Gabor Hunya of Vienna Institute for International Economic Studies -
The Vienna Institute for International Economic Studies, or WIIW, has released its 6th annual study of FDI in CEE. Not surprisingly, FDI fell heavily in CEE to levels not seen since 2007, but in many countries in the region FDI is already starting to recover.
According to the United Nations Conference on Trade and Development (Unctad), global foreign direct investment (FDI) fell to $1 trillion in 2009 from $1.7 trillion in the previous year. This is an estimation based on data for three quarters of the year. The decline in Europe was smaller than in the US and Japan. It was more severe in the emerging Europe than in other parts of Europe. The OECD reports stagnating FDI inflows in the European OECD area in the third quarter of 2009 as compared with the level a year before and forecasts a 20% FDI decline in 2009 as against 2008, which year in turn saw a 20% drop over 2007. During 2009, fDi Intelligence recorded a total of 13,678 FDI projects worth also nearly $1 trillion and expects a small increase in 2010 mainly in countries achieving fast economic growth.
The causes of the FDI setback are manifold. The economic decline has triggered a drop in FDI just as in fixed capital investment as a whole, due to falling global demand, excess capacities, difficulties in investment financing, the decline in subsidiary profits, etc.
Emerging overcapacities make new investments both in the home and host countries unnecessary. The export-oriented industries in particular have cut output and idled capacity. Tight credit conditions curtail FDI in two ways: FDI in the form of loans to subsidiaries shrinks or even becomes negative and the bank-financing of equity investments becomes more costly. FDI projects may be cancelled or delayed due to the lack of affordable financing and uncertain market prospects. Another important part of FDI, reinvested profits, contract when foreign investors' profits shrink. In addition, profits may be withdrawn by parent companies from more successful locations to finance losses in the home country.
Return to mid-naughties
After a year of stagnation, FDI inflows to emerging Europe halved in 2009, falling to about the 2005 level. The setback was most serious in the new EU member states (NMS), less significant in Southeast Europe and the CIS. In the two latter regions, the 2009 inflows were above those reached in 2005, thus some achievements of the economic upswing period could be consolidated. Inflows to the NMS were nearly as low as in 2003 when the drop was related to the "dotcom" crisis.
All NMS were seriously hit by the FDI decline in 2009. Two of them, Slovakia and Slovenia, booked negative FDI inflows, implying that accumulated capital reserves were repatriated.
In some countries the setback was more than 50%, such as in the Czech Republic, Hungary, Latvia and Lithuania. Less hit were Poland, which showed the strongest economic performance overall, and Estonia, which consolidated its economic position. The recent FDI decline in the NMS ought to be seen in the context of the very high FDI intensity attained in these countries. The NMS have a longer history of receiving FDI than the other CEECs. A related feature is that all the three forms of FDI - equity, reinvested earnings and other capital (mainly inter-company loans) - have a significant position and frequently show diverging developments. The foreign sector is important, often dominant in several sectors of the NMS' economies. It contributes essentially to the overall economic growth performance in general and participated particularly in the severe declines in several countries of the region in 2009. It is important to note that equity investments were positive throughout the region in 2009 and comprised a much higher share of FDI than earlier. The resilience of equity FDI means that new projects and restructuring investments were not stopped even under the impact of the crisis. As for the individual countries, equity investments declined in 2008, but recovered slightly in 2009 in the Czech Republic, Estonia and Latvia. Continuous high equity inflows of €2bn or more to Bulgaria, Hungary, Poland and Romania prove that these countries maintained their attractiveness for new investments. There may be another interpretation: Parents might have increased equity of subsidiaries to improve the equity ratios of their balance sheets, in particular banks facing higher capital requirements.
Reinvested earnings fell strongly in most NMS as investors' income declined. The share of reinvested income in the total was in the range of 50-90%, somewhat below the level of the previous year. Investors repatriated less income than earlier despite financial difficulties in both home and host economies. In the two countries hit most severely by the crisis, Latvia and Lithuania, reinvested earnings turned negative, as did overall FDI-related income. Hungary suffered from very modest reinvested earnings while the amount of repatriated income was the highest in the region. In more stable countries, especially in Poland and also in the Czech Republic, reinvestments recovered and were larger than equity FDI.
The main form of the FDI flows responsible for the overall decline was "other capital," which comprises mainly loans of the parent company to the subsidiary. Under the pressure of the financial crisis, such credits dried out, particularly in the financial sector. In some cases it was the subsidiaries that credited the parent, so that other capital inflows became negative in the Czech Republic, Estonia, Hungary, Slovakia and Slovenia. In the two latter countries, the repatriation of other capital was more than the inflow of equity and reinvested earnings.
The two largest NMS, Poland and Romania, continued to receive the largest amounts of FDI in nominal terms in 2009. Bulgaria maintained its third position, ahead of the (larger) countries Czech Republic and Hungary, for the fourth consecutive year. In per-capita terms, Estonia comes ahead of Bulgaria. The next two ranks are occupied by the two large countries Poland and Romania, while the long-time favourites, Czech Republic and Hungary, follow with some distance. In the latter two countries and also in Slovakia, the modern export-oriented manufacturing sector built up by foreign investors in the past was hit particularly hard by the decline of demand in Western Europe so that FDI lost momentum.
Southeast European countries are still at a lower level of development and most of them attracted relatively less FDI than the NMS, especially in the export-oriented sectors. In some of them privatization is still going on, which boosted FDI in Albania and Montenegro and mitigated the decline in Serbia. Inflows to Croatia fell to less than half of the previous year's level, but continued to be the second highest in the region. This is the only country in the Western Balkans where not only equity FDI is significant, but also other forms maintain strong positions. As the investors rarely set up export-oriented projects, the Western Balkan countries have not yet succeeded in becoming part of international production networks as have the NMS. This may have been a short-term advantage during the current crisis when shrinking exports aggravated economic decline and FDI flows.
In all four European CIS countries investigated here, FDI declined in 2009 - less so in Belarus, which is in a delayed transformation process, and most severely in Moldova, where the inflow of FDI almost stopped completely. Inflows to Russia dropped by nearly half as compared with the previous year, in line with the severe GDP decline. The consumption boom that had fuelled domestic market-oriented FDI including real estate development and retail trade in the past few years came to a halt and investors postponed projects. Investors could afford much less new equity injection, only one quarter of the equity invested in the previous year. They also had less profits available for reinvestment, and repatriated a larger part of the incomes earned in Russia than in the previous years.
As another new feature, FDI in the form of other investments doubled in 2009, which can be considered a very fragile engine. In Ukraine the FDI inflow fell to less than half of the previous year's level as a result of the economic crisis and political uncertainties.
Another source of information on FDI that relies on press reports and covers mainly greenfield investment shows similar FDI trends in 2009 as the balance of payments data.
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