Where will the FDI flow?

April 27, 2012

For years the four mighty BRIC nations have grabbed increasing shares of world investment flows. But the coming years may not be so kind.  These countries bring up the bottom of the Economic Freedom Index (EFI) for 2012. Compiled by Washington D.C.-based think-tank The Heritage Foundation the EFI measures 10 freedoms —  from property rights to entrepreneurship — and according to a note out today from RBS economists, there is a strong positive link between a country’s EFI score and the amount of FDI (foreign direct investment) it can secure. So the more “free” a country, the more FDI inflows it can expect to receive — that’s what an RBS analysis of 2002-2008 investment flows shows.

So back to the BRICs. Or BRICS if you add in South Africa (part of the political grouping though not yet included in the BRIC investment concept used by fund managers). The following graphic shows Russia languishing at the bottom of the EFI, China just above Russia and India third from bottom.  Brazil is sixth from bottom while South Africa ranks two places higher.

At the other end of the spectrum is tiny Singapore. Its EFI score is double that of Russia and between 2002-2008 it attracted FDI equivalent to 50 percent of its economy. Russia in contrast saw negative net FDI (outflows exceeded inflows)

What comes next will be interesting. China grabbed the most FDI in absolute terms in the past decade (around $1.3 trillion or almost half the $2.1 trillion flows to the 21 leading EMs) but RBS notes this is slowing. That’s because China’s low-value manufacturing base is becoming less competitive relative to the rest of Asia and stringent restrictions remain in place in many sectors. Corruption, red tape and general business-unfriendliness prevail. “The decreasing allure of China from a manufacturing perspective means the country is at risk of suffering a decrease in FDI inflows in coming years,” RBS writes. The bank also notes the nature of FDI into China is changing: half the 2011 flows went to real estate.

On the other BRICS:

India: RBS sees the FDI outlook clouded by a poor business backdrop, restrictions on foreign participation in many sectors, slow reform and  the lack of commodities.

Brazil: Commodity rich but a poor record on property rights, political influence on the judiciary and corruption. There are risks that the recent pace of increase in flows cannot be sustained without meaningful reform, RBS says in its report.

Russia: The worst EFI score in emerging markets and a track record of high-profile expropriations.  Barring substantial reform RBS predicts Russia will continue to suffer FDI flight as Russian firms invest overseas.

South Africa: Lack of infrastructure a major bottleneck. But the outlook is brighter because of the government’s keenness to stimulate FDI into services and efforts to improve infrastructure. RBS adds: “We anticipate the country will benefit from increasing FDI flows as investors use it as a portal to the rest of the continent.”

The EFI-FDI linkage is not foolproof however. Taiwan and South Korea are third and fourth in the EFI index yet FDI inflows are just 5.6 percent and 2.7 percent of GDP. But that’s not such a bad thing — both countries are capital-rich, labour-poor and clearly on the cusp between developed and emerging markets. They are the only two countries in Asia to experience net FDI outflows in the past decade. That suggests they have sufficient capital at home,  RBS says.

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