Will hot money matters have an effect on long-term money?

February 27, 2009

Let’s not dwell on hot money flows and on the raging politics of bailout packages and bank nationalisations. Let’s look at those cross border long-term investments called Foreign Direct Investment (FDI). These are often less controversial in the debate over globalization because they have a long-term horizon and hands-on feel to them: it’s about taking stakes in actual factories or services companies, about building a plant, and creating jobs. Of course it’s also about investing in resource extraction in mining or hydrocarbons, here a much more politically charged business. But how is the current financial crisis affecting FDI?

2007 was an absolute record year for for FDI: US $ 1.8 trillion. The last peak was in 2000, with US $ 1.2 trillion, according to UNCTAD, the international organization that keeps track of FDI trends in its famous World Investment Report. While doing some other research I bumped into a short report the Geneva-based UN body published last month entitled “Assessing the impact of the current financial crisis on global FDI flows”. It contains a few very interesting findings and analyses. A few snapshots:

In 2008, already, global FDI declined “by 21 per cent”, and 2009 is not looking good at all.

“However, the impact of the crisis varies widely, depending on region and country, with consequences for the geographic pattern of FDI flows. One has to keep in mind that the present situation is very different from that of the most recent previous financial crisis, which originated in developing countries […] and had a significant negative influence on FDI inflows in a number of them (such as Indonesia).In contrast, the current crisis began in the developed world, though it is rapidly spreading to developing and transition economies.”

“In many developed countries, preliminary data suggest that in 2008, as a result of the protracted and deepening problems affecting financial institutions, as well as the liquidity crisis in the money and debt markets, FDI flows have fallen, leading to a decline estimated at about 33 per cent for this group as whole.”

What type of FDI is more affected? And how will this affect the emerging and developing economies? Depends, says UNCTAD:

“International investment theory usually distinguishes between types of FDI according to three major motives for investing abroad  (…) market-seeking, efficiency-seeking, and resource-seeking. All three are impacted by the ongoing financial and economic crisis, but with differences in magnitude and location pattern of impact.”

“The most directly affected types of investment so far have been market-seeking projects, especially those aimed at developed countries. As advanced economies might experience a negative growth in 2009, companies are restraining the launching of new projects aimed at increasing their market-oriented production capabilities there (…), while they remain more committed to capacity expansion in emerging and developing economies (…). But this commitment might weaken in 2009 as growth slows in the latter group of economies, due – among other reasons – to a decline in the value of their exports as a result of weakening external demand from the developed countries and a fall in commodity and energy prices.”

Will FDI flows recover? Depends, says UNCTAD, again:

“Public policies will obviously play a major role in the implementation of favourable conditions for a quick recovery in FDI flows. Structural reforms aimed at ensuring more stability in the world financial system, renewed commitment to an open environment for FDI, the implementation of policies aimed at favouring investment and innovation are key issues in this respect. For effectively dealing with the crisis and its economic aftermath, it is important for policymakers to resist the temptation of quick-fix solutions or protectionism, and to maintain an overall favourable business and investment climate.”

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