Global FDI flows fell 13% last year, bumpy recovery ahead

Global flows of foreign direct investment dropped in 2016, while a projected recovery this year could be affected by significant policy uncertainties, according to UNCTAD.

by Kanaga Raja

GENEVA: Global foreign direct investment (FDI) flows declined by 13% in 2016, to reach an estimated $1.52 trillion, the United Nations Conference on Trade and Development (UNCTAD) has said.

In its latest Global Investment Trends Monitor (No. 25, 2 February 2017), UNCTAD attributed the fall to weak world economic growth and a lacklustre increase in the volume of world trade.

“FDI recovery continues along a bumpy road. Particularly of concern is the sharp drop-off in manufacturing investment projects, which play such an important role in generating badly needed productivity improvements in developing economies,” UNCTAD Secretary-General Mukhisa Kituyi said in a press release.

“Looking ahead, economic fundamentals point to a potential increase in FDI flows by around 10% in 2017,” Kituyi further said. “However, significant uncertainties about the shape of future economic policy developments could hamper FDI in the short term.”

The UNCTAD report said that economic fundamentals are supportive of a potential rebound in FDI flows in 2017. World economic growth is projected to accelerate in the coming year, reaching 3.4% compared to the post-crisis low of 3.1% in 2016.

Growth in developed countries is expected to improve, including in the United States through fiscal stimulus. Emerging and developing economies are also forecast to rebound significantly in 2017, led by a sharp rise in growth in natural-resource-exporting countries as commodity prices are expected to increase, especially for crude oil.

Moreover, greater economic activity will help boost world trade volumes, which are forecast to expand by 3.8% in 2017 compared with just 2.3% in 2016. In this context, investment activity may also quicken.

UNCTAD has projected that global FDI flows will increase by around 10% over the year.

“Nevertheless, there are significant uncertainties that could have a material impact on the scale and contours of any FDI recovery in 2017,” UNCTAD cautioned.

The “normalization” of monetary policy in the United States – after nearly a decade of historically low interest rates – could result in a significant shift in composition of capital flows, with implications for exchange rates and financial systems throughout the world and especially for developing economies.

UNCTAD said that rising cost of capital may hinder investment by multinational enterprises (MNEs) which have taken on significant levels of corporate debt in recent years.

There is also substantial uncertainty about the shape of economic policies in the near-future, especially in developed economies, which may serve to dampen FDI.

“Political developments such as the decision by the United Kingdom to exit the European Union (Brexit), announcements by the incoming administration in the United States to renegotiate key trade agreements such as NAFTA and to leave the TPP, as well as recent and upcoming elections in Europe have all heightened these uncertainties,” said UNCTAD.

Uncertainties and risks

Asked to elaborate on these uncertainties at a media briefing on 1 February, James Zhan, Director of the UNCTAD Division on Investment and Enterprise, pointed to policy uncertainties, noting that this year is an election year for some major European countries. This creates uncertainty over future policies regarding trade and investment, tax policies and competition policies.

Zhan also pointed to the new administration in place in the United States, where the “policies are unfolding. For the time being, we still do not know what will happen with regard to some aspect of the policies.”

He further pointed to the great uncertainty due to Brexit. The prospects for investment in Europe and the UK are very much dependent on the result of the deal, he said, so that creates a kind of uncertainty to business.

Zhan also highlighted geopolitical risks in some areas which will affect FDI flows as well.

Asked about President Donald Trump’s call for US companies to invest in the country and whether this will lead to a rise in FDI in that country this year, Zhan referred to such policy measures as being “investment retention” measures trying to keep investment at home. Besides the US, some other countries also have different types of measures that aim to retain investment domestically, which may to a certain extent affect the outward investment of some major source countries.

Apart from measures which seek to discourage local firms from going outward, there are measures geared towards encouraging companies to repatriate earnings that are parked outside the country, said Zhan. He said the reduction of tax on the repatriation of profits will have a positive impact in encouraging firms to remit their earnings, but making sure that these remittances are reinvested in the country remains challenging.

Asked if he sees “investment retention” as “investment protectionism” conceptually, Zhan declined to comment, saying that there is no agreed definition of protectionism in the area of investment.

As regards a multilateral investment approach, Zhan noted that there was a breakthrough towards multilateral cooperation last year, when the G20 grouping of major economies adopted guiding principles for global investment policymaking. They built what was basically a consensus on the core elements of any possible future investment framework, whether it is at multilateral, regional or bilateral level. “In the current context, in the current situation, further efforts [in] this direction will be extremely difficult,” he said, adding that a multilateral system for investment is “highly unlikely”.

Asked about the retreat of multinational companies, as argued in a recent issue of The Economist, Zhan, who said that he is exchanging letters with the magazine on this subject, pointed out that there are different indicators to assess whether multinationals are retreating or not.

He referred to two “tendencies”. One is shifting from internalization to externalization. In a sense, there is a tendency of manufacturing and even services companies trying to do outsourcing, engaging in contract manufacturing and contract farming. The other trend involves transforming the business model by greater recourse to cross-border e-commerce or e-trade.

While this brings about a change in mode of operation, the multinational companies are still coordinating the global value chains, said Zhan.

Regional trends

According to the UNCTAD report, the decline in FDI flows in 2016 was not equally shared across regions, reflecting the heterogeneous impact of the current economic environment on countries worldwide.

Equity investments at the global level were boosted by a 13% increase in the value of cross-border mergers and acquisitions (M&As), which rose to their highest level since 2007, reaching $831 billion.

The value of announced greenfield projects reached an estimated $810 billion – a 5% rise from the previous year, although this was largely due to a number of very large projects announced in a handful of countries.

At the regional level, falling flows to Europe (-29%), Developing Asia and Oceania (-22%), Latin America and the Caribbean (-19%) and Africa (-5%) reduced the global total.

In contrast, FDI flows rebounded among transition economies (38%) and more than doubled in other developed economies, thanks to a strong recovery of investment in Australia and Japan. There was also continued growth – if less dynamic than in the previous year – of inflows in North America.

As a result of these regional differences, the share of developed economies in world FDI flows as a whole is estimated to have risen further, reaching 57% of the total. Nevertheless, developing economies continue to comprise half of the top 10 host economies.

The United States remained the largest recipient of FDI, attracting an estimated $385 billion in inflows, followed by the United Kingdom with flows of $179 billion, vaulting up from 12th position in 2015. China remained in third position with a record inflow of $139 billion.

The overall trend for developed economies was conditioned by FDI dynamics in Europe, where inflows experienced a significant fall of 29% to an estimated $385 billion. During 2016, a number of European countries experienced strong volatility in FDI flows compared with the previous year, said UNCTAD.

FDI flows to North America increased modestly (6% to $414 billion), despite a 15% increase in the value of cross-border M&As in the region. Inflows in Canada retreated (from $43 billion to an estimated $29 billion), as M&A sales and greenfield projects in the country tumbled. Flows to the United States grew by 11% (from $348 billion to an estimated $385 billion), bolstered by strong equity investment inflows as cross-border M&As in the country rose 17% in value, led by a number of mega-deals.

According to UNCTAD, slowing economic growth and falling commodity prices weighed on FDI flows to developing economies in 2016. Inflows to these economies fell 20% (to an estimated $600 billion) in the year, because of significant falls in Developing Asia and in Latin America and the Caribbean.

There was a widespread downturn in cross-border M&A activity across developing sub-regions during the year, which fell 44% in terms of aggregate value. In contrast, the value of announced greenfield projects rose 19% to reach $540 billion, but this was largely due to the announcement of a few very large investments in a small number of countries, as the majority of countries recorded falls.

In Developing Asia, the decline in inflows (-22% to an estimated $413 billion) was relatively widespread, with every major sub-region registering double-digit reductions. In absolute terms, the majority of the decline in flows to the region was centred in Hong Kong (China) – down from $175 billion to an estimated $92 billion – returning to the levels prevailing before the spike in 2015. In contrast, foreign investment in mainland China remained robust, rising by 2.3% to a new record of about $139 billion.

Economic recession in Latin America and the Caribbean, coupled with weak commodity prices for the region’s principal exports, factored heavily in the decline in FDI flows to the region (down 19% to $135 billion). In South America, there were sizable falls in Brazil (from $65 billion to an estimated $50 billion) and Chile (from $16 billion to an estimated $11 billion). In Central America, despite its relatively stronger economic performance, flows also fell, led by a 20% reduction in Mexico (from $33 billion to $26 billion).

FDI flows to Africa also registered a decline (-5% to $51 billion), with the region sharing similar external vulnerabilities with Latin America. The low level of commodity prices continues to have an impact on resource-seeking FDI.

FDI flows to transition economies rose by 38% to an estimated $52 billion. This largely reflected a doubling of inflows in Kazakhstan (from $4 billion to $8.1 billion) as well as a 62% uptick in flows to the Russian Federation (from $12 billion to an estimated $19 billion), said UNCTAD. (SUNS8395)                  

Third World Economics, Issue No. 632, 1-15 January 2017, pp9-11