Foreign direct investment during a global financial crisis

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Since the 2nd World War, the world economy has encountered the most severe global financial crisis in 2008-2009. A "financial crisis" is generally defined to be "a wider range of disturbances, such as sharp declines in asset prices, failures of large financial intermediaries, or disruption in foreign exchange markets" (Allen and Snyder 2009 adapted from De Bonis et al., 1999).

About Financial crisis

All happen in August 2007 in America where a subprime mortgage crisis created the financial turmoil that soon affected the entire world (Tong and Wei, 2009). During this apocalyptic period (2007-2008), the banks were mostly hit internationally creating a pessimistic situation for the future development of the industry (Gupta, 2010). First of all, chief financial organizations have been unsuccessful affecting the financial system. Secondly, many stock markets have declined and thirdly treasury securities have widened considerably (Chari, Christiano and Kehoe, 2008). The main concern was to 'fix' the financial system by undertaking measures all over the world. However the limitation on the accessibility of credit created a gloomy condition in the world of financial market. Many subprime lenders were declared bankrupt and most catastrophic were the hundred thousand of borrowers who were compelled to non-payment. In the same light, mortgage lending such as Northern Rock and home construction companies were most influenced by this financial crisis. Unfortunately, on 11 July 2008, the biggest mortgage lender in the US collapsed starting to impact on the universal accessibility of credit to non housing related business and FIS indirectly related with the mortgage lending. The most shocking news during this catastrophic condition was in 14 September 2008 with the insolvency of Lehman brothers. This financial turmoil affected mostly the well-known banks in America and Europe which result from many bank losses. Thus, this weakens the global economic performance (Gupta, 2010).

In this document, some initial answers concerning the global FDI flows are evaluated and the changes related to the international capital flows across a variety of developed, developing and emerging economies are assessed.

In business activities when a company made an investment which include acquisition of material goods or a controlling stock in a firm, in a host country this correspond to Foreign Direct Investment. The FDI is a focused firm activity and is advantageously meant at boosting the market position of a company. For this reason, such actions can enable country to achieve economic growth and development (Ali and Shedlock, 2010 adapted from UNCTAD, 2003.). The compositions, supplies and the destinations of capital flows have considerably changed for the reason that there has been the coming out of multinational corporations (MNC's) and the exploration of new market.


According to the FDI Perspectives of January 2011, in the past 20 years, the Foreign Direct Investment (FDI) has progressively developed into a significant aspect of the globalized economy. In the year 2004 there was the start of the growth cycle in international investment that was put to an end in the year 2008 due to the impact of financial crisis that also affected Foreign Direct Investment (reaching $ 1.8 trillion in 2007). In the same ground, it was observed that FDI was decreasing more than 20% and this fall was continued in the year 2009 because the financial retrenchment affects the transnational corporation investment expenditure (UNCTAD, 2009).


Since the past three decades, the increase in global FDI has been significant. For the year 1980 to 1985, global FDI flows amounted unevenly to US$50 billion annually. The interesting part is that global FDI had grown by an index of forty to attain US$2.1 trillion in 2007 (Sauvant and al. 2009). Of course, the former three global crises were less comparable to the recent economic crises. The worst one was during the years 1981 to 1983 where FDI fell almost by 35% but the decline from 2007 to 2010 is far from this index. Therefore, the intriguing similitude is therefore the FDI slowdown in early 2000s. FDI fell more than 40% in 2001 to reach 25% in 2002 and a further 12% the following year (Poulsen and Hufbauer, 2011). However, during the year 2008, the global FDI flow fell by 10% to reach US$1.9 trillion due to the global economic downturn (Sauvant and al. 2009). Furthermore, FDI flows took almost 3 years recoil after the oils shocks in the early 1990's. In spite of the protectionism policies of certain economies during the 1970's and 1980's, global capital flows remained largely progressive (Poulsen and Hufbauer, 2011; Graham and Krugman, 1995).

Just for the period of 2004-2007, global capital flows displayed a stable and hasty growth of 155%, from US$717.7 billion at early 2004 to reach US$1,833.3 billion in 2007. It is to note that developed economies absorbed most of these FDI, i.e. US$1248 billion representing 68.1% of the whole. The USA was the biggest beneficiary of these capital flows followed by other EU countries such as the UK, France. However, the recent economic downturn had altered this trend drastically and global FDI flows had started to move towards emerging markets (kumo, 2011).

Various studies have shown that the different categories of FDI flows fluctuate in accordance to business cycles and most commonly, during period of crises (Sarno and Taylor, 1999; Levchenko and Mauro 2007; Calderon and Didier, 2009). From an analysis of a collection of data of 66 countries during 1970-2003, Levchenko and Mauro, 2007 concluded that the Net Equity flows are less risky while compared to Net Debt flows. Net debt ratio had demonstrated a sudden fall due to a rise in cash holdings and net debt flows continued to fall further until it reached into a negative downturn by mid-2007, just before the start of the financial crisis (Tong and Wei, 2009; Bates and al, 2007). Tong and Jin Wei, 2009 argued that prior to the financial crisis, international capital flows were not importantly related to some serious credit complexities but it was the composition of capital inflows that matters.

However, Calderon and Didier 2009 argued that though FDI remained resilient during previous, it may not follow the same trend again since recent crises were confined mostly to the emerging economies (Calderon and Didier, 2009). Prior to the financial crisis, cross-border business acquisitions, more precisely, Asian firms buyout, were frequent since there had been an easy access to various sources of finance (Tong and Jin Wei, 2009, Bates and al, 2007). From 1985 to November 2008, cross-border mergers and acquisitions amounted to 607 000 transactions (Calderon and Didier, 2009).

In an another work, Hyun (2006) had tried to link the short and long-run dynamics between institutional quality and FDI from data of 62 developing countries during 1984 to 2003. However, he found no evidence to support his argument and Paziena and Vecchione (2009) highlighted later in their work that quality of institutions are now becoming prominent in assessing the FDI flows towards emerging economies (Ucal and al, 2010).

Ferretti and Tille (2011) mentioned that international bank integration was of more importance compared to cross-border bank lendings. These banks were dealing directly with foreign customers or through agents in the cross-border territories. Under the first strategy, the transaction between the local bank and the foreign client was recorded in the balance of payment. While the second strategy entails a foreign affiliates to deal directly with the foreign country. Thus, this is totally excluded in the balance of payment of the parent bank. The overall foreign claims of BIS-reporting banks rose form 33 to 63 percent of the world GDP. This shows an increase of around 50 persent while operations through foreign subsidiary represented 44 percent of all claims in developed markets and 52 percent in emerging ones prior to the crisis.

Several studies have been carried out to analyze how to anticipate crises associated to the banking and financial sector, including currency crises. These research works have combined macro-economic indices to forecast the financial crises (Ucal and al, 2010; Coulibaly, 2009; Ozlale and Metin-Ozcan, 2007; Kaminsky and Reinhart, 1998; Eichengreen et al, 1996).


The main factors that have caused a fall in the global FDI are the lack of financial resources either internally and externally to invest. The impact of the financial meltdown on FDI has two major consequences. Firstly there was a negative effect on the flow of FDI because of vigorous impact on financial resources and market growth. Secondly, it created a situation of uncertainty for the future inflow of the FDI (UNCTAD, 2009). Additionally, during this financial meltdown, the trade flow is declining compared to recent global financial turmoil (Baldwin, 2010).

Most 'touched' were the manufacturing industries including steel, automobile among others and also the service sector such as airline (UNCTAD, 2009). Even parent firms kept on sending back big shares of profit rather than to make investment in host countries (Poulsen and Hufbauer, 2011, adapted from UNCTAD, 2009).

Main types of FDI that were affected by the financial crisis:

Three components of the FDI namely market-seeking, resource-seeking and efficiency-seeking were greatly affected by this chaotic situation. But market- seeking was the most straightforwardly affected especially in developed countries since firms concentrate more on the possibility to expand in promising and developed countries. However this strategy proved to be a failure because the declining external demand from those countries has led to a decrease in the value of export.

In the same light, it is complex to assess the crisis on the efficiency seeking project since it is known that companies were limited in terms of investment because of unavailability of finance but however this phenomenon can force them to reduce cost and to increase efficiency creating an opportunity for them to survive in this turbulent environment.

Lastly, the resource-seeking project was affected in the short term due to a fall in world demand and in prices. But however there can be some imbalances that boost the prices leading to the launching of new projects by companies (UNCTAD, 2009).

According to a survey carried out in April-June 2008 by the United Nations Conference on Trade and Development (UNCTAD) for 2008-2010 World investment prospects survey, 40 percent of the respondents companies declared that their investment program and expenditures were very negatively affected by this phenomenon. Also this survey showed that the future prospect for medium term investment was less optimistic especially for the cross borders mergers, acquisition and FDI.

Furthermore there was an increasing trend in divestment where actual production capacity were reduced by selling the assets to other companies or closing down firm, and restructuring of operation where costs were cut and to improve balance sheet.

Example of companies that experience a fall in FDI (UNCTAD, 2009).

The service sector such as the aircraft was affected by this crisis since there were many cancellations mentioned by EADS (France) and Boeing (US).

The biggest steelmaker in the world, ArcelorMittal, in Luxembourg, is revisiting its growth plan and decided to cancel its ambitious project in India (total investment $20 billion) because prospect sales are low. Also there was a hold back in steel production in countries such as United Kingdom, Japan and Russian Federation.

Financial services were also hit by this financial turmoil. AIG in Unites states sold its Philippines and Japanese insurance affiliates. Additionally, FDI inward in Netherland has fallen more than 70 percent.

One reason behind the slowdown of FDI which affect the developed countries can be the downturn economic of these countries as one of the most determinants of FDI for attracting investment is the economic growth and moreover this was emphasized by the financial crisis making these most important markets less attractive to invest. This crisis (recession) hit the financial sectors in the developed countries but most important is that the liquidity crisis in debt and money market has caused FDI to fall leading to a decrease in the inward flow. So it can be seen that this financial turmoil not only affected the financial sector but had also a consequence on the real economy where tighter credit conditions limit future investment for the companies (UNCTAD, 2009). However, this restricted the ability of firms to invest in foreign country and to finance the main significant form of entering overseas countries for multinationals, which are the cross-border mergers and acquisitions. Even where it do occur this have involved lower values than as share prices which declined the worth of firms which as a result depressed the value of FDI. In the same way, this decrease might be due to the recent economic difficulties, by which parent companies can be forced to send back their earnings or to sell it to foreign partner in order to strengthen their balance sheet (Sauvant, 2010).

Consequently, it is to be noted that in 2008, for 'promising' countries, even though their bank lending and their inward of Portfolio investments were negative (Poulsen and Hufbauer, 2011, adapted from IMF, 2009), both their inflow and outflow increased although at a slower rate than precedent years. Nevertheless this scenario deteriorated in 2009 where the outflow and inflow started to decrease. As many authors above have pointed out the negative impact of financial crisis and recession on FDI, it is important to see that there has been some recovery concerning these issues. Fortunately, the inflow of the FDI started to improve in Latin America and Asia in the year 2010 (Poulsen and Hufbauer, 2011). Also the number of Southern TNC's that begins to invest in other countries especially in emerging countries is rising (Sauvant, Maschek, and McAllister, 2010).


On the other hand, as said by Kekic (2009) even if the overall global FDI is decreasing, we noticed that there is a rise in the FDI flows to emerging markets have experienced a raise of 11% while the inflows of developed country have decrease by one third in 2008. To a large extent, the advanced performance of emerging markets is, of course, due to the sustained rapid development of China and India. Conversely, although China and India are removed of this, a large amount of the emerging markets have done better than the developed world in 2009. Hence, emerging markets have to some level "decoupled" from the developed economies.

Likewise, Ali and Shedlock (2010) also emphasise on the importance of the rising nations in the world financial system which is principally due to the rapid growth of China, India and Brazil in the world trade and by their rate of economic growth compared to developed countries. In addition the financial crisis of 2008, bring to light the impact of the emerging economies and their role in alleviating the world economy. These authors argued that even if the average FDI flows of these countries experienced a decline for the years 2000-2005 due to the Asian crisis, nevertheless, the FDI flows of these emerging economies during the 2008 crisis do not react negatively compared to the developed nations. Additionally, pointing out by the study of same authors the reasons behind such increasing trend of emerging countries can be the following:

These countries might have dynamic investor who is self-assured and who seized prospect in other regions. It may also indicate that these investors purposively associate their business growth to the global market. And intercontinental investors have self-reliance in the economic strength of these countries.

There is indication also that the economy of these countries flexible to the crisis and has a better ability to recover from it.

These emerging countries have a rise of MNCs, and above all, the international investors are increasingly attracted to these nations which represent a qualitative revolution in business operations around the world.

Despite the fact that, it may demonstrate that these countries are crucial contributor to the strength of the world economy, it clearly indicates that the FDI is no longer focused in the triad regions. That is, progressively, FDI is developing into something global.


Developed countries have to this point been the most affected, through deterioration in FDI inflows in 2008. A global financial slowdown recession is already seizing a number of major urbanized economies. Businesses expected to be especially affected are a number of manufacturing industries, including automobiles, aircraft, building materials, consumer goods, steel, and services such as transport services (airlines, logistics) (UNCTAD, 2008).

Provided that the crisis began in Western countries and economic growth is undoubtedly the supreme determinant of FDI, it comes as no surprise that FDI flows to and from developed countries have declined the most to date. The depression has had a outstandingly deep impact on Western banks and financial institutions, which consequently had to abandon, call off or cut back cross-border mergers and acquisitions (M&As)-the uppermost means of entry for FDI. The international drop in FDI has consequently for the most part been due to the 'dive' in cross-border M&A deals of developed-country companies since 2007, which has led to a 67 percent decline in cross border M&As worldwide (despite a slight M&A rebound in 2010).

Furthermore, inward flows have be particularly low in Finland, Germany, Hungary and Italy while flows to the United Kingdom, France and the United States are estimated to have declined by a significant margin in the case of France and the United Kingdom compared to their 2007 historical high levels. Overall, FDI flows have declined, directing to a fall estimated at about 33 per cent for these countries. Following, decreased earnings of developed-country TNCs and a decline of syndicated bank loans have particularly limited financing for investment.

Also, trade in Japan has fallen at a much faster speed than that in the US. The impact of the economic crisis on Japan has up to now been rather moderate - at least in financial institutions - yet Japanese trade has been badly hit. Figures for February 2009 indicate a 50% year-on-year contraction in Japanese export volumes and a 43% decrease in volumes of imports (Tanaka, 2009).


Two separate literatures have analyzed closely the effect of foreign direct investment (FDI) on economic growth and financial development on economic growth (Kholdy and Sohrabian, 2008). Only a few has examined the interaction between FDI and financial development (Kholdy and Sohrabian, 2008; Alfaro et al, 2004; Carkovik and Levine, 2003).However, previous research have rarely studied how, in the presence of political corruption, FDI and financial development would interact. A substantial amount of infrastructure for market support is required for financial development and where the dominant élite consider it as a threat to their power and position they would limit opportunities for new competitive investors and this infrastructure would not be develop.

The distribution of corporate control and the role of financial elite as the major barriers to financial development and economic growth is underlined by many researchers (Kholdy and Sohrabian, 2008; La Porta et al., 1998; La Porta et al., 1999, 2000, 2002; Mauro 1995; Morck et al., 2000).Other authors such as Rajan and Zingales (2003) and Morck and Yeung (2004) confirm that strong political influences is being used to alter the institutional framework by financial elite to favour themselves and their firms. The conclusion was in countries where there was a high level of political corruption such as excessive patronage, nepotism, job reservation and secret party funding FDI was affected badly but however more theoretical and empirical research is needed to conclude whether political corruption is the main influence of FDI and financial development.

Moreover, Bancel and Mittoo (2010), in their studies after the recent financial crisis interviewed some Chief Financial Officers in some French firms about the global impact before and after the financial crisis to their firms' financial flexibility levels. Liquidity problems, banks' reluctance to lend and cost cutting were cited by two-thirds of the CFOs who had a strong impact of the financial crisis. Furthermore they found that firms with greater internal financing are more likely to have lower leverage, higher cash-to-asset ratios, and experience a lower crisis impact on their business operation. Other studies confirms that in order a firm will be able to respond effectively to unanticipated shocks to its cash flows or its investment opportunities, it should be financial flexible. Financial flexibility was identified by worldwide managers as the primary driver of their capital structure decisions (Bancel and Mittoo 2004; Graham and Harvey 2001).

Furthermore other studies have carried out to analyse the impact of the recent financial crisis. For example Azvedo and Terra (2009) analysed how the Brazilian economy was affected as compared to the great depression of 1930 and the crisis which occurred in 1990.they concluded that this crisis was much less severe than those two before, this is so because Brazil adopted a flexible exchange rate regime and keeps on maintaining and improving their economic policies such as higher markets diversification for exports and increased external solvency.

Figure 1.0 Global FDI flows during 2002 to 2009 and forecasted figures for 2010 to 2012 (US$ billions)

Source: UNCTAD

The 3 different situations illustrated in the above figure depend upon the base-case speculation of a growth in global GDP in 2010. They are in line with the latest IMF macroeconomic financial forecasts (IMF, 2010) and the opinions of other recognised research centres. The IMF has estimated a rise in the net foreign direct investment inflows, for both emerging and developed markets, to be $294.1 billion or 2010 whereas in 2009, the same FDI inflows amounted to $274.8 billion (IMF, 2010). Similarly, the Institute for International Finance (IIF) forecasted $435 billion of FDI inflows for 30 emerging countries in 2010 while it was estimated at $347billion in 2009 (IIF, 2010). However, according to the estimates of the Economist Intelligence Unit, global FDI may attain $1.3 trillion in 2010 but are unlikely to be equivalent to the $2 trillion FDI inflows in 2007 and FDI may not be fully recovered until 2014 (EIU, 2010).