TWN Info Service on Finance and Development (Nov10/02)
9 November 2010
Third World Network

G20 has resisted investment protectionism - UNCTAD/OECD
Published in SUNS #7034 dated 5 November 2010

Geneva, 4 Nov (Kanaga Raja) -- The G20 countries have largely resisted a retreat into investment protectionism during the period from mid-May through mid-October this year. Instead, the majority of investment measures taken during this period carried on the trend towards investment liberalization and facilitation.

This is the main finding of the fourth joint report on G20 investment measures by the UN Conference on Trade and Development (UNCTAD) and the Organization for Economic Cooperation and Development (OECD).

The report, released on Thursday, comes in advance of the 11-12 November G20 Summit in Seoul, South Korea.

It contains up-to-date country-specific information about developments in foreign investment policies at the national and international levels.

According to the joint report, its findings provide no grounds for complacency. Recent measures by some G20 emerging markets attest to these countries' concerns about the impacts of global macroeconomic imbalances on their economies.

"If these imbalances and related risks for other countries are not dealt with in a credible manner, the resulting policy tensions could degenerate into a protectionist spiral. In non-financial sectors, risks of discrimination against foreign investors are still real as well."

G20 Leaders will want to continue their vigilance in this area, the report recommended.

In a media briefing on the joint report, Mr James Zhan, Director of the Investment and Enterprise Division of UNCTAD, said that the key message from the report is that the G20 countries have largely continued resisting protectionist pressures (during the reporting period).

He said that from May to October of this year, 17 G20 countries took some sort of investment policy actions, and eight G20 countries - Australia, Brazil, Canada, China, India, Indonesia, Korea, and Saudi Arabia - took investment-specific measures. Three of them - Brazil, Indonesia and Korea - took measures designed to reduce the volatility of short-term capital flows.

He further said that G20 countries have almost stopped introducing new emergency schemes, but numerous existing ones continue to be open for new entrants. Only two countries introduced new schemes (Italy and the United States), while other schemes have already been discontinued.

He also highlighted some messages that he said could be read in between the lines of the report.  He said that the report records only new investment policy measures taken by G20 members, and has not covered measures taken by other countries (i.e., non-G20 members). It has also not covered the investment protectionist actions taken by governments in implementing the existing investment laws and regulations.

"When we say the picture is very positive in the sense that the majority or overwhelming majority of  new G20 investment-specific measures has aimed at facilitating and encouraging investment flows, and largely resisting protectionist measures, it doesn't tell about the other side of the story... We do observe a kind of covert investment protectionism in the implementation of existing investment policies, particularly, at the entry level in the approval of foreign investment projects..."

He further said that while globally, the overall trend is in the direction of liberalization, promotion and protection of investment, the share of restrictive measures as part of overall policy developments has increased considerably over time. For example, between 2000 and 2009, the restrictive measures as a share of total new investment measures have grown from 2% to 30% and the share of liberalization/promotion measures has declined from 98% to 70%.

"This is the global picture compared with the G20," Zhan said, adding that despite the overall balance on the side of liberalization and promotion, the impact of the ongoing implementation of restrictive measures cannot be overestimated.

According to the joint UNCTAD-OECD report, which covers investment policy and investment-related measures taken between 21 May 2010 and 15 October 2010, foreign direct investment (FDI) flows to G20 countries declined sharply by 36% in the second quarter of 2010, after four quarters of modest recovery in the wake of the financial crisis.

As the economic recovery remains fragile and new risk factors (such as competitive devaluations) are emerging, G20 and global FDI flows for 2010 as a whole are estimated to remain stagnant. That implies that 2010 FDI flows will still be some 25% lower than the average of the last three pre-crisis years (2005-2007).

"A new FDI boom remains a distant prospect," the report says.

During the reporting period, 17 G20 members took some sort of investment policy action (investment-specific measures, investment measures relating to national security, emergency and related measures with potential impacts on international investment, international investment agreements). Emergency measures with potential impacts on international investment continued to account for most of the measures during the period.

Eight G20 members took investment-specific measures (those not designed to address national security or emergency concerns) during the reporting period. For example, Australia tightened the rules applicable to foreign investment in residential real estate, while India sought to make its foreign investment regulations more accessible to investors by consolidating regulations relating to FDI and cross-border capital flows.

Canada removed foreign ownership restrictions regarding international submarine

cables, earth stations that provide telecommunications services by means of satellites, and satellites, while Brazil reinstated restrictions on rural land-ownership for foreigners by modifying the way a law dating back to 1971 is to be interpreted. The reinterpreted law establishes that, on rural land-ownership, Brazilian companies which are majority owned by foreigners are subject to the legal regime applicable to foreign companies.

Furthermore, China increased the threshold that triggers central level approval for foreign-invested projects in the "encouraged" and "permitted" categories. It also extended existing business permits of foreign-controlled companies for retail distribution to online sales over the internet. Korea meanwhile extended FDI zones for the services sector, while Saudi Arabia allowed foreign investors to invest in an exchange-traded fund of Saudi Arabian shares.

The report notes that Indonesia amended its rules that determine to what extent foreigners can invest in specific industries in the country. Among others, the changes further liberalise foreign investment in construction services, film technical services, hospital and healthcare services, and small-scale electric power plants.

Three countries took measures designed to reduce the volatility of short term capital flows: Brazil doubled the tax levied on non-residents' investment in fixed-income securities to 4%; Indonesia introduced a one-month minimum holding period on Sertifikat Bank Indonesia (SBIs), a debt instrument, and tightened banks' net foreign exchange positions; and Korea introduced limits on forward exchange positions of banks, restricted the use of foreign currency loans granted by financial institutions established in Korea to residents to overseas purposes, and tightened regulations on banks' foreign exchange liquidity ratio.

"The measures show some continued moves toward eliminating restrictions and improving clarity for investors (Canada, China, India, Indonesia, the Republic of Korea and Saudi Arabia), but also some steps toward increasing restrictions (Australia, Brazil, Indonesia, and the Republic of Korea)."

The report finds that none of the G20 members took investment measures related to national security in the reporting period.

Noting that emergency measures continued to be the most frequent measure covered (by the report), the report says that the evolution of support schemes in different economies and in the financial and non-financial sectors shows varying patterns.

"More than two years after the financial crisis struck, G20 countries have almost stopped introducing new emergency schemes but numerous existing ones continue to be open for new entrants. Other schemes have already been discontinued and assets and liabilities resulting from the interventions are being wound down."

Two countries introduced new emergency schemes: Italy reintroduced a scheme for the financial sector that it had discontinued earlier, and the United States established a new support scheme.

Ten countries continued to implement emergency measures with potential impact on international investment at the end of the reporting period. Many schemes, especially broad support schemes for the real economy, remain open to new entrants.

The report further finds that only three G20 members - Australia, Japan and the United States - closed one or more support schemes for the financial sector during the reporting period. Also, emergency schemes dedicated to non-financial sectors are, for the most part, still open for new entrants.

At the end of the reporting period on 15 October 2010, 35 of the 36 schemes listed in this and earlier reports to G20 Leaders are still open for new entrants - only one scheme, in the United States, has so far been discontinued.

Even where schemes have been closed to new entrants, some G20 members continue to hold assets and liabilities left as a legacy of emergency measures, stresses the report. This legacy is significant and continues to influence market conditions even after the closure of programmes to new entry.

At the end of the reporting period, nine countries held legacy assets and liabilities resulting from emergency schemes for the financial sector and 10 countries held them as a result of schemes dedicated to non-financial sectors. Total outstanding public commitments under emergency programmes - equity, loans and guarantees - on 15 October 2010 exceeded US$2 trillion.

In the financial sector, public expenditure commitments for certain individual companies represented hundreds of billions of US Dollars. For instance, the German government's financial commitment for a special purpose vehicle - "bad bank" - exceeds US$220 billion, and a British bank benefits from a guarantee of assets of over 280 billion pounds sterling. In the United States, Government Sponsored Enterprises operating in the mortgage lending sector now benefit from an explicit unlimited guarantee.

As of 15 October 2010, says the report, several hundred financial firms continue to benefit from public support, and only about 15% of the financial firms that had received crisis-related support have fully reimbursed loans, repurchased equity or relinquished public guarantees.

In non-financial sectors, over 30,000 individual firms have benefited or continue to benefit from emergency support; governments estimate that the total number of firms that will receive crisis-related aid will exceed 40,000 companies. Individual companies operating in the non-financial sectors have received advantages worth several billion US Dollars.

According to the report, some governments have begun to unwind financial positions - assets or liabilities - acquired as part of their crisis response. These actions took several forms: sales by governments of their stakes in companies (United Kingdom and United States) or paying down of loans or relinquishing state guarantees by companies participating in the programmes (France, Germany, and the United States).

Only one country - India - has so far dismantled all emergency programmes for the financial sector and has no outstanding legacy assets or liabilities.

Two countries have dismantled guarantee or capital injection programmes for the financial sector, but still have outstanding legacy assets or liabilities left over from these programmes (Australia and the United Kingdom). Three countries have guarantee or capital injection programmes that are still open for new entrants (Germany, Italy, and Japan).

"The disposal of assets acquired as part of governments' emergency response to the crisis may again influence international capital flows and, depending on the approach chosen for disposal, may entail risks of discrimination against foreign investors. Not all governments have communicated their approach and timelines for unwinding financial positions they have taken as part of their crisis response,"the report says.

The few cases where governments have already disposed of assets show a range of methods. In France, Germany and the United States, financial institutions have repurchased government participation at predetermined prices at the moment of their choice. The United States has also disposed of some positions on the market through sales agents and has auctioned off warrants.

Noting that governments are not always in a position to determine the timing of their exit, the report cautions that the "potential impact on competitive conditions of legacy assets and liabilities is thus likely to persist for the years to come."

During the reporting period, G20 members continued to negotiate or pass new international investment agreements (IIAs), thereby further enhancing the openness and predictability of their policy frameworks governing investment. Between 21 May and 15 October 2010, six bilateral investment treaties and three other agreements with investment provisions were concluded by G20 members.

The report summarizes that "G20 members have continued to honour their pledge not to retreat into investment protectionism. On the contrary, the majority of investment measures taken during the review period carry on the trend towards investment liberalisation and facilitation."

It notes that managing the investment impacts of emergency measures taken in response to the crisis still constitutes a great challenge for G20 governments.

"These measures could be applied in a discriminatory way toward foreign investors. In addition, they pose serious threats to market competition in general and to competition operating through international investment in particular."

Governments have, in some cases, begun dismantling and unwinding emergency schemes. This process will take several years, it adds.

Again in this phase, risks of protectionism may arise, the report cautions, adding that governments' choice of the approach and timing of unwinding will determine the prevalence of these risks and thus the trust and confidence that investors will have in governments' fairness and openness.

"It remains a crucial challenge for G20 Leaders to ensure that emergency programmes are wound down as quickly as is prudent, given remaining systemic concerns and the continued fragility of the economic recovery. Assets that were acquired as a legacy of crisis-related schemes should be disposed of in a timely, non-discriminatory and open manner. Exit strategies should be transparent and accountable and should not be used as a pretext to discriminate directly or indirectly against certain investors, including foreign investors.

"There are also grounds for concern that support policies are becoming an entrenched feature of the policy landscape in some countries. The fact that many emergency schemes are still operating two years after the crisis points to the political dilemmas facing governments. Although there may be a few cases where concerns about systemic stability persist, there is now a growing risk that governments are being captured by a logic for subsidisation from which it is difficult to escape. Internationally, government subsidies in one country create pressure on governments elsewhere to subsidise or shoulder the structural adjustment shifted on to them by other subsidising governments," says the report.

It stresses that G20 Leaders should also be mindful of the risks for international investment resulting from global macroeconomic imbalances.

These pose two types of problems for international investment policymakers. First, in a general way, global macroeconomic imbalances and related policy tensions detract from investor confidence and therefore dampen investment, both domestic and international.

Second, countries have begun adopting policies (capital controls and financial regulations with similar effects) aimed at buffering their economies from volatility of foreign exchange markets and capital flows induced by these imbalances.

Such policies will, if they become entrenched, lead to fragmentation of international capital markets along national lines and may be difficult to dismantle once in place, the report stresses.

"Progress by G20 Leaders in credibly addressing global macroeconomic imbalances will help create an environment in which international investment can make its full contribution to global prosperity and sustainable growth," it concludes.+