FDI: Opportunities for emerging markets post-COVID

 

Friday, 18 December 2020

The pandemic is causing massive disruptions to flows of foreign direct investments. Developing countries are likely to be hit the hardest. Disruptions to flows of Foreign Direct Investments (FDI) — which are part and parcel of trade and globalisation — are no exception. 

In late March, the International Monetary Fund announced that investors had removed $ 83 billion from developing countries since the beginning of the COVID-19 crisis, the largest capital outflow ever recorded. According to the UN Conference on Trade and Development (UNCTAD), global FDI flows are expected to contract between 30-40% during 2020/21. 

All sectors will be affected, but sharp contractions in FDI are especially evident in consumer cyclicals, such as airlines, hotels, restaurants and leisure, as well as manufacturing industries and the energy sector. The contraction in FDI is going to hit developing countries particularly hard. 

The reasons for this are that first, FDI inflows to developing countries are expected to drop even more than the global average, considering that those sectors that have been severely impacted by the pandemic account for a larger share of FDI inflows in developing countries. The drop in global FDI is therefore very much related to the disruptions in global supply chains, which we have also witnessed as a result of the COVID-19 pandemic.

 

Sri Lanka

In 2019, Sri Lanka attracted $ 700 million in FDI, Vietnam got $ 40 billion and Ireland got $ 30 billion. The low level of Foreign Direct Investment is becoming a serious constraint to sustained rapid economic development. However, it is not only the amount of Foreign Direct Investment that matters but the types of Foreign Direct Investment. 

The country has been unable to attract the kinds of investments that would have multiplier benefits to the economy from increased exports and transfer of technology. The drop in export income also reflects this trend. 

Foreign investment is a significant driver of economic development. FDI fills the savings-investment gap and enhances investment and economic growth. FDI contributes to improving work ethics, discipline, skills and knowledge of workers. It is an important means of technology transfer and transmission of best practices in management and often brings with them international markets. 

It is the realisation of these economic benefits that has made former communist countries like China and Vietnam, and the formerly inward looking Indian economy to actively seek foreign investment.

 

Policy reforms

Despite policy reforms towards private sector development, private sector investment is constrained by several factors which need urgent corrective action by strengthening institutional set up. If Sri Lanka is to achieve 6% growth, foreign investment has to be increased to around 30% of GDP.

Foreign Direct Investment (FDI) generally refers to long-term participation by one country in another country. It usually involves participation in a JV, capital transfer, transfer of technology and expertise. There are two types of FDI: inward foreign direct investment and outward foreign direct investment, resulting in a net FDI inflow (positive or negative) and «stock of foreign direct investment. There is substantial evidence that such investments benefit host countries.

In Sri Lanka, during periods of relative economic and political stability, foreign direct investment inflows have responded positively. FDI generally benefits the host country, however its potential impact should be carefully and practically accessed. Foreign direct investment has been proven to many to be resilient during a financial crisis. 

A good example would be the Mexican crisis that took place during 1994-1995 and the Latino crisis in the 1980s. The resilience of Foreign Direct Investment during a financial crisis can lead to many developing countries to monitor it as private capital inflow of choice, rather than investing in other forms of private capital such as portfolio equity, debt flows, and in particular, short term flows which were all subjected to large reversals during the same period. 

Generally, private capital flows across borders, because it allows capital to seek out the highest rate of return. Countries often choose to exempt some of its revenue when they cut corporate tax rates in an attempt to attract FDI from other countries. FDI also allows the transfer of expertise and technology, particularly in the form of varieties of capital inputs, which cannot be got via financial investments or trade in goods and services. 

However, there are many findings that show FDI is a relatively bigger portion of total inward investment in some countries, where the risks are very high. This is often because FDI tends to take advantage of the countries where the market is inefficient. It happens because of foreign investors prefer more to operate directly instead of relying on local financial markets, supplies, or legal arrangements. In high-risk countries, the share of total inflows is higher and the risk is measured by the countries credit ratings.

 

Attracting FDI

The best solution for developing countries to increase their overall amount of inward investment of all kind, is to focus on concentrating on improving the environment for investment, the functioning of capital markets and private companies need to improve governance within their enterprises, skills level, internationalise and work towards becoming multinational enterprises. By doing so, they are likely to be rewarded with increased investment as well as with more capital inflows. 

Given the very low returns in the West, there will be a clear shift of focus post COVID to frontier and emerging markets since they remain the only source of growth in the world economy. Given the limitation of our market, Sri Lanka could very well attract more foreign investment, and develop faster, if we improve our infrastructure, workforce skills, have policy consistency, efficient capital markets, provide sustainable legal guarantees to protect investment and strengthen governance in both the public and private sectors. 

The BOI also needs to develop a competitive value proposition that can compete with the likes of EDB Singapore, IDA Ireland, MIDA Malaysia and Sharjah Investment and Development Authority to position Sri Lanka for the future. Also, international actions to support countries during and after the pandemic need to pay particular attention to least developed countries. Therefore international organisations and country groupings, like the United Nations and the G20, needs to respond by facilitating cooperation in the area of international investment and trade policy post pandemic.