As investors diversify, emerging markets rebound in FDI index, which excludes Turkey
Anew study from the consultancy firm A.T. Kearney shows that emerging markets rebounded last year in foreign direct investment.
According to the Foreign Direct Investment Confidence Index for 2017, emerging markets accounted for 28 percent of positions this year, from a historical low of 20 percent last year. This could signal a nascent trend of global investors increasing their risk tolerance and eyeing emerging markets for growth opportunities.
The top two emerging-market performers on the index are China and India, and these are also the two markets whose economic prospects investors are most optimistic about, compared with a year ago.
Investors are more mixed on the economic outlooks of other emerging markets, which could mean that weaker economies are seen as opportunities, in terms of the price of making investments, now or in the long-term, rather than as shortterm growth opportunities. Turkey did not rank in the Top 25 of FDI destinations.
Another notable characteristic of this year’s index is the shifting fortunes of European markets. As was the case last year, the only European countries in the top 25 are developed markets. However, European markets account for most of the entries that fell off the index this year. And it appears that investors are planning to shift some of their operations within Europe, possibly because of Brexit.
Such calculations could have contributed to Germany’s rise to second place this year, as well as Swe- den making the largest positive gain in rank, up seven places on the 2017 index. The next two largest gains in terms were made by Italy and Ireland, both up three places, suggesting these may be other Brexit winners in terms of attracting FDI.
However, Britain rose one notch, which could indicate that businesses that are currently only in continental Europe may be seeking a foothold in the British market as well. Meanwhile, Belgium suffered the second-largest drop in rankings this year, down three notches, and Switzerland fell one spot.
Other countries also experienced declines in this year’s index. The largest drop was seen in Brazil, moving down four spots, which is continuing its two-year slide from sixth in 2015 to 16th in 2017. After Belgium, the next two largest declines were Canada and Australia, both down two places.
The countries that were on the index last year but do not appear this year are Denmark, Norway and Taiwan. Newcomers are diverse: the United Arab Emirates,
New Zealand and South Africa. This marks New Zealand’s first appearance, while the UAE and South Africa are returning after a two-year absence.
The UAE and South Africa’s entry also mark the first time since 2014 that an African and Middle Eastern country appeared among the Top 25. Along with a slight shift toward investing in emerging markets overall, the variety of newcomers this year could signal a desire by investors to diversify their FDI holdings more in the coming years.
Overall, this year’s index scores indicate greater diversity in FDI targets than last year. While the average score reached a multiyear low of only 1.56 in 2016, it rebounded to 1.61 this year.
In addition, the gap between the top-ranked United States and the second-ranked country, Germany narrowed slightly this year, as did the gap between scores of the United States and South Africa, the country ranked 25th on the index.
The higher average score and the tighter clustering of scores in the index both point to global investors seeing stronger FDI prospects in a wider variety of markets than last year.
Risk tolerance a primary factor
The availability of quality investment targets is the most oft-cited reason to increase investments, followed by the macroeconomic environment. These two factors could be related, as slow economic growth in recent years may have made some high-quality targets vulnerable to takeovers because of weaker performance, while lower FDI levels since the 2008 global financial crisis may have created a backlog of potential investments. Investors also point to an availability of funds motivating their decision to increase FDI, which could signal a forthcoming rebound in business more generally.
It is also notable that risk tolerance is a primary factor driving FDI in the coming years, as this relates to the incipient shift back to emerging markets as investment destinations as well as an overall diversification in the markets where companies plan to invest.
Consistent with previous years, investors are still most interested in developed and emerging markets, with 78 and 75 percent of investors planning to maintain or seek new investments in these types of markets respectively. Frontier markets remain somewhat less popu- lar, with only 69 percent of investors planning to maintain or seek new investments there.
While almost one in five investors are seeking to divest from frontier markets, the same proportion are seeking new opportunities in these markets. This suggests there will likely continue to be considerable churn as some companies land on winning strategies while others struggle to succeed in these more challenging consumer and regulatory environments. Among investors that are already in or are seeking investments in each type of market, selling into the market is the most popular form of investment across asset classes. However, investors prefer producing in emerging markets (48 percent) and, somewhat surprisingly, sourcing from developed markets (45 percent).
More attention to governance
According to the report, more broadly the all-too-visible hand of political risk is on full display in terms of the factors that investors evaluate when determining where to make investments. Governance and regulatory issues account for the top three factors – as well as seven of the top 10 – in terms of factors that determine which markets appeal to investors. This contrasts starkly with last year’s results, in which market asset and infrastructure factors held the top two spots and half of the top 10.
Investors’ heightened attention to governance and regulatory factors helps to explain why developed markets continue to perform well in the index, as these markets tend to have the most stable security environments and the most transparent regulatory and taxation environments. However, this focus on governance also suggests investors will be closely monitoring developments in the United States and Europe for signs of populism and protectionism creating a deterioration of FDI environments.
Three-fourth of investors believe FDI will drive profitability and competitiveness in the next three years. It is also indicative of the apparent strategy of companies to continue globalizing, even in a low-trade and increasingly protectionist environment. Investors may actually see FDI as a safeguard against nationalist and protectionist policies, as it gives them a presence in local markets and thus makes them more immune to increasing populist sentiments.