Glass half full: The 2017 Foreign Direct Investment Confidence Index
Investors are bullish about economic growth and FDI prospects, but are monitoring political risks for abrupt changes to the business environment.
A New Risk on Attitude
Global investors may finally be emerging from the financial crisis hangover.
The results of the 2017 FDI Confidence Index indicate investors are becoming more optimistic about the global economy and more open to investment diversification. Such strong investor sentiment suggests pent-up business investments around the world are likely to be unlocked, creating a virtuous cycle and strengthening economic growth.
Sixty percent of investors say they are more optimistic about the global economy than they were last year. International Monetary Fund forecasts support what investors are telling us: growth projections for 2017 and 2018 are 3.4 and 3.6 percent respectively – up from 3.1 percent in 2016. Regionally, Asian investors are most bullish of all. This could reflect the region’s improved prospects and the increasingly vital role of the Pacific Rim in the global economy. In fact, investors are much more optimistic about the outlook for Asia Pacific and the Americas this year. Investor optimism is particularly strong for economic performance in large developed markets in these regions, including the United States, Canada, Japan, and Australia.
Investors are also displaying a greater risk appetite and willingness to diversify investments into different markets. After investors flocked to the perceived safe havens of developed markets in recent years, emerging markets account for seven spots in this year’s Index, up from an all-time low of five in 2016. And newcomers to the 2017 Index are diverse: the United Arab Emirates, New Zealand, and South Africa. This is the first time since 2014 that an African or Middle Eastern country has made the Index – a positive sign that investors may propel further upward momentum in the global economy.
FDI as a Localization Strategy
Investors are using FDI as a strategy to hedge against weakening international trade and globalization.
Globalization seems to be taking a hit in many respects, with persistently weak global trade growth, rising protectionism, and increasing anti-immigrant sentiments. But FDI continues to be seen as a growth opportunity in this environment. Last year, 71 percent of investors told us they planned to increase FDI in the coming years – and this year, 75 percent say the same. Why are more investors focusing on FDI as a pillar of their global growth strategies?
In the current volatile global environment in which globalization is shifting to islandization, investors likely see FDI as an important localization strategy. While a government may seek to limit imports, foreign companies with a local presence in the market are already in – and likely provide local jobs as well. Therefore, FDI may become crucial to maintaining access in large markets that risk turning inward. And more broadly, after years of subpar economic growth and lower levels of FDI, the quality of investment targets and the macroeconomic environment are improving across markets.
The United States tops the Foreign Direct Investment (FDI) Confidence Index for the fifth year in a row. This streak ties with the longest prior run that the United States had at the top of the Index (ending in 2001), and likely reflects the enduring attractiveness of the US market in terms of sheer size and a relatively open regulatory environment for foreign investment. Investors may also be motivated by protectionist rhetoric, as FDI would give them a local footprint in the world’s largest economy. In addition, investors have a very bullish outlook for the North American economy – with the United States and Canada the two domestic economies about which investors are most optimistic this year compared with last year. It is thus no surprise that Canada rounds out the top five in this year’s Index.
Germany rises to second place, while China drops to third place. This is Germany’s highest ranking in the nearly two-decade long history of the FDI Confidence Index and likely reflects its business-friendly regulatory environment and improving economic prospects. Europe’s largest economy might also be benefitting from the fallout from Brexit. After holding the number two position for four consecutive years, China falls to third place this year – despite the fact that investors’ outlook for the Chinese economy is much more bullish than it was last year.
Europe’s share of spots on the FDI Confidence Index falls this year, but the five largest European economies all rise in the rankings. The number of European markets in the Index falls for the second year in a row to 11 countries. This is still more than any other region (Asia Pacific is second with eight) but may reflect a downward trend in investor interest in Europe overall. However, many European markets – including the five largest European economies – make gains in the ranking this year. Brexit is a likely motivating factor for some of the gains of continental European countries, as investors may relocate there from the United Kingdom. For instance, Germany rises two spots to rank second (as noted above), Sweden makes the largest positive gain in rank (+7) this year, followed by Italy (+3) and Ireland (+3), and France rises one spot. The United Kingdom also rises one spot, which may suggest that businesses that are currently only in continental Europe may be seeking a presence in the post-Brexit UK market as well.
Developed markets continue to dominate the Index, but their position is weakening. After hitting an all-time high of 80 percent of the 25 spots on the FDI Confidence Index in 2016, developed markets account for only 72 percent of the positions in this year’s Index. Developed markets still dominate as investment destinations, but this year marks a reversal of a five-year trend in which their share of the spots in the FDI Confidence Index rose each year. The flip side of this is that emerging markets are beginning to stage a comeback, accounting for 28 percent of the spots on the 2017 FDI Confidence Index, up from an all-time low of 20 percent last year.
Investors are beginning to diversify their FDI destinations again. The past two years of the FDI Confidence Index have been characterized by a perceived flight to safety in developed markets, particularly in Europe. However, newcomers to the 2017 Index are diverse: the United Arab Emirates (UAE), New Zealand, and South Africa. This marks the inaugural appearance of New Zealand and the first time since 2014 that an African or Middle Eastern country has appeared on the Index. Along with a slight increase in investment intentions in emerging markets generally, this could signal a desire by global investors to diversify the location of their FDI as well as a greater risk appetite than they have had in recent years.
The all-too-visible hand of political risk is on full display in how investors determine where to invest. This year, governance and regulatory issues represent the top three factors – and seven of the top 10 – that investors consider when deciding where to invest. This is a marked contrast from last year, when issues relating to market asset and infrastructure accounted for the top two investor considerations and half of the top 10. This may explain why developed markets continue to dominate the Index, as they are generally perceived to be more secure and have more transparent regulatory environments. However, it may also mean investors are monitoring policy and regulatory developments in developed markets more closely than in the past – in fact, significantly more global investors perceive a more restrictive regulatory environment in a developed market as a likely wild card this year than in the past two years.
FDI continues to be seen as a channel for growth in an environment of weakening global trade flows and increasing protectionism. In the current volatile global environment in which globalization seems to be backsliding, investors continue to see FDI as a primary pillar of their growth strategy. As highlighted in last year’s Index, this is likely because of rising protectionist sentiments creating the need to establish a local presence in key markets. Although the UN Conference on Trade and Development (UNCTAD) estimates that the global flow of FDI fell in 2016, this was from an unusually high level in 2015 because of a few large M&As. The flow in 2016 was significantly above 2014 levels, and a continued upward trend in the global flow of FDI is likely. In fact, 75 percent of investors told us that they plan to increase their FDI in the next three years.
Investors are more bullish on the global economy this year but see rising geopolitical tensions as the top wild-card risk. Sixty percent of global investors are more bullish on the global economy this year than they were last year, a notable increase from the 50 percent who were more optimistic last year than the year before. In particular, global investors are much more optimistic about the economic outlook for the Asia Pacific and Americas regions this year and are also somewhat more optimistic about the Europe and Eurasia regional economic outlook. However, for the third year in a row, increasing geopolitical tensions top investors’ list of likely wild cards.
Find out more in the full report on the A.T. Kearney website.