Political and Economic Uncertainties Trail Foreign Direct Investments Across Nations

The world is facing unprecedented challenges in the wake of the COVID-19 pandemic, which has disrupted the global economy and trade. One of the most affected sectors is foreign direct investment (FDI), which refers to the cross-border flow of capital from one country to another for the purpose of establishing, acquiring, or expanding a business. FDI is a key driver of economic growth, innovation, and job creation, especially in developing and emerging markets.

However, FDI has been severely hit by the political and economic uncertainties that have trailed the pandemic, as well as other factors such as trade tensions, geopolitical risks, and regulatory changes.

The world is facing unprecedented challenges in the wake of the COVID-19 pandemic, which has disrupted global trade, supply chains, and investment flows. One of the most visible impacts of the crisis has been the decline in foreign direct investment (FDI), which is a key driver of economic growth, innovation, and development.

According to the latest report by the United Nations Conference on Trade and Development (UNCTAD), global FDI flows fell by 35% in 2023, reaching their lowest level since 2005. The decline was more pronounced in developed countries, where FDI plunged by 58%, while developing countries saw a smaller drop of 8%. However, the outlook for FDI recovery remains uncertain, as many factors continue to weigh on investor confidence and decision-making.

One of the main factors affecting FDI is the political and economic uncertainty that prevails in many regions and countries. Political uncertainty refers to the unpredictability of government policies, regulations, and institutions that affect the business environment and the protection of investors’ rights. Economic uncertainty refers to the volatility of macroeconomic indicators, such as growth, inflation, exchange rates, and fiscal balances, that affect the profitability and risk of investments.

Political and economic uncertainties can have both direct and indirect effects on FDI. Direct effects occur when uncertainties deter or delay investors from entering or expanding their operations in a host country, or when they prompt investors to exit or divest from a host country. Indirect effects occur when uncertainties affect the overall economic performance and stability of a host country, which in turn affects its attractiveness for FDI.

Some examples of political and economic uncertainties that have affected FDI in recent years are:

• The trade tensions and disputes between major economies, such as the US-China trade war, which have increased tariffs, non-tariff barriers, and geopolitical risks for cross-border investments.

• The Brexit process and its implications for the future relationship between the UK and the EU, which have created legal and regulatory uncertainties for investors operating in or through these markets.

• The social unrest and political instability in several countries, such as Hong Kong, Chile, Lebanon, Belarus, Myanmar, and Ethiopia, which have disrupted economic activity and raised security concerns for investors.

• The debt crisis and fiscal challenges in some emerging markets, such as Argentina, Turkey, South Africa, and Zambia, which have increased the risk of default, currency depreciation, and inflation for investors.

• The environmental and climate change issues that pose physical and transition risks for investors in sectors such as energy, mining, agriculture, and tourism.

These uncertainties have not only reduced the volume of FDI flows, but also changed their composition and direction. For instance, UNCTAD reports that greenfield investment projects, which involve the creation of new productive assets and jobs, declined by 42% in 2020, while cross-border mergers and acquisitions (M&As), which involve the transfer of existing assets and ownership, increased by 10%. This suggests that investors are more interested in acquiring existing assets at lower prices than in undertaking new investments with higher risks.

However, FDI is also subject to various risks and uncertainties, especially in times of crisis. Political and economic uncertainties can deter investors from committing their resources to long-term projects in foreign markets. Some of the factors that can influence FDI decisions are:

Political stability and security: Investors prefer to operate in countries that have stable and predictable political systems, respect for the rule of law, and protection of property rights. Political instability, violence, corruption, and policy changes can increase the costs and risks of doing business abroad.

Economic performance and outlook: Investors are attracted by countries that have strong and resilient economies, with high growth potential, low inflation, and sound fiscal and monetary policies. Economic downturns, recessions, currency fluctuations, and debt crises can reduce the profitability and viability of FDI projects.

Trade and investment policies: Investors seek to benefit from favorable trade and investment regimes that facilitate market access, reduce tariffs and non-tariff barriers, and provide incentives and guarantees for FDI. Trade and investment disputes, protectionism, sanctions, and regulatory changes can hamper FDI flows and create uncertainty for investors.

Global and regional dynamics: Investors are influenced by the trends and developments in the global and regional markets, as well as by the actions and reactions of other actors. Global shocks, such as pandemics, natural disasters, wars, or terrorist attacks, can disrupt FDI flows and supply chains. Regional integration or disintegration, such as Brexit or the US-China trade war, can create opportunities or challenges for FDI.

Given these factors, it is not surprising that FDI has been severely affected by the COVID-19 pandemic. According to the United Nations Conference on Trade and Development (UNCTAD), global FDI flows declined by 35% in 2020, reaching their lowest level since 2005. The decline was more pronounced in developed countries (-58%) than in developing countries (-8%), reflecting the uneven impact of the pandemic across regions. The sectors that suffered the most were tourism, hospitality, transport, and manufacturing.

The outlook for FDI recovery remains uncertain and depends on several factors, such as the pace and effectiveness of vaccination campaigns, the extent and duration of lockdown measures, the availability and distribution of fiscal stimulus packages, the evolution of trade tensions and geopolitical conflicts, and the adoption of digital technologies and green transitions. UNCTAD projects that global FDI flows will increase by 10-15% in 2021 but will still remain well below their pre-pandemic levels.

In this context, it is crucial for policymakers to adopt measures that can enhance the attractiveness and resilience of their countries for FDI. Some of the possible actions are:

Strengthening political stability and security: Policymakers should foster dialogue and cooperation among different stakeholders, including governments, businesses, civil society, and international organizations. They should also address the root causes of conflict and violence, such as poverty, inequality, discrimination, and human rights violations.

Improving economic performance and outlook: Policymakers should implement policies that can boost economic growth and development, such as investing in infrastructure, education, health care, and innovation. They should also pursue sound fiscal and monetary policies that can maintain macroeconomic stability and sustainability.

Enhancing trade and investment policies: Policymakers should promote trade liberalization and integration through multilateral or regional agreements that can expand market access and reduce barriers for FDI. They should also provide incentives and guarantees for FDI that are transparent, consistent, and non-discriminatory.

Leveraging global and regional dynamics: Policymakers should monitor and anticipate the trends and developments in the global and regional markets, as well as the actions and reactions of other actors. They should also seek to cooperate and coordinate with other countries on issues of common interest, such as pandemic response, climate change, cybersecurity, and human rights. By taking these measures, policymakers can create a more conducive environment for FDI, which can contribute to economic recovery and development in the post-pandemic era.