Foreign direct investments slip to $143B in 2002

Net foreign direct investment (FDI) has slipped from a 1999 peak of $179 billion to $143 billion in 2002, but remains the dominant source of external financing for developing countries. Likewise, net private debt flows to developing countries – bonds and bank loans – peaked at about $135 billion a year in 1995-96 and have since declined steadily, becoming net outflows in most years since 1998.

According to the Global Development Finance 2003 report, net private debt flows were negative again in 2002 – developing countries paid $9 billion more on old debt than they received in new loans. The report was initiated and completed by the World Bank.

Net portfolio flows were $9 billion, bringing total equity flows (FDI and portfolio) to more than $152 billion. Workers’ remittances reached $80 billion in 2002, up from $60 billion in 1998.

Net lending by official creditors to developing countries was positive, at $16 billion, with another $32.9 billion provided in grants.

Still, developing countries overall ran a $48-billion current account surplus with the rest of the world, up from $28 billion in 2001, meaning that developing countries continued to be net exporters of capital. The increase was more than accounted for by developments in Latin America, where devaluations and falling imports yielded sharp increases in trade surpluses.

East Asia continued to have about a $43-billion current account surplus, while higher oil prices had divergent effects across other regions, the report added.

The Philippines FDIs in 2002, according to the latest data supplied by the Bangko Sentral ng Pilipinas (BSP), grew by almost 67 percent from $857.87 million in 2001 to $1.43 billion last year.

But there are strong indicators that investments would decrease anew in 2003 due mainly to the poor showing of its revenue collections resulting in a possible failure to meet budget deficit targets this year.

The decline in debt was driven in part by investors’ preferences. Banks and bond holders became wary of holding debt claims on developing countries, whereas non-financial corporations nonetheless recognize that a growing number of developing countries offer the potential for growth, according to the World Bank report.

The increased reliance on FDI was generally positive for developing countries, since FDI investors tend to be committed for the long haul and therefore prepared than debt holders to tolerate near-term adversity. Many governments that previously borrowed abroad are instead borrowing domestically, on shorter maturities. While this reduces their foreign exchange risk, the shorter-term debt increases the risks from local interest rate fluctuations and the reluctance of local investors to roll over exposures at times of stress, the World Bank said.

FDI’s are less volatile then debt. Its stability cannot be taken for granted, since both domestic and foreign investments depend on a positive investment climate.

"The shift from debt to equity highlights the importance of developing countries’ efforts to foster a sound investment climate," Nicholas Stern, World Bank chief economist and senior vice president for Development Economics said in the report. "Nine-tenths of investment in developing countries comes from domestic sources. But domestic investors’ needs for a positive working environment are similar to those of foreign investors. Both seek stable macro conditions, access to global markets, reliable infrastructure, and sound governance, including restraints on bureaucratic harassment and corruption."

Like FDI, remittances are a more stable source of external finance than debt. Indeed, remittances tend to be counter-cyclical, buffering other shocks, since economic downturns encourage additional workers to migrate abroad and those already abroad increased the amount of money they send to families left behind. For most of the 1990s, remittances have exceeded official development assistance (ODA). Recent trends, including tighter restrictions on informal transfers and lower banking fees mean that remittances through the banking system are likely to continue to rise.

Despite the relative strength of equity flows and remittances, adapting to weak private debt flows poses a challenge for many developing countries that have come to rely on foreign loans. The net $9 billion that developing countries repaid private-sector creditors in 2002 came on top of a 2001 figure of almost $25 billion.

While it is likely that the third quarter of 2002 marked the bottom of the current credit cycle, any rebound is likely to be hesitant. Net debt flows to developing countries are likely to be broadly flat in 2003, the report added.

More broadly, the short-term growth prospects for developing countries will continue to depend heavily on the outlook for high-income countries, which in turn will be influenced by geopolitical factors.

"In the near term – the next six to eight months – much will depend on factors that are beyond the control of policymakers in developing countries," Uri Dadush, director of the Development Prospects Group indicated. "Over the medium term, however, the improvements that developing countries make in their policy framework and investment climate can be a powerful force for higher growth and more rapid poverty reduction."

Based on the assumptions of a temporary rise in the oil price, but no severe lasting dislocations, growth in rich country GDP is expected to accelerate from 1.4 percent in 2002 to 1.9 percent in 2003, reaching near-term peak rates of 2.9 percent by 2004 before easing to 2.6 percent in 2005.

Growth in developing countries, according to the World Bank report, was 3.1 percent in 2002, up by a small 0.3 percentage points from weak 2001 results. Growth was restrained by the lackluster recovery in the rich countries and by financial and political uncertainties in several large emerging markets.

World trade grew by a meager three percent, while prices for non-oil commodities rose by 5.1 percent.

Financial conditions facing developing countries are expected to be a little less austere in 2003 than in 2001-02. Flows of FDI are projected to rebound slightly, while net flows from private sources should be modestly positive, albeit still quite anemic. As noted, this outlook is based on the assumption of a quick resolution to the situation in Iraq and a significant decline in the oil price as 2003 progresses.