TWN Info Service on Finance and Development (Aug11/01)
8 August 2011
Third World Network
 
Global FDI flows saw modest rise last year
Published in SUNS #7203 dated 3 August 2011
 
Geneva, 2 Aug (Kanaga Raja) -- Global foreign direct investment (FDI) inflows rose modestly by 5 percent to reach $1.24 trillion in 2010, and are predicted to continue their recovery to reach some $1.4-1.6 trillion in 2011.
 
This is the assessment of the UN Conference on Trade and Development (UNCTAD) in its latest World Investment Report 2011.
 
According to the report, released last week, for the first time, developing and transition economies together attracted more than half of global FDI flows.  Outward FDI from those economies also reached record highs, with most of their investment directed towards other countries in the South.
 
In contrast, FDI inflows to developed countries continued to decline.
 
As international production and, more recently, the weight of global consumption shift towards developing and transition economies, both efficiency-seeking and market-seeking projects in those economies are on the increase, said UNCTAD.
 
Half of the top 20 host economies for FDI in 2010 were developing and transition economies. Their outward FDI also rose sharply in 2010, climbing by 21 percent. These economies now account for 29 percent of global FDI outflows. Six developing and transition economies were among the top 20 investors.
 
The report says that as stimulus packages and other public fiscal policies fade, sustained economic recovery becomes more dependent on private investment. At present, transnational corporations (TNCs) have not yet taken up fully their customary lead role as private investors.
 
Global FDI inflows rose modestly in 2010, following the large declines of 2008 and 2009. At $1.24 trillion in 2010, they were 5 percent higher than a year before. This moderate growth was mainly the result of higher flows to developing countries, which together with transition economies - for the first time – absorbed more than half of FDI flows.
 
While world industrial production and trade are back to their pre-crisis levels, FDI flows in 2010 remained some 15 percent below their pre-crisis average, and 37 percent below their 2007 peak.
 
According to the report, the moderate recovery of FDI flows in 2010 revealed an uneven pattern among components and modes of FDI. Cross-border mergers and acquisitions (M&As) rebounded gradually, yet greenfield projects - which still account for the majority of FDI - fell in number and value.
 
The report notes that increased profits of foreign affiliates, especially in developing countries, boosted reinvested earnings - one of the three components of FDI flows - while uncertainties surrounding global currency markets and European sovereign debt resulted in negative intra-company loans and lower levels of equity investment - the other two components of FDI flows.
 
While FDI by private equity firms regained momentum, that from sovereign wealth funds (SWFs) fell considerably in 2010.
 
FDI inward stock rose by 7 percent in 2010, reaching $19 trillion, on the back of improved performance of global capital markets, higher profitability, and healthy economic growth in developing countries.
 
UNCTAD predicts that FDI flows will continue their recovery to reach $1.4-1.6 trillion, or the pre-crisis level, in 2011. In the first quarter of 2011, FDI inflows rose compared to the same period of 2010, although this level was lower than the last quarter of 2010. They are expected to rise further to $1.7 trillion in 2012 and reach $1.9 trillion in 2013, the peak achieved in 2007.
 
The record cash holdings of TNCs, ongoing corporate and industrial restructuring, rising stock market valuations and gradual exits by States from financial and non-financial firms' shareholdings built up as supporting measures during the crisis, are creating new investment opportunities for companies across the globe.
 
However, says the report, the volatility of the business environment, particularly in developed countries, means that TNCs have remained relatively cautious regarding their investment plans.
 
In addition, risk factors such as unpredictability of global economic governance, a possible widespread sovereign debt crisis and fiscal and financial sector imbalances in some developed countries, rising inflation and apparent signs of overheating in major emerging market economies, among others, might derail FDI recovery, the report cautions.
 
Global FDI inflows in 2010 reached an estimated $1,244 billion - a small increase from 2009's level of $1,185 billion. However, there was an uneven pattern between regions and also between sub-regions.
 
FDI inflows to developed countries and transition economies contracted further in 2010. In contrast, those to developing economies recovered strongly, and together with transition economies - for the first time - surpassed the 50 percent mark of global FDI flows.
 
FDI flows to developing economies rose by 12 percent (to $574 billion) in 2010, thanks to their relatively fast economic recovery, the strength of domestic demand, and burgeoning South-South flows.
 
The value of cross-border M&As into developing economies doubled due to attractive valuations of company assets, strong earnings growth and robust economic fundamentals (such as market growth).
 
The report notes that the rise of FDI to developing countries hides significant regional differences. Some of the poorest regions continued to see declines in FDI flows. In addition to least developed countries (LDCs), landlocked developing countries (LLDCs) and small island developing States (SIDS), flows to Africa continued to fall, as did those to South Asia.
 
In contrast, major emerging regions, such as East and South-East Asia and Latin America experienced strong growth in FDI inflows.
 
FDI flows to South, East and South-East Asia picked up markedly, outperforming other developing regions. Inflows to the region rose by about 24 percent in 2010, reaching $300 billion, rising especially in South-East Asia and East Asia.  Similarly, strong economic growth, spurred by robust domestic and external demand, good macroeconomic fundamentals and higher commodity prices, drove FDI flows to Latin America and the Caribbean to $159 billion. Cross-border M&As in the region rose to $29 billion in 2010, after negative values in 2009.
 
In contrast, inflows to Africa, which peaked in 2008 driven by the resource boom, continued the downward trend which started in 2009. Inflows to South Africa declined to little more than a quarter of those for 2009.
 
North Africa saw its FDI flows fall slightly (by 8 percent) in 2010; the uprisings which broke out in early 2011 impeded FDI flows in the first quarter of 2011.
 
FDI inflows to developed countries contracted moderately in 2010, falling by less than 1 percent to $602 billion.
 
Europe stood out as the sub-region where flows fell most sharply, reflecting uncertainties about the worsening sovereign debt crisis. However, says the report, while Italy and the United Kingdom suffered, FDI in some of the region's other major economies fell only slightly (e.g. France) or increased (e.g. Germany).
 
In contrast, FDI flows to the United States surged by almost 50 percent largely thanks to a significant recovery in the reinvested earnings of foreign affiliates. However, FDI flows were still at about 75 percent of their peak level of 2008.
 
At $1,323 billion, global FDI outflows in 2010, while increasing over the previous year, are still some 11 percent below the pre-crisis average, and 39 percent below the 2007 peak.
 
FDI flows from developing and transition economies picked up strongly, reflecting the strength of their economies, the dynamism of their TNCs and their growing aspiration to compete in new markets.
 
The downward trend in FDI from developed countries reversed, with an 10 percent increase over 2009. However, it remained at half the level of its 2007 peak.
 
According to the report, outward FDI from developing and transition economies reached $388 billion in 2010, a 21 percent increase over 2009. Investors from South, East and South-East Asia and Latin America were the major drivers for the strong growth in FDI outflows.
 
Developed countries as a group saw only a limited recovery of their outward FDI. Reflecting their diverging economic situations, trends in FDI outflows differed markedly between countries and regions: outflows from Europe and the United States were up (9.6 and 16 percent respectively) while Japanese outward FDI flows dropped further in 2010 (down 25 percent).
 
According to the report, the lingering effects of the crisis and subdued prospects in developed countries forced many of their TNCs to invest in emerging markets in an effort to keep their markets and profits: in 2010, almost half of total investment (cross-border M&A and greenfield FDI projects) from developed countries took place in developing and transition economies, compared to only 32 percent in 2007.
 
In terms of FDI by sector and industry, data on FDI projects (both cross-border M&As and greenfield investment) indicate that the value and share of manufacturing rose, accounting for almost half of the total. The value and share of the primary and services sector declined.
 
The value of FDI projects in manufacturing rose by 23 percent in 2010 compared
to 2009, reaching $554 billion.
 
The financial crisis hit a range of manufacturing industries hard, but the shock could eventually prove to be a boon to the sector, as many companies were forced to restructure into more productive and profitable activities - with attendant effects on FDI. In the United States, for example, FDI in manufacturing rose by 62 percent in 2010, accompanied by a substantial rise in productivity.
 
UNCTAD said that within manufacturing, flows fell in business-cycle-sensitive industries such as metals and electronics. The chemical industry, including pharmaceuticals, remained resilient through the crisis, while industries such as food, beverages and tobacco, textile and garments, and automobiles, recovered in 2010.
 
The value of FDI projects in the services sector continued to decline sharply in 2010, with respect to both 2009 and the pre-crisis level of activity.
 
All main service industries (business services, finance, transport and communications and utilities) fell, although at different speeds. FDI in the financial industry - the epicentre of the current crisis - experienced the sharpest decline, and is expected to remain sluggish in the medium term.
 
In terms of modes of entry, the report finds that there are diverging trends between the two main modes of FDI entry: M&As and greenfield (new) investment.
 
The value of cross-border M&A deals increased by 36 percent in 2010, to $339 billion, though it was still roughly one-third of the previous peak in 2007.
 
On the other hand, greenfield investment - the other mode of FDI - declined in 2010. Developing and transition economies tend to host greenfield investment rather than cross-border M&As. More than two-thirds of the total value of greenfield investment is directed to these economies, while only 25 percent of cross-border M&As are undertaken there.
 
During the first five months of 2011, both greenfield investments and cross-border M&As registered a significant rise in value. Cross-border M&As rose by 58 percent, though from a low level, compared with the corresponding period of 2010.
 
"Judging from the data on FDI flows, cross-border M&As and Greenfield investment for the first few months of 2011, the recovery of FDI is relatively strong. This trend may well continue into the remaining period of 2011."
 
New investment opportunities await for cash-rich companies in developed and developing countries. Emerging economies, particularly Brazil, China, India and the Russian Federation, have gained ground as sources of FDI in recent years. A recovery in FDI is on the horizon, says the report.
 
However, the report warns, the business environment remains volatile, and TNCs are likely to remain relatively cautious regarding their investment plans. Consequently, medium-term prospects for FDI flows - which have not really picked up yet after the sharp slump in 2008 and 2009, and which had only a moderate recovery in 2010 - may vary substantially, depending on whether or not the potential risks in the global economy materialize or not.
 
UNCTAD estimates that FDI flows could range from $1.4-1.6 trillion in 2011 (with a baseline scenario of $1.52 trillion) - the pre-crisis average of 2005-2007. They are expected to rise further to $1.7 trillion in 2012 and reach $1.9 trillion in 2013, the peak achieved in 2007.
 
However, there is also a possibility of stagnant FDI flows (pessimistic scenario) if the above-mentioned risks such as the unpredictability of global economic governance, worsening sovereign debt crisis, and fiscal and financial imbalances were to materialize.
 
The recovery in world output growth rests on a number of factors, including stabilization of the financial system, the resilient growth of emerging markets, the stimulus package programmes implemented in various major economies in the world, and the pickup in final demand in developed countries, following a return to confidence for both households and companies.
 
While improving macro- and microeconomic fundamentals, coupled with rising investor optimism and the strong pull of booming emerging markets, should signal a strong rebound in global FDI flows, risks and uncertainties continue to hamper the realization of new investment opportunities, says the report.
 
Such factors include the unpredictability of global governance (financial system, investment regimes, etc.); the worsening sovereign debt crisis in some developed countries and the resultant fiscal austerity; regional instability; energy price hikes and risks of inflation; volatility of exchange rates; and fears of investment protectionism.
 
Although each can serve as a disincentive to investment in its own right, the prominence of all of these risks at the same time could seriously obstruct FDI globally, the report concludes.+