Geneva, 16 Jun (Kanaga Raja) – Global foreign direct investment (FDI) flows are forecast to fall by up to 40 per cent in 2020, bringing their value to below $1 trillion for the first time since 2005, the UN Conference on Trade and Development (UNCTAD) has said.
In its World Investment Report (WIR), released on Tuesday, UNCTAD has projected FDI to decrease by a further 5 to 10 per cent in 2021 and to initiate a recovery in 2022.
A rebound in 2022, with FDI reverting to the pre-COVID-19 pandemic underlying trend, is possible, but only at the upper bound of expectations.
The outlook is highly uncertain and prospects depend on the duration of the health crisis and on the effectiveness of policy interventions to mitigate the economic effects of the pandemic. In addition, geopolitical and financial risks and continuing trade tensions add to the uncertainty, it said.
ECONOMIC IMPACT OF COVID-19 ON SOUTH
At a virtual media briefing, Dr Mukhisa Kituyi, the Secretary-General of UNCTAD, said that the economic impact of COVID-19 will hit developing countries hard, especially the structurally vulnerable economies in Africa and least developed countries in all regions, with disruptions to major productive sectors and industries, declining remittances and receipts from tourism and contracting world trade.
The shock will be further compounded by the impact on food security as production of major food items is concentrated in a few big countries where the pandemic is expanding rapidly. Managing the disease is only part of the persistent challenges facing the developing world, he said.
The development impact of the pandemic is also aggravated by decreasing demand and falling prices of natural commodities, especially oil. For many developing regions, export earnings and foreign investment are still tied to a large degree to natural resources.
The dual shock of COVID-19 and falling commodity prices puts many countries in precarious economic and financial positions, undoing progress towards structural transformation and economic diversification.
Today, the news gets worse, said Dr Kituyi, pointing out that the main headline of UNCTAD’s WIR 2020 is that flows in foreign direct investment will fall dramatically in 2020 and beyond.
UNCTAD has forecast that global FDI flows will decrease by up to 40% this year, down from the 2019 value of $1.54 trillion, reaching the lowest level in the last two decades.
Developing economies are expected to see the biggest fall in FDI because they rely more on investment in Global Value Chain (GVC)-intensive and extractive industries, which have been severely hit, and because they are not able to put in place the same economic support measures as developed economies are being able to do.
The outlook is highly uncertain. Prospects depend on the duration of the health crisis and on the effectiveness of policy interventions to mitigate the economic effects of the pandemic, he said, adding that the pandemic does represent a supply, demand, and policy shock for FDI.
Lockdown measures are slowing down existing investment projects, prospects of a deep recession are leading MNEs (multinational enterprises) to re-assess new projects and crisis measures taken by governments include new investment restrictions.
COVID-19 is not the only game-changer for FDI and international production, said Dr Kituyi.
The new industrial revolution, the policy shift towards more economic nationalism, and sustainability trends will all have far-reaching consequences for the configuration of international production in the decade to 2030.
The directional trend identified in this report points towards shorter value chains, higher concentration of value added and declining international investment in physical productive assets, he said.
That will bring challenges for developing countries. For decades, their development and industrialization strategies have depended on attracting FDI, increasing participation and value capture in GVCs, and gradual technological upgrading in international production networks.
The expected transformation of international production, despite its inherent challenges, also brings opportunities for development, such as promoting resilience-seeking investment, building regional value chains and entering new markets through digital platforms, said the Secretary-General.
In this new context, a degree of re-balancing towards growth based on domestic and regional demand, and promoting investment in infrastructure, domestic services, the green economy and the blue economy is necessary, he added.
“The impact, although severe everywhere, varies by region. Developing economies are expected to see the biggest fall in FDI because they rely more on investment in GVC-intensive and extractive industries, which have been severely hit, and because they are not able to put in place the same economic support measures as developed economies,” said Mr James Zhan, Director of the UNCTAD Division on Investment and Enterprise.
“Despite the drastic decline in global FDI flows during the crisis, the international production system will continue to play an important role in economic recovery and development. Global FDI flows will continue to add to the existing FDI stock, which stood at $37 trillion at the end of 2019,” he added.
COVID-19 CRISIS AND DRAMATIC FALL IN FDI
According to the WIR, the COVID-19 crisis will cause a dramatic drop in foreign direct investment (FDI) in 2020 and 2021. It will have an immediate negative impact in 2020, with a further deterioration in 2021.
In relative terms, the projected fall is expected to be worse than the one experienced in the two years following the global financial crisis. At their lowest level ($1.2 trillion) then, in 2009, global FDI flows were some $300 billion higher than the bottom of the 2020 forecast.
UNCTAD said the downturn caused by the pandemic follows several years of negative or stagnant growth; as such it compounds a longer-term declining trend.
The expected level of global FDI flows in 2021 would represent a 60 per cent decline since 2015, from $2 trillion to less than $900 billion.
The outlook beyond 2021 is highly uncertain. A U-shaped trajectory, with a recovery of FDI to its pre-crisis trend line before 2022, is possible but only at the upper bound of the expectations. Economic and geopolitical uncertainty look set to dominate the investment landscape in the medium term.
At the lower bound of the forecast, further stagnation in 2022 will leave the value of global FDI well below the 2019 level.
According to the WIR, the COVID-19 crisis has had immediate effects on FDI and will have potentially lasting consequences.
The sudden and simultaneous interaction of supply- and demand-side shocks, combined with policy reactions to the crisis around the world, is triggering a series of effects on FDI. The impact will be felt with exceptional vehemence in 2020 when the cumulative effect across all transmission mechanisms is strongest.
The physical closure of places of business, manufacturing plants and construction sites to contain the spread of the virus causes immediate delays in the implementation of investment projects. Some investment expenditures continue (e.g. the fixed running costs of projects), but other outlays are blocked entirely.
Announcements of greenfield projects are also delayed. Similarly, many mergers and acquisitions (M&As) are temporarily suspended. Like greenfield projects, M&As are generally long-term commitments to overseas markets.
Nevertheless, completions of already announced M&A transactions have been running into delays that could result in cancellations, said UNCTAD.
Foreign affiliates are facing exceptionally challenging operational, market and financial conditions. Their profits are expected to plummet in 2020. The vast majority of the top 5,000 largest multinational enterprises (MNEs) revised their earnings expectations for 2020 between February and May, with the average downward revision surpassing 35 per cent.
With reinvested earnings accounting for more than 50 per cent of FDI flows, on average, the impact of lower foreign affiliate profits on global FDI could be severe, said WIR.
On the policy side, in parallel with temporary trade restrictions taken in some countries to prevent shortages of critical medical supplies during the pandemic, several governments have taken measures to avoid fire sales of domestic firms during the crises, introducing new screening requirements and investment restrictions.
For example, the European Union (EU) brought out guidance concerning investment from non-member economies for the protection of member States’ strategic assets; Australia introduced investment reviews to protect national interest and local assets from acquisition.
Already in the early stages of the pandemic, macroeconomic forecasts for 2020 were revised down into negative territory. Current expectations are for a modest and highly uncertain recovery of GDP in 2021 if economic activity picks up with the support of policy stimulus, said UNCTAD.
A deep contraction of demand will have strongly negative effects on international production. Uncertainty about economic prospects will dampen new investment plans. Financial distress and liquidity issues limit the room for manoeuver for many businesses, which during this crisis are forced to divert any funds available for investment to working capital.
Depending on the severity of the recession, ongoing or announced projects that were initially delayed due to the lockdown measures could be shelved indefinitely.
“Over the two critical years 2020 and 2021, the demand shock will be the biggest factor pushing down FDI. Although in general the trend in FDI reacts to changes in GDP growth with a delay, the exceptional combination of the lockdown measures and the demand shock will cause a much faster feedback loop on investment decisions.”
As to the long-term effects, UNCTAD said the pandemic will drive TNCs to consider options to achieve greater supply chain resilience and could lead to a policy push for a higher degree of national or regional self-sufficiency in the production of critical supplies – which may extend to broader strategic industrial capacity.
Tighter restrictions on international trade and investment have already emerged as a result of the pandemic. The trend towards rationalization of international operations, re-shoring, near-shoring and regionalization looks likely to accelerate, leading to downward pressure on FDI, it added.
GLOBAL AND REGIONAL FORECASTS FOR FDI
UNCTAD said its forecasts show a sharp decline in global FDI in 2020 and 2021, to a level about 40 per cent lower than in 2019.
Even before the outbreak of COVID-19, UNCTAD’s model forecasts a stagnant trend (-3 per cent in 2020 and +1 per cent in 2021) as a result of political and trade tensions and an overall uncertain macroeconomic outlook.
All regions and economic groupings will see negative FDI growth rates in 2020. Developed economies as a group are projected to see a decline of between -25 and -40 per cent.
FDI in Europe will fall most (-30 to -45 per cent relative to 2019), as the vehemence of the virus adds to economic fragility in several large economies. Due to the economic integration of investment and trade within the EU, shocks in individual countries will easily propagate within the region.
Developing economies as a group are expected to see a larger decrease in the range of 30 per cent to 45 per cent.
Developing economies appear more vulnerable to this crisis (contrary to the situation after the global financial crisis, which had a much stronger effect on FDI to developed countries). Their productive and investment footprints are less diversified and thus more exposed to systemic risks.
Dependence on commodities for Latin America and the Caribbean and Africa and on GVC-intensive industries for Asia push these regions to the frontline of the crisis from an FDI perspective.
Political responses and support measures – critical at this juncture to limit the depth of the crisis and initiate a recovery – are likely to be significantly weaker in these regions than in developed economies because of their tighter fiscal space.
Longer term, developing economies may be further penalized by the trend towards re-shoring or regionalization of international production, which could accelerate in response to the COVID-19 crisis, said WIR.
Projections indicate that FDI in developing Asia, normally the growth engine of FDI worldwide, will decrease by 30 to 45 per cent. While early indicators suggest that the region has already initiated an investment recovery after the shock of the early outbreak of the virus in China, the dependence on GVC-related investment leaves international production and FDI in Asia highly exposed to economic and policy trends in developed economies.
Latin America and the Caribbean is expected to experience the largest decline, with a projected drop in FDI of between 40 and 55 per cent in 2020. Much of FDI in the region is concentrated in extractive industries, which make up a significant share of total FDI in Argentina, Brazil, Chile, Colombia and Peru.
The combination of collapsing oil prices and the demand shock due to the pandemic affecting prices of most commodities is driving down FDI forecasts in this region more than elsewhere. Relatively weak starting conditions due to structural vulnerabilities and political uncertainty also make the region more exposed to the shock.
Africa is expected to see a decline of FDI between 25 and 40 per cent in 2020. Despite early concerns about the potential spread of COVID-19 in Africa, the continent appears to have been spared the initial outbreak seen in other parts of the world. Although it also suffers from structural vulnerabilities and commodity dependence, recent macroeconomic indicators show a relatively more solid growth path than in other regions.
FDI flows to transition economies are expected to fall by 30 to 45 per cent. In natural-resource- based projects, prospects are being revised downward as demand for commodities weakens and the price of oil, one of the main exports from several economies in transition, remains depressed. Export-oriented production for GVCs, e.g. in special economic zones, will also be heavily affected, said UNCTAD.
FDI TRENDS IN 2019
According to the WIR, global FDI flows rose modestly in 2019, following the sizable declines registered in 2017 and 2018. At $1.54 trillion, inflows were up by 3 per cent. They remained below the average of the last 10 years and some 25 per cent off the peak value of 2015.
The rise in FDI was mainly the result of higher flows to developed economies, as the impact of the 2017 tax reforms in the United States waned.
Flows to transition economies also increased, while those to developing economies declined marginally. FDI stock increased by 11 per cent, reaching $36 trillion, on the back of rising valuations in global capital markets and higher MNE profitability in 2019.
FDI flows to developed economies rose by 5 per cent, to $800 billion, from their revised level of $761 billion in 2018. The increase occurred despite weaker macroeconomic performance and policy uncertainty for investors, including trade tensions and Brexit. The trend was mainly driven by FDI dynamics in Europe, where inflows increased by 18 per cent to $429 billion.
Flows remained flat in North America, at $297 billion. Despite a slight decline of FDI in the United States (-3 per cent), that country remained the largest recipient of FDI. Declining FDI flows were also registered in Australia, mainly due to a decrease in the value of cross-border M&As.
FDI flows to developing economies declined marginally, by 2 per cent, to $685 billion. Since 2010, flows to developing economies have been relatively stable, hovering within a much narrower range than those to developed countries, at an average of $674 billion.
The slump in FDI flows to Africa in 2019, by 10 per cent to $45 billion, was due to more moderate economic growth and dampened demand for commodities.
In 2019, FDI flows into developing Asia declined by 5 per cent, to $474 billion. Despite the decline, it remained the largest FDI recipient region, hosting more than 30 per cent of global FDI flows. The decline was driven primarily by a 34 per cent fall in Hong Kong (China).
FDI flows to Latin America and the Caribbean (excluding financial centres) increased by 10 per cent to $164 billion. FDI rose in Brazil, Chile, Colombia and Peru, much of it in commodities, although investment in utilities and services increased as well.
Transition economies saw FDI inflows increase by 59 per cent, to $55 billion, prompted by a recovery of FDI in the Russian Federation, an up-tick in Ukraine following two years of decline and an increase in newly liberalizing Uzbekistan.
In 2019, MNEs from developed economies invested $917 billion abroad – a 72 per cent increase from the previous year. This increase notwithstanding, their level of FDI remained relatively low, at only about half of the 2007 peak.
Outflows from developing and transition economies declined. These trends resulted in a significant shift in the overall share of developed economies in world FDI outflows, from 54 per cent in 2018 to 70 per cent in 2019.
Outflows from MNEs in Europe rose by 13 per cent, mainly due to large investments by MNEs based in the Netherlands, and a doubling of re-invested earnings by German MNEs abroad.
Investment by MNEs based in North America reached $200 billion. Outflows from the United States turned positive (mostly in the form of re-invested earnings) after falling to -$91 billion in 2018 when firms repatriated funds as a result of tax reforms. Investment by Canadian MNEs jumped by 54 per cent.
Japan remained the largest investor in the world. Investments by Japanese MNEs rose by 58 per cent to a record $227 billion, due to a spike in cross-border M&As (reaching $104 billion from $36 billion in 2018, including a large mega-deal).
Investment activity abroad by TNCs from developing economies declined by 10 per cent, reaching $373 billion. Outflows from developing Asia fell by 19 per cent as outflows from China declined for the third consecutive year.
Outward investment by Latin American TNCs increased sharply in 2019 to $42 billion, mostly driven by a reduction of negative outflows that dampened the totals in previous years. The biggest increases were registered in Brazil, Mexico and Chile.
Brazilian companies, in particular, appear to have suspended their practice of collecting funds through foreign affiliates to finance operations at home, because of the falling domestic interest rate.
FDI outflows from economies in transition declined by 37 per cent, to $24 billion, in 2019. As in previous years, the Russian Federation accounted for almost all outward FDI.
In 2019, the values of net cross-border M&As and announced greenfield projects decreased, said UNCTAD.
The value of greenfield projects decreased by 14 per cent to $846 billion. A lower average project size was the main driver, as investment activity measured by the number of projects fell by only 1 per cent.
The value of net cross-border M&As fell by 40 per cent to $491 billion, the lowest level in the last five years. The decrease was mainly due to the lack of large deals, as the number of deals declined only by 4 per cent, said UNCTAD.