Market Forces: Foreign Direct Investment Recovers

• Foreign direct investment flows are recovering in the Asia-Pacific region, outperforming the global economy.
• China and India are the likely top foreign direct investment destinations for 2010-2012.
• Strong economic performance will secure steady gains in foreign direct investment.

Investment fell off sharply during the global recession, foreign direct investment in particular. The credit crunch, lower corporate earnings, and economic uncertainty kept businesses shy about risking capital during the downturn. Foreign direct investment often involves more uncertainty than domestic investment, as businesses enter new markets with different economic and legal environments. It is hence no surprise that the falloff was even steeper than for overall investment.

Now signs point to foreign direct investment growing again in some Asia-Pacific countries. The recent uptick in flows into Thailand and Australia is encouraging, and there are also indications that more foreign capital is flowing into Hong Kong and Singapore. Japan remains the laggard, with slow investment both outward and inward.

Foreign direct investment plunged in sync with total capital formation but has not seen the strong rebound made by total gross fixed capital formation. Fixed investment has been growing in most of developed Asia for a year, but foreign direct investment is only beginning to pick up. The weak performance of Japan's inward and outward foreign direct investment is matched by weakness in total capital formation and reflects the output gap and disappointing performance of Japan's manufacturing.

Fixed investment is also recovering in developing Asia. Some developing countries experienced milder downturns of fixed investment than developed Asia did. India's performance is particularly impressive; fixed investment hardly dropped during the downturn, and investment growth in the first quarter was among the fastest in the region. India attracted relatively strong foreign direct investment in 2009; receipts from abroad declined only 14% compared with 2008.

China and India outperformed in attracting foreign direct investment in 2009. Though flows declined, the fall was less than elsewhere. China's inward foreign direct investment dropped 12% in 2009, below the region's 25% loss of FDI. The region also outperformed global inward FDI, which dropped 37% in 2009.

The main drag on the region's FDI performance was Japan's outward direct investment. Japan is the region's largest individual source of foreign direct investment, but the country's sharp recession curbed investment both in Japan and by Japanese businesses overseas. Despite this, Asia-Pacific outward FDI nevertheless outperformed global outward FDI, which dropped 43%.

Little reliance on FDI flows

Overseas businesses are attracted to the region's growth potential, supporting FDI. The relatively bright economic outlook should make FDI firm further this year and next. UNCTAD's World Investment Report 2010 outlines China and India as the top destinations for FDI flows in 2010-2012.

While significant, FDI flows take a backseat in the Asia-Pacific region to investments originating from within each economy. These have made capital formation accelerate in the last year. Thailand, the country most dependent on FDI inflows in 2009, still received only 9.2% of its fixed capital formation from abroad. This fraction is only marginally larger than the global average dependence on FDI, which was 9.1% in 2009, and all other Asia-Pacific economies are less dependent on inward FDI than the global average.

Inward FDI dropped more than overall fixed capital formation everywhere but in the Philippines. This confirms FDI’s higher exposure to the economic downturn.

What's next for FDI?

China and India are likely to carry the region forward as an FDI destination. Continued economic expansion in these major economies is vital, both for generating FDI within the Asia-Pacific region and from elsewhere in the world.

A slower recovery in Europe and the U.S. could weigh on FDI inflows to the Asia-Pacific region, but receipts from these regions are already low, reducing the effect of a slowdown. Intraregional FDI is growing, and Asia Pacific is becoming more self-reliant. Thailand received more than half of inward FDI from Asia in the first four months of the year. The monthly average of investments into Thailand from Singapore, China, Malaysia and the Philippines more than doubled when comparing the first four months to 2009.