Volatile, but slowly more sustainability-focused investment flows
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 investmentForeign Direct Investment (FDI) is an investment involving a long-term relationship and reflecting a lasting interest and control by a resident entity in one economy (foreign direct investor or parent enterprise) in an enterprise resident in an economy other than that of the foreign direct investor (FDI enterprise or affiliate enterprise or foreign affiliate) -—
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—-., towards the achievement of national development objectives and the SDGsSustainable Development Goal -—
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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. SDGSustainable Development Goal target 10.b seeks to “encourage official development assistanceOfficial Development Assistance (ODA) are resource flows to countries and territories which are: (a) undertaken by the official sector; (b) with promotion of economic development and welfare as the main objective; (c) at concessional financial terms (implying a minimum grant element depending on the recipient country and the type of loan). In addition to financial flows, technical co-operation is also included -—
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—-. and financial flows, including foreign direct investment, to States where the need is greatest”.
LDCsLeast developed country, LLDCsLandlocked developing country and SIDSSmall island developing states (SIDS) were recognized as a distinct group of developing countries at the Earth Summit in Rio de Janeiro in June 1992. More information on UNCTAD official page. are facing heightened challenges in achieving their development goals (Figure 1). After 2008, total resource flowsIn the context of the IAEG-SDG, these flows quantify the overall expenditures that donors provide to developing countries, including official and private flows, both concessional and non-concessional. Specifically, they include ODA, OOFs and private flows -—
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—-. to LDCs and LLDCs have increased slowly with higher volatility during and after the COVID-19COVID-19 is an infectious disease caused by the strain of coronavirus SARS-CoV-2 discovered in December 2019. Coronaviruses are a large family of viruses which may cause illness in animals or humans. In humans, several coronaviruses are known to cause respiratory infections ranging from the common cold to more severe diseases such as Middle East Respiratory Syndrome (MERS) and Severe Acute Respiratory Syndrome (SARS). The most recently discovered coronavirus causes coronavirus disease COVID-19 -—
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—-. pandemicCommonly described by the WHO as ‘the worldwide spread of a new disease’, no strict definition is provided. In 2009, they set out the basic requirements for a pandemic: • New virus emerges in humans
• Minimal or no population immunity
• Causes serious illness; high morbidity/mortality
• Spreads easily from person to person
• Global outbreak of disease.
The US Centre for Disease Control uses a similar approach, but with a reduced set of criteria. It is very difficult to gauge whether the spread of a disease should be termed an outbreak, epidemic or pandemic. In other words, when to declare a pandemic isn’t a black and white decision -—
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—-.: 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.
Source: UNCTAD calculations based on data from -—
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Foreign direct investment to developing economies up by 30 per cent in 2021
FDIForeign Direct Investment (FDI) is an investment involving a long-term relationship and reflecting a lasting interest and control by a resident entity in one economy (foreign direct investor or parent enterprise) in an enterprise resident in an economy other than that of the foreign direct investor (FDI enterprise or affiliate enterprise or foreign affiliate) -—
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—-. 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, ODAOfficial Development Assistance (ODA) are resource flows to countries and territories which are: (a) undertaken by the official sector; (b) with promotion of economic development and welfare as the main objective; (c) at concessional financial terms (implying a minimum grant element depending on the recipient country and the type of loan). In addition to financial flows, technical co-operation is also included -—
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—-. and remittancesThe term remittances can refer to three concepts, each encompassing the previous one. “Personal remittances” are defined as current and capital transfers in cash or in kind between resident households and non-resident households, plus net compensation of employees working abroad. “Total remittances” include personal remittances plus social benefits from abroad, such as benefits payable under social security or pension funds. “Total remittances and transfers to non-profit institutions serving households (NPISHs)” includes all cross-borders transfers benefiting household directly (total remittances) or indirectly (through NPISHs) -—
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—-., amounted to 15 per cent or more of total GNIGross national income 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.
Source: UNCTAD calculations based on -—
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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 flowsNet private capital flows include net FDI, net portfolio investment and net other investment, as defined in the balance of payments. 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 G20Group of Twenty Debt Suspension Initiative and the allocation of new SDRsSpecial Drawing Rights (SDR) -—
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—- by the IMFInternational Monetary Fund, 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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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 OFDIOutward foreign direct investment 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-SouthBroad framework of collaboration among countries of the Global South in the political, economic, social, cultural, environmental and technical domains. It includes trade, FDI, regional integration efforts, technology transfers, sharing of solutions and experts, and other forms. Involving two or more developing countries, it can take place on a bilateral, regional, intraregional or interregional basis -—
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—-. 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).
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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 ESGEnvironmental, social and governance criteria. Non-binding guidelines by international organizations, such as the OECD’s “Common Approaches” -—
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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 guaranteeAn insurance, offered by governments or other institutions, to investors to protect against certain political risks in host countries, such as the risk of discrimination, expropriation, transfer restrictions or breach of contract (UNCTAD, 2015). -—
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—-, in partnership with MIGAMultilateral Investment Guarantee Agency, 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 capacityUNCTAD defines productive capacities as consisting of the productive resources, entrepreneurial capabilities and production linkages that together determine a country’s ability to produce goods and services that will help it grow and develop -—
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—-, 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
- Values refer to net disbursements.
References
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