The Hindu Business Line : Tracking the global FDI movement

Going by recent economic trends, an FDI upturn is in the works following the recent investment recession. Generally, the UNCTAD report says, that prospects for almost all regions "are expected to be bright in both the short and the medium term". Even so, for 2004-2005, performance is expected to be the best for Central Europe and Asia, less bright for Western Europe, Africa and Latin America.

DURING THE 1990s, foreign direct investment flows scaled new heights every year, one result of which was that such increases in FDI came to be taken for granted by nearly every national economy that was in the market as a prospective recipient for such resources. Beginning with roughly $200 billion in 1990, and after witnessing a slight decline in 1991 and 1992, the global FDI flow began to rise gradually till in 1998 it crossed $700 billion. During the next two years, that is, till 2000, the figure scaled a new height of more than $1,400 billion. Since then — that is, till 2003 — there has been a decline with the flow touching around $600 billion in 2003.

Given this setting, UNCTAD has brought out a new study on how international FDI flows will behave till 2007,which could help national economies generate some idea about the scope and extent of this sort of international resource on which they could rely in chalking out their development plans for the immediate future. As the report itself, titled Prospects for Foreign Direct Investment and the Strategies of Transnational Corporations, 2004-2007, says: "The turbulent developments of recent years have increased the uncertainty on the part of companies and policymakers alike as to what the future holds. There is now more than ever an interest in, and need for, information to help understand future trends in FDI. Will companies start expanding and investing again, or will the present slump continue? What policies should be put in place to respond to the expected upturn in FDI flows, or to be well equipped for even greater competition to attract FDI?"

Stable relationship

Examining the immediate prospects for FDI flows, the study underscores the finding that there is a stable and positive relationship between overall FDI flows and world GDP growth. Among other things, it says that the ongoing global economic recovery is slated to continue. In 2003 the world's GDP growth rate was 2 per cent. It increased to more than 3 per cent in 2004-2005. The report says that the "longer-term prospects are considered even brighter with growth expected to gather further momentum in the world's major economies".

As far as the spatial distribution of growth is concerned, the point is made that while the favourable prospects are broad-based, there are differences in its strength over regions. Thus, a growth rate of 4.3 per cent and 3.1 per cent has been forecast for the US and Japan respectively, attention been drawn to the fact that in both cases the rates are substantially higher than the average growth rate of the past 10 years.

The report also says that Western Europe has entered recovery later than other major developed countries, and its GDP growth is likely to remain below potential in 2004 before accelerating in subsequent years. For developing economies, the report says that growth prospects are bright for the short and medium term. Strong growth is also forecast for Central and Eastern Europe. Elaborating, the report says that, "on the supply side, FDI is affected by the availability of investible funds from corporate profits or loans, which in turn are affected by domestic economic conditions. On the demand side, growing overseas markets lead transnational corporations (TNCs) to invest more, while depressed markets inhibit them".

If a period of strong economic growth is forecast, a study of empirical data indicates that FDI flows will increase. The report says: "Over the past two decades, booms in global FDI have followed periods of high economic growth, while declines have followed recessions or periods of slow growth. The decline in FDI flows in 2001 and 2002 followed rapid increases in FDI growth during the late 1990s.

There was a similar pattern during the late1980s and early 1990s, as well as in 1982-1983. Each downward cycle in FDI punctuates a long upward trend in FDI every 10 years or so".

The study says that, going by recent economic trends, an FDI upturn is in the works following the recent investment recession. Now where precisely will this increased FDI flow to in terms of regions? Generally, the report says that FDI prospects for almost all regions "are expected to be bright in both the short and the medium term". Even so, for 2004-2005, performance is expected to be the best in the case of Central Europe and Asia. Prospects for Western Europe and Africa, "while positive, are seen as less bright". For all regions taken together, for the medium term (2006-2007), the prospects for FDI flows are expected to be bright, "but less so for Latin America than the others".

For developed countries, the report says that FDI inflows in 2003 declined by 25 per cent the main reason for the drop in North America being a drop in inflows into the United States (-53 per cent), which was the result of the repayment of intra-company loans by foreign affiliates to their parent firms. In EU, FDI inflows declined by 19 per cent for which sluggish economic growth coupled with a fall in equity investment were mainly responsible. But this dismal state is not expected to continue because both the "leading macroeconomic and microeconomic indicators point to a recovery in FDI".

Broad-based growth

As indicated earlier, GDP growth in the US, Japan and the EU is expected to reach around 3.5 per cent in 2004-2005 and also be broad-based, even including some countries that have suffered from low or negative growth rates in the past. The study's considered conclusion is that "the positive growth, in combination with the generally increased profitability of TNCs, can be expected to trigger additional FDI flows into these countries" with the US continuing to remain the most important FDI recipient among developed countries.

Talking of the developing world, it is of some interest to learn that Africa is "not yet on the strategic map of the overwhelming majority of the world's largest TNCs" with companies preferring non-equity engagements, for example management contracts with local investors, to reduce political and economic risk, which is generally perceived to be higher in Africa than elsewhere. This, the study says, holds true particularly for companies based in the developed countries. China and South Africa are the two largest foreign direct investors in the continent. While some increase in FDI in Africa is expected in the medium term, there is little doubt that the world's foreign direct investment focus continues to be Asia, the proof being provided by the rebound in FDI from a temporary slump in early 2003.

One of the study's findings is that investment flows are expected to pick up further in Asia, with China considered to be the most attractive destination. Among other sectors, investment is expected to flow into production, distribution and sales, and logistics and support services in the short term. The survey results also suggest that Asia will benefit from considerable FDI in the form of R&D-related investments which, however, are likely to be concentrated in a few countries. This apart, the point has also been made that there are FDI options other than greenfield operations and M&As (29 per cent), which suggests that the entrepreneurship and access to capital available in Asian countries and the kinds of activities located there by foreign investors provide considerable scope for non-equity/contractual arrangements between foreign and domestic firms.

Tourism, construction, computer/ICT, wholesale and retail sectors are expected to lead the way in 2004-2005, suggesting that the share of services in total FDI inflows into the region will continue to increase. Since FDI flows are slated to increase in the next two years, what are policy implications for the recipient economies, particularly of the developing variety? One thing is certain and it is that there will be "fierce competition" for the available FDI pie.

Increased incentives will be offered and economies will be liberalised.

The study, however, warns against the indiscriminate provision of incentives, particularly the practice of "racing to the top" in providing costly incentives the benefits of which are low and diminishing.

They should also avoid trying to "race to the bottom" in social and environmental standards. Instead, the study recommends that the recipient economies should focus more on improving their overall investment climate, which, of course, is easier said than done as India, among other countries, has found out for itself the hard way.

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