FDI During Covid-19: Up, Down And Sideways

The impact of Covid-19 on global foreign direct investment (FDI) has been enormous, according to Unctad’s World Investment Report 2021. Total flows plummeted in the first half of 2020, and even a second-half recovery left global FDI down 42% for the year, to levels “well below the low point reached after the global financial crisis a decade ago.”

Overall, the richer, developed economies saw the biggest drop. Cross-border M&A, normally the dominant element in FDI between developed countries, went into retreat as deals were pulled. Total flows into Europe plummeted 80%. FDI into the United States fell 40%, although the US remained the biggest recipient, with $156 billion. China, a longtime FDI regional magnet, was right behind with $149 billion inbound, and its performance, in tandem with strong intraregional activity, pushed Asia’s FDI 4% higher.

But other developing regions were harder hit. FDI across Latin America and the Caribbean fell by 45%. Flows into Africa were 16% below 2019 levels. Middle-income transition economies lost nearly half of the previous year’s inflows. For the largest recipient, Russia, there was a 69% shortfall in 2020.

Perhaps most worrisome in the long run, greenfield investment in new multinational facilities and international project finance deals—the type of investments in infrastructure and increased capacity that build a nation’s future—both fell sharply.

That bodes ill for emerging and developing economies. 

Global FDI flows are now bottoming out and should expand by the end of this year, but still leave the world around 25% below pre-pandemic levels. “We are cautiously optimistic about global FDI prospects in 2021,” says James Zhan, Unctad’s director of Investment and enterprise and lead author of the report. “For next year we are forecasting growth of 20% to 30%, which would bring global FDI flows back to pre-pandemic levels,” Zhan says. “Of course that depends on how the pandemic develops, the recovery in spending, corporate restructurings and geopolitical tensions.”

But the recovery is likely to expand the gap between rich and poor. Advanced economies are expected to have the highest FDI growth as their economies open and large-scale public investment programs kick in—higher levels of economic activity have already reignited cross-border M&A. Developing nations may have a harder struggle, yet ultimately be able to find possibilities in the expanding green finance sector.

Asia’s Star Turn

The pandemic has certainly seen a shift of gravity drawing FDI eastward. “Developing Asia now accounts for nearly half of global flows,” says Zhan. Furthermore, “its share is expected to remain stable in 2021, with China remaining at high levels and the ASEAN [Association of Southeast Asian Nations] members recovering from a sharp downturn last year, while flows into India are expected to fall back from record levels.” 

Japan and South Korea play key roles in boosting East Asia’s very large intraregional flows—FDI from Korea into Malaysia being just one example. And while China seems destined to become the dominant player.

In both its handling of the Covid-19 crisis and its continuing ability to attract FDI, China has done far better than any of its peers. “China suffered a major shock in the spring,” observes Xiaolan Fu, professor of technology and international development at Oxford University, “but due to its very strict lockdown, recovered rapidly. Policy measures were introduced to support [multinationals’] subsidiaries in China and stabilize foreign investment.” Such measures, she adds, included speeding up customs clearance, help with shipping products to markets, and special immigration windows so key business and technology people and partners could enter China despite the lockdown.

“China became a safe destination for global capital, not just for FDI but also for portfolio investors,” Xiaolan says.

The contrast between India’s rapid post-lockdown recovery last year—with soaring financial markets helping to generate a record number of dollar billionaires—and the country’s current trauma following the devastating impacts of Covid-19’s Delta variant is likely to weigh on multinationals’ investment decisions.

Unlike Asia, Latin America saw FDI inflows almost halved last year, especially affecting economies dependent on commodities or tourism. “Countries that are very resource dependent are more vulnerable to the drop in FDI due to weak demand for energy resources such as oil,” says Roger Fon, a management fellow at the London School of Economics (LSE), “and are therefore suffering more severely.”

For other countries that are highly dependent on natural resources—including Russia and the Central Asian republics—FDI fell by more than half last year to its lowest level since 2003. The outlook for them, says Zhan, is “no significant recovery in the short term.” And while the sharp rebound in commodities markets this year, may provide more fiscal headroom for governments battling the pandemic, Xiaolan argues that fluctuations in commodities prices have only limited impact on FDI flows, which are mainly driven by longer-term strategic decisions. 

The Carribbean and Central America, meanwhile, suffered heavily from the overnight evaporation of tourism. Recovery will be sluggish at best, Xiaolan adds, and after what could be a further decline this year.

The sharp downturn in Latin America–bound FDI owes partly to the trajectory of the contagion, to be sure; but another major factor was the spring market meltdown in the US and Europe—the main sources of FDI into the region—that drove many Western multinationals to pause planned investments.

Greenfields Lagging

The contraction in global FDI flows may have passed, but the ongoing pandemic means any recovery to previous levels will be gradual and uneven. “The FDI cycle normally trails six months to a year behind broader economic and business cycles,” observes Zhan.

“Volumes of both greenfield and project finance investments are based on announced deals, so these are indicators of future rather than current flows. And while we expect FDI flows to return, we are not seeing enough new deals to have a major impact on developing economies, especially in Latin America and Africa.”

Compared with other developing regions, overall levels of FDI into Africa held up well last year, with a net reduction of just 16% compared with 2019, down to $40 billion—a 15-year low nevertheless.

However, greenfield investments fell by 62% for the continent, while the $32 billion of iinternational project finance deals announced was 74% lower than the previous year’s total.

Fon says the sharp drop in greenfield FDI is “highly problematic” for African and other developing economies because such projects are built from scratch and add to the host nation’s productive capacity.

“They include the setting up of new factories which can be crucial to a country’s industrialization prospects. They also help integrate developing economies into the global economy, but higher up the global value chain.” And because most FDI into Africa is through greenfield investments, Fon says that African countries are more vulnerable to a sudden shortfall.

“The reason for this significant drop in greenfield FDI projects is that from the perspective of the multinational enterprise, greenfield investments are high risk and capital-intensive, with a high ‘sunk cost.’” says Fon. “It is not surprising that with the pandemic bringing greater economic and policy uncertainty, multinationals are extremely cautious.” The same applies to cross-border mergers and acquisitions. Due to increased levels of uncertainty, these—which are also a riskier category of FDI—fell in Africa by 45%.

In the longer term, FDI inflows into African countries will not be determined solely by their capacity to deal with the Covid-19 pandemic, but by the extent to which their governance and physical infrastructure are improved.

“The implementation of the African Continental Free Trade Area, in January this year will lead to policy convergence through the creation of an African single market and increase the need to close the infrastructure deficit to meet the demands of expanding intra-African trade,” Fon says. “These could lead to FDI inflows into Africa as well as intra-African investments picking up beyond 2022.”

Sustainable Potential

Africa and Latin America could, in the future, become the principal beneficiaries of the rapid shift into sustainable–or environmental, social and governance (ESG) investing–especially among the wealthier developed nations. According to Unctad, total capital tied into ESG, when sovereign wealth funds and international portfolio investors are factored in, is currently estimated at $3.2 trillion and it was growing at a rate of 80% last year.

Multinationals seeking to meet ESG investment criteria are moving to diversify their activities—for instance, energy companies are switching long-term investment away from fossil fuels and into renewable energy—and developing nations offer some of the best opportunities to achieve this transition rapidly.

In some cases, the demands of sustainability may temporarily reduce FDI flows into a developing country, as carbon-intensive projects are shelved or decisions are made to leave less-profitable oil and gas reserves in the ground. But that is partly offset by rising demand for the raw materials needed for electric car batteries, which is likely to spur further investment in those countries—mainly in Africa and Latin America—that account for most of the world’s cobalt, copper, manganese and lithium production.

Much will depend on what global measures are agreed upon at the UN’s COP 26 climate change summit to be held in Glasgow from October 31 to November 12, and how policymakers choose to implement them. Similarly, FDI decisions are likely to be further affected by growing geopolitical tensions that are already having an impact on global supply chains as multinationals seek to relocate closer to their principal markets. There will be winners and losers, with low-cost but geographically distant suppliers most likely to lose out on future investments.

If the future is uncertain, the base from which it must grow is not looking too healthy. Analyzing some of the longer-term trends in global FDI, Zhan notes that a “structural change” occurred during the 10 years before the pandemic hit. “We saw a stagnation in FDI growth compared to the previous two decades. When you take out distorting factors such as FDI going in and out of conduit countries like the Netherlands, real flows were stable.” He concludes that the sudden 35% decline last year was therefore “mainly due to the pandemic.” But the stagnation  of what had previously been a fastgrowing segment of global investment could become entrenched.

Moreover, global FDI has been shrinking relative to total world GDP, trade flows and investment since well before the onset of the pandemic, according to the London-based Centre for Economic Policy Research’s latest Global Trade Alert, and last year reached its lowest level since 1995.

The report’s lead author, Simon Evenett, professor of international trade and economic development at the University of St. Gallen in Switzerland, notes that this decline is partly due to multinationals facing tougher government screening and demands for greater contributions to sustainable development and transitioning to a low-carbon economy—but mostly due to the shrinking financial returns on FDI, especially in developing markets, relative to “safer” destinations.

Evenett points out that after factoring in the risk premium, FDI returns fell most sharply in Africa, from 12% to 6.5% over the eight years to the end of 2018. “Returns on FDI,” he says, “in allbut one emerging market region, are barely above those in safer industrialized countries.” And while sectors like manufacturing, wholesale and retail trade offer higher returns, those that are seen to contribute most to sustainable development—including waste management, educational services, agriculture, health care and telecoms—have lower returns and much longer payback times on investment.

“There are legitimate grounds for asking why the private sector is not making a greater contribution through FDI to sustainable development,” he says. “For some, this is enough to blame the private sector and to demand it does more.” He suggests instead a more constructive dialogue between policymakers and multinationals that incentivizes new and “better” FDI in a post-pandemic world.