Volatile, but slowly more sustainability-focused investment flows

SDG indicators
Goal 10: Reduced inequalities

Target 10.b: Encourage official development assistance and financial flows, including foreign direct investment, to States where the need is greatest, in particular least developed countries, African countries, small island developing States and landlocked developing countries, in accordance with their national plans and programmes

Indicator 10.b.1: Total resource flows for development, by recipient and donor countries and type of flow


Goal 17: Partnerships for the goals

Target 17.5: Adopt and implement investment promotion regimes for least developed countries

Indicator 17.5.1: Implement investment promotion regimes for LDCs

Half-way through the 2030 Agenda, national policies to create an enabling environment for investments can guide private and public capital flows, including foreign direct investment, towards the achievement of national development objectives and the SDGs -—
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. The financing gap to achieve the SDGs and support long-term economic transformation can only be bridged through the effective mobilization and utilization of the different sources of finance.

These could be found in government borrowing from international development finance institutions, private capital markets and flows, international official support, among others. Different economic flows can have a vastly varying impact on short and long-term sustained development depending on their source, type, and volume. For this reason, financing for development efforts should be aligned with the national development priorities of recipient countries and global efforts to implement the SDGs.

Many developing countries lack the capacity to mobilise sufficient funds due to their inability to borrow affordably for investment. Finding the right mix and adequate terms of financing is key to a lasting effect on individuals, households and communities with the most urgent needs. Challenges are also posed by the vulnerability of many developing countries to the volatility of private capital flows, which has increased in recent years -—
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. The challenge is even more critical when countries graduate to the next income group, lose eligibility for concessional finance (or part thereof), and are instead expected to rely more on private financial markets.

Resource disbursements for development more volatile in recent years

Sufficient financing remains a critical challenge for progress towards the 2030 Agenda. SDG target 10.b seeks to “encourage official development assistance and financial flows, including foreign direct investment, to States where the need is greatest”.

LDCs, LLDCs and SIDS are facing heightened challenges in achieving their development goals (Figure 1). After 2008, total resource flows to LDCs and LLDCs have increased slowly with higher volatility during and after the COVID-19 pandemic: both groups saw the highest values ever recorded in 2020. Regardless of a significant decline since, total resource disbursements were still higher in 2021 than before the COVID-19 pandemic: US$64.4 billion for LDCs and US$37.2 billion for LLDCs. Funding for SIDS is more modest at US$4.2 billion in 2021 with greater volatility around the peak in 2007. Since then, SIDS’ external financing has declined steeply, turning negative1 in 2018 before rebounding somewhat in 2019. The 2020 decline and stagnation of external financing in 2021 was less dramatic for SIDS than for LDCs and LLDCs.

Figure 1. Sharp decline in total resource flows after the COVID-19 pandemic for LDCs and LLDCs; for SIDS the flows remain stagnant
(Billions of current US$, SDG 10.b.1)

Source: UNCTAD calculations based on data from -—
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and -—
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Foreign direct investment to developing economies up by 30 per cent in 2021

FDI flows to developing economies grew by 30 per cent in 2021, to US$837 billion, the highest ever recorded. At the same time, this growth was slower than the growth of FDI to developed regions -—
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. Strong growth was seen in FDI flows to Asia, a partial recovery in Latin America and the Caribbean, and an upswing in Africa. The share of developing countries in global flows remained just above 50 per cent.

FDI together with other external financing flows, ODA and remittances, amounted to 15 per cent or more of total GNI of LDCs, LLDCs and SIDS (Figure 2). In recent years, this share has been decreasing, driven mostly by decreasing FDI or ODA flows. In 2020, however, ODA for LDCs and LLDCs increased substantially followed by a significant drop in 2021. In these groups, this was balanced by the slowly rising share of FDI and remittances. For SIDS, on the other hand, remittances rose sharply during and after the COVID-19 pandemic to more than offset the declining FDI for this group. ODA flows to SIDS also slightly decreased in 2021. Combined financing flows for SIDS stood at 13.9 per cent of GNI in 2021, compared to around 10 per cent just before the pandemic.

Figure 2. Sharp increase in remittances drove an upward trend in SIDS’ external financing after the pandemic
(Percentage of GNI)

Source: UNCTAD calculations based on -—
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and -—
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Note: The ODA figures refer to net ODA

The all-time high of FDI flows to developing economies in 2021 was good news -—
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since FDI inflows are vital for financing development as they are directly linked to the drivers of productive growth and job creation. However, they are not distributed evenly. Rather they tend to concentrate in countries with higher growth prospects, stronger rule of law and respect for contracts, and stable institutions. Moreover, of the three financial flows, FDI shows the highest volatility and an overall downward trend in offering financing for the three country groupings since 2008. For LDCs, however, FDI has been a stable source since 2017, standing at around 2 per cent of GNI.

ODA plays a unique role in supporting global development. In addition to its concessional nature, ODA is the only source of financing available in many cases. Especially in situations of low rentability or high risk, official support can become important for mobilizing additional resources. While ODA has been somewhat less volatile than FDI, it is concerning that ODA has exhibited a slight downward trend for LDCs and LLDCs, except for a temporary rise in 2020. For SIDS, the long-term average for ODA was 2 per cent of GNI until 2020, when it rose to 3.7 per cent and diminished only slightly in 2021. This source of funding is described in greater detail in Official international assistance insufficient to reach 2030 Agenda.

Remittances lack the job creation potential of FDI because they are managed directly by individuals and are mostly directed towards household consumption. Their capacity to raise productive investment is, therefore, limited. However, remittances are an indispensable source of income for many people. Moreover, they represent the most stable inflow at about 4 per cent of GNI in LDCs, LLDCs, and SIDS, with a notable rise to nearly 7 per cent for SIDS in 2021.

Volatility of net private capital flows to developing countries continues

Net private capital flows to developing countries since the 2008 crisis remained extremely volatile (Figure 3), as a reaction to the increasing occurrence of jitters or shocks in global financial markets. The mobilization of these resources was unsurprisingly challenged during the COVID-19 pandemic. Expansionary monetary policies in the North, alongside measures from the international community, such as the G20 Debt Suspension Initiative and the allocation of new SDRs by the IMF, managed to eventually contain the huge capital flight of the first quarter of 2020. The emergence of new COVID-19 variants, looming inflation and prospects for tightening of monetary conditions in the United States of America led net private capital flows to developing countries to plummet in 2021. In 2022, however, despite earlier projections of cascading effects to a world economy due to the war in Ukraine, compounded with the COVID-19 pandemic and climate change -—
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, the net private capital flows to developing countries recovered and reached a positive value for the first time in the last six years: US$37.7 billion.

Net private capital flows experienced a positive surge in the last quarter of 2022, driven by several factors. The anticipation of a lower terminal interest rate by the US Federal Reserve, following a decrease in inflationary pressures in the United States of America, led to significant inflows of capital. Additionally, investors were increasingly flocking to emerging market stocks and bonds due to expectations over falling global inflation and the reopening of China's vast economy. With key economic uncertainties lifting, the stage is set for further inflow rebounds in 2023 -—
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Figure 3. Net private capital flows to developing countries recovered after the COVID-19 pandemic and are now positive
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Outward investment promotion instruments increasingly integrate sustainability criteria

SDG target 17.5 encourages countries to promote investment for LDCs. Although most outward FDI promotion regimes do not prioritize certain destination countries over others, a selected number of investment instruments from national promotion regimes limit their eligibility to investments made in developing countries. In 2022, at least 9 countries had implemented policies that specifically promote outward investment in developing countries, including LDCs (Austria, Denmark, Germany, Japan, Netherlands, Norway, Portugal, United Kingdom, United States of America).

As a custodian of SDG indicator 17.5.1, on investment promotion regimes for developing countries, including LDCs, UNCTAD carries out an annual survey of countries. In this survey, -—
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identified 32 countries that provide for at least one type of instrument for promoting OFDI in developing countries, including LDCs (Figure 4). Almost one-third of them are developing economies (e.g., Brazil, Chile, China, India), which is consistent with the trend of increasing South-South FDI inflows. The most common policy instruments are investment guarantees or insurance policies (22 countries), but countries also provide loans for the internationalization of local companies (17), state-sponsored programmes providing equity participation in investment projects abroad (14). In addition, at least 17 countries offer investment facilitation tools to promote FDI in developing countries including LDCs. Some countries provide for all four types of investment promotion instruments (e.g., France, Poland, United States of America).

Figure 4. Outward FDI promotion schemes towards developing countries, including LDCs, are predominantly provided by developed countries
(Number of countries, SDG 17.5.1)

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A novel aspect of OFDI promotion schemes for developing countries, including LDCs, is the inclusion of sustainability considerations among the eligibility criteria for accessing the schemes. Accordingly, several outward investment promotion schemes require the proposed investment project to generate positive economic, social and/or environmental impact in the host country, which may include specific ESG criteria. Non-binding guidelines by international organizations, such as the OECD’s “Common Approaches” -—
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, or industry-based frameworks for risk management, such as the Equator Principles -—
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, are often used for the sustainability assessment of proposed investments benefitting from OFDI promotion (e.g., in Australia). In some countries, sustainable investment is also promoted by offering more beneficial conditions for investment projects aligned with the objectives of the Paris Agreement (e.g., Spain).

Conversely, some countries have created exclusion lists to ban OFDI promotion support for certain sectors or economic activities deemed incompatible with sustainability or ESG. For example, in Denmark, the -—
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has extended, since 2022, its exclusion list to fossil fuel as well as other non-sustainable industries such as “export-oriented agribusiness models that focus on long-haul air cargo for commercialization” or “biomaterials and biofuel production that makes use of feedstock that could otherwise meaningfully serve as food or compromise food security”.

Alternatively, creating schemes targeting specific sustainable development objectives, Norway has launched a new investment guarantee scheme -—
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, in partnership with MIGA, to mitigate non-commercial risks involved in FDI in renewable energy projects in developing countries. This scheme is targeting specifically renewable energy investments and aims to increase decarbonization in developing countries.

A long way towards aligning global investment flows with SDGs

The need for investment in SDGs, productive capacity, and climate mitigation and adaptation is pressing. UNCTAD’s World Investment Report -—
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finds that although global FDI flows rebounded strongly in 2021, industrial investment remains weak and well below pre-pandemic levels, especially in the poorest countries. It also notes that SDG investment, in areas such as infrastructure, food security, water and sanitation, and health, is growing but not enough to reach the goals by 2030. The data show that investment in climate change mitigation, especially renewables, is booming but most of it remains in developed countries and adaptation investment continues to lag. There is a need for more targeted information on the costs of achieving SDGs to identify investment areas that can accelerate progress across multiple SDGs. First insights in this direction are discussed in this years’ In-Focus (SDGs costing) with UNCTAD’s cost estimates of SDG transition pathways, developed as a contribution to a UN-wide effort. In addition, the World Investment Report (UNCTAD, 2023) will provide an assessment of investment gaps by SDG investment areas which link SDGs to traditional investment sectors to facilitate alignment of efforts.

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estimates that the value of sustainability-themed investment products reached US$5.2 trillion in 2021, up by 63 per cent from 2020. These investment products include sustainable funds (US$2.7 trillion), green bonds (over US$1.5 trillion outstanding), social bonds (US$418 billion), mixed-sustainability bonds (US$408 billion) and sustainability-linked bonds (US$105 billion). Most of these, however, are domiciled in developed countries and targeted at assets in developed markets. Moreover, the war in Ukraine led to disruptions in the energy markets (Resilience at risk), with fears of setbacks in the energy transition, and increased fossil fuel production. Challenges in aligning global investment flows with SDGs remain to be fully addressed.

Notes

  1. Values refer to net disbursements.

References

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