Creating favourable conditions for FDI

Creating favourable conditions for FDI

The current crisis has precipitated a significant downturn in world foreign direct investment (FDI) flows which, over the past year, has spread to all sectors and regions. Last year marked the end of a growth cycle in international investment that began in 2003 and reached a historic high of nearly $2 trillion in 2007.

The subsequent decline in FDI was at first quite modest and affected primarily developed countries. However, since late 2008, it has further accelerated and is now affecting many developing countries as well. UNCTAD’s most recent estimates are that global FDI declined by 14 per cent in 2008. This year, we expect an even sharper fall: recent UNCTAD figures show global FDI inflows down by 44 per cent and mergers and acquisitions by 76 per cent. In developing countries, inward FDI has declined by 39 per cent so far in 2009 and by more than 40 per cent in transition economies.

The unfolding crisis has affected firms’ investment decisions primarily in two ways: First, it has impacted their capabilities to invest because of declining corporate profits and lower availability and higher cost of finance. Secondly, the propensity of companies to invest overseas has been affected by gloomy economic prospects.

True picture

Although FDI flows to developing countries continued to grow in 2008, this year has already started to reveal a different picture. Many advanced-economy transnational corporations (TNCs) are reviewing their strategies of searching for efficiency gains by locating in countries with cheaper factor productivity and resource inputs to production. So-called efficiency- and resource-seeking FDI in developing countries has therefore been negatively affected by the recession in advanced economies.

The spread of the crisis to developing economies has also reduced opportunities for firms in search of greater global or regional market share — so called market-seeking FDI. UNCTAD’s World Investment Prospects Survey 2009-2011, confirms the negative outlook for 2009. It shows that 85 per cent of firms are reporting that their investment plans have already been significantly affected and that 90 per cent have a pessimistic or very pessimistic outlook for global FDI prospects this year.

The crisis is opening new opportunities for developing countries in at least two respects. First, developing-country firms looking for outward FDI opportunities could take advantage of low asset prices to expand their international operations into markets and assets formerly out of reach. Second, as the world economy recovers, FDI flows will resume at a strong or even stronger pace for countries that have reformed their investment framework.

The policy response to the crisis is therefore crucial to creating favourable conditions for FDI and maximising its potential contribution to development.
Among the looming global risks that may affect TNCs’ investment plans, one concern is a rise in protectionism by home-country governments. Just as liberalisation of investment regimes in the 1990s helped many countries to attract investment which contributed to economic growth and development, so policymakers need to maintain a renewed commitment to an open environment for international investment.

Foreign aid

In addition to private capital flows, many developing countries depend on foreign aid to support investment. In the context of the current crisis, they lack the financial resources to successfully compete with the stimulus and rescue packages put in place by advanced and emerging economies, which now amount to more than $5 trillion. Developed countries should therefore take steps to help developing countries deal with the crisis.
Two immediate responses include an increase in aid flows to developing countries, and introducing a temporary moratorium on official debt repayments. In this respect, I am happy to note the recent decision by the IMF to reduce interest repayments to zero on outstanding concessional loans until 2011.

The current crisis has also exposed the need for an enhanced global framework for financial regulation and supervision. The interrelated effects of financial and investment decisions in a global market on the activities of the real economy have become all too apparent. International regulatory reform is thus necessary to reduce the scope for excessive leveraging and risk-taking, and to ensure comprehensive oversight of the finance sector.