China sets another foreign investment record in 1997,
but a decline now seems probable,
according to UNCTAD's World Investment Report 1998

Important changes are emerging in foreign direct investment (FDI) across the Asian and Pacific region. They are attributable to the current financial crisis, changing approaches by European corporations, and critical developments that call into question the sustainability of China's inward investment boom, according to the World Investment Report 1998: Trends and Determinants (WIR98), released today by the United Nations Conference on Trade and Development (UNCTAD).

In 1997, FDI to China reached a record US$45.3 billion (US$40.8 billion in 1996), accounting for almost one-third of total FDI to all developing countries, but a moderation in flows to China now seems probable. More generally for the region, today's report highlights new FDI trends. These include:

• European transnational corporations (TNCs), having largely neglected Asia until recently, are now taking an active interest in the region. The current financial crisis provides some immediate opportunities for European firms, as well as others, to enter the Asian market or expand existing operations there.
• The financial crisis has curbed the capacity of many Asian TNCs to invest elsewhere in the region.
• Increasing FDI flows to the region are being directed to the services sector, notably banking, insurance and telecommunications. The restructuring of certain service industries in some of the countries affected by the crisis is providing opportunities for foreign investors.
• Mergers and acquisitions (M&As) are becoming increasingly important in FDI to Asia; majority foreign sales more than tripled in 1997 from 1996 with a rise to US$13 billion from US$4 billion.

Key FDI data for Asia regions

FDI into Asia and the Pacific reached a formidable US$87 billion in 1997 (US$80 billion in 1996), while FDI outflows from the region rose to US$51 billion (US$46 billion). More than 90 per cent of the FDI inflows and outflows in 1997 were accounted for by East and South-East Asia. China and Hong Kong, China alone accounted for US$48 billion of the inflows and for US$28.5 billion of the outflows, according to WIR98.

Substantial FDI flows to the East and South-East Asia region appear to be in prospect this year, despite the financial crisis (See TAD/INF2763) and a probable moderation in the volume flowing to China. WIR98 notes, for example, that "one reason why inflows of FDI to the crisis-affected countries could be expected to increase in the short and medium term is the decrease in the costs, for all firms, of establishing and expanding production facilities in these countries."

A number of large mergers and acquisitions have been seen in the 5 most affected economies (Indonesia, Republic of Korea, Malaysia, Philippines, Thailand) since the turmoil began. Overall, the value of M&As as a percentage of FDI flows into these 5 countries has been relatively low as compared to that for Latin America, but higher than that for Asia as a whole.

South Asia leaps forward

FDI flows to South Asia rose to another record level in 1997 of about US$4.4 billion (US$3.3 billion in 1996), mostly reflecting a 37 per cent gain in flows to India.

While the Indian volume is rising rapidly, it remains, for example, less than the FDI flows to much smaller economies such as Chile. Today's report stresses that India has the potential to secure very significant gains in FDI. Flows to the other economies in the region remain low. FDI into Pakistan has stagnated for some years, due to administrative bottlenecks and weak economic conditions.

Flows to West and Central Asia

FDI flows to Central Asia rose to US$2.4 billion in 1997, with 80 per cent going to Kazakhstan and Azerbaijan, largely because investment in the region's burgeoning oil industry. The Republic of Korea was the largest foreign investor in the region, followed by the United States and the United Kingdom.

WIR98 highlights the potential, but also notes that FDI faces many problems in Central Asia, "such as the low transparency of privatization programmes, the unreliable information on investment projects, the uncertainty in legal matters and, in some countries, the inconvertibility of currencies."

FDI into West Asia rose last year to US$1.9 billion from US$300 million in the previous year and UNCTAD states that the potential for FDI gains exists in a number of areas other than oil and gas, such as petrochemicals, agriculture, agro-processing, tourism and infrastructure.

Pacific Islands

Finally, the report notes a substantial gain in FDI flows last year to the island economies of the Pacific. But it points out that, given their narrow production base, the absorptive capacity for FDI is limited. Total FDI into this area rose to US$378 million in 1997 from US$190 million in 1996. Papua New Guinea saw its FDI inflows triple, to US$300 million from US$111 million in the previous year. Vanuatu attracted US$30 million, compared to US$28 million in 1996.

China's FDI boom

WIR98 concludes that a decline in FDI flows to China in the short run is likely. There are a wide array of factors leading to this conclusion:

Weakness in some of the economies that are the prime sources of FDI to China, such as Hong Kong, China; Japan; the Republic of Korea; Thailand and Malaysia;

• recent data on FDI approvals in China show a significant reduction from past record levels;
• a slowing in China's economic growth may weaken market-seeking FDI;
• massive past FDI inflows may have resulted in some excessive capacity in some industries in China;
• competition in the coastal area for sales in the domestic market may be undermining profits;
• wage increases and eroding incentives for FDI in some areas of China that have received a great deal of past FDI may lead to a moderation in inflows; and,
• China's price competitiveness relative to some other Asian countries has declined.

Outward FDI prospects

The leading TNCs in Asia are important foreign investors, especially in the region. They invest both in the more developed Asian countries and in some of the very poorest. For the most part the focus is on greenfield investments, although M&A activity is rising.

WIR98 reports that the overall growth of outward FDI on the part of the Asian economies has been partly offset by a considerable reduction of outflows from Malaysia, Thailand and the Republic of Korea. TNCs from these countries have been affected by the financial crisis, and a particularly significant decline is being seen on the parts of TNCs from the Republic of Korea with their outflows to the United States falling by 69 per cent and to Europe by 37 per cent.

Indonesia's sharp jump was exceptional, due to a substantial investment in the oil industry of Kazaksthan.

WIR98 concludes that FDI outflows from developing Asia can be expected to remain at low levels in the short and perhaps the medium term.