The era of FDI-driven growth is over

Free flow of foreign investment (direct and portfolio) has been a major plank of globalisation and liberalisation. FDI is a key economic constituent, accounting for 40 per cent of incoming resources and 10 per cent of capital formation in developing countries — and can go up to 50 per cent in some economies. Recent trends, however, show that not all is well on the FDI front. As per UNCTAD, global FDI inflows reached a peak of $2 trillion in 2007 but bottomed out after the 2008 global financial crisis; they were expected to recover to $1.6-2 trillion by 2012. The reality, however, is that global FDI could only reach to $1.1 trillion in 2018. Looking back, the rise of FDI inflows from $225 million in the early 1990s to $1.5 trillion in 2000 was impressive, but the pace has now ebbed.

Other sources for external capital too are seeing a slowdown. Net debt and equity flows to the low and middle income countries have fallen from $1.27 trillion in 2017 to $1.03 trillion in 2018, with a sharper fall noticed in long-term debt, that fell from $404 billion to $303 billion; private creditors from $352 billion to $225 billion; and net equity flows from $540 billion to $503 billion; with only remittances holding fort at about $481 billion. The growing spat between the US and China might be a cause of the reversal, but the outcome is a major concern for the developing world.

Recent figures

Though the trend of developing countries replacing the industrial nations in the top 20 recipients of global FDI is inspiring, there are some other developments in this context that are discomfiting. First, the flows are getting concentrated over time, as the share of the top 20 recipient countries in global FDI flows rose from 64 per cent in 2009 to 90 per cent in 2018. Of the $7 trillion that flowed into the developing world during the 2008-18 period, East Asia (36 per cent) and South-East Asia (16 per cent) accounted for 53 per cent and Latin America another 24 per cent.

Second, rates of return on FDI are showing a gradual decline, with the world average falling from 8.1 per cent in 2012 to 6.7 per cent in 2018: in the developing world, it fell from 10 per cent to 8 per cent; Africa from 12.3 per cent to 6.3 per cent, Latin America from 7.9 per cent to 5.6 per cent and South Asia from 7.2 per cent to 5.7 per cent during this period.

India made a splash, albeit not a spectacular one. South Asia, where India leads, managed to get $499 billion of FDI during 2008-18; a global share (7 per cent) similar to Africa. India has progressed, as inflows increased from $4 billion in 2001-01 to nearly $42 billion in 2008-09. But since then, it could not cross the $45-billion level achieved in 2015-16, with big drops seen during 2010-15 when flows fell to levels of $29-35 billion. During 2008-18, China received an average of $124 billion a year, Brazil $62 billion, Singapore $52 billion, India $37 billion, Russia $34 billion and Mexico $30 billion. China has also emerged as the country with largest outflow of outward FDI.

Public financing

A need is now increasingly being felt globally to look for lasting solutions to ensure steady resource flows, as the limitations of the Washington Consensus — that promoted private capital as the pivot of development and efficient resource allocation — is now beginning to fall short of expectations. Adding to the anguish, a series of economic and financial crises in quick succession threaten global systemic stability. This has led to public-sector capital once again gaining attention and finding favour with the global policy.

“Public banking is undergoing something of a renaissance…partly in response to concerns that private banking has failed to do enough for development, and partly in recognition of the positive role public banks have played in providing countercyclical finance,” notes a recent UNCTAD report.

The fillip to public sector finance renewed in the aftermath of the 2008 financial crisis — with BRICS nations setting up the New Development Bank (2014), China floating the Asia Infrastructure Investment Bank (2016) and the launch of South America’s Banco del Sur (2009) — with enhanced level of engagement seen in multilateral and regional development finance. The rise of sovereign wealth funds is doing its bit, with India, too, setting up the National Investment and Infrastructure Fund.

Development Finance Institutions (DFIs) for small businesses were set up in countries like Great Britain, Malta, France, Bulgaria, Latvia and Portugal. Mudra Bank is one such effort from India.

Institutional framework

Going forward, India may see a testing time in finance that could hinder its pace of growth — signs of which are already flashing — and could warrant a course correction. With development banking on being the backfoot, commercial banking in deep distress, non-bank finance in turmoil, anaemic new capital issuance in public markets, absence of strong corporate bond markets, rising number of failing companies, growing threat of debt defaults etc, sentiments and prospects for growth could be undermined.

Dependence on central bank surplus can at best be occasional, as it could raise more questions over time than find solutions.

The saving grace are the personal balance sheets in India that have largely remained positive and conducive to a higher rate of savings. During much of the reform period, people with fewer skills were pushed into risky markets that not only eroded sizeable savings of a large number of people but also raised concerns on safety and scope for strengthening private savings.

India needs to embark, with all seriousness and greater urgency, on a thorough review and recast its template of finance, instead of tweaking and tinkering the failing and faltering models. There is a dire need for an institutional framework for financing long-term infrastructure, as commercial banks are not equipped to don the mantle of development banking. Public capital, that has this merit of being patient and catalytic, needs to be strengthened by matching its importance with resource needs, not divert it to speculative assets and to support inclusive and sustainable development. That is where lies the challenge for policy.

In this effort, India can find an ally in the UN. While the IMF and the World Bank may still advocate private finance as the panacea, agencies like the UNCTAD and the UNDP are increasingly veering towards reforming public finance as a resolution for recurring crises, restoring growth and to reign in rising inequalities. An opportunity awaits India for new ideas that could trail-blaze development finance to reach its goal of becoming a $5-trillion economy, and in the process provide thought leadership to the developing world on sustainable development.

The writer runs the consulting firm ‘Growth Markets Advisory Services’. Views are personal

COMMENT NOW