Global foreign direct investment (FDI) flows this year are set to stabilize at around the depressed level seen in 2002, but "a rebound is likely in 2004", says UNCTAD Secretary-General Rubens Ricupero, launching the World Investment Report 2003(1) today in Geneva. Last year´s total $651 billion was just half the record volume of 2000. The decline was broad-based: 108 of 195 economies saw lower inflows in 2002 than in 2001 (table 1).
The report stresses that prospects for FDI flows do, however, vary widely by industry - brighter for consumer pharmaceuticals, electronics and semiconductors, but dimmer for automobiles, metals and machinery and aerospace.
Global FDI inflows, already down by over 40% in 2001, fell by another 21% in 2002 to $651 billion (table 2). Outflows were also down in 73 of 151 countries, according to the UNCTAD report. At $120 billion, United States outflows rose by 15% from 2001, while EU outflows, at $394 billion, decreased by 13% last year, and Japan´s, at $31 billion, by 18%. FDI from developing countries ($43 billion) dipped by $4 billion, but their share in world outflows remained almost the same, at 7%. However, FDI from Central and Eastern Europe (CEE) climbed by $700 million to $4.2 billion, with the Russian Federation the largest investor in the region.
Driving the decline in FDI flows in 2001-2002 - the most significant downturn of the past three decades - was a combination of macroeconomic factors (weak economic growth or slump in economic activity linked to the business cycles in many parts of the world, especially the developed countries, and tumbling stock markets), microeconomic factors (low corporate profits, financial restructuring) and institutional factors (winding down of privatization, loss of confidence in the wake of corporate scandals and the demise of some large corporations).
Last year´s FDI downturn was uneven in four ways:
- Geographically. Regions fared differently, and a handful of countries accounted for the bulk of the decline worldwide. The slump in the developed world (22%) was concentrated in the US and the UK (figure 1), which together accounted for 54% of the fall in the 108 countries with reduced inflows. The decline in the developing world (23%), which faced even sharper cuts in other private external capital flows, was steepest in Africa (41%) and in Latin America and the Caribbean (33%). In the latter region, 2002 was the third consecutive year of declining inflows. Flows to the world´s most populous region, Asia and the Pacific, fell minimally, thanks to record high flows to China, the largest FDI recipient globally (figure 2).
- Sectorally. The slow recovery from the global economic slump hit both manufacturing and services hard, while FDI in the primary sector rose. Finance, transport, storage and communications were severely affected; FDI in other industries remained virtually unchanged (health and social services), or even rose (mining, quarrying and petroleum).
- Financially. While investment flows fell in all three components of FDI - equity capital, reinvested earnings and intra-company loans - the decline in intra-company loans last year exceeded that in equity flows. In 2001, by contrast, all financial components of FDI were down by about half. Interest rate differentials, possible moves by transnational corporations (TNCs) to improve the debt-to-equity ratios of foreign affiliates and the reduced need to finance mergers and acquisitions (M&As) are among the factors behind the plunge in intra-company loans.
- Mode of entry. Cross-border M&As fell more than greenfield FDI. In fact, most of the decline in FDI came from a dramatic drop in cross-border M&As - from $1.1 trillion in 2000 to $594 billion in 2001 and $370 billion in 2002. The average value per transaction also slid - from $145 million in 2000 to $98 million in 2001 and $82 million in 2002 - as the number of megadeals (worth over $1 billion) fell from 175 in 2000 to 113 in 2001 and only 81 in 2002, the lowest since 1998. A slowdown in corporate restructuring reinforced the impact on M&As. Further aggravating the decline in M&As was a pause in privatization.
The unevenness of the downturn was also captured in this year´s ranking of countries by UNCTAD´s FDI Performance Index and FDI Potential Index. Belgium and Luxembourg continued to hold top place in the former index for two consecutive three-year periods (1998-2000 and 1999-2001). Unsurprisingly, the FDI Potential Index, whose value is based on more steady determinants of FDI, such as structural economic factors, was more stable, with the United States topping the ranking throughout the past decade. By combining the two indexes, the Report identifies four groups of countries: front-runners - countries with high FDI potential and performance (such as China, France, Hungary, Germany); above potential - countries with low FDI potential but strong performance (such as Brazil, Kazakhstan, Morocco, Uganda, Viet Nam); below potential - countries with high potential but low performance (such as Japan, Saudi Arabia, Russian Federation, Republic of Korea, Taiwan Province of China); and under-performers - countries with low FDI potential and performance (such as Bangladesh, Ethiopia, India, Indonesia, Zimbabwe).
Slower growth for foreign affiliates´ operations
Reflecting the decline in FDI flows, growth in the operations of all foreign affiliates in the world also slowed (table 2). For the top 100 TNCs, foreign operations had already dipped in 2001 - the beginning of the current downturn period - for the first time since 1993, when UNCTAD began tracking corporate operations, with foreign sales, foreign assets and employment abroad all registering a decline. Vodafone ranked first, based on foreign assets of non-financial TNCs. Less affected by the conditions that UNCTAD views as being conducive to the FDI downturn, the top 50 TNCs based in developing countries continued to expand foreign operations, as did the top 25 TNCs based in Central and Eastern Europe. Hutchison Whampoa consolidated its top position among developing country TNCs.
Despite these developments, said Karl P. Sauvant, UNCTAD´s Investment Division Director and team leader for the report, "it is increasingly evident that governments of developing countries are attaching more priority to attracting FDI". According to UNCTAD data, the inward stock of FDI of developing countries amounts to about one third of their GDP, compared to just 10% in 1980. The world stock of FDI reached $7 trillion in 2002, up more than 14 times since 1980, and this stock is the basis of international production by the 64,000 or so TNCs that now control 870,000 foreign affiliates. "This year´s World Investment Report notes that estimated value added of foreign affiliates of TNCs amounts to around $3.4 trillion, which is about 10% of global GDP and double the share seen 20 years ago", Mr. Sauvant added.
World FDI stock generated sales by foreign affiliates of around $18 trillion, compared with global exports of $8 trillion. Employment by foreign affiliates reached an estimated 53 million workers in 2002, which is three times the number in 1982. FDI stock is concentrated within the Triad (European Union, Japan and the United States), with around 80% accounted for by the world´s outward stock and 50%-to-60% by the world´s inward stock. Clusters of non-Triad countries have strong FDI links to each Triad member (figure 3). This FDI block pattern is roughly mirrored in - and supported by - international investment agreements - agreements that, at least in part, address FDI issues, as shown by a higher propensity of the Triad to conclude bilateral investment agreements and double taxation treaties with the clusters than with other countries.
The report says that the "bleak performance" of FDI in terms of flows and operations of TNCs, as well as its unevenness manifested on several fronts, have induced countries to intensify efforts to improve their investment environment and use better targeting methods to attract FDI. After the record number of favourable changes in national FDI legislation in 2001, 2002 saw another record: of 248 changes in legislation in 70 countries, 236 were favourable to FDI, with a third related to promotional measures. Competition for FDI has stepped up, and wars of incentives are already taking place as developing countries strive to soften the impact of the downturn.