Aug 19, 20213 min read

To turbocharge the economy, focus on FDIs and sustainable recovery

The economic theory points to foreign direct investment (FDI) as a key driver of economic growth. However, the FDI flows have taken a huge dip, thanks to the COVID-19 pandemic.

According to the UNCTAD World Investment Report 2021, global FDI flows reduced to $1 trillion in 2020, 35 percent lower than the pre-pandemic level. Moreover, greenfield investment announcements plummeted by 44 percent in value, and international finance by 53 percent for developing economies, compared to 16 percent and 28 percent, respectively, for the developed economies.

These figures show that developing economies faced the brunt of the pandemic since greenfield FDI in these economies is mainly aimed at infrastructure development and other productive aspects.

The story in India is no different, where greenfield FDI shrivelled to $24 billion in 2020, 19 percent lower than 2019. Greenfield FDI is further expected to contract in 2021 due to the COVID-19 second wave. Given the severity of the pandemic, which affected global FDI, focus should shift towards reviving the FDI flows amidst rising levels of vaccination.

Path To Recovery

The pandemic severely affected multinational firms, given their extensive involvement in global value chains. Hence, building resilient supply chains remains at the top of the agenda for firms and policymakers.

From a firm-based perspective, building resilience requires three key components. First, the firm’s decision on production-network restructuring, which is a trade-off between reshoring and reducing excessive concentration on a single supplier.

The second is risk management solutions, which focus on strengthening supply chain networks to absorb shocks through better monitoring, creating flexibility in production through redistribution of production load across multiple outlets, holding sufficient inventory level, and moving away from the ‘just-in-time’ production model. The third is attention towards adopting sustainable business practices, which mitigates supply chains from environmental, social, and governmental (ESG) risks.

Focus On Productive Projects

In order for the economy to recover, it is crucial to prioritise investment in sustainable recovery, which condones a strategy where investment is directed towards improving productive capacity. In this regard, the UNCTAD report highlights a positive correlation between the Productive Capacities Index (PCI) and the FDI stock. Hence, FDIs in productive capacity enhances investment, especially in developing countries, due to the flow of knowledge, technical know-how, and improved access to global networks.

Thus, it becomes important to prioritise investment in productive projects with a greater push among those industries that could recuperate the losses incurred due to the pandemic, and restart the economic growth process.

Moreover, during the past 18 months, policy makers across the globe have provided stimulus packages, with plenty of it directed towards infrastructure projects. This provides a window of opportunity for incorporating the sustainable development goals (SDGs) while undertaking recovery measures.

In addition, the importance of achieving the SDGs is crucial for overall development. Investment and improvement in the SDGs acts as a signalling mechanism about the enabling conditions. Since, the SDGs encompass various aspects including health, education, governance, energy, infrastructure, among others, a focus on them will improve the ease of doing business. This, in turn, leads to an uptick in FDI.

Evidence in the Indian context highlights that a one percent increase in ease of doing business is associated with 6.32 percent increase in FDI. Further, it is observed that the FDI flows are larger in states that perform better on the SDG index. Therefore, FDI is the potential driver of growth, subject to states investing in achieving various SDGs.

Financing Recovery

The importance of investment in SDG projects has resulted in application of sustainability in the finance sector. Sustainable finance has largely transpired through specific funds and indexes with objectives of sustainability. For instance, in 2020, the $3.2 trillion SDG-related investment consisted of 53 percent of sustainable funds, over 30 percent in green bonds, and investments in social bonds and mixed-sustainability bonds.

Sustainability-themed funds have managed to recover quickly within the first half of 2020, with the inflow of funds amounting to $164 billion, and estimated to reach over $300 billion full-year on. The rapid surge of these funds highlights their popularity and of them as a viable investment option. In this regard, leveraging capital markets for sustainable development has become the key.

However, despite their growing importance, sustainability funds are mostly associated with developed economies. It’s important for a developing economy such as India to adopt sustainable financing for the growth of the overall market.