Pandemic Distorts FDI Trends For China And The US

THE HEADLINE FROM the initial estimates of foreign direct investment (FDI) flows last year by the UN Conference on Trade and Development (UNCTAD) is that China overtook the United States as the primary destination for FDI.

While that is consistent with a long-term trend — that the world’s centre of gravity is shifting eastwards — a peep behind the headlines is warranted.

Last year was exceptional. Global FDI fell by 42% to $859 billion. That was a plunge 30% steeper than followed the global financial crisis in 2008 and took FDI worldwide back to the levels of the 1990s. The pandemic shaped the winners and losers, both by geography and sectors (IT and pharma were among the winners).

Yet so did geopolitics.

With the then Trump administration in the United States pursuing the denial of US capital and technology to Chinese firms, FDI to the United States almost halved to $134 billion in 2020 from $251 billion the previous year, with cross-border mergers and acquisitions particularly hard hit. And 2019 was way below the giddy heights of 2015-16 before Beijing reined in Chinese companies’ exuberant global aspirations, largely focused on US assets.

At the same time, FDI into China, the only large economy to grow last year, rose to $163 billion in 2020 from USD140 billion the previous year, a rise of 16%.

China will likely continue to attract more FDI than the United States during the recovery, which the new mutations of Covid-19 may well extend. US plans to use infrastructure investment, including in digital infrastructure, and the development of renewable energy as the backbone of economic recovery will likely cause FDI in the United States to snap back. However, this will take time and FDI worldwide this year is likely to remain weak.

In contrast, China’s needs to move its economy up the value chain and drive for technological self-sufficiency will sustain its inward FDI on a steady but more modest growth path.

The combination of the two will put FDI patterns back on their historical paths.

ADB Lays Out Rocky Climb Back Up The Cliff

NO ONE CAN say how widely the Covid-19 pandemic may spread, and containment may take longer than currently projected. The possibility of severe financial turmoil and financial crises cannot be discounted. Sharp and protracted declines in commodity prices and tourist arrivals will challenge dependent economies across [Asia].

On such a downbeat, but realistic note, the Asian Development Bank introduces its 2020 Outlook, published on April 3. Its underlying theme is that the nascent recovery from last year’s decelerating pace of growth because of US-China trade tensions and the related global manufacturing recession has been snuffed out by the pandemic, and then some. Growth will rebound next year, the Bank believes, but not before it declines steeply this year.

For China, the Bank is forecasting growth to tumble to 2.3% for the year, against 6.1% last year and 6.7% in 2018. The high-frequency indicators from the early months of the year showing double-digit contractions in industry, services, retail sales and investment imply that the economy could likely see a double-digit contraction reported for the first quarter. The GDP figures are due on April 17.

To put that into context, the likely impact of Covid-19 will be more severe for China than that of the Asian financial crisis in 1997–98, the SARS (severe acute respiratory syndrome) epidemic of 2003 and the 2008 global financial crisis.

However, the recovery in the second half of the year implied by the growth forecast for the full year is seen carrying into 2021. The ADB expects growth will rebound to 7.3% in 2021, helped not just by the return of regular commercial activity but also by easy monetary policy and hefty and probably repeated fiscal and infrastructure stimulus on the part of governments.

The knock-on effect across the region will be as severe, as trade growth weakens further on the back of waning domestic demand, a halt to tourism, and transport and other supply disruptions because of the pandemic. The ABD forecasts regional growth of 2.2%, down from 2019’s 5.2%, but then a recovery to 6.2% in 2021. Excluding Asia’s newly industrialised economies (South Korea, Taiwan, Hong Kong and Singapore), growth is seen to slow to 2.4% in 2020 from 5.7% in 2019, and then to pick up to 6.7% in 2021.

A further drag on growth in China and the region, noted by the United Nations Conference on Trade and Development (UNCTAD), will be the fall in profits for foreign affiliates of multinational enterprises operating in the region, which in turn will reduce funds available for direct reinvestment:

On average, the top 5,000 multinationals, which account for a significant share of global foreign direct investment (FDI), have now seen downward revisions of 2020 earnings estimates of 30% due to Covid-19, and the trend is likely to continue. Hardest hit are the energy and basic materials industries, (-208% for energy, with the additional shock caused by the drop in oil prices), airlines (-116%), and the automotive industry (-47%). The latter industry was fate first to see earnings revisions anticipating the supply chain shock. Industries now expecting to be hit by a global decline in demand are rapidly catching up.

UNCTAD Investment Trends Monitor, March 2020 Special Edition

As the reinvested earnings component of FDI in Asia was 41% in 2018, these substantial downward revisions foretell sizeable effects on FDI from earnings losses. Downward revisions to multinationals earnings in China average 21%, UNCTAD notes.

The risks to its forecasts, as the ADB acknowledges, are nearly all to the downside and substantial. The assumption that the pandemic will be contained globally this year and normal business conditions will return next is a ‘good-case’ one: vast uncertainty about the duration and severity of the pandemic remains. The potential for second and third waves of the outbreak exist.

Thus the ADB’s broad range for the total global cost of the pandemic of between $2.0 trillion and $4.1 trillion, equivalent to between 2.3% and 4.8% of global GDP, with China’s cost approaching 5% of GDP. As the ADB also says, ‘the possibility of a financial crisis cannot be discounted and the pandemic could also bring about fundamental changes to the global economy over the long term’.

Most notable of those would be a retreat from the globalization that has underpinned the rise of developing Asia, with multinationals repatriating production and shortening global supply chains.

However, it is not just the pandemic that hangs heavy over the outlook for the region. Trade conflict between Washington and Beijing remains a significant risk, especially if the pandemic causes China to fall short on its commitment to increase imports of US goods and services in 2020 and 2021 by $200 billion over 2017 values, as the Phase One trade agreement between the two countries requires.

As this Bystander has noted, this was always an ambitious target, as are its components for imports of agricultural, manufacturing and energy products and services. With the president of the United States facing re-election in November and the US economy already taking a severe hit from the pandemic, nothing adverse can be ruled out.

China Invests Abroad

CHINA IS NOW the second largest investing economy. This reflects Beijing’s ‘Go Global’ policy that delivered a surge of cross-border M&A purchases in manufacturing and services by Chinese firms last year while individuals stepped up their purchases of real estate in developed countries. Chinese firms accounted for 8% of inbound cross-border M&A in the United States last year, worth a record $29 billion.

But China is also the world’s third favourite destination for foreign direct investment (FDI) after the United States and the United Kingdom. According to the UN Conference on Trade and Development (Unctad)’s newly released World Investment Report, 2017, China had FDI inflows of $134 billion last year. That was 1% down on the previous year, mostly because of lower inflows into the financial sector.

However, Unctad notes that:

In non-financial sectors, [China] recorded 27,900 new foreign-invested enterprises (FIEs) in 2016, including 840 with investments above $100 million. In addition, 450 existing FIEs significantly expanded their businesses, undertaking additional investment above $100 million. Non-financial services continued to underpin new FDI, with inflows in the sector growing by 8% while foreign investment into manufacturing continued to shift to higher value added production. In March 2017, for example, Boeing started to build an assembly facility in China, the first such project outside the United States.

Inflows via Hong Kong fell much more sharply, from $174 billion to $108 billion over the same period, though 2015 was an exceptional year and 2016 represented something of a return to trend.

China’s outflows increased to $183 billion in last year from $128 billion in 2015. Those via Hong Kong slowed slightly, from $72 billion to $68 billion.

The Unctad report identifies state-owned multinationals as major players in global FDI. China is home to the most — 257 or 18% of the total, way ahead of second-ranked Malaysia (5%). In 2016, the report notes, greenfield investments announced by state-owned multinationals accounted for 11% of the global total, up from 8% in 2010.

The investments of China’s state-owned multinationals “are instrumental in the country’s outward FDI expansion strategy”, Unctad says. It notes that generally the investments of state-owned multinationals tend to be weighted more heavily in financial services and natural resources than those of multinationals as a whole.

Seven of the 10 largest financial state-owned multinationals are headquartered in China, as are four of the 25 largest non-financial ones — China National Offshore Oil Corp. (CNOOC), China COSCO Shipping Corp., China MinMetals Corp. and China State Construction Engineering Corp. (CSCSC).

China remained the largest investor economy in the least developed economies, far ahead of France and the United States, and showed more interest than most in investing in transition economies, and particularly landlocked ones like Kazakhstan and Ethiopia, though the sums remain relatively small. However, state-owned oil firm Sinopec acquired the local assets of Russian oil company Lukoil for $1.1 billion.

A future focus of China’s investment will be via its One Belt One Road (OBOR) initiative. Beijing has already signed around 50 OBOR-related agreements with other nations, covering six international economic corridors. FDI to Pakistan, for example, rose by 56% year-on-year last year, pulled by China’s rising investment in infrastructure related to the China-Pakistan Economic Corridor, one of the most advanced OBOR initiatives.

Unctad notes:

Stretching from China to Europe, One Belt One Road is by no means a homogenous investment destination. However, investment dynamism has built up rapidly over the past two years, as more and more financial resources are mobilized, including FDI.

A number of countries located along the major economic corridors have started to attract a significant amount of FDI flows from China as a result of their active participation in the initiative.

Central Asia, unsurprisingly, is at the leading edge of this. The implementation of OBOR is generating more FDI from China in industries other than natural resources and diversifying the economies of various host countries.

Chinese companies already own a large part of the FDI stock in extractive industries in countries such as Kazakhstan and Turkmenistan. The ongoing planning of new Chinese investments in the region, however, has focused on building infrastructure facilities and enhancing industrial capacities. In addition, agriculture and related businesses are targeted. For example, Chinese companies are in negotiation with local partners to invest $1.9 billion in Kazakh agriculture, including one project that would relocate tomato processing plants from China.

South Asia benefits from the development of the China-Pakistan Economic Corridor.

This has resulted in a large amount of foreign investment in infrastructure industries, especially electricity generation and transport. For instance, Power Construction Corporation (China) and Al-Mirqab Capital (Qatar) have started to jointly invest in a power plant at Port Qasim, the second largest port in Pakistan. In addition, the State Power Investment Corporation (China) and the local Hub Power Company have initiated the construction of a $2 billion coal-fired plant.

OBOR also stretches to North Africa. Indeed, it seems decreasingly to recognise any geographic limits to its ambition and scope.

Egypt has signed a memorandum of understanding with China, which includes $15 billion in Chinese investment, related to Egypt’s involvement in the initiative. It is undertaking a number of cooperative projects under the One Belt One Road framework, including the establishment of an economic area in the Suez Canal Zone and investments in maritime and land transport facilities.