Global FDI flows plunged 39% to $1trn in 2009 due to downturn

Activity expected to recover moderately in 2010 amid slow and unsteady recovery in world economy. Decline stopped in China in latter half of the year. (EB FILE)

The financial crisis took a toll on inflows of foreign direct investment (FDI) in 2009, which plunged 39 per cent over the previous year. They are expected to recover moderately this year amid slow and unsteady recovery in the global economy, according to a study released yesterday.

Global flows of FDI fell to nearly $1 trillion (Dh3.67trn) in 2009 from $1.7trn in the previous year, said the study by United Nations Conference on Trade and Development (Unctad).

Developed countries

The study's estimates showed that FDI flows to developed countries continued to fall in 2009, declining roughly 41 per cent compared to the previous year.

FDI inflows declined sharply in the United States, the United Kingdom, Spain, France, and Sweden. The fall in inflows to the US reflects the strong decline – in both number and size – of mergers and acquisitions transactions made by foreign companies from major home countries, which themselves were suffering from the consequences of the economic slowdown. The combination of falling profits – which pushed reinvested earnings downwards – and a re-channelling of loans from foreign affiliates back to their headquarters, contributed to a fall in FDI flows to many counties in the European Union.

Japan's decline can be attributed, in part, to the sale of a large foreign affiliate (Nikko Cordial Securities) to local companies. A drop in leveraged buyout transactions by private-equity funds from many countries, served to further dampen cross-border M&A sales which, in turn, further depressed FDI flows to developed states.

Developing countries

As the impact of the global financial crisis on FDI unfolded relentlessly, inflows to developing countries declined by 35 per cent in 2009, after six years of uninterrupted growth.

Shrinking corporate profits and plummeting stock prices have greatly diminished the value of, and scope for, cross-border M&As globally – an increasingly important mode of FDI entry into developing countries.

Africa saw inflows fall roughly 36 per cent in 2009 after the peak year of 2008. This decline is a matter of concern as FDI is a major contributor to the continents' capital formation; indeed, the share of FDI flows in gross fixed capital formation was as high as 29 per cent in 2008. Furthermore, FDI flows to Africa's 33 least developed countries (LDCs) suffered a major decrease in 2009 due to a crisis-induced lull in the global demand for commodities, which is a major driver for FDI in these economies. The cancellation of some cross-border M&A deals, combined with absence of any exceptionally large one-off acquisitions, depressed the value of cross-border M&A operations in Africa during 2009 compared to the previous year.

In South, East and South-East Asia, the upward trend lasting for six years came to an end, as the region experienced its worst downturn since the Asian crisis of the late 1990s. This downturn reduced FDI flows across the region to $203 billion in 2009, an estimated decline of 32 per cent over 2008.

In particular, falling external demand for Chinese and Indian made goods and services has caused foreign companies to cut back on their investment plans in these two large countries.

The severity of FDI falls however varied by country, depending on the structure of their economies, the effectiveness of policy responses to the crisis, and the strength of the subsequent economic recovery. In addition, as the region leads the rebound in global consumer and business confidence, FDI stopped declining in a number of countries, such as China, in the latter half of 2009.

In Latin America and the Caribbean, preliminary estimates point to a nearly 41 per cent decrease (to $86bn) of FDI inflows in 2009. Both sub-regions – South America, and Central America and the Caribbean – experienced a sharp decline in FDI flows during the year. A large number of divestments of foreign affiliates to local owners impacted on the overall level of cross-border M&As.

FDI to Brazil, which is a significant FDI recipient, declined by 49 per cent; but the country remained the region's top FDI destination with inflows reaching $23bn. Flows to Mexico, the region's second largest recipient, registered a 41 per cent plunge to $13bn, the study said.

FDI flows to the transition economies of South-East Europe and the Commonwealth of Independent States (CIS) slumped by 39 per cent during 2009. In South-East Europe, the economic and financial crisis, coupled with the near-exhaustion of major privatisation opportunities and the structural weakness of their economies, were major contributing factors. For the CIS, the combination of a significant slowdown in economic growth and a deterioration in demand for, and the price of, major export commodities significantly affected FDI flows into natural-resource-abundant countries.

The components

The downturn of 2009 manifested itself in all three components of FDI flows. Reinvested earnings, normally a relatively stable component, were squeezed by falling transnational corporation (TNC) profits at the end of 2008 and the beginning of 2009 – though they showed some signs of recovery in the latter half of the year. Intra-company loans also went through a decline. These falls paled, however, compared to those witnessed in equity investment, largely reflecting the lower propensity of TNCs' ability to invest, especially abroad, against the backdrop of the economic and financial crisis.

All types of equity investment were affected by this decline. The most dramatic fall was observed in cross-border M&As, the value of which declined by 66 per cent over the year, reflecting both the shrinking value of assets on the stock market and the lower financial capability of potential buyers to carry out such operations. The number of international greenfield projects also declined markedly (by 23 per cent) due to the cancellation of many operations and the downsizing of international expansion programmes.

Global FDI flows in the third quarter remained practically unchanged from the previous quarter. Unctad's Global FDI Quarterly Index slightly declined, dropping roughly 2.5 points from 113.4 to 110.8 between quarters. The index therefore remains at a quite low level, as compared to the values observed prior to the crisis: 36 points lower than in the same period of 2008, and 182 points lower than the all-time record reached in the fourth quarter of 2007.

This sluggishness in flows was aggravated by the fact that among the three majors components of FDI flows, equity investment – the one most directly related to TNCs' long-term investments strategies – failed to shift from its already low second quarter level. This suggests that companies remained very cautious about their international expansion programmes during the third quarter. In contrast, reinvested earnings showed initial signs of rebounding from their extremely low second quarter levels, reflecting overall economic improvements in the third quarter in major host countries. Other capital flows, mainly highly volatile intra-company loans, decreased slightly.

On a geographical basis, there were marked rises in third quarter flows to Canada, the Netherlands, Norway, the UK and the US; whereas flows to Belgium, Hong-Kong (China) and Spain decreased significantly.

Slow recovery

Initial indicators for the fourth quarter underscore that a steady recovery of FDI growth may not yet be under way. In particular, global cross-border M&As during the fourth quarter reverted from the previous upward trajectory, falling markedly from the low, but improved, level of activity observed during the third quarter. The number of large deals remained practically unchanged at a modest level: 10 cross-border M&As with a value of more than $3bn were undertaken during the fourth quarter of 2009, as compared to nine during the previous quarter.

International greenfield investments – another indicator of FDI activity – remained much lower than during the same period of 2008, although they showed a slight pick up during the fourth quarter.

Based on these initial indications, and also on monthly data on FDI inflows available for some countries, flows during the fourth quarter of 2009 are expected to show little increase as compared to the level in the third quarter; and as a consequence, remain far lower than those for the same period in 2008.


Inflow to Middle East down 43%

In the Middle East, the worsening regional and global economic outlook, together with frozen global credit markets, has negatively impacted the financing of mega development projects in the oil-rich countries of the Gulf.

This, coupled with plummeting cross-border M&A activities and decreased intra-regional FDI flows, resulted in a 43 per cent decline in FDI to the region during 2009, to $51 billion (Dh187bn) compared to the previous year.


Modest recovery in 2010

A number of macroeconomic indicators signal that the overall environment for international investment is slowly improving.

The IMF's World Economic Outlook forecasts a 3.1 per cent growth in world GDP for 2010 as against -1.1 per cent in 2009.

At the company level, profits of TNCs world-wide have been rising since the second quarter of 2009, thus reversing the sharp drop observed at the end of 2008.

According to Standard & Poor's, profits made by the firms that make up the S&P 500 bounced back as early as the second quarter of 2009, to levels equivalent to those of the same period of the previous year.

Improving conditions will ultimately encourage companies to revise upward their international investment plans for 2010 onward, which in turn should give rise to growing FDI flows in 2010. However, as the recovery in economic growth and profits remains fragile, especially because it has been boosted by the potentially transitory impact of special economic packages implemented by major economies, the recovery in FDI is expected to be modest.

Nevertheless, overall medium-term prospects remain positive.

 

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