With a double digit decline in global foreign direct investment (FDI) inflows already projected for the year, one economic analysis agency is warning that the FDI flows will fall sharply in the last half of 2008 and continue to decline in 2009.
The OECD Investment Committee (OIC), in its Investment Newsletter, warned that as the financial crisis has evolved into a global economic crisis, the outlook for FDI has likewise darkened. On current trend, inflows will be down 13 percent and outflows by 6 percent by the end of the year.
"It seems likely that FDI flows will fall sharply in the second half of 2008 and continue to decline into 2009, especially considering the speed with which the global economic crisis deepened during Q3 and into Q4 of 2008," the OIC said.
Pointing to the trends in relation to cross-border mergers and acquisitions (M&A, a major component of FDI), the committee forecast that international M&A will decline by 29 percent from the record levels reached in 2007 ($US1.7 trillion).
Furthermore, the bursting of the dot.com bubble in 2000 showed how sensitive international M&A activity is to economic crises, with the value of international M&A activity declining by 47 percent in 2001 and 34 percent in 2002.
"The more severe nature of the current crisis therefore suggests that there remains considerable scope for further declines in international M&A activity," the committee warned.
The committee said there are two forces are at play that give rise to the grim outlook for FDI.
First, the freezing of credit markets, combined with sharp declines in equity markets, have forced firms to rely largely on cash reserves to finance investment. In a number of industries (such as automotive), many firms are also facing severe internal liquidity constraints.
Second, with global growth forecast for 2009 at 2.2 percent and growth in the OECD economies expected to fall to 0.3 percent, the need for companies to investment in new capacity is considerably reduced.
The OECD area has experienced what the committee called a rare bright spot, however, in that FDI has served to channel capital from places where it has been abundant to where it has become scarce during the crisis.
"Barring a serious protectionist response (resulting, for example, from political pressure to stop foreign investors from "taking advantage" of the economic crisis), this positive role for international investment from developing countries will likely increase over time as both experience and available capital grow," the committee said.
The composition of international capital flows to developing countries has changed dramatically between 1999 and 2007. During this period, FDI’s share of total capital inflows fell from almost 90 percent to under 50 percent and the combination of portfolio flows and private debt increase from 6 percent to 55 percent.
This diversification has been a positive development, and reflects a number of factors, including strong growth in developing countries, accompanied by high rates of return on investment, as well as the sound investment frameworks that developing country governments have been putting in place.
However, under the current circumstances, this increased reliance on portfolio flows and private debt could result in a sharp contraction of international capital flows for many developing countries, the OIC warned.
For example, according to the Institute of International Finance, private credit financing into 30 developing countries surveyed (including the BRICS – Brazil, Russia, India and China) will decline by half between 2007 and 2009 (from US$600 billion to $300 billion), while net portfolio inflows, which are already negative, will decline further (from – US$6 billion to -$US20 billion).
FDI flows into these 30 developing countries, however, are only expected to decline by seven percent (from US$302 billion to US$282 billion).
