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MNC Operations in Emerging Markets: Post-Crisis Adjustments of FDI Inflows in China and Russia
In this emerging market brief, we conclude that the financial crisis, which resulted in tighter credit and slowed down overall investment activity worldwide, has been the driving force behind the falling FDI into emerging markets, including into both Russia and China. The decline of FDI inflows into China can be attributed to three factors. First, tight credit caused by the global crisis. Second, part of the profits or cash reserves generated by MNCs in China has been redirected to support troubled parent companies, instead of being reinvested in the country. Third, the once-guaranteed appreciation of Chinese currency, yuan, has slowed down since the start of the crisis, which, as a result, has removed one of the key incentives of FDI by MNCs in China. The decline of FDI inflows into Russia can be largely attributed to the sharp decrease of commodity prices and personal wealth.
To counteract the negative effects of the crisis, some countries tried to boost FDI inflows via government policies. In China, for instance, the government instituted FDI-enhancing measures on both local and regional level. In addition, in November, 2008 the government unveiled a $586 billion stimulus package meant to stimulate the economy and adjusted policies to attract foreign investment, which included relaxing and decentralizing the regulations on foreign investment (e.g. local governments are now authorized to approve foreign investment projects worth up to $100 million without seeking ministry-level approval). In Russia, where the government’s behavior towards FDI inflows has always been an ambivalent mix of protectionist mistrust and willingness to attract more investment, the government instituted various incentives meant to attract FDI into certain sectors, such as energy generation and automotive manufacturing. Going forward, the government, at both federal and regional levels, will continue to play a key role in driving FDI dynamics in Russia. More recently, both President Medvedev and Prime Minister Putin stated their support for FDI-enhancing policies. It is yet to be seen, however, whether it proves true in practice.
Today, multinational firms are holding back on investment in emerging markets due to risk aversion, capital constraints and tight access to credit. In China, FDI inflows fell by about 17 percent in the first half of 2009 year on year. In Russia, the global financial crisis has pushed FDI downward significantly. According to the Central Bank of Russia, FDI inflows dropped by more than half in the first quarter of 2009 compared to the same period a year ago, from $21 billion to barely $10 billion overall and from $14 billion to just $5.5 billion in the non-financial sector.
With respect to the source countries and regions, the crisis did not result in any major shifts. China still receives the majority of FDI inflows from a number of tax haven countries, including the British Virgin Islands, Cayman Islands, West Samoa, and Mauritius. In 2008, FDI inflow from these tax haven countries totaled $24.40 billion, accounting for 26.41 percent of the total FDI utilized in China. In Russia, most FDI comes from the countries in European Union (EU), with low-tax jurisdictions, such as Luxembourg and Cyprus as well as the Netherlands, Germany, and Britain, which gave up its leading role as a source for inward FDI into Russia prior to the crisis, but has now been surpassed by the Netherlands and Japan.
Impact of the Global Financial Crisis on FDI
Although China absorbed a record of $92.4 billion in FDI inflows in 2008, the growth rate of monthly FDI inflows (on a year-to-year basis) actually turned into negative in the fourth quarter of the year. This trend continues in 2009. Up to June 2009, FDI inflows to China have experienced negative growth for the nine consecutive months. China absorbed only $43 billion in FDI during the first half of 2009, representing a 17% decrease from the first half of 2008.
The global financial crisis has pushed FDI in Russia downward significantly. According to the Central Bank, FDI inflows dropped by more than half in the first quarter of 2009 compared to the same period a year ago, from overall and from $14 billion to just $5.5 billion in the non-financial sector.
To some extent, this drop can be explained by the fact that new construction comes significantly cheaper this year than in the first half of 2008. However, the most important factor is the much lower attractiveness of investment projects in Russia due to a much bleaker economic forecast.
MNC Reactions and Adaptations
Many MNCs have adjusted their investment strategies as a result of the global financial crisis. FDI inflows to Russia in the first quarter of 2009 largely went into projects already started. Few major new projects were started.
Some sectors suffered more than others. For instance, in Russia the retail and whole sale sector experienced the biggest change. Overall, FDI in the Russian retail and wholesale sector dropped to 22% of the total in the first quarter of 2009 from 39% two years earlier . This drop is probably due to falling consumer income and increasing competition, both of which have a negative impact on profit margins.
In China, where many MNCs chose localization strategy as a result of the crisis, may local firms will face greater competition. With the increasing importance of the Chinese market, the relaxed government regulations about M&As by foreign firms, and the intention of MNCs to increase their market share and become industry leaders, secondary local Chinese firms are more likely to become acquisition targets of foreign firms. Finally, the acceleration of localization by MNCs can also create many opportunities for local Chinese firms, particularly those in the supporting industries.