competition. While the overall conditions for foreign mining investment are slightly more positive in China than in India, they are far from attractive for foreign mining companies and the two countries, by and large, show a high degree of resemblance. Although China and India have introduced regulatory and legislative changes that promote foreign investment, some policy makers in both nations view foreign involvement in their mining sectors with suspicion, viewing them as exploiting the national heritage or patrimony. Both nations also perceive it to be a national duty to have direct control of the sector. China has a very strong domestic mining industry, and the country has managed to become one of the leading non-fuel mineral economies in the world without much foreign mining investment. In fact, its state-owned mining companies have recently also moved to become a major engine of FDI in mining. In the case of China, and India to a lesser extent, the policy to maintain and grow domestic mining companies clearly affects the policy direction towards an FDI in the sector.

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While it is beyond the scope of this paper to offer policy recommendations to the Chinese and Indian governments, some minor points are in order. If their policy is aimed at increasing inflows of foreign capital into the sector, the performance of regulatory regimes governing foreign mining investment must be improved, along with a host of other factors. Attracting foreign mining investment not only requires favourable and consistent government policies and effective regulatory and fiscal systems, but needs to be supplemented with active marketing programs, designed to attract investors. For mining companies to be willing to engage in exploration and extraction, they need to assess whether the volume and quality of the minerals are likely to be sufficient to make an investment profitable. This requires, among other things, access to basic geological data. Regulatory and other required changes in China and India’s mineral industry foreign investment conditions do not have to imply that they should embrace a system that is in effect a ‘‘race to the bottom,’’ where all benefits flow to the company and risks are minimised. The bottom-line is that many systemic and geological risks remain that are beyond the control of government. Rather, they can improve the likelihood of mineral sector investment by taking steps to satisfy investor decision criteria through regulatory structures that are clearly established and that guarantee ‘security of tenure’ (Otto, 2006). At the same time, the challenge for developing countries such as China and India is to regulate multinational companies’ activities in line with national development priorities, while making it attractive for these companies to invest. For an instance, an effective fiscal regime for mining should seek to satisfy the requirements of both the government and the companies.

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