Global FDI flows fell by 18% last year

Last year saw a strong decline in global inflows of foreign direct investment, according to a UN development agency.

by Kanaga Raja

GENEVA: Global foreign direct investment (FDI) inflows fell by 18% from $1.65 trillion in 2011 to $1.35 trillion in 2012, the United Nations Conference on Trade and Development (UNCTAD) has said.

 In its World Investment Report 2013, released on 26 June, UNCTAD said that this strong decline in FDI flows is in stark contrast to other macroeconomic variables, including GDP, trade and employment growth, all of which remained in positive territory in 2012.

 In its forecast for 2013, UNCTAD said that FDI flows are expected to remain close to the 2012 level, with an upper range of $1.45 trillion.

 “As macroeconomic conditions improve and investors regain confidence in the medium term, transnational corporations (TNCs) may convert their record levels of cash holdings into new investments. FDI flows may then reach the level of $1.6 trillion in 2014 and $1.8 trillion in 2015,” it said.

 Nevertheless, it cautioned, “significant risks to this scenario persist, including structural weaknesses in the global financial system, weaker growth in the European Union (EU) and significant policy uncertainty in areas crucial for investor confidence.”

 According to the UNCTAD report, FDI flows to developing economies remained relatively resilient in 2012, reaching more than $700 billion, the second highest level ever recorded. In contrast, FDI flows to developed countries shrank dramatically to $561 billion, almost one-third of their peak value in 2007.

 Consequently, developing economies absorbed an unprecedented $142 billion more FDI than developed countries. They accounted for a record share of 52% of FDI inflows in 2012.

 Global FDI outflows fell by 17% to $1.4 trillion, down from $1.7 trillion in 2011. Developed economies, in particular those in the EU, saw their FDI outflows fall close to the trough of 2009, in part because of uncertainty about the euro.

 In contrast, said UNCTAD, investors from developing countries continued their expansion abroad. Together, the share of developing and transition economies in global outflows reached 35%. Among developing and transition economies, the BRICS countries (Brazil, Russia, India, China and South Africa) continue to be important outward investors.

 In contrast to the sharp decline of FDI flows from developed countries, FDI flows from developing economies rose slightly in 2012, amounting to $426 billion. As a result, their share in global outflows rose to a record 31%.

 Among developing regions, FDI outflows from Africa nearly tripled, flows from Asia remained unchanged from their 2011 level, and those from Latin America and the Caribbean declined slightly. Asian countries remained the largest source of FDI in the developing world, accounting for almost three-quarters of the group’s total.

Greenfield projects and M&As

UNCTAD said that the estimated capital expenditure of announced greenfield projects fell by 33% compared with 2011, reaching $600 billion, the lowest level in the past 10 years. The contraction was even more pronounced in developing economies (-38%), raising additional concerns about the development impact of the downturn.

 The value of cross-border mergers and acquisitions (M&As) declined by 45%, back to levels similar to those of 2009 and 2010, after the financial crisis had knocked down M&A activity in developed economies.

 The primary sector was the most heavily hit in relative terms, in both greenfield projects and cross-border M&As. The decline was driven by the downturn in the mining, quarrying and petroleum industry, which represents the bulk of the  overall FDI activity in the sector. The contraction was particularly dramatic in developing countries, where the announced value of greenfield projects  fell  to  a fourth of the 2011 value.

 “Similarly, FDI inflows to developing economies generated by cross-border M&A activities plunged from some $25 billion in 2011 to a slightly negative value, revealing a predominant divestment trend by foreign investors in the sector.”

 Manufacturing was the sector with the largest decrease in FDI project value in absolute terms, originating mainly from a decline in the value of greenfield projects across all three groups of economies – developed, developing and transition economies.

 The UNCTAD report further found that in 2012, FDI flows to offshore financial centres (OFCs) were almost $80 billion, despite a contraction of about $10 billion (-14%) compared with 2011. Flows to OFCs have boomed since 2007, following the start of the financial crisis. The average annual FDI inflows to OFCs in the period 2007-12 were $75 billion, well above the $15 billion average of the pre-2007 period (2000-06).

 “Tax haven economies now account for a non-negligible and increasing share of global FDI flows, at about 6%,” it said, noting that a significant part of inflows consists of “round-tripping” FDI to the original source countries. For example, the top three destinations of FDI flows from Russia – Cyprus, the Netherlands and the British Virgin Islands – coincide with the top three investors in Russia.

 “Such flows are more akin to domestic investments disguised as FDI. The bulk of inflows in OFCs consists of FDI in transit that is redirected to other countries.”

 While UNCTAD said that financial flows through special purpose entities (SPEs) in Luxembourg, the Netherlands and Hungary are not counted in its FDI data, it found however that relative to FDI flows and stocks, SPEs are playing a large and increasing role in a number of important investor countries.

 “These entities play a role similar to that of OFCs in that they channel financial flows for investment and redirect them to third countries. Luxembourg and the Netherlands are typical examples of countries that provide favourable tax treatment to SPEs.”

 The UNCTAD report stressed that although most international efforts to combat tax evasion have focused on OFCs, flows through SPEs are far more important. Three countries alone – namely, Hungary, Luxembourg and the Netherlands – reported more than $600 billion in investment flows to SPEs for 2011 compared with $90 billion of flows to OFCs.

 “Tackling OFCs alone is clearly not enough, and is not addressing the main problem,” said UNCTAD, adding that tax avoidance and transparency in international financial transactions are global issues that require an intensified multilateral approach.

Regional trends

Highlighting investment trends on a regional basis, UNCTAD found that FDI inflows to Africa grew to $50 billion in 2012, a rise of 5% over the previous year. The overall increase in FDI inflows translated into increased flows to North Africa, Central Africa and East Africa, whereas West Africa and Southern Africa registered declines.

 Africa is one of the few regions to enjoy year-on-year growth in FDI inflows since 2010. Investment in exploration and exploitation of natural resources, and high flows from China both contributed to the current level of inward flows.

 “More generally, the continent’s good economic performance – GDP grew at an estimated 5% in 2012 – underpinned the rise in investment, including in manufacturing and services.”

 UNCTAD noted that TNCs from developing countries are increasingly active in Africa, building on a trend in recent years of a higher share of FDI flows coming from emerging markets.

 Malaysia, South Africa, China and India (in that order) are the largest developing-country sources of FDI in Africa. Malaysia, with an FDI stock of $19 billion in Africa in 2011 (the latest year for which data are available), has investments in all sectors across the continent, including significant FDI in agribusiness and finance.

 Outward FDI flows from Africa nearly tripled in 2012, from $5 billion in the previous year to an estimated $14 billion. South African companies were active in acquiring operations in mining, wholesale and healthcare industries, helping raise outflows from the country to $4.4 billion in 2012.

 On the other hand, FDI inflows to East and South-East Asia declined by 5%, while outflows from the two subregions rose by 1% in 2012. The subregions now account for 24% of the world’s total FDI inflows and 20% of outflows.

 FDI inflows to East and South-East Asia fell to $326 billion in 2012 – the first decline since 2009 – as a result of drops in major economies such as China, Hong Kong (China), Malaysia and the Republic of Korea. “The sluggish global economy, fiscal constraints in Europe, a significant shrinkage in global M&A activities and cautious sentiment in investing by TNCs were among the key reasons for the decline.”

 East Asia experienced an 8% drop in FDI inflows, to $215 billion. China continues to be the leading FDI recipient in the developing world despite a 2% decline in inflows. FDI remained at a high level of $121 billion, in spite of a strong downward pressure on FDI in manufacturing from rising production costs, weakening export markets and the relocation of foreign firms to lower-income countries.

 In contrast to East Asia, South-East Asia saw a 2% rise in FDI inflows (to $111 billion), partly because of higher flows (up 1.3% to $57 billion) to Singapore, the subregion’s leading FDI host country. Higher inflows to Indonesia and the Philippines also helped, as did the improved FDI levels in low-income countries such as Cambodia, Myanmar and Vietnam.

 Overall, said UNCTAD, outward FDI from East and South-East Asia rose by 1%, to $275 billion, against the backdrop of a sharp decline in worldwide FDI outflows. This marks the fourth consecutive year of increasing flows from the region, with its share in global FDI outflows jumping from 9% in 2008 to 20% in 2012, a share similar to that of the EU.

 In East Asia, FDI outflows rose by 1% to $214 billion in 2012. Outflows from China continued to grow, reaching a new record of $84 billion. The country is now the world’s third largest source of FDI.

 FDI outflows from South-East Asia increased 3% to $61 billion in 2012. Outflows from Singapore, the leading source of FDI in the subregion, declined by 12% to $23 billion. However, outflows from Malaysia and Thailand rose by 12% and 45%, amounting to $17 billion and $12 billion, respectively. The rise of these two countries as FDI sources was driven mainly by intra-regional investments.

 According to UNCTAD, FDI inflows to South Asia dropped by 24% to $34 billion as the region saw sharp declines in both cross-border M&As and greenfield investments. Meanwhile, outflows declined by 29%, to $9 billion, due to the shrinking value of M&As by Indian companies.

 “India continued to be the dominant recipient of FDI inflows to South Asia in 2012. However, the Indian economy experienced its slowest growth in a decade, and a high inflation rate increased risks for both domestic and foreign investors. As a result, investor confidence has been affected and FDI inflows to India declined significantly.”

 A number of other factors, however, positively influenced FDI prospects in the country. Inflows to services are likely to grow, thanks to ongoing efforts to further open up key economic sectors, such as retailing. Flows to manufacturing are expected to increase as well, as a number of major investing countries, including Japan and the Republic of Korea, are establishing country- or industry-specific industrial zones in India.

 FDI outflows from South Asia dropped sharply by 29% in 2012. Outflows from India, the region’s largest FDI source, decreased to $8.6 billion (still 93% of the regional total) owing to the shrinking value of cross-border M&As by Indian companies.

 According to UNCTAD, the 2% decline in FDI inflows to Latin America and the Caribbean in 2012 masked a 12% increase in South America. Developed-country TNCs continued selling their assets in the region, increasingly acquired by Latin American TNCs that are also expanding into developed countries.

 South America continued to sustain FDI flows to the region. FDI flows to Latin America and the Caribbean in 2012 maintained almost the same level as in 2011, declining by a slight 2% to $244 billion. However, this figure hides significant differences in subregional performance, as inward FDI grew significantly in South America (12% to $144 billion) but declined in Central America and the Caribbean (-17% to $99 billion).

 The growth of FDI to South America took place despite the slowdown registered in Brazil (-2% to $65 billion) – the subregion’s main recipient – after two years of intensive growth. Growth was driven by countries such as Chile (32% to $30 billion), Colombia (18% to $16 billion), Argentina (27% to $13 billion) and Peru (49% to $12 billion), which were South America’s main recipient countries after Brazil.

 “A number of factors contributed to the subregion’s FDI performance, including the presence of natural resources (such as oil, gas, metals and minerals) and a fast-expanding middle class that attracts market-seeking FDI.”

 Central America and the Caribbean, excluding the offshore financial centres, saw a 20% decrease in FDI inflows to $25 billion, attributable mainly to a 41% drop in inflows to Mexico.

 FDI to the offshore financial centres decreased by 16% to $74 billion in 2012 but remained at a higher value than before the global financial crisis, UNCTAD said, adding that the share of offshore financial centres in the region’s total FDI increased from 17% in 2001-06 to 36% in 2007-12.

 Outward FDI from Latin America decreased by 2% to $103 billion in 2012, with uneven growth among countries. Outflows from offshore financial centres decreased by 15% to $54 billion, and those from Brazil remained downscaled to negative values by the high levels of repayment of inter-company loans to parent companies by Brazilian affiliates abroad.

By contrast, outflows from Mexico registered a strong increase (111% to $26 billion), and outflows from Chile continued growing in 2012 (4% to $21 billion) after the jump recorded in 2011 (115% to $20 billion).

 In 2012, inward FDI flows in transition economies fell by 9% to $87 billion, due in part to a slump in cross-border M&A sales. Flows to South-East Europe almost halved, while those to the Commonwealth of Independent States (CIS) remained relatively resilient. FDI flows to Russia remained at a high level, although a large part of this is accounted for by “round-tripping”.

 Inflows remained concentrated in a few economies, with the top three destinations (Russia, Kazakhstan and Ukraine) accounting for 84% of the subregion’s total inflows. Despite declining by 7%, FDI inflows to Russia remained high at $51 billion.

 “Foreign investors were motivated by the growing domestic market, as reflected by high re-investments in the automotive and financial industries. The Russian Federation’s accession to the World Trade Organization (WTO) has also had an impact on investors’ decision-making for certain projects, such as the acquisition of Global Ports by the Dutch company APM Terminals.”

 Outward FDI flows from transition economies also declined in 2012. Russia continued to dominate outward FDI from the region, accounting for 92% of outflows in 2012. Outflows from Kazakhstan, Ukraine and Azerbaijan exceeded $1 billion.

Developed-country flows

According to UNCTAD, FDI from and to developed countries nosedived in 2012. Inflows to the group of 38 economies, in aggregate, declined by 32% to $561 billion; outflows fell by 23% to $909 billion.

 “At a time of weak growth prospects and policy uncertainty, especially in Europe, many TNCs pursued a strategy of disposing of non-core businesses and assets. The commodity boom, which had driven FDI in resource-rich developed countries in the recent past, began to cool. In addition, intra-company transactions, which tend to be volatile, had the effect of reducing flows in 2012.”

 By region, inflows to Europe contracted by 42% and to North America by 21%. Inflows to Australia and New Zealand together declined by 14%. Outflows from Europe fell by 37% and from North America by 14%. Outflows from Japan, in contrast, held their momentum, growing by 14%.

 The sharp decline in inflows effectively reversed the recovery of FDI over 2010-11. The share of developed economies in global inflows declined from 50% in 2011 to 42%. Within the group, 23 economies saw a decline in their inflows, including the two largest recipients in 2011, Belgium and the United States.

 The fall in FDI to European countries was particularly marked; it diminished to $276 billion, which was considerably lower than the recent low ($405 billion) in 2009. The EU alone accounted for almost two-thirds of the global FDI decline.

 UNCTAD said that the decline in FDI outflows from developed countries accounted for almost all the decline in global outflows in 2012. Outflows declined in 22 developed economies, including four of the top five investor countries in 2011.

 Outflows from the United States, which had been driving the recovery of FDI in developed countries, saw a large decline. Outflows from the European countries were less than one-third of their peak ($1.33 trillion) in 2007.

 Among the countries that bucked the trend were Ireland, Japan and Germany. Apart from Ireland, the four eurozone countries that have been most affected by the financial crisis – namely Greece, Italy, Portugal and Spain – showed a generally low level of FDI flows in 2012.

 According to UNCTAD, “three aspects of recent FDI in those countries are worth highlighting: foreign acquisition of distressed assets, injection of capital to foreign-owned banks, and exit and relocation of firms from the crisis-hit countries.”

 Given the depth of the contraction in cross-border direct investment in 2012, it is unlikely that the FDI flows of developed countries will decline much further in 2013, said UNCTAD.

 “The economic downturn in Europe might create opportunities for buyout firms to acquire undervalued assets. Companies with stressed corporate balance sheets might be under pressure to sell assets at a discount. However, overall, the recovery of FDI flows of developed economies in 2013, if it occurs at all, is likely to be modest.” (SUNS7615)

Third World Economics, Issue No. 548, 1-15 Jul 2013, pp 12-14