News: Indian FDI, FII inflows may slow down

(DNA 04/06/2006) New Delhi - If you think 2006 has been a bad year - so far - for foreign investor inflows, you are in for more bad news. According to the World Bank’s Global Development Finance report for 2006, even 2007 may not be a great year for foreign private capital flows to developing countries.

The report says the outlook for 2007 would be mixed, with both foreign direct investment (FDI) and foreign institutional investment (FII) inflows being subdued, though they will continue to grow.

Equity markets in developing countries would be better placed than those in developed countries in 2006-07, the report admits.

This is because of fundamental macroeconomic improvements and the prospects of growth above 5%. However, the pace will not be as frenetic as in 2005.

That year, portfolio equity flows to developing countries rose a mammoth 64% to $61 billion from $37 billion in 2004, thanks to sound fundamentals. Three countries - China, India and Thailand - together accounted for 94% of equity flows into Asia, which itself pulled in the lion’s share of 63% of equity flows. Most of these were in the form of international corporate equity placements in emerging markets and foreign investment in emerging market stocks.

Stockmarkets in emerging markets did far better than in other regions through 2005, on the back of an expanded investor base and attractive valuations, with 10% of the transactions accounting for 64% of the total volume, the report noted.

The bulk - 63% — of equity transactions in emerging markets were in the form of initial public offers (IPOs) against 47% in 2004. China took the lion’s share - 21% of global IPOs and 61% of those in emerging markets.

FDI inflows into developing countries also logged robust growth, touching what the report calls a record level of $237.5 billion, which accounts for 2.8% of the aggregate gross domestic product (GDP) of developing countries.

But there has been some change in the pattern of FDI flows. The share of the top 10 countries fell from 75% in the late 1990s to 65% in 2005. The 10 countries are China, India, Russia, Brazil, Mexico, Czech Republic, Poland, Chile, South Africa and Malaysia. The share of low-income countries, on the other hand, increased to 10%.

An interesting trend the report points to is increasing FDI flows among developing countries. South-South FDI, the report notes, increased from $14 billion in 1995 to $47 billion in 2003, while the share of such flows in total FDI to developing countries rose from 16% to 36% over the same period. In fact, Brazil, Chile, India, China, South Africa and Thailand are now giving aid to other developing countries.

What’s driving the financial integration of developing countries is being driven by increased opening up of economies as well as the growing number of regional trade agreements.

What needs to be done to keep these greenbacks flowing in? Ensuring macroeconomic stability is the first and most important step, the report cautions. In addition, domestic financial markets and institutions need to be strengthened to cope more effectively with the risks associated with growing capital flows and to maximize the efficiency of capital allocation.