The changing dynamic of FDI

1. The changing dynamic of FDI By Laza Kekic Economist Intelligence Unit Vienna, May 14th 2012

2. Outline • Emerging markets and the growth outlook • Differentiation in performance among emerging markets • Risks to the outlook • Changing FDI patterns • FDI and political risk

3. Emerging markets resilience during crisis • Early 2008-2009 very sharp falls in trade, commodity prices, capital inflows; fears of global meltdown • However, no emerging market crisis and performance was far better than expected • Growth acceleration in 2010 and 2011 • Normal rule – ‘when the rich world sneezes, emerging markets get flu’; but not any more; partial ‘decoupling’ from developed world • Better fundamentals than in earlier crises; debt/GDP ratio of 20 largest ems half of that of 20 richest nations. Will be one third by 2016 • Accelerated shift in economic power to East

4. Surging ahead The cost of the crisis Difference, in % terms, of real output per head before the recession started in 2007 compared with 2012 (forecast) % Sources: National governments, Haver, EIU

5. Where’s the growth? Real GDP growth; % change, year on year. ASEAN = Association of South East Asian Nations. CIS = Russia, Ukraine etc. As of April 2012. Source: Economist Intelligence Unit, CountryData.

6. Key stuctural points • Emerging markets the place to be • Favourable costs; rising productivity • Generally young populations • Slowly shifting to reliance on domestic demand • Competitive multinational companies • Rich countries: slower growth • Battered financial sectors • Fiscal austerity • Poor demographics

7. Contribution to global growth, %

8. Real GDP growth, %

9. Emerging markets regions • Asia: will continue to enjoy the fastest growth; regional growth driven by China and India; strong exports; high rate of domestic savings. Most attractive for FDI among ems. • Eastern Europe: hit veryhard by crisis in developed world; impact of EU membership less than hoped; becoming less attractive for foreign investors; Russia still dominates. • Latin America: Fundamentals better than in the past. But still heavy dependence on primary commodities; low domestic savings. • MENA: good business in parts of MENA on the back of high oil prices. But political turmoil and uncertainty, huge commodity dependence and questions about growth sustainability. • Sub-Saharan Africa: fastest growth in decades but dependent on commodity prices; South Africa and Nigeria account for 60% of regional GDP – minus South Africa the rest is the size of Austria.

10. Key risks to the outlook • The global economy falls into prolonged recession • Sovereigns default as public debt spirals out of control • Euro zone breaks up • China’s economy experiences a hard landing • Social and political unrest • Protectionism takes hold • Geopolitical shocks

11. Changing global FDI patterns • Sharp decline in global FDI in 2009 (34% in US$ terms); weak recovery in 2010, stronger in 2011 • For the first time ever in 2010 emerging markets attracted over 50% of global inflows • Not only because of differential impact of recession • Impact of improving business environments • Increasing competitive pressure on companies increase opportunity cost of not going into more dynamic and lower-cost destinations • EIU surveys: strong positive link between firm performance and presence in emerging markets • Increased outward FDI by emerging markets; disproportionate share to other emerging markets

12. GlobalFDI inflows (% of GDP)

13. Global FDI inflows (US$ bn)

14. Inward FDI flows, US$, % change

15. Small em club (FDI inflows, US$ bn)

16. Medium-term FDI outlook 1 • The positives Back to growth Competitive pressures Improvements in business environments in some countries • But constraining factors Policy tightening Political risks Financial sector weakness • Downside risks Global macroeconomic imbalances Commodity markets volatility Protectionism

17. Medium-term FDI outlook 2 • Global recovery from recession sluggish and fragile; no quick return to pre-2008 trend • Global FDI inflows will recover slowly • Supply side damaged by recession; appetite to invest in new plant and equipment is down • Weakened banks and tighter regulation will dampen foreign capital flows; will affect FDI too, although less seriously than other forms of flows • South-South FDI will be more resilient • Medium-term FDI flows to ems to decrease from previous boom-period 3.5-4% of GDP to about 3% of GDP at most

18. FDI and political risk • Despite global macroeconomic concerns, political risk is still near the top of the list of perceived constraints on investment into emerging markets. • The economic crisis has brought to the forefront again some traditional concerns for investors in emerging markets, including the risk of the non-honouring of contracts and transfer and convertibility risk. • Some surveys also reveal a significant concern about the risk of conflict and civil disturbances. • Risk of trade and FDI protectionism around the world in response to the global crisis.

19. EIU-MIGA definition of political risk • Covers breach of contract by governments; adverse regulatory changes by governments; restrictions on currency transfer and convertibility; expropriation; political violence; non-honouring of sovereign guarantees. • Political risk measure based on EIU Risk Ratings and EIU-MIGA definition (based on the ratings of the risk of armed conflict, terrorism, violent demonstrations, social unrest, various measures of governmental instability, external tensions, enforceability of contracts, expropriation, and the risk of the imposition of current and capital account controls).

20. Political risk, 2008-2012, EIU measure

21. Economic weakness and political risk • Clear trend of rising political risk since 2008 • Interplay of underlying vulnerabilities and economic weakness. • Political instability and social unrest follows economic downturns with a lag. • Severe social impact in many countries, primarily in the form of rising unemployment. • Increases in the number of people in poverty and reduced size of the middle class in some. • Weak state of many countries' politics. Support for democracy is fragile in many regions; public trust in institutions is low. • Reduction in access to foreign funding and unpopular austerity policies.