The global economic and financial crisis has had a major impact on foreign direct investment (FDI) flows.

After declining in 2008 by 17 percent to $1.73 trillion from $2.09 trillion in 2007 - the high point of a four-year long boom in cross-border mergers and acquisitions (M&As) and FDI - global FDI inflows are forecast to plunge by 44 percent to less than $1 trillion in 2009.

The big drop in 2009 is occurring despite the improvements in the global economy in recent months.

However, a notable feature of trends in 2009 is that emerging markets for the first time are set to attract more FDI inflows than the developed world.

Global FDI

Global FDI inflows are estimated to have contracted by 49 percent in the first half of 2009, compared with the same period in 2008.

The estimate is based on data for 54 countries (20 developed countries and 34 emerging markets) that accounted for just under 90 percent of total global FDI inflows in 2008.

For 47 of the countries, FDI inflows in the first half of 2009 were lower than in the first half of 2008; only seven countries recorded growth in inflows over this period. The decline in inflows to developed countries was significantly sharper than the drop for emerging markets - by 54 percent and 40 percent, respectively.

The declines were especially marked in the United States and United Kingdom, by 68 percent and 85 percent, respectively. Among emerging market regions, the sharpest decline, by 55 percent, was to Eastern Europe.

Flows to Latin America and to emerging Asia declined by one-third in each case. China, the main emerging market FDI recipient, had a decline of only 18 percent, while FDI flows to Brazil and Mexico dropped by 25 percent.

Only a modest improvement is expected in the second half of 2009. Despite improved global economic trends in recent months, a significant recovery in M&As will not happen soon.

Rising confidence and a rally in equity markets have failed to boost M&As, since corporations remain very cautious and bank financing is constrained. The nine-month 2009 data for M&As was not encouraging.

According to data provider Dealogic, the value from M&A deals globally of $1.62 trillion in the first nine months of 2009 was down by 37 percent on the same period in 2008.

FDI to emerging markets

Flows to emerging markets initially proved resilient to the impact of the global crisis.

Inflows into the developed world declined by one-third in 2008, whereas flows to emerging markets increased by 11 percent.

FDI flows to emerging markets will decline considerably in 2009, albeit by less than FDI flows to the developed world.

In 2009, for the first time ever, emerging markets are likely to attract more FDI than developed countries. The forecast is obviously subject to considerable uncertainty.

For example, a few large cross-border deals in the final quarter of 2009 could tip the balance back in favor of developed countries.

But even should the emerging market share in global FDI inflows fall short of 50 percent, the share in 2009 will almost certainly be the highest on record.

Practice and theory

The overall decline in global FDI flows is thus being accompanied by a distinct shift in the pattern of FDI.

Economic theory tells us that capital should flow from capital-abundant rich countries to capital-scarce poor countries.

In practice, that has not been the case, since developed countries have consistently attracted the bulk of global FDI flows.

High risk in many emerging markets, the benefits of advanced institutions and infrastructure, and a superior overall business environment in developed countries have tended to outweigh the attractions of greater market dynamism and lower costs in emerging markets.

This time, practice might be catching up to theory. FDI has tended to rise during recessions, as slumps in M&As have hit the developed world disproportionately. Some 80 percent of cross-border M&A sales are still in developed states.

However, other factors are also pushing up the share of emerging markets in global FDI inflows.

FDI flows to emerging markets have held up better because their overall economic performance has been much better than that of the developed world, which has experienced its worst recession since the Second World War.

Much of the superior performance of emerging markets is, of course, due to the continued fast growth of China and India.

However, even if China and India are taken out of the equation, most emerging markets will have outperformed the developed world in 2009. Emerging markets have thus to some extent "decoupled" from the developed economies.

Globalization and increasing competitive pressure on companies have increased the cost in lost opportunities of not investing in emerging markets.

Outlook for 2010

Although the global economy is still weak, conditions are now improving in many countries. Global growth resumed in the second half of this year, creating momentum that will carry into 2010.

The recovery in 2010 will, however, be sluggish and fragile. Global growth is unlikely to return any time soon to the trend rate of recent years, since it will be constrained by the after-effects of the crisis in 2008 and 2009.

As a result, although global FDI inflows are likely to grow in 2010, the recovery will be modest. The growth rates of FDI into the developed world and emerging markets are expected to be similar, so that their shares in global FDI are unlikely to change significantly from 2009.

Companies' plans for the next five years, as reflected in the recent Economist Intelligence Unit survey, "Survive and Prosper," imply that emerging markets will attract considerable FDI and probably more than developed countries.

Just under 60 percent of companies expect to derive more than 20 percent of their total revenue in emerging markets in five years' time - almost double the present proportion of 31 percent.

This would suggest that the shift in the distribution of global FDI flows in 2009 is a longer-term development and not just a transitory phenomenon.

The article is part of the Columbia FDI Perspectives series, published by the Vale Columbia Center on Sustainable International Investment. The views expressed here are his own.

(China Daily 10/19/2009 page2)