Assessing the impact of the current financial and economic crisis on global FDI flows
Authors: Study prepared by an UNCTAD team composed of Masataka Fujita, Fabrice Hatem. joachim karl and Guoyong Liang under the overall guidance of Anne Miroux
Editor: UNCTAD
The year 2008 marked the end of a growth cycle in international investment that started in 2004 and saw world foreign direct investment (FDI) inflows reach a historic record of $1.9 trillion in 2007. Due to the impact of the ongoing worldwide financial and economic crisis, FDI flows are estimated to have declined by 15% in 2008. A further decrease in FDI flows can be expected in 2009, as the full consequences of the crisis on transnational corporations’ (TNCs)’ investment expenditures will continue to unfold.
The fall in global FDI in 2008-2009 is the result of two major factors affecting domestic as well as international investment. First, the capability of firms to invest has been reduced by a fall in access to financial resources, both internally – due to a decline in corporate profits – and externally – due to lower availability and higher cost of finance. Second, the propensity to invest has been affected negatively by economic prospects, especially in developed countries that are hit by the most severe recession of the post-war era. The impact of both factors is compounded by the fact that, as of early 2009, a very high level of risk perception is leading companies to extensively curtail their costs and investment programmes in order to become more resilient to any further deterioration of their business environment. All of the three major types of FDI (market-seeking, efficiency-seeking, and resources-seeking) will be impacted by these factors, though with different magnitudes and consequences on location patterns.
The setback in FDI has particularly affected cross-border mergers and acquisitions (M&As), the value of which was in sharp decline in 2008 and early 2009 as compared to the previous year’s historic high. It has also taken the form of a rising wave of divestments and restructurings.
International greenfield investments were less impacted in 2008, but are likely to be increasingly affected in 2009 as a large number of new investment projects are presently being cancelled or postponed.
The impact of the crisis on FDI is different, depending on region and sector. Developed countries have so far been the most affected, with a decline in FDI inflows in 2008, due mainly to sluggish market prospects. However, the United States registered higher FDI inflows in 2008 due to a rise in equity flows and intra-company debt, while there were significant falls in flows to other major host developed countries.
Flows into developing economies continued to grow in 2008, but at a much lower rate than the year before. All developing regions except West Asia experienced higher FDI inflows in 2008. However, an outright decline in FDI inflows to those countries is probable in 2009, due to a pull-back both in efficiency and resource-seeking FDI aimed at exporting to advanced economies that are currently depressed, and in market-seeking FDI aimed at servicing local markets where growth prospects – though still positive – are receding. FDI outflows from developing economies rose in 2008 by 2% to account for now 15% of the world total.
Among industries, FDI flows to financial services, automotive industries, building materials, intermediate goods and some consumption goods have been the most significantly affected in 2008. But the consequences of the crisis are quickly expanding to FDI in other activities, ranging from the primary sector to non-financial services. Practically all sectors have been affected by a decrease in cross-border M&A in 2008, with the exception of oil, mining and agrifood businesses.
In the short term, the negative impact of the present economic recession on global FDI prospects should be the dominant one. Preliminary results of UNCTAD’s World Investment Prospects Survey 2009-2011 (WIPS) confirm this: some four fifths of TNCs surveyed expressed the view that there were negative impacts of the financial crisis and the economic downturn on their international investment plans. Medium-term FDI prospects are more difficult to assess, due to the exceptional magnitude of the present crisis and to the fact that it could lead to major structural changes in the world economy. Nevertheless, some favourable factors for FDI growth are still at work, some of which are even a consequence of the crisis itself. Driving forces such as investment opportunities triggered by cheap asset prices and industry restructuring, large amounts of financial resources available in emerging countries, quick expansion of new activities such as new energies and environment-related industries, and a resilient trend in the internationalization of companies will presumably trigger, sooner or later, a new pickup in FDI flows.
The exact date of this upward switch will, however, depend on a series of uncertain factors such as the speed of economic and financial recovery, the efficiency of public policy in addressing the causes of the present crisis, the return of investor confidence and the ability to prevent protectionist tendencies. To illustrate those uncertainties and provide a framework for further discussion and analysis, this paper presents a set of three possible scenarios: V (quick recovery of FDI as soon as 2010), U (slow recovery beginning in 2011), and L (no recovery before 2012). Preliminary results of WIPS show that the U-shape scenario is the one presently considered as the most probable by TNC executives.
Public policies will obviously play a major role in the restoration of favourable conditions for a quick recovery in FDI flows. Structural reforms aimed at ensuring more stability in the global financial system, renewed commitment to an open environment for inward and outward FDI, the implementation of policies aimed at promoting investment and innovation are key issues in this respect. For dealing effectively with the crisis and its economic aftermath, it is important for policymakers to resist the temptation of quick-fix solutions or protectionism, and to maintain a favourable business and investment climate overall. Recent announcements and commitments made at the London G-20 Summit in April 2009 have reconfirmed this policy stance.
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