Foreign Investment During the Recent Global Economic Recession

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Foreign Investment during the recent global economic recession

The year 2008 marked the end of a growth cycle in international investment that started in 2004 and saw world foreign direct investment (FDI) inflows reach a historic record of $1.9 trillion in 2007. Since then FDIs have been decreasing. The fall in global FDI in 2008–2009 is the result of two major factors affecting domestic as well as international investment. First, the capability of firms to invest has been reduced by a fall in access to financial resources, both internally – due to a decline in corporate profits – and externally – due to the lower availability and higher cost of finance. Second, the propensity to invest has been affected negatively by economic prospects, especially in developed countries that are hit by the most. The setback in FDI has particularly affected cross-border mergers and acquisitions (M&As), the value of which was in sharp decline in 2008 and early 2009 as compared to the previous year’s historic high. It has also taken the form of a rising wave of divestments and restructurings. Nevertheless, some favorable factors for FDI growth are still at work, some of which are even a consequence of the crisis itself. Public policies will obviously play a major role in the restoration of favourable conditions for a quick recovery in FDI flows. Structural reforms aimed at ensuring more stability in the global financial system, renewed commitment to an open environment for inward and outward FDI and the implementation of policies aimed at promoting investment and innovation are key issues in this respect.

The current global financial crisis has its roots in the US, Europe and other advanced countries. Its proximate causes include sub-prime lending, faulty distribution models, unsustainable financial engineering and derivatives usage, and faulty credit rating by agencies, a lax regulation and large global imbalances in those countries. But the fundamental cause of the crisis was the loose and excessively accommodative monetary policy followed by the US and other advanced economies from 2002-04. The global economic crisis has triggered a slowdown in global economic growth that is manifesting itself in a demand-driven fall in international trade exacerbated by the deficit of credit and trade finance; falling commodity prices; declining remittances; contracting foreign direct investment (FDI); and the potential of declining official development assistance (ODA). With a globalized system, a credit crunch can ripple through the entire (real) economy very quickly turning a global financial crisis into a global economic crisis.

The financial instability triggered by the United States subprime crisis which began in summer 2007 has led to a progressive deterioration of the investment situation. Foreign direct investment (FDI) flows declined by more than 20% in 2008 .In 2007, the capital outflows from US to emerging market economies spurted to around $600 billion per annum, only to crash soon . The effect of the sudden reverse flow of capital (particularly of portfolio investments) was a particularly traumatic experience for the EMEs. It had severe implications for their monetary management and financial stability. The global crisis has a direct bearing on capital inflows into India. The rate of FDI inflow recorded an increase in 2008-09 compared to the previous year, the FIIs (net) recorded heavy stream of outflows from India in 2008-09 contrary to a healthy rate of inflow in the previous year . A major challenge for developing countries is to continue to attract foreign investment during the crisis to stimulate economic activity, especially for investments that serve long-term development goals and enhance competitiveness (e.g. investments in infrastructure, agriculture, sustainable energy, material/resource/energy efficiency and technology). While 2007 was a record year for FDI...
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