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TWN Info Service on WTO and Trade Issues  (Sept08/13)
30 September 2008
Third World Network

United Nations: Record FDI flows in 2007, but set to decline this year
Published in SUNS #6555 dated 25 September 2008

Geneva, 24 Sep (Kanaga Raja) -- Despite the global financial and credit crises which began in the second half of 2007, global foreign direct investment (FDI) inflows rose in 2007 by 30% to reach an all-time high of $1,833 billion, surpassing the previous record set in 2000 by some $400 billion. However, it is estimated that FDI flows in 2008 will be about $1,600 billion, representing a 10% decline from 2007.

This was highlighted by the UN Conference on Trade and Development (UNCTAD) in its "World Investment Report 2008" released Wednesday.

At a media briefing on Tuesday, UNCTAD Secretary-General Dr Supachai Panitchpakdi said that 2007 witnessed FDI flows rising to reach an all-time high of $1.8 trillion. This is $400 billion higher than the record year of 2000. This is in spite of the global financial crisis that emerged in the second half of 2007.

He said that in 2008-2009, because of the spiral effects of the crisis and economic downturn, "we are predicting that there would be [a] decline in the FDI flows in 2008 of around 10% from 2007. So here, there would be no upward trend from 2007. So, 2008, is likely that the total global FDI flow would be around $1.6 trillion."

"Nevertheless, we are of the opinion that FDI flows to developing countries as a group are likely to remain quite stable," Supachai added.

In response to a question, Supachai said that investment-related issues will be determined by the magnitude and length of the financial crisis that is still going on. "I think everyone in the world today agrees that it is a commendable attempt by the US administration to tackle the financial crisis by having a comprehensive package to support the system, which is much needed."

(On 19 September, US Treasury Secretary Henry Paulson unveiled a bailout plan for US financial institutions to the tune of $700 billion. The plan is meeting with considerable resistance in Congress, both among Democrats and Republicans, and critical comments from a large number of mainstream economists, both progressive and neo-conservative, including Paul Krugman and Martin Wolf. Paul Krugman, in his blog at the New York Times, has quoted Alan Blinder at a Princeton panel discussion on the plan as calling it a "Hanky Panky" plan.)

Supachai stressed that UNCTAD has been speaking all the time "about the need to put in some regulatory framework into the financial system in a way that we can see more transparency and accountability," and could be on the same level as the trade regime. He said that UNCTAD has also emphasized the fact that in spite of the functioning of the market mechanism, it is just inevitable that the State will have to come back in and play a more pronounced role in this area.

According to the report, after four years of high GDP growth, a slowdown is expected in 2008 due to the financial and credit crises which are now affecting a number of countries worldwide. High levels of energy and food prices may aggravate this situation.

Based on 75 countries for which data on FDI flows for the first quarter of 2008 were available, annualized FDI flows for the whole of 2008 are estimated to be some $1,600 billion, about 10% less than in 2007. The data on cross-border M&As (mergers and acquisitions) for the first half of 2008 also show a fall of 29%, compared to the second half of 2007.

The report said that globally, FDI inflows continued to rise in 2007: at $1,833 billion, they reached a new record level, surpassing the previous peak of 2000. The financial and credit crisis, which began to affect several economies in late 2007, did not have a significant impact on the volume of FDI inflows that year, but it has added new uncertainties and risks to the world economy. This may have a dampening effect on global FDI in 2008-2009. At the same time, the global FDI market is in a state of flux, making it difficult to predict future flows with any precision.

The continued rise in FDI in 2007 largely reflected relatively high economic growth and strong economic performance in many parts of the world. Increased corporate profits of parent firms provided funds to finance investment and reduced the impact of decreasing loans from the banks affected by the sub-prime credit crisis. In foreign affiliates, higher profits, amounting to over $1,100 billion in 2007, contributed to higher reinvested earnings, which accounted for about 30% of total FDI flows in 2007. These profits are increasingly generated in developing countries rather than in developed countries, said the report.

The growth in FDI flows was also driven by cross-border M&A activity, which expanded in scope across countries and sectors. Its strong growth and a record number of mega-deals (i. e. deals with a transaction value of over $1 billion) pushed the value of total cross-border M&As to a record $1,637 billion in 2007 -- 21% higher than even the value in 2000. The number of such transactions grew by 12% to 10,145.

In addition, said the report, large TNCs in most industries remained in good financial health, reporting rising profits. In the financial industry, however, liquidity problems of several transnational banks spurred further consolidation, with participation by a number of sovereign wealth funds (SWFs).

Despite a change in lending behaviour since mid-2007, caused by a general reassessment of credit risk, the growth of cross-border M&As in the second half of 2007 reached a peak of $879 billion. This was essentially due to the completion of large deals, many of which had begun earlier. More cautious lending behaviour of banks hampered M&A financing in the first half of 2008, especially the financing of larger acquisitions, which plummeted to their lowest semi-annual level since the first half of 2006.

Overall, said the report, the financial crisis that began in the second half of 2007 in the US sub-prime mortgage market did not exert a visible dampening effect on global cross-border M&As that year. However, the current crisis has led to a liquidity crisis in money and debt markets in many developed countries. This liquidity crisis has begun to depress the M&A business in 2008, especially leveraged buyout transactions (LBOs), which normally involve private equity funds. This contrasts with the situation in 2007: cross-border M&As involving such funds almost doubled, to $461 billion -- the highest share observed to date, accounting for over one quarter of the value of worldwide M&As.

Through its dampening effects on cross-border M&As, the decline of buyout transactions in the current financial market crisis is likely to have depressed FDI flows in the beginning of 2008. It is difficult for private equity firms to obtain necessary loan commitments from banks for highly leveraged buyouts. While they raised a new record amount of funds totalling $543 billion in 2007, their fund-raising in the latter half of 2007 declined by 19%, to $254 billion, compared to the first half of that year.

However, the report observed, the decline can be seen as a normalization or return to a more sound and much more sustainable situation, and a shift towards distressed debt and infrastructure funds from buyout funds. Several institutions had warned for some time that the credit standards for corporate credits, particularly for highly leveraged buyout loans, were too loose and could represent a danger for the financial system.

The report said that virtually all the major geographical regions registered record inflows as well as outflows in 2007. However, higher growth rates of FDI inflows to developed countries than to developing countries reduced the share of developing countries in FDI inflows from 29% to 27%. Regarding outflows, the share of developing countries also declined from 16% to 13%. By contrast, the share of economies in transition (i. e. South-East Europe and Commonwealth of Independent States) rose for both inflows and outflows.

FDI inflows into developed countries grew once again in 2007, for the fourth consecutive year, to reach $1,248 billion -- 33% more than in 2006. The US maintained its position as the largest FDI recipient country, while the European Union (EU) as a whole continued to be the largest host region within the developed-country group, attracting almost two thirds of total FDI inflows to the group in 2007.

Outflows from developed countries in 2007 grew even faster than their inflows. They increased by 56% to the unprecedented level of $1,692 billion, exceeding inflows by $445 billion. The continued upswing of outward FDI was mainly driven by greater financial resources from high corporate profits. While the US maintained its position as the largest source of FDI in 2007, outflows from the EU countries nearly doubled, to $1,142 billion.

The various risks prevailing in the world economy are likely to influence FDI flows to and from developed countries in 2008, said the report. The short-term prospects for FDI flows to and from developed countries have deteriorated as a result of financial turbulence and weaker economic growth. Economic growth in developed countries -- one of the key drivers of FDI flows in past years -- has slowed markedly since the fourth quarter of 2007. Economic expansion of the US economy in 2008 is expected to fall below 2%. A similar slowdown is projected for Western Europe and Japan.

Deteriorating profits of TNCs in the wake of the economic slowdown will make the cash financing of FDI more difficult. In addition, the strong tightening of credit standards and the rise in risk premiums, especially for buyouts by collective investment funds (e. g. private equity and hedge funds), are likely to subdue cross-border M&As. High and volatile commodity prices (especially oil prices), inflationary pressures in several developed countries and sharp exchange-rate fluctuations further contribute to uncertainty in long-term investment decisions.

In the medium-term, said the report, FDI growth prospects are uncertain due to continued slow growth and difficult market conditions in developed countries.

The report noted that FDI inflows into developing countries rose by 21%, to reach a new record level of $500 billion. Those to least developed countries (LDCs) alone reached $13 billion, a 4% increase over the previous year.

In Africa, FDI inflows in 2007 rose to a historic high of $53 billion. The inflows were supported by a continuing boom in global commodity markets. The commodities-market boom also helped drive FDI outflows from Africa amounting to $6 billion, although this was a decline from 2006 when they reached $8 billion. Cross-border M&As in the extraction industries and related services continued to be a significant source of FDI, in addition to new inbound M&A deals in the banking industry. Nigeria, Egypt, South Africa and Morocco were the largest recipients. In 2008, FDI inflows to Africa as a whole are expected to grow further as a result of the current boom in commodity markets, notwithstanding the global financial crisis and economic slowdown, said the report.

FDI inflows to South, East and South-East Asia, and Oceania maintained their upward trend in 2007, reaching a new high of $249 billion, an increase of 18% over 2006. They accounted for half of all FDI to developing economies. Prospects for FDI to the region remain promising despite concerns about the impact of the financial crisis. In West Asia, overall, inward FDI increased by 12% to $71 billion, sustaining a period of steady growth in inflows. Turkey and the oil-rich Gulf States continued to attract the most FDI, but geopolitical uncertainty in parts of the region affected overall FDI.

FDI inflows into Latin America and the Caribbean increased by 36%, to a record level of $126 billion. Significant increases were recorded in the region's major economies, especially Brazil and Chile where inflows doubled. Contrasting with the experience of the 1990s, the strong FDI growth was driven mainly by greenfield investments (new investments and expansion) rather than cross-border M&As. This pattern was the result of strong regional economic growth and high corporate profits due to rising commodity prices. FDI inflows to the region are expected to increase in 2008, mainly driven by South America, where high commodity prices and strong economic growth of the sub-region will continue to sustain TNCs' profits.

FDI outflows from the developing world remained high in 2007 at $253 billion. More African TNCs expanded their activities within and outside the region, driving FDI outflows from the region to $7 billion on average in the past two years. South, East and South-East Asia and Oceania, with FDI outflows of $150 billion in 2007, has become a significant source of FDI, particularly for other developing countries both within and outside the region.

With the doubling of FDI outflows from West Asia to $44 billion, this region remains an important source of FDI, led by the countries of the Gulf Cooperation Council (GCC). FDI outflows from Latin America and the Caribbean fell by 17% in 2007, to around $52 billion. This was due to the decline in outflows from Brazil to $7 billion following the exceptionally high level of $28 billion reached in 2006. FDI outflows from Latin America and the Caribbean, excluding offshore financial centres, are expected to increase in 2008.

FDI inflows into the transition economies of South-East Europe and Commonwealth of Independent States (CIS) increased significantly by 50% to reach a new record of $86 billion in 2007 -- the seventh year of uninterrupted growth of FDI flows to the region. Inflows to the region's largest recipient, the Russian Federation, rose by 62%. FDI outflows from South-East Europe and CIS also rose to record levels in 2007, reaching $51 billion -- more than twice as high as the previous year. FDI from the Russian Federation reached a new high in 2007 ($46 billion).

In recent years, said the report, there has been a significant increase in FDI flows to the primary sector, mainly the extractive industries, and a consequent increase in the share of that sector in global FDI flows and stock. The primary sector's share in world FDI is now back to a level comparable to that of the late 1980s. The services sector still accounts for the largest share of global FDI stocks and flows, while the share of manufacturing has continued to decline.

The report noted that today, an estimated 79,000 TNCs control some 790,000 foreign affiliates around the world. Their production continues to grow. For example, the value-added activity (gross product) of foreign affiliates worldwide accounted for 11% of global GDP in 2007. Sales amounted to $31 trillion, about one fifth of which represented exports, and the number of employees reached 82 million.

The sub-prime mortgage crisis that erupted in the US in 2007, which caused property prices to plunge and a slowdown in the US economy, has had worldwide repercussions. World economic growth in 2007 was relatively strong, but the effects of the crisis had begun to take their toll by mid-2008, and forecasts for 2008 have been revised downwards pointing considerably lower growth rates. So far, the impact of the crisis on FDI flows has been mixed.

The problems related to sub-prime mortgage lending and their fallout in the US since the latter half of 2007 have disrupted financial markets, with broad impacts on the US economy as a whole. The resultant liquidity problems have extended to some European countries as well.

At the firm level, said the report, given that in developed countries FDI is mostly in the form of M&As, it is mainly the direct impact of the crisis on cross-border M&As that is affecting FDI flows. The degree of the impact depends on the extent to which the sub-prime fallout affects lending to the corporate sector and other foreign investors (e. g. private equity funds).

At the macroeconomic level, the economies of developed countries could be affected by the slowdown of the US economy and its subsequent impact on the most important financial centres, affecting bank liquidity and credit supply. It has led to a decline in issuance of corporate bonds, while credit available for investment has fallen not only in the US, but also in several European countries. Both FDI inflows and outflows to and from these countries may therefore slow down.

The question is whether such effects are also being experienced in developing economies, in particular those where there is strong and growing demand for FDI. The fact that economic growth of these economies has remained resilient suggests that this may not be the case, said the report.

To date, the financial crisis has mainly affected North American and European commercial and investment banks, whereas the negative effects on the Asian financial system have been fairly limited. Asian banks, and especially Chinese banks, have gained strength recently. In contrast, many banks in developed countries had to bear substantial losses in the market value of their equity.

In 2007, the exchange rates of the major currencies of developed countries continued their trend that started at the beginning of this decade. From 2000 to 2007, the US dollar lost 33% of its nominal value against the euro and 24% against the pound sterling. However, the effects of exchange rate changes on aggregate FDI flows are not straightforward. While it is difficult to isolate the effects of exchange rate changes from the effects of other determinants on FDI flows, there are some discernible cases of European firms that increased their FDI in the US in reaction to the appreciating euro.

The fact that TNCs can raise funds in the capital markets in host countries or in international capital markets suggests that they may avoid effects from currency change movements. As some TNCs are also skilful in using derivatives (such as futures, forwards, options and swaps) to hedge against exchange rate changes, FDI flows into tax havens (e. g. Caribbean island economies) and special purpose entities are increasing for this purpose. The current depreciation of the dollar has stimulated this type of FDI as well. For example, FDI flows to tax havens in the Caribbean more than trebled in 2006, and continued to be high in 2007.

The report noted that a growing number of individual and institutional investors invest in collective investment institutions (e. g. hedge funds, private equity funds), which have become direct investors by acquiring 10% or more of equity, with voting power, in enterprises abroad. However, sovereign wealth funds (SWFs) have also begun to expand abroad as a result of a rapid accumulation of reserves in recent years. The size of these funds (or assets under management) is estimated to be about $5 trillion today.

There are some 70 such funds in 44 countries with assets ranging from $20 million (Sao Tome and Principe) to more than $500 billion (United Arab Emirates). However, their holdings are concentrated in China, Hong Kong-China, Kuwait, Norway, the Russian Federation, Saudi Arabia, Singapore and the United Arab Emirates.

Despite their larger size, FDI by SWFs was only $10 billion in 2007, accounting for a mere 0.2% of their total assets and only 0.6% of total FDI flows. By comparison, private equity funds, although much smaller in size, invested more than $460 billion in FDI that year. Nevertheless, growth of FDI by SWFs during the period 2005-2007, the majority originating in the United Arab Emirates, was dramatic. Of the $39 billion of FDI invested by SWFs during the past two decades, as much as $31 billion was committed in the past three years.

The report noted that the recent behaviour of SWFs has been motivated by various market trends and changes in global economic fundamentals, and by the structural weaknesses in the global financial architecture. Recent investments by SWFs in the financial sector may have exerted a stabilizing effect on financial markets, as they seem to have contributed to restoring the capital base of hard-hit banks.

The report also said that meeting the huge needs of developing countries for infrastructure such as roads, ports, and electricity supply is a major challenge and requires better use of private-sector resources, including those of TNCs.

The report said that infrastructure plays an increasingly important role in international trade and investment. Developing countries cannot link into the global economy and export products at competitive prices without sufficient -- and good quality -- electricity, telecommunications and transport networks, and without other basics such as widespread access to drinking water. Because massive infrastructure improvements are required in such countries, it is important to enhance the contributions of TNCs, but in a way that fits in with national development plans.

FDI in infrastructure has increased rapidly. From 1990-2006, global FDI committed to infrastructure increased 31-fold, to $786 billion. The amount directed to developing countries increased 29-fold, to an estimated $199 billion.

The report also noted that the future investment needs of developing countries for infrastructure development far exceed the amounts currently planned by governments, the private sector and other stakeholders. It cited the World Bank as estimating that, on average, developing countries actually invest about 3-4% of their GDP on infrastructure annually, whereas that they should be spending about
7-9% on new investment projects and maintenance of existing infrastructure, if broader economic growth and poverty reduction goals are to be achieved.

UNCTAD cautioned countries not to attract TNCs at any cost. Failed investment projects can adversely affect infrastructure availability and the price of infrastructure services. Countries should ensure that they have the technical and administrative capabilities for managing contracts and concessions involving TNCs.

UNCTAD said that meeting the infrastructure challenge requires a concerted, cooperative effort. This implies an appropriate combination of improved governance and capabilities in host countries, greater support from the international community and an understanding of development priorities and processes on the part of investors. +

 


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