The COVID-19 pandemic has led, in addition to dramatic health implications for people around the globe, to an almost immediate and profound economic upheaval in many economies. The health and economic crises have governments scrambling for responses to limit the damage and impact on their societies and economies. This note considers the implications and challenges for international investment and offers initial responses from the OECD investment policy community as economies around the world address the crisis and prepare for the recovery.
OECD investment policy responses to COVID-19
OECD Policy Responses to Coronavirus (COVID-19)
Abstract
COVID-19 impact on capital flows
FDI: Fast Drop Imminent
Foreign Direct Investment (FDI) is expected to decline sharply as a consequence of the pandemic and the resulting supply disruptions, demand contractions, and pessimistic outlook of economic actors. Even under the most optimistic scenario – in which the economy begins to recover in the 2nd half of 2020 – FDI flows in 2020 are expected to fall by more than 30% compared to 2019. This decrease is accentuating and accelerating the steady decline of FDI flows observed in the past five years (Figure 1). Reinvested earnings – which play an increasingly important role in FDI flows – will drop substantially in the short term, as the crisis will depress earnings and investors are expected to reinvest a smaller share of their earnings than they have done in the recent past. Equity capital flows will also decline as many new investments, both M&As and greenfield investments, have been put on hold.
Intracompany loans and injections of equity capital from parent companies to their struggling foreign affiliates may offset some decline in reinvested earnings. Such behaviour has been observed during the 2008 Global Financial Crisis and in times of severe currency depreciations; this constitutes an advantage of foreign ownership: financial linkages between investors and their foreign affiliates contribute to the affiliates’ resilience to economic crises.
Figure 1. Global FDI inflows by instrument, 2005 to 2019
Note: 2019 data are preliminary. Debt in FDI consists of loans between related parties.
Source: OECD FDI Statistics Database.
The pandemic and crisis-response measures are having much greater impacts on some sectors than others, and FDI flows will reflect this. The information and communication sector may see an increase in earnings, while the manufacturing and primary sectors will see large drops in earnings, for instance. As some of the worst-hit sectors, including accommodation, food service, and transportation and storage usually account for relatively small shares of FDI, their suffering will not show proportionately in FDI statistics overall (Figure 2). There will be large cross-country variation: While the primary sector for example accounts for only 4% of FDI in the OECD average, this share is much higher in Australia, Canada, Chile, New Zealand, and Norway. The primary sector is also much more important in FDI in many emerging and developing economies, including Brazil, Indonesia, the Russian Federation, and South Africa.
Figure 2. Share of inward FDI stocks by major industry sectors in OECD countries, end-2018
Note: Includes inward FDI positions by industry sectors reported by all OECD countries except Mexico, at-end 2018 or for the latest available year. Excluded are resident Special Purpose Entities (SPEs) of Austria, Belgium, Denmark, Estonia, Hungary, Iceland, Korea, Lithuania, Luxembourg, Netherlands, Norway, Poland, Portugal, Spain, Sweden, Switzerland and the United Kingdom.
Source: OECD FDI Statistics Database.
If the public health and economic policy measures do not yield sufficient results, FDI flows may still decline further in the medium term. Divestments could be an additional factor, besides lower earnings and fewer new investments, if financially struggling firms are forced to sell or liquidate some of their foreign operations. Projections of FDI flows under different scenarios of the effectiveness of the public health and economic policy measures are set out in the April 2020 issue of FDI in Figures and the note on FDI Flows in the Time of COVID-19. In the long term, disruptions due to COVID-19 could lead some MNEs to rethink their supply chains, with broader impacts on FDI flows.
Portfolio flows to emerging markets freeze and flee
Portfolio investments, typically more volatile than FDI, have reacted even earlier to the shock that the pandemic inflicted on the global economy. Emerging market economies (EMEs) and those that had entered the crisis with weaker positions have experienced a massive drop of portfolio investment inflows. This repeats a familiar pattern, whereby international investors transfer capital back home or invest in safer assets during periods of uncertainty.
Figure 3. Portfolio investments to EMEs (bn USD)
Note: Cumulative non-resident portfolio flows to EMEs since 21 Jan 2020.
Source: Jonathan Fortun, Daily capital flows tracker. ©2020 Institute of International Finance, Inc. All rights reserved.
Figure 4. Exchange rate developments
Note: Nominal effective exchange rate (broad index), rebased at 15 Jan 2020=100. An increase indicates an appreciation of the economy’s currency against a broad basket of currencies.
Source: BIS.
The current sudden stop of portfolio flows into EMEs is faster and more incisive than observed during outflow events in recent years, including during the 2008 Global Financial Crisis. The Institute of International Finance (IIF) daily flows tracker estimates that USD 103 billion were drawn from EMEs between mid-January and mid-May 2020 (Figure 3). As a consequence of the pandemic and the steep oil price fall, exchange rates of key emerging markets, including Brazil, Mexico, Russian Federation, and South Africa declined substantially, while currencies of advanced economies have generally strengthened over the period (Figure 4). From April onwards, currencies and flows have started to rebound in several but not all countries. While the initial shock was largely common to all EMEs, latest developments thus illustrate more country differentiation.
Investment policy considerations
Complex policy trade-offs in emerging markets
Countries that face sudden portfolio outflows must carefully assess policy trade-offs in the short run to avoid dramatic and prolonged financial disturbance; international coordination can help achieve better outcomes. For now, governments have relaxed policies across the board. They have: eased monetary policy, boosted USD liquidity through international swap lines, introduced fiscal stimulus, offered credit guarantees, relaxed prudential policies and engaged in regulatory forbearance. Some countries have eased measures on inflows: China, Peru and India have relaxed controls on cross-border borrowing, short-term external liabilities, and foreign portfolio investment respectively. Several others have relaxed currency-based measures, including Korea, Indonesia, Peru and Turkey. In early May, Turkey tightened restrictions on foreign exchange trading to limit speculation in foreign exchange markets.
In severe outflow situations, the optimal policy-mix must match the country’s position at the onset of the crisis. Fiscal policy may be constrained by the initial level of debt. Monetary policy is a double-edged sword: easing rates protects domestic balance sheets where debt burdens are already high – but may accelerate outflows. Decisions to intervene in the foreign exchange markets will take into account the initial level of over- or undervaluation of the domestic currency, and the capacity to intervene largely depends on the initial level of international reserves. Wherever countries were able to build buffers in the upward phase of the cycle, macroprudential measures may be relaxed. As for capital account policy, easing inflow controls can be considered and has proven helpful in slowing exchange rate depreciation in some cases. Capital controls on outflows, on the other hand, are typically implemented as a last-resort tool in crisis circumstances, and EMEs have so far not resorted to it. In this situation, international cooperation is particularly important to find the best means of ensuring finance stability, including through multilateral platforms and frameworks such as those provided by the OECD’s Capital Movements Code.
Reviewing or preventing acquisitions of sensitive assets
Government measures should protect essential security objectives while still promoting openness to foreign investment. Some countries have adjusted their instruments that enable them to prevent potential acquisitions of sensitive assets that are exposed due to pandemic-related valuation changes or that are currently critical for the supply of healthcare goods.
Before and independent of the current crisis, many countries already had mechanisms to protect their essential security interests against threats associated with acquisitions of certain sensitive assets. The current scenario is a further incentive for countries to consider such mechanisms, and adds to the growing interest in these policies in the past years. As suggested for example by the European Union, these mechanisms may play a particular role under the current market conditions, where price disruptions and economic stress may make sensitive assets more readily accessible to potentially problematic investors.
Temporary changes to the inward investment review frameworks have been put in place in Australia, France, India, Italy, and Spain to respond to the scenarios they are facing. The measures include lowering of trigger thresholds for the application of their mechanisms and expansion of more stringent rules to a broader range of transactions than was previously the case. Some mechanisms, in particular those that do not feature trigger thresholds or sector specifications, are broad or flexible enough to respond to the changed situation without explicit modifications.
In addition, France, Germany and Hungary have made permanent changes in relation to the new situation, and Germany and New Zealand have accelerated reforms of their policies that had been underway independent of the current crisis situation. Poland and Slovenia had reform legislation which was at least partially motivated by the consequences of the pandemic, pending in end-May.
In a period where economies need foreign investment, FDI review mechanisms can increase uncertainty and costs and delay transactions. It is thus paramount that policy design and implementation are guided by principles of non-discrimination, transparency, predictability, proportionality and accountability, and measures should be closely tailored to specific threats to essential security interest as set out in the OECD Guidelines for Recipient Country Investment Policies relating to National Security.
In addition to reviewing certain acquisitions to protect their essential security interests, some governments have taken or are considering taking public ownership stakes in sensitive assets, particularly in airline companies, an approach that has already been followed during the 2008 Global Financial Crisis and which then predominantly concerned the financial and automotive sectors. Some countries, such as Belgium and France, already use state-ownership or golden shares as a complement or substitute for review mechanisms to safeguard their essential security interests.
When taking companies into temporary state ownership to reduce exposure of essential security interests, governments need to avoid rescuing structurally unviable or inefficient firms that were in distress prior to the crisis to avoid market distortions that would ultimately harm the prospects of the recovery. As temporary owners, governments should be guided by the OECD Guidelines on Corporate Governance of State-Owned Enterprises.
Testing times may test investment treaties
Measures taken by governments to protect their societies and economies during the pandemic affect companies and investors. Many governments have pledged financial support to companies; in its volume, this support already exceeds what was made available during the global financial crisis of 2008. Governments are also placing restraints on businesses including closures of non-essential facilities during lock-down periods, confinement of employees, new export restrictions and border closures. Certain companies are compelled to produce goods such as ventilators or provide accommodation or other services. Limits on contracts for credit, real estate or other goods and services have also been imposed, and dividend payments to shareholders or share buybacks are being discouraged or prohibited.
The roughly 3,000 investment protection treaties apply to some investors. These treaties prohibit discrimination and uncompensated expropriation. Many also require governments to provide “fair and equitable treatment” to covered investors or investments. Such provisions, which apply to non-discriminatory measures and are the most frequent basis for investor claims under the treaties, are subject to varying interpretations and approaches that have different impacts including on governments’ regulatory policy space. Coverage of an uncertain range of non-discriminatory measures can make it difficult to evaluate whether measures will generate government liability for damages.
Investment treaties should allow governments to respond effectively to the crisis and to take vital measures such as securing quick access to essential goods and services. Experiences with the crisis may shape how governments view key treaty provisions or interpretations. Governments have been addressing the balance between investment protection and the right to regulate in investment treaties through analysis and discussion at the OECD.
Crisis response and recovery depend on global value chains
Ensuring sufficient supply of goods and services needed to fighting the pandemic should be the immediate priority for trade and investment policymakers. Pharmaceuticals, medical supplies and equipment, and increasingly healthcare provision, depend much more than in the past on global value chains (GVCs) and international investment (Figure 5).
Figure 5. FDI flows into health-related industries, 2004 and 2019
In addressing the medical supply shortage, governments should leverage investor networks and investment promotion agencies to encourage and support businesses that can shift their production toward essential healthcare goods and services. Some governments have been quick to embrace this approach, by facilitating imports, providing incentives and engaging with multinationals, and enabling alternative ways of producing essential goods to meet domestic needs. In turn, some businesses have seized these initiatives to temporarily reorient their production lines in less-affected regions and deliver the essential goods to where they are needed. Challenges faced by IPAs around the world, and measures they have taken to respond to the pandemic are set out in the note on Investment promotion agencies in the time of COVID-19, released in May 2020.
Extraordinary restrictive measures to address the health crisis should be “targeted, proportionate, transparent and temporary”. Immediate urgencies at home are sometimes at odds with global objectives and the smooth functioning of GVCs, as suggested by the spread of export curbs on medical supplies introduced by numerous governments in March 2020. As emphasised in the G20 Trade and Investment Ministerial Statement of 30 March 2020 and explored in more detail in the OECD note on COVID-19 and international trade: Issues and actions, these distortionary measures should remain temporary tools to mitigate the crisis, and not permanent fixtures in the world trade system. As emphasised in the G20 Ministerial statement, these distortionary measures should remain temporary as needed to mitigate the crisis, and not permanent fixtures in the world trade system.
Value chains are essential beyond the immediate crisis response and need to be rethought and rebuilt for the recovery and beyond. The crisis has exposed weaknesses, dependencies and bottlenecks that were hitherto unknown or tacitly accepted. Strong, resilient supply chains are crucial to future-proof essential functions of our societies, including and beyond health services.
Sustainable FDI improves resilience
FDI strengthens the resilience of economies and supply chains. Linkages between companies allow them and, by extension, economies to absorb future shocks and stress that may result from crises, pandemics or climate-change – in addition to other benefits associated with FDI such as the strengthening of R&D capacity, and dissemination of responsible business conduct and management practice.
Vulnerable economies in particular need support to avoid development setbacks and the risk of a resurgence of COVID-19 or other new epidemics in the near future. While first responses to the COVID-19 crisis understandably prioritise urgencies at home, developing and least developed countries are suffering considerable damage as their exposure to the virus have increased. Already more vulnerable due to fragile healthcare and infrastructure systems, developing countries are facing outflows of portfolio and direct investment combined with declining remittances that are destroying jobs and eroding domestic income. These factors will further strain states’ abilities to provide much needed welfare to their pandemic-affected societies as they implement measures to prevent contagion.
Donor and investment policy communities should coordinate to help counter the socio-economic impacts of the crisis in developing countries, and create additional incentives to maintain investment in these countries. As budgetary constraints in advanced economies may now delay official development assistance (ODA) commitments and disbursements, private investment – especially FDI that brings innovation, decent and inclusive jobs, and sustainable production methods – can help attenuate the impact of the pandemic on these more vulnerable economies. While health should be the priority of official development assistance and public spending, mitigating disruptions to FDI and GVCs can also help alleviate the burden on public spending. Private investment will be key in contributing to the development finance equation, in a time where capital and public investment will be heavily stretched.
Responsible business conduct should be part of business and government responses during and after the COVID-19 crisis
The COVID-19 crisis has exposed major vulnerabilities in company operations and supply chains linked to conditions of work, disaster preparedness and corporate governance. In a period of crisis, it is important to strike the right balance between a quick recovery, the continuity of certain enterprises and sectors, and the application of environmental, social and other regulatory safeguards and protections. At the same time, proactive steps by governments and companies to address the risks related to the COVID-19 crisis in a way that also mitigates adverse impacts on workers and supply chains are likely to reinforce long-term value and market resilience, improving viability for short term response and the prospects for recovery in the medium to long term.
In order to navigate numerous legal, ethical and political hazards associated with emergency relief funds, governments can use RBC standards to condition support. Including commitments to internationally-recognised RBC standards and instruments, such as the OECD Guidelines for Multinational Enterprises and the OECD Due Diligence Guidance for Responsible Business Conduct, can help ensure that benefits of fiscal support measures are shared equitably, and that businesses receiving fiscal support are appropriately managing their broader environmental, social or governance risks (see the policy note on COVID-19 and Responsible Business Conduct).
Preparing an inclusive, fair, green and resilient recovery
Governments currently address the urgent needs of their societies and economies, but will soon turn their attention to ensuring a swift and sustainable recovery. While the starting point of a recovery is still uncertain, principles of openness, transparency, fairness and sustainability, as stipulated by the OECD investment instruments, are important during the crisis and will continue being important in its aftermath.
The profound impact of the pandemic on societies and economies around the world presents an important juncture for the investment policy community to consider the adequacy of past approaches. Already before this crisis, the OECD has recognised that while open markets are important, the qualities of investment are crucial to achieve the Sustainable Development Goals. This should remain and be strengthened during the recovery. Key considerations include how investment can contribute to greater resilience, what institutions and policies are needed to address pressing problems of inequality, poverty, and the climate crisis; and how all economies can benefit to the fullest extent from the opportunities of international investment.
The OECD’s FDI Qualities initiative will make a significant contribution to this reassessment, presenting a new policy toolkit for maximising the sustainable development impacts of FDI, including in the health sector. With these and other initiatives, the OECD will provide a forum for policy makers to draw lessons from the current crisis that help refine domestic policies and potentially complement existing investment policy instruments as part of the process of encouraging market-based economies that create a more resilient, inclusive and climate-friendly society.