FDI inflows paint a mixed picture in 2018

FDI inflows paint a mixed picture in 2018

Foreign direct investment (FDI) in Latin America posted a mixed performance in 2018, according to data from the UN Economic Commission for Latin America and the Caribbean (ECLAC). Total inflows rose by 13% year on year in 2018, reversing a five-year period of decline.

However, analysis by component shows that the improvement was driven not by new capital investment, but by reinvested earnings and intra-company loans. Moreover, FDI was concentrated in just a few countries. With a still less supportive external environment, the picture will darken this year, with ECLAC estimating a contraction in overall inflows of 5% year on year in 2019 and stagnation (at best) in 2020.

It is noteworthy that ECLAC's methodology for calculating investment flows, which is in line with the IMF's definition and includes new capital, reinvested earnings and intra-company loans, differs from that of the UN Conference on Trade and Development (UNCTAD), which excludes loans from the total.

Using ECLAC's measure, total inward FDI flows stood at US$184bn—a relatively healthy level and equivalent to 3.8% of regional GDP, but still below the US$213bn received at the peak of the commodities price boom. New investment, however, declined by 20% compared with 2017, to US$69bn, indicating a reduced appetite among multinational companies for setting up or expanding operations in the region. This also reflected global trends—total worldwide crossborder investment declined by 13% year on year in 2018, explained by factors such as a slowing global economy, growing trade tensions, and US tax reforms that encouraged repatriation of profits. Factors within Latin America that are likely to have discouraged capital investment include subdued economic growth and policy uncertainty in countries such as Brazil and Mexico ahead of elections last year.

More positively, reinvested earnings rose by 16%, to US$61bn. By itself, this is a sign of confidence on the part of investors already established in the region. Intra-company loans jumped by 139%, to US$52bn, with the bulk of this (US$32bn) accounted for by Brazil. However, such loan inflows are highly volatile, and it is difficult to interpret the key drivers, which are often related to the internal needs of companies or their headquarters, rather than factors inherent to the recipient country.

Brazil and Mexico take the lion's share

Brazil and Mexico remained the two countries that received the largest amounts of inflows, taking 48% and 20% of the total, respectively. They also registered among the highest increases in percentage terms (25.7% for Brazil and 15.2% for Mexico). However, these figures do not suggest a greater interest among multinationals to put new money at stake.

The increase in Brazil was exceptional because of the level of intra-company loans—five times the 2017 total—whereas new capital investment declined by 24%.

Of the US$32bn that Brazil received in intra-company loans, US$26bn came from the affiliates of Brazilian companies to their parent companies in Brazil. On a positive note, reinvested earnings by established investors rose by 49%. Manufacturing received the bulk of FDI (56%). Overall, Brazil's total of US$88.3bn in inflows was higher than the annual average for 2013-17, but still below the peak levels of 2011-12, when inflows averaged US$96.5bn.

Mexico's case is similar, with the biggest share of FDI last year also in the form of intracompany loans (up by 42% year on year), whereas new capital inflows declined modestly (by 2%). Reinvested earnings were also up (by 11%). Half of all FDI went to manufacturing (investment in which rose by 9%), mostly in the automotive and autoparts sectors. With Mexico's electricity sector now open to foreign investment, it was the second-largest recipient of FDI last year and achieved an increase of 140% over 2017 levels. Overall inflows in 2018 were larger than the annual average for 2010-17 (US$31bn).

Concerns about the global economy, along with economic and policy uncertainty in both countries—which are both experiencing sub-optimal GDP growth—are hindering the entry of new capital investment. In Mexico's case, the delayed ratification of the US-MexicoCanada Trade Agreement (USMCA), which is unlikely to be approved in the US Congress before the 2020 elections, is another obstacle to higher FDI.

Other trends

Other key points of the ECLAC data include the following.

Sectoral differences. By sector, manufacturing and services remained the most attractive destinations for FDI in Latin America, although their relative weightings in the total shifted. Manufacturing's share of inflows rose from 39% of the total in 2017 to 47%, while services fell from 49% to 39%. Inflows to natural resources rose to 18% of the 2018 total, from 11% a year earlier, driven by a partial recovery in global commodities prices (although this was still below the annual average of 20% in 2010-13, and 30% in 2010 alone).

 Mergers and acquisitions (M&A) trends. M&A transactions totalled US$38.5bn last year, a stable level compared with the previous three years, even though the number of transactions declined by 21%. The largest number were concentrated in Brazil and Chile, with high technology and renewable energy proving to be the most dynamic sectors in terms of growth in recent years. For example, there were 110 agreements involving software and IT services in the region in 2012-18, up from 62 in 2005-11. In renewable energy, the respective figures were 102 and 53. In terms of size, the biggest transaction in 2018 was the sale of 24% of mining company Sociedad Química y Minera de Chile by its Canadian owners to Tianqi Lithium Corporation of China, for US$4.1bn. The second-largest transaction was the sale of 96% of Banmédica, a Chilean medical services company, to UnitedHealth Group of the US for US$3.3bn.

Average return on investment (ROI). The average ROI of FDI was 5.5% in 2018, remaining relatively stable from the levels of the previous few years. However, this was below the average of 8.1% achieved during 2005-12, a period of high commodity prices.

Rising FDI from South Korea. An interesting trend has been the growing role of South Korean firms in Latin America. The region received 5% of South Korea's total FDI outflows in 2007-18. The country's investment is focused on greenfield projects and has supported the development of high-value-added manufacturing operations, notably in the automotive sector in Brazil and Mexico.

Prospects for 2019-20 are muted

Prospects for FDI inflows to Latin America will be heavily influenced by the trajectory of the global economy, including the impact of the ongoing trade war between the US and China, the region's two biggest trading partners. In view of less supportive external conditions, with global economic and trade growth expected to slow and greater competition for FDI, The Economist Intelligence Unit projects an overall decline in investment inflows to Latin America in 2019, and stagnant levels or perhaps a further decrease in 2020 amid our expectations of a global slowdown.

In this context, advises ECLAC, countries in the region should focus less on attempting simply to attract larger volumes of FDI, but more on attracting the type of capital that will contribute to improved productivity and job creation, advance the development of a knowledge economy, and support more sustainable energy usage, production and consumption.