After a depressingly dismal spell, a spectacular return to corporate deal making last year gave a knock-on boost to global foreign direct investment levels. The outlook is good for this year too, with another big increase expected, although some countries are set to benefit far more than others. Foreign direct investment (FDI) inflows surged ahead in 2006, clocking up the third consecutive annual increase, according to figures produced by the United Nations. The total for 2006 was $1.2trn, a 34 percent increase on 2005, and just a few deals shy of the record $1.4trn set in 2000. The rapid rise in FDI flows largely reflects high economic growth and strong economic performance in many parts of the world, according to the United Nations Conference on Trade and Development (UNCTAD), which calculates the figures. Such growth has occurred in both developed and developing countries. Increased corporate profits and resulting higher stock prices have boosted the value of the cross-border mergers and acquisitions (M&As) that constitute a large share of FDI flows. UNCTAD said continued liberalisation of investment policies and trade regimes gave FDI levels a further kick. But there are warning signs, too. In some African and Latin America countries there were notable changes in economic policy towards a greater role for the state, says UNCTAD, as well as changes in policies that directly concern foreign investors or industries, in particular the natural resources industry. These are likely to depress FDI growth.

Recovered position
FDI performance has varied greatly among regions and countries. Investment in developed countries rose by 48 percent last year, well over the levels of the previous two years, and reached $800bn. The US recovered its position as the largest single host country for FDI in the world, overtaking the UK, the top FDI recipient in 2005. The European Union (EU) as a whole continued to be the largest host region, accounting for 45 percent of total FDI inflows in 2006. But UNCTAD warned that several risks for the world economy – most of them not new – may have implications for FDI to and from developed countries. Global current-account imbalances have widened dramatically and could cause abrupt exchange-rate shifts. High and volatile oil prices have caused inflationary pressures, and a possible tightening of financial market conditions can’t be ruled out. High fiscal deficits in Europe, in combination with rising interest rates, could lead to tax and wage pressures. “All these considerations underline the need for caution in assessing future FDI prospects for developed countries,” it said. For now, these countries are doing well. FDI inflows to developing countries and economies in transition – which comprises south-east Europe and the Commonwealth of Independent States – rose by 10 percent and 56 percent, respectively, in 2006. Those are both record levels. In Africa, FDI inflows in 2006 exceeded their previous record level of 2005. “High prices and buoyant global demand for commodities were once again a key factor,” says UNCTAD, “particularly in the oil industry, which attracted investment not only from developed countries but also from some developing countries.” Cross-border M&As in the extraction and related service industries of Africa tripled in the first half of 2006, as compared to the same period in 2005. However, UNCTAD warned that, “the regional FDI picture is not uniformly bright across sectors, countries and sub-regions.” Most of the inflows are concentrated in the West, North and Central African sub-regions. “Inflows will continue to be small in low-income economies lacking natural resources,” it said. FDI inflows to Latin America and the Caribbean slowed in 2006. Mexico and Brazil, in that order, remained the largest recipient countries with inflows remaining virtually at the same level in Mexico and increasing by six percent in Brazil, in spite of a fall in cross-border M&As. FDI inflows to Chile increased by 48 percent due to a continued rise in reinvested earnings resulting from windfall benefits from mining. FDI inflows to Colombia and Argentina decreased by 52 percent and 30 percent, respectively, because of a decrease in cross-boarder M&As.

Additional changes
In the Andean countries, growing demand for commodities and resulting higher prices propelled changes in policy in the direction of more control by the state. That resulted in less favourable fiscal regimes for investors in such countries as Bolivia, Ecuador, and Venezuela. The possibility of additional regulatory changes and of their extension to more countries may have raised uncertainty among investors in the primary sector, resulting in the decrease in FDI flows to the region. In addition, high commodity prices and resulting improvements in current-account balances have led to an appreciation of the value of many countries’ currencies. That could affect prospects for FDI in export-oriented manufacturing, said UNCTAD. FDI inflows to South, East and South-East Asia, and Oceania maintained their upward trend in 2006, reaching a new high of $187bn, an increase of 13 percent over 2005. Investments in high-tech industries by trans-national corporations (TNCs) are growing rapidly, particularly in China. Meanwhile, other countries, including India, are attracting increasing FDI for traditional manufacturing. At the sub-regional level, a shift continues in favour of South and South-East Asia. China, Hong Kong and Singapore retained their positions as the three largest recipients of FDI in the region. India surpassed the Republic of Korea and became the fourth largest recipient. Outward FDI from the region surged with China consolidating its position as an important source of FDI. India is rapidly catching up, with 2006 FDI outflows almost doubling. China and India are challenging the dominance of Asia’s newly industrializing economies as the main sources of FDI in the developing world. In West Asia, FDI flows, both inward and outward, maintained their upward trend in 2006. Turkey and oil-rich Gulf States continued to attract most FDI inflows, accounting for a record level in 2006 in spite of geopolitical uncertainty in parts of the region. Energy-related manufacturing and services were the most targeted industries. FDI outflows from the region increased, mainly from the Gulf countries led by the United Arab Emirates. Cross-border M&As, particularly by state-owned enterprises, continued to be the main mode of outward FDI. Such outflows are increasingly taking place in energy-related activities, supported by the region’s tightening ties with China and India and other economies in Asia and Africa.

Buoyant
After a minuscule increase in 2005, FDI inflows to the 19 countries of South-East Europe and the CIS expanded significantly in 2006, the sixth year of uninterrupted growth of FDI in the region. The Russian Federation, the region’s largest host country, experienced a mini-boom, with inflows almost doubling. UNCTAD says that FDI is likely to be particularly buoyant in the countries that joined the EU on January 1, 2007 – Bulgaria and Romania – and in the large economies such as the Russian Federation and Ukraine. FDI prospects for the Russian Federation are, however, affected by the impact of tightening Russian natural resource regulations and by disputes that emerged in 2006 over environmental protection and extraction cost, such as those involving two major oil development projects in Sakhalin. “It is uncertain whether large increases in such sectors as chemicals and petrochemicals, services, and real estate – categories where investor confidence is currently high – could fully compensate for a possible slowdown of oil-related FDI,” said UNCTAD.

One of the most significant developments in FDI over the past two or three years has involved natural resources and related industries. Despite some bad news for foreign investors in such industries, high demand for natural resources – and, as a result, the opening up of new potentially profitable opportunities in the primary sector, such as gas and oil development in Algeria – are likely to attract further FDI to the extractive industries. Economic growth in 2007 is projected to slow moderately. Continuing global external imbalances, sharp exchange rate fluctuations, rising interest rates, and increasing inflationary pressures, as well as high and volatile commodity prices, pose risks that may also hinder global FDI flows. Combined, those factors “could lead to a slowdown in the fast growth in global FDI registered over the past few years,” UNCTAD believes.