Prepare for foreign money to dry up

The importance of foreign capital in the economies of major developed nations divides opinion. Critics argue that the flood of money and overseas direct investment into the West, especially from petrodollar states and Asia over the last decade, has distorted asset prices and helped to fund unsustainable deficits.

On the other hand, proponents of the free movement of wealth around the world dismiss these fears as protectionist scaremongering that is detached from the realities of how the global economy works.

Whichever view you take on the role of foreign direct investment, or the free movement of capital, the events of the past year could result in a dramatic reversal in the flows of money from the oil-rich sheikhdoms of the Middle East, Russia and the industrial powerhouse of China.

The collapse in oil prices is now beginning to force even the biggest producers of crude, such as Saudi Arabia, to rethink their economic strategies and their policies of exporting a large share of their oil earnings to the West, either directly through investments or by purchasing government debt.

In China, a stock market crash has wiped billions of dollars off personal fortunes and prompted the Chinese government to directly intervene in order to prevent a full-blown meltdown.

It has in turn unmasked the fragility of Asia’s largest economy, although it remains to be seen whether this will lead to a withdrawal of Chinese investment overseas.

The argument can be made that 2016 will see a dramatic pullback in outward capital flows and investment from all of these countries, as policymakers and investors look to cover their losses.

Of course, this could be a good thing for frothy asset prices in areas such as property in the West.

Cosmopolitan cities from London to Paris and New York have all seen the values of prime real estate pumped up by an unprecedented inflow of capital from the Middle East, Russia and China.

In all of these cases this has distorted property markets and added to a cost of living crisis, which is not just a problem of overheated markets such as the UK.

Beyond the largely superficial implications of potentially fewer Russian, Chinese and Saudi billionaires buying up swaths of Knightsbridge or Mayfair, a more worrying threat is presented to debt markets.

Although this strictly falls under the category of reserve accumulation – and not foreign direct investment – it is still symptomatic of the broader shift under way as the previously fast-growing nations of the last decade look to shore up their slowing economies.

China has already withdrawn $315bn (£205bn) from its foreign currency reserve holdings and is thought to have sold more than $100bn of reserve assets including US Treasurys in the past two weeks, according to Bloomberg.

Saudi Arabia is also thought to have sold Treasurys and this may account for a 1pc drop in the country’s foreign reserves by about $65bn since the fall in oil prices kicked in last year.

In pure foreign direct investment (FDI) terms, the trend is equally worrying. According to the United Nations Conference on Trade and Development, the slowdown in FDI around the world has already begun.

UNCTAD research shows that FDI inflows fell by 16pc to $1.23 trillion in 2014.

This is blamed on the fragility of the global economy, policy uncertainty for investors and elevated geopolitical risks.

Flows into developed economies were hit especially hard, falling by 28pc to $499bn over the same period.

This downward trend is likely to continue this year and beyond as the vast pools of wealth that were created in capital exporters by the era of $100 oil and China’s rapid economic expansion are drained.

The big question for developed economies such as the UK will be how to replace these investment and capital inflows should these sources of wealth dry up.

For some this will be a good thing and lead to a re-pricing of assets, especially in real estate.

However, the counter argument is that the turmoil recently seen on China’s stock markets and the collapsing oil prices will drive even more capital into safe havens such as London’s luxury property and UK gilts, further distorting the imbalances that have already built up to epic proportions in major developed nations.

‘Maybe fewer foreign billionaires will be buying up swaths of Mayfair’