Foreign Investment during the recent global economic recession ABSTRACT:- 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. Since then FDIs have been decreasing. 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 the 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.
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. Nevertheless, some favorable factors for FDI growth are still at work, some of which are even a consequence of the crisis itself. 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 and the implementation of policies aimed at promoting investment and innovation are key issues in this respect. INTRODUCTION:- The current global financial crisis has its roots in the US, Europe and other advanced countries. Its proximate causes include sub-prime lending, faulty distribution models, unsustainable financial engineering and derivatives usage, and faulty credit rating by agencies, a lax regulation and large global imbalances in those countries.
But the fundamental cause of the crisis was the loose and excessively accommodative monetary policy followed by the US and other advanced economies from 2002-04. The global economic crisis has triggered a slowdown in global economic growth that is manifesting itself in a demand-driven fall in international trade exacerbated by the deficit of credit and trade finance; falling commodity prices; declining remittances; contracting foreign direct investment (FDI); and the potential of declining official development assistance (ODA). With a globalized system, a credit crunch can ripple through the entire (real) economy very quickly turning a global financial crisis into a global economic crisis. EFFECT ON FOREIGN INVESTMENT:- The financial instability triggered by the United States subprime crisis which began in summer 2007 has led to a progressive deterioration of the investment situation. Foreign direct investment (FDI) flows declined by more than 20% in 2008 . In 2007, the capital outflows from US to emerging market economies spurted to around $600 billion per annum, only to crash soon . The effect of the sudden reverse flow of capital (particularly of portfolio investments) was a particularly traumatic experience for the EMEs. It had severe implications for their monetary management and financial stability. The global crisis has a direct bearing on capital inflows into India.
The rate of FDI inflow recorded an increase in 2008-09 compared to the previous year, the FIIs (net) recorded heavy stream of outflows from India in 2008-09 contrary to a healthy rate of inflow in the previous year . A major challenge for developing countries is to continue to attract foreign investment during the crisis to stimulate economic activity, especially for investments that serve long-term development goals and enhance competitiveness (e. g. investments in infrastructure, agriculture, sustainable energy, material/resource/energy efficiency and technology). While 2007 was a record year for FDI to developing countries , equity finance is under pressure and corporate and project finance is already weakening . The proposed Xstrata takeover of a South African mining conglomerate was put on hold as the financing was harder due to the credit crunch . There are several other examples e. g. in India . In the face of the global economic slowdown (and recession in a number of major economies), tighter credit conditions and falling corporate profits, many companies have announced plans to curtail production, lay off workers and cut capital expenditure, all of which has implications for FDI . However, the impact of the crisis varies widely, depending on region and country, with consequences for the geographic pattern of FDI flows . The current crisis began in the developed world, though it is rapidly spreading to developing and transition economies. Developed countries have thus been directly hit by the financial crisis, while its effects on developing economies have so far been indirect in most cases, with varying degrees of severity among regions and countries. This has direct consequences on the geographical patterns of FDI inflows. There is ample evidence that the global crisis is having a negative impact on international investment. Tighter credit conditions and lower corporate profits have weakened companies’ capability to finance their overseas projects; while the global economic recession and a heightened appreciation of risks have eroded business confidence.
Many large TNCs have revised their global expansion plans downward, and divestments have taken place . The trend is widespread, hitting all sectors and all three major types of foreign investment (i. e. market-, efficiency- and resource-seeking foreign investment) . FDI flows to financial services, automotive industries, building materials, intermediate goods, and some consumption goods have been the most significantly affected, but the consequences of the crisis have been quickly expanding to FDI in other activities, ranging from the primary sector to non-financial services. Concrete examples of decreases in FDI •Financial services are experiencing a wave of restructuring in most affected countries. AIG of the United States, for example, is selling off its Japanese and Philippines insurance affiliates . In the mining industry, Rio Tinto (United Kingdom and Australia) and Anglo American (United Kingdom) have indicated that they will reconsider their global expansion plans in the light of waning business confidence and the worsening economic outlook . British Petroleum announced in October 2008 that it will cut 5,000 jobs worldwide in 2009, mainly in developed markets . •In the Democratic Republic of the Congo, for example, there has been a spate of mine closures forced by the global economic downturn, and fly-by-night investors have undermined the mining industry’s sustainability and the welfare of its workers. In the automotive industry, leading United States automobile maker General Motors announced in November 2008 – even before the bailout granted by the United States Federal Government – plans to cut costs and capital spending while raising funds through the sale of assets . Daewoo, a subsidiary of General Motors, announced that it would temporarily close Republic of Korea factories in the same month . Opel, a subsidiary of General Motors, has asked for more public support from the German Government . Ford shut down its operations in Berdaux, France, due to poor sales, from October 2008 to January 2009 . French automaker PSA halted its car production in China, and it intends to temporarily close factories in Spain and France. Another French automaker, Renault, also plans to reduce jobs significantly in Europe. Nissan also eliminated 20,000 jobs . •Lafarge the world’s largest cement producer also sold its cement and aggregates units in Italy to local group Sacci . •GlaxoSmithKline (United Kingdom), the world’s second largest drug maker by revenue, is cutting its operations in the United States . French cosmetics group L’Oreal, faced with a sales slump, announced in November that it would close two factories in Europe, one in Monaco and one in Wales (United Kingdom) . •ArcelorMittal (Luxembourg) and POSCO (Republic of Korea) have started to revise their growth plans . The setback in FDI has particularly affected cross-border mergers and acquisitions (M&As). It has also taken the form of a rising wave of divestments and restructurings. International Greenfield investments have been less impacted to this point, but could be increasingly affected in 2009 as a large number of projects are presently being cancelled or postponed. In developing and transition economies, FDI inflows have so far remained more resilient.
The growth rate of FDI inflows to developing countries, while lower than in 2007 (when it exceeded 20 per cent) should still reached 4 per cent. The situation is rapidly deteriorating. UNCTAD estimates that global FDI inflows declined by 15 per cent in 2008, to about $1. 6 trillion This sharp decrease marks the end of a growth cycle which lasted four years. Further decline is anticipated for 2009, especially as regards flows into developing countries. While the decrease in FDI inflows has hit developed countries the hardest, some developing economies with open but weak financial systems are also very vulnerable to external shocks . They face unprecedented challenges from the possible drying up of financial flows from both official and private sources. For example, FDI inflows are expected to have declined sharply in such countries as Indonesia, the Republic of Korea, Pakistan, Singapore and Turkey, due to fallout from the financial crisis. A major exception is the United States, where FDI flows may have risen by 38 per cent in 2008 to $321 billion (annex table). This can be explained by two major factors: foreign parent companies may have transferred capital to their United States affiliates in financial distress, in the form of equity or intra-company loans, and/or the crisis in the United States economy has triggered new opportunities for the acquisition of local firms by foreign interests . Reduced access to finance. Financial factors have negatively affected TNCs’ capacity to invest , both internally and externally, as tighter credit conditions and lower corporate profits curtail TNCs’ financial resources for overseas investment projects (as well as domestic ones). On the one hand, credit has become less abundant and more expensive.
The external funding environment for non-financial companies has deteriorated markedly since mid-2008 , making it more difficult for them to invest in foreign operations or to make cross-border M&A deals. The gloomy evolution of markets, including the looming sharp economic recession worldwide (and even recession in a number of developed countries) and a heightened appreciation of risk, has also reduced firms’ propensity to invest for further expansion both domestically and internationally of production capacity. Risk aversion. Companies’ investment plans may also be scaled back due to a high level of perceived risks and uncertainties, in order to develop resilience to possible “worst-case” scenarios regarding financial and economic conditions . There has been a recent rise in divestments and restructuring of operations. Companies indeed undertake divestments and make cuts in existing production capacity – either by shutting down plants or factory lines, or by selling some of their assets to other companies– to restructure foreign operations, save costs, or improve their balance-sheet situation, especially through lowering the debt-equity ratio . There is also evidence that cross-border M&As have already been sharply affected as a direct consequence of the crisis, with a 17 per cent decline in cross-border M&As in the first 10 months of 2008 as compared to the same period of 2007. The decline in cross-border M&As is of utmost importance for FDI flows, which are strongly correlated with cross-border M&A amounts. However, positive driving forces remain at work. There are a number of reasons why TNCs might remain committed to FDI, even in the midst of the crisis.
First, a number of large emerging economies, such as Brazil, China, India and the Russian Federation, have remained attractive to FDI, particularly to market-seeking FDI. They maintained relatively high economic growth rates (compared to advanced economies) in 2008 . As prospects continue to deteriorate in developed countries (more markedly than in developing ones), investors will favour the relatively more profitable options available in developing countries . Examples of FDI in developing and transition economies arising from continuing market opportunities in those countries, or the longer-time horizons of investing TNCs include: •PepsiCo announced in early November that it would invest an additional $1 billion to expand its production in China in the next four years , while at the same time shutting down six factories and laying off 3,300 workers in the United States in order to cut costs . Italian automaker Fiat Group and OJSC Sollers signed a letter of intent in November to expand production of Fiat cars in the Russian Federation , where demand remains strong, despite the slowdown in the automobile industry in Europe and the United States. This is part of the shift of production towards emerging economies.
For example, in 2008, the total number of car sales in the “BRIC” countries (Brazil, the Russian Federation, India and China) was expected to exceed that in the United States . Second, financial crises and tough economic periods also offer opportunities to companies to buy assets at “bargain prices” and take advantage of large-scale industry consolidation in some activities. For aggressive, cash-rich TNCs – or those from cash-rich countries – the acquisition of undervalued assets may boost their investment in both developed and developing countries, depending on the circumstance and opportunities . Examples of increases in FDI through cross-border M&As:- Japanese financial companies have recently acquired several United States financial companies affected by the financial crisis . •Financial companies established abroad by Icelandic firms were also bought up: Glitnir AB (a branch of Glitnir in Sweden), and DLG Ltd. and Kaupthing Singer & Friedland Premium Finance Ltd. in the United Kingdom, both of which were owned by Kaupthing Bank, were acquired by HQ AB (Sweden), DM Plc (United Kingdom) and Close Brothers Group Plc (United Kingdom), respectively, in 2008 . Several mega M&A deals (those with an acquisition value of over $1 billion) have occurred in manufacturing industries (such as computer equipment, aircraft and pharmaceuticals) in the United States since September 2008 . Third, companies are still committed to increasing their level of internationalization in the medium term, a finding which constitutes a significant indicator for a future upturn in FDI flows . Large TNCs around the world still seem to be eager to pursue internationalization strategies (and thus increase FDI expenditures in the medium-to-long term). Fourth, new sources of FDI have emerged, especially from the South. Emerging economies and countries well-endowed with natural resources are becoming a growing source of FDI, either through the internationalization strategies carried out by their TNCs, or through the investment activities of their SWFs. FDI inflows The global economic crisis has translated into a sharp decline in FDI inflows both for developed and developing countries. FDI into developed countries in 2008 decreased by an estimated 25 per cent compared to 2007, mainly as a result of the protracted and deepening problems affecting financial institutions and the liquidity crisis in financial markets. As cross-border mergers and acquisitions account for the bulk of FDI in most developed countries, these countries are particularly vulnerable to the credit crunch . Almost all developing countries and countries with economies in transition have been affected by the global financial and economic crisis, but to different degrees. The setback is associated with a rising wave of restructuring and divestment and the cancellation of a large number of Greenfield projects, as well as a decline in cross-border mergers and acquisitions. Compared to cross-border mergers and acquisitions, international Greenfield investments were less impacted in 2008. But they were increasingly being affected in 2009, as a large number of projects awere being cancelled or postponed. FDI outflows FDI outflows from the United States went down as large repatriations of reinvested earnings and debt from foreign affiliates of the United States corporate sector took place and new investments abroad were halted . FDI outflows from Europe also declined. FDI outflows from the South slowed down, but to a lesser degree than those from the North. Therefore, the share of developing countries in global FDI outflows continues to rise, highlighting an increasingly significant presence of TNCs from the South. Many of them see their capability and propensity to invest abroad inevitably weakened due to the global financial crisis.
However, in a few dynamically growing countries, the driving forces of capital outflows, such as a large amount of foreign currency reserves, enhanced firm competitiveness and supportive government policies are still at work . In addition, companies and sovereign wealth funds from these economies are, in general, less affected by the financial turmoil than are enterprises in developed countries; they may continue to be active in overseas investment as part of their long-term strategies and become more important actors in the global FDI arena . For them, the global financial crisis and tough economic period ahead may create good opportunities to buy bargain assets, which can help promote cross-border mergers and acquisitions. However, they have also become more cautious in view of the considerable financial losses that some recent overseas investments have caused. POLICY RESPONSES – KEEPING INTERNATIONAL TRADE AND INVESTMENT FLOWING AND REVIEWING DEVELOPMENT STRATEGIES India has made changes in its FDI regulations several times. One in December 2008, wherein larger share of foreign ownership in many activities such as industrial parks, mining and petroleum, air transport was decided. And the other in February 2009 , which facilitated application of caps on foreign ownership in strategic sector (defence, aviation, telecommunications). It also swt out new paramenters to calculate parameters for calculation of indirect foreign investment in an Indian company . It further clarified the circumstances in which an Indian company with foreign investment will be required to obtain government approval for making downstream investments in India. Another protectionist measures include state initiatives to come up with a funding package of $6. 8 billion or 300 billion rupees – this fund will be used for infrastructure, i. e. schools, roads, and hospitals . The offers announced by Union Finance Minister, Pranab Mukherjee, in Union Budget 2010-11, to enhance investment ambiance in India on February 26, 2010 entail: •Measures implemented to un-complicate the FDI system •System for computation of indirect foreign investment in Indian firms has been comprehensively classified. •Entire liberalization of costing and imbursement of technology transmit charges and trademark, and royalty expenses. Additionally, the Indian government has permitted the Foreign Investment Promotion Board (FIPB), to sanction FDI tenders of up to US$ 358. 3 million. The global financial and economic crisis has stimulated consideration and implementation of mitigating policies and measures by countries and the international community. Some of these measures are valid in terms of safeguarding domestic industries and jobs . The challenge is to restore the credibility and stability of the international financial system, to provide stimulus to economic growth and to encourage investment and innovation. A number of policy initiatives at the national level could stimulate FDI. Three categories of policy measures can be distinguished.
First, many developed countries have adopted large-scale bailout plans and rescue packages for the financial sector . Providing State guarantees to financial institutions could have a crowding-in effect on FDI, as these companies might be considered as “safe” investments by foreign investors. Moreover, some countries have even actively sought the participation of foreign investors in individual rescue deals . Second, several countries – such as the United States, France, Germany and Spain – have announced large public investment programmes, mainly aimed at infrastructure investments, which not only builds confidence in economy but also opens up investment opportunities by TNCs. Third, a number of countries have adopted fiscal or monetary stimulus measures which might also have a positive impact on FDI flows. PROTECTIONISM IS STILL A THREAT Over recent months, many national governments have resorted to various policy measures to safeguard domestic industries and employment affected by the global crisis. With regard to investment, there are few signs of deliberate government actions to impede the cross-border flow of investment in reaction to the crisis. However, there is a risk that the massive increase in state intervention and the greater role of governments as economic agents could have a downside in terms of indirectly impacting investment policies, especially in terms of active policies favoring investment domestically and discouraging investing abroad. One of the more interesting aspects of the current wave of investment protectionism is governments” response to sovereign investments. The number and size of worldwide SovereignWealth Funds (“SWFs”) have both seen substantial increase between 1990 and today.
Numerous governments in developed countries have partially or fully nationalized domestic companies or are envisaging such a step . For instance, the French Government established a Strategic Investment Fund in December 2008 , which since then has acquired shares in several distressed companies. In February 2009, it augmented its capital participation in VALEO, a French producer of car parts . Reducing foreign investment, including divestment abroad, may be an economic necessity and may be unavoidable even in the absence of state intervention. Much depends on whether the trend towards more state ownership and control remains a temporary “fire fighting” measure during the crisis, or whether it results in more permanent structural changes with long-term implications. Nationalization policies and increasing state interference reduce investment opportunities for private investors – domestic and foreign – and may create an investment disincentive. While many private investors may currently not have much interest in acquiring enterprises that were or are to be bailed out, state ownership or control may become a more serious investment obstacle in the future if it is maintained after the actual crisis is over. A key global priority must be to resist and arrest tendencies towards protectionism and economic nationalism. In this regard, confidence in the multilateral trading system must be strengthened, with strong support by all countries to conclude the Doha Round on balanced and pro-development terms on an urgent basis. To avoid divestment, developing countries need to consider how to accommodate the cost-saving strategies of TNCs. For instance, a number of developing countries have included tax relief in their economic stimulus packages . CONCLUSION: The negative impact of the current financial crisis and the economic aftermath from it on FDI are likely to become stronger, and a further decline in global FDI flows is expected at least in the short-to-medium term. Countries with healthy macroeconomic fundamentals and robust financial systems are likely to recover sooner. Despite clear signals of economic slowdown, a number of large dynamically growing economies may remain attractive to market-seeking FDI, There are however a few positive forces still at work that can provide some relief to global investment flows. These include, for example, investment opportunities triggered by cheap asset prices and industry restructuring, large amounts of financial resources available in some dynamically growing countries such as sovereign wealth funds, and quick expansion of new activities such as fuel switching, renewable energy, material/resource/energy efficiency and some other environment-related industries. The crisis was less destructive to FDI than had been feared.
While investment budgets, including those for FDI, were squeezed during the crisis, TNCs did not engage in wholesale divestment of their foreign affiliates. The crisis did, however, accentuate one recent trend, namely the shifting of TNCs? geographical focus to developing and transition economies.
Also, the various economic stimulus programmes recently launched in many countries may have a positive impact on FDI inflows. The commitment of G20 leaders to take steps to facilitate trade and investment may also help to improve business confidence among companies. BIBLIOGRAPHY:- Articles •The Global Economic Downturn and Protectionism, Raymond J. Ahearn, Congressional Research Service •Protectionism And Sovereign Investment Post Global Recession, Dr. Efraim Chalamish , OECD Global Forum on International Investment •UNCTAD Investment Brief, Global FDI in Decline due to the Financial Crisis, and a Further Drop Expected, November 1, 2009 •Does Foreign Direct Investment Promote Development? , Theodore H. Moran, Edward M. Graham, and Magnus Blomstrom, Institute for International Economics •Assessing the impact of the current financial and economic crisis on global FDI flows. Note prepared by the UNCTAD secretariat. April 2009 •“Congo miners suffer as boom turns to bitter bust”. Barney Jopson Financial Times. 10 March 2009.
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