Putting it to Work in Developing Countries - Nathan Associates

FDI inflows also fell in developing countries,
but only by 10 percent from the 1999 peak of
$187 billion and to $169 billion in 2003. The
decline appears to have been largely a function
of a drying up of FDI to middle-income
economies, particularly in Latin America and
South East Asia, as developed country multinationals
retrenched; privatizations were concluded
in the infrastructure, petroleum, and financial
sectors; and interest in cross-border mergers and
acquisitions waned in the face of financial crises
in both regions.
In other parts of the developing world, including
the low-income countries as a group, FDI
inflows remained stable or increased slightly
between 1999 and 2003. China and India,
where inflows continued to rise after 1999, were
major factors in this pattern.
2004–2005 RETURN TO GROWTH
After a four-year slump, FDI inflows to the
developing world began to rise substantially.
Growth in 2004 and 2005 has been dramatic—
69 percent from the 2003 trough. Total FDI
inflows now stand at $285 billion, a new record
for the developing world. FDI activity also
reignited and expanded in developed countries,
though to levels considerably below the peak
inflows of 2000.
Reasons for this turnaround are clear. Economic
growth in the developed world, first in the
United States and then in the European Union
and Japan, produced major gains in developed
country stock markets and sustained increases in
corporate profits. This generated FDI activity
worldwide. Much of the global increase in FDI
took the form of large-scale cross-border M&A
transactions by multinationals, particularly—but
not exclusively—within the developed world.
Similarly, in the developing world, macroeconomic
conditions have been favorable, with economic
growth annually averaging 6 percent to 7
percent in real terms. 3 Economic expansion has
been particularly robust in China (9.9 percent)
and India (8 percent). Continuing business environment
liberalization and policy reform, vigorous
global trade expansion (10.6 percent in
2004 and 7.1 percent in 2005), and booming
commodity prices, especially for oil (up 30.6
percent in 2004 and 41.5 percent in 2005), all
fuel this growth. Rising corporate profits and
stock markets in developing countries also contributed
to the new flow of FDI deals.
MEDIUM-TERM PROSPECTS
For the rest of this decade developing countries
as a group are likely to maintain the present
record volumes of FDI inflows. 4 But the pace of
growth may level off. According to a mediumterm
forecast by the Economist Intelligence
Unit, total FDI inflows to developing countries
reached a new peak in 2005 and will now rise
by only about 7 percent by 2010, a far cry from
the trajectory of the past two years. Some developing
economies will certainly do much better
than this (e.g., China, a global manufacturing
export platform, and India, a world leader in IT
services exports, and both also attractive for
their mass domestic markets).
The factors favoring current sustained high levels
of FDI inflow for the rest of the decade
appear to be the same ones that generated the
recent reversal: continuing global economic
recovery and robust trade expansion, strong
demand for key commodities, progress in liberalizing
markets and investment climates, and
worldwide competitive pressures to achieve cost
efficiency. Multinationals’ interest in cross-border
M&As in the developing and developed
worlds, and ample financial liquidity for such
activity, will also sustain inflows. A continuing
shift toward FDI in services, where cross-border
investment opportunities may still be untapped
and where various developing countries may
seek to attract FDI to upgrade infrastructure
standards, will be important to support M&A
activity.
Of course, prospective FDI flows face risks.
Economic nationalism and protectionism seem
to be gaining strength in the developed and
developing world alike, and might begin to
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