**Since the 2008-09 global financial crises, developing countries’ increasing importance has become even more pronounced in global FDI flows—both inward and outward.** Stress in global financial markets, risk aversion, and uncertain profits made it more difficult to finance M&A across the globe. In this tough environment, FDI inflows actually contracted more in developed countries than in developing ones. In 2007-09, developed counties’ inward FDI flows declined 53.9 percent, while flows to the developing countries fell by only 12.3 percent.<sup>7</sup>

**To a large extent, trends in global outward FDI flows mirror inward FDI flows.** Outward flows from developed countries experienced a 46.2 percent decline in 2007-10. Outward FDI flows from developing countries also fell over the same period—but by just 8 percent. While FDI outflows have slowly begun to recover globally, they bounced back quite strongly in developing countries and reached 21 percent of total world FDI at the start of 2011.

# **_The Global Context: Despite Fast Growth, South Asia’s FDI Is Low_**

**South Asia’s FDI inflows as a share of GDP are among the lowest of all developing regions and can be a good case study to examine for other regions and countries confronting low FDI.**<sup>8</sup> South Asia is one of the world’s fastest growing regions, averaging 6.7 percent annual increases in real GDP over the past decade (Figure 4, left).<sup>9</sup> However, South Asia’s FDI inflows as a share of GDP are the lowest of all developing regions, averaging less than 2 percent in 2000-11 (Figure 4, right).<sup>10</sup> Although the gap had been narrowing, it reversed somewhat after the global crisis. South Asia’s economy is almost twice as large as Sub-Saharan Africa’s; yet over the 2000-11 decade, South Asia’s average annual inward FDI flow of US$18.3 billion was smaller than Sub-Saharan Africa’s US$19.4 billion.

> 7 In this report, developing economies include both developing and transitional economies as defined in UNCTAD. 8 “FDI inflows” are defined as net investments in domestic firms by foreigners.  This is a different concept then “net” FDI (net investment in domestic firms by foreigners minus the net purchases of foreign firms by domestic agents).  (Broner, et al. August 2011) find that “gross” capital flows tend to be more volatile than “net” capital flows.  When foreigners invest in a country, domestic agents tend to invest abroad, and vice versa.  Gross capital flows are also pro-cyclical, with foreigners investing more in the country and domestic agents investing more abroad during expansions.  During crises, especially during severe ones, there is a retrenchment in both capital inflows by foreigners and capital outflows by domestic agents.  Research has shown that a financial crisis is associated with the exit of investors; however, such crises are equally consistent with an inflow of foreign capital in the form of M&A, dubbed “fire-sale FDI” by (Aguiar and Gopinath 2005). After noting that foreign acquisitions increased by 90 percent in the East Asian crisis 1996-98, Aguiar and Gopinath provide an explanation for FDI’s puzzling stability during crises. Firms plagued by liquidity problems are willing to sell their assets at lower prices to foreign investors—hence, the fire sale. India and China were the standout survivors of the financial crisis of 2008-09, invited to the Group of Twenty high table and expected to help steer the course for 21st century commerce. During the financial crisis, we observed large M&A activities flowing from India and China into those countries at the crisis epicenter—an outcome consistent with the theory.

> 9 Regional group definitions are from the World Bank: <u>http://data.worldbank.org/about/country-classifications/country-andlending-groups .</u>

> 10 FDI to GDP ratios are frequently used to control for the size of the economies when doing comparisons of FDI.

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