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Will Covid-19 kill FDI?

The Covid-19 pandemic has triggered a quantum shift in the world of FDI, and it may take years or decades for things to return to 'normal', if they ever do.

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US hardware company Stanley Black & Decker announced in mid-2019 that it would open a 40,000-square-metre plant in Fort Worth, Texas, in a move that pre-dated the Covid-19 trend to bring manufacturing nearer to domestic markets. (Photo by Scott Olson/Getty Images)

Across the global economy, prospects are bleak. For one, worldwide foreign direct investment (FDI) is expected to fall by a whopping 40 per cent in 2020, according to the United Nations Conference on Trade and Development (UNCTAD).

While FDI figures from mid-2020 are still patchy, the number of cross-border merger and acquisition (M&A) deals in April – and the number of announced greenfield projects in March – fell by more than 50 per cent compared with 2019’s figures for those months, according to UNCTAD’s World Investment Report 2020.

Will the pandemic be a coup de grâce for foreign direct investors? This seems unlikely, though the rate of recovery will vary by location and sector, while regionalisation and the reshoring of FDI in certain industries is set to accelerate.

Bringing it all back home

The pandemic is plunging the global economy into the worst recession since the Second World War.

Advanced economies are forecasted to face a decrease in gross domestic product (GDP) of 8 per cent, according to data from a June 2020 update of IMF’s World Economic Outlook report, while emerging or developing countries are predicted to record a decline of 3 per cent.

With many companies seeing reduced profits in 2020, expansions and foreign investment are less of a priority. Meanwhile, as confidence in international travel remains low, and the premium on secure and reliable supply chains grows, more and more foreign investors are likely to bring new investments and projects closer to home.

Glenn Barklie, chief economist at Investment Monitor, explains that the pandemic has shown companies how truly efficient they are, pushing many to reassess their strategies.

“In terms of FDI, this may mean a pausing of activity, reshoring or the near-shoring of activities to reduce reliance on their global supply chains. Globalisation could well become more regionalised in the short to medium term,” he predicts.

Dennis J. Donovan, principal at the Site Selectors Guild, explains that “what we are seeing is a trend that was taking hold before Covid-19. Companies are rethinking these long, extended supply chains. There’s too much risk, they are costly, they’re inflexible.”

This is more true for some industries than others. “We’re going to see more of a regional supply chain model, which will mean more companies will be establishing more regional manufacturing plants,” adds Donovan.

Of course, this trend predates Covid-19, especially for manufacturing. For example, US hardware company Stanley Black & Decker announced in mid-2019 that it would open a 40,000-square-metre manufacturing plant in Fort Worth, Texas, while still planning to continue to operate in China – where the company has 10 factories.

The new site will be a manufacturing plant for tools company Craftsman, acquired by Stanley Black & Decker in 2017. In a press release for the announcement, Jim Loree, Stanley Black & Decker CEO and president, said that the company is “determined to revitalise this iconic US brand and bring back its American manufacturing heritage”.

US-China trade war impact

The pandemic is exacerbating global tensions that existed before Covid-19. In particular, the US-China trade war.

“Given the US-China fallout we would expect some impact on FDI. Many countries may see this as an opportunity if the levels of trade and investment between the two superpowers continues to weaken. The US may turn [more] attention to other Asian countries and China may look to escalate its presence in Europe,” says Barklie.

Indeed, the world is becoming increasingly split into US and China spheres of influence, says Dr Sultan Salem from the University of Birmingham’s Department of Economics. This will weigh on foreign investors more and more, he adds.

For multinational companies, this means a slowing of their labour-intensive operations being moved to China, where for decades they have reaped the advantages of low operating and labour costs. This slowing trend pre-dates Covid-19, but it seems set to accelerate.

Of this, Donovan says, “Companies are pulling some production that is intended for consumers outside of China, and moving that production elsewhere in Asia – it could be Vietnam, it could be the Philippines, it could be Malaysia – as part of a ‘China plus two’ strategy.”

The China plus two strategy is an update on the China plus one strategy, which stemmed from diversifying risk by not investing in China alone when investing in Asia.

The risk associated with long supply chains – including the fear of tariff wars – and the rise of production costs in China are the main reasons for this change in thinking, according to Donovan. Added to this are the increased investment in new technologies, such as robotics, artificial intelligence and other areas of Industry 4.0, which make labour costs a less crucial factor when it comes to site selection.

Agatha Kratz, associate director at research provider Rhodium Group, says companies that produce in China but sell to the rest of the world are the ones being most affected by the US-China trade war .

“You’ve got two types of companies, those that produce in China to sell to the rest of the world, that are most impacted by the trade war, and the companies that are in China for the Chinese market,” she adds. “The latter have continued their interest and continued their investment in China, but for the ones that are more high tech or more involved in international value chains, they have been hedging their bets.”

An uneven FDI recovery

FDI will not recover all at once, or evenly, from the Covid-19 outbreak.

Individual government’s handling of the pandemic, and their pace of economic recovery, will determine the flow of FDI, according to Riccardo Crescenci, professor of economic geography at the London School of Economics. Emerging economies are expected to see the slowest recovery of FDI flows, he adds.

“The risk is there for emerging countries and for less developed regions in advanced economies. The type of FDI projects that might be deterred or that might be cancelled are more likely to be those targeting Central and Eastern European countries in Europe, or in emerging economies,” says Crescenci.

A fall on greenfield FDI – where companies set up operations in a foreign country – will affect emerging economies in particular. As UNCTAD’s Trade and Development Report 2020 highlights, these types of investment “are far more meaningful carriers of potentially beneficial forces for economic development than are flows related to M&A or intra-firm financial flows and profit shifting”.

Drawing from the lessons of the last global financial crisis, Barklie predicts M&A deals will take off before greenfield FDI does.

“If we can use the last global recession to assess future recovery, we would expect M&A deals to spur growth, with greenfield FDI playing catch up. This is because acquisitions become more cost effective (for those companies that can afford them) and they also offer diversification routes for holding companies,” he says.

Winners and losers in Covid recovery

Barklie expects technology-based sectors to be “one of the quickest to recover due to quick demand recovery and ease of adaptability and delivery”, followed by the life sciences, professional services and renewable energy sectors.

“There may be even some sub-sectors that report higher growth numbers this year compared with last year. E-commerce has seen a surge in demand due to lockdown restrictions and the further development of changing consumer habits,” he adds.

Backing up this point, Amazon has been one of the real ‘winners’ of the pandemic. Its share price has more than doubled since the virus took hold in the Western world ($1689.15 on March 16, 2020 versus $3450.96 on August 31st). It has also announced the opening of many new foreign operations in 2020.

On the other side of the coin, tourism and manufacturing-based sectors such as automotive and aerospace are expected to recover at a lower pace, according to Barklie.

“These sectors are not as adaptable and are negatively correlated to lockdown restrictions. Recovery is expected to be slower as the demand for these goods and services is more sluggish. Lockdown restrictions negatively affect demand (people cannot go to hotels, travel via air, and so on) and supply (staffing restrictions in manufacturing assembly lines, for example),” Barklie concludes.

More scrutiny

As countries look for ways to get their economies back on track, Salem highlights the increase of FDI screening measures worldwide as governments protect national companies from ‘destructive buyouts’.

“The pandemic seems to have brought the global GDP down to negative levels, which in turn brought significant uncertainty for the international capital flow in the short, medium and long run. Also, the pandemic has transformed worldwide FDI into predatory M&A opportunities as the crisis has already wiped off trillions of dollars from companies’ valuations,” Salem explains.

“As a result, countries across the world may be wise to introduce safeguards with immediate effect for sensitive industries from destructive buyouts, but they must do so with a reasonable balance… [Already] we have seen ever-increasing FDI screenings at the national levels,” he adds.

FDI screening and restrictions are going to be stronger in the EU and the US, according to Kratz.

Since lockdown began, governments in Australia, Canada, the EU, France, Germany, India, Italy, Japan, Poland, Spain, the UK and the US have all stepped up their foreign investment screening mechanisms to prevent predatory acquisitions.

Guidelines regarding foreign investment were already tightened by the European Commission at the end of March, points out Salem.

As economic nationalism grows, the level at which countries around the world become wary of foreign investment remains to be seen, especially when the distrust stemming from the US-China trade war and other such factors is taken into account.