Funding crisis deepening for emerging economies

The latest report of the United Nation Conference on Trade and Development (UNCTAD) highlights that the funding deficit for the developing economies to meet Sustainable Development Goals (SDGs) is rising. As per the report, the gap is now about US$4trn, up from US$2.5trn in 2015 when the SDGs were adopted.

The amount of global foreign direct investment (FDI) has been on decline since peaking at US$2.05trn in 2015. In fact, a percentage of world GDP, FDI peaked at 4% of global GDP in the year 2000 and has been on decline since then. In the year 2023, global FDI fell to US$1.3trn or 1.27% of global GDP.

 

As per a recent Moody’s report, “Global foreign direct investment flows have shrunk in recent years. The COVID-19 pandemic, supply-chain chaos, surging inflation, and tighter funding conditions have taken a toll on global FDI. Investment flows are also being reshaped by economic fragmentation, trade and geopolitical tensions, industrial policies, and supply-chain diversification. But many of the ups and downs in FDI in recent years are due to tighter regulations to thwart the usage of tax havens. These have curbed the flow of investment through conduit economies, especially in Europe. While retreating inflation and easing monetary policy settings might offer some relief, economic fragmentation will hinder the smooth flow of FDI. Climate change will increasingly shape FDI flows in longer term.”

UNCTAD report emphasizes that “Tight financing conditions in 2023 led to a 26% downturn in international project finance, which is crucial for infrastructure investment in areas such as power and renewable energy. As a result, investment in sectors linked to the Sustainable Development Goals (SDGs) fell by more than 10%. The report highlights that agrifood systems and water and sanitation registered fewer internationally financed projects in 2023 than in 2015, when the goals were adopted.”

FDI in China and India shrinking, despite India’s manufacturing push

The Moody’s report highlights that “The drop in FDI flows to developing economies was largely because of shrinking investment in China and India. The world’s second-largest recipient of FDI, China, saw a downturn in 2023. Inflows turned negative in the third quarter as withdrawals and downsizing outpaced new investments. More recent data showed a fresh decline in the second quarter of 2024. FDI into India has also seen better days, falling in recent years despite the country’s push into manufacturing and notable investments from tech giants such as Apple Inc. On the bright side, FDI into Southeast Asia has held at a high level.”

Most renewable energy funds allocated to the developed economies

Although renewable energy investments have nearly tripled since the adoption of the Paris Agreement in 2015, most of the money has gone to developed countries. While developing countries need about $1.7 trillion each year in renewable energy investments – including for power grids, transmission lines and storage – they only attracted about $544 billion in 2022.

The report shows that more than 30 developing countries still haven’t registered a large international investment project in renewables.

And in most of the 10 developing countries with the highest levels of international investment in renewable energy, investment in renewables represents between one tenth and one third of total FDI.

OECD rules impacted FDI

Changes in taxes and regulatory requirements appear to have materially impacted the FDI flows – amount as well as direction. Moody’s report mentions that OECD members “have strengthened regulations to make it harder for companies to locate profits in zero-tax jurisdictions. Also, a revised corporate tax rule in the U.S. in 2018reduced the incentive for U.S. multinationals to reinvest earnings and hold intangible assets abroad, leading to a significant drop in outward FDI that year. These efforts, later bolstered by laws to establish a global minimum tax, have dampened FDI flows to and from low-tax jurisdictions in Europe.

This appears to be macro trend. Nonetheless, it may have implications for the investment portfolios of several investors, especially those investors who are overweight in capital intensive businesses relying on foreign capital for growth. If the decline in FDI flows sustains the current trend, we may see downward revision in growth projections and hence valuation multiples. It is therefore advisable to watch this trend closely over the next couple of years.