India has emerged as the third-largest recipient of foreign direct investment (FDI) from the United States (US) between 2015 and 2020, experiencing a 20% increase in new investments. In contrast, FDI from the US to China decreased by 40% between 2020 and 2022 compared to the previous five-year period.
According to a recent paper by the International Monetary Fund (IMF) on the fragmentation of the global economy, US FDI flows to emerging European countries increased by 19.4%, to the rest of the Americas by 9.2%, and to the rest of Asia (excluding China) by 2.3%.
In contrast, FDI flows from advanced European countries to China declined by 19.7% and to the rest of Asia by 9.8%, while increasing by 7.5% to the US. China's FDI flows to the US decreased by 22.1% and to Europe by 17.8%.
The IMF warns that the fragmentation of FDI, characterized by increased barriers to importing investment inputs between blocs, could potentially reduce global output by approximately 2% in the long term. The concentration of FDI is likely to occur within aligned blocs of countries. These findings are significant in the context of escalating tensions between the US and China, with the IMF presenting the paper ahead of the spring meetings of the IMF and the World Bank.
The IMF suggests that emerging and developing economies are particularly vulnerable to this fragmentation. While India has positioned itself as an alternative investment destination outside of China, benefiting from US FDI, the IMF warns that the diversion of investment inputs may lead to gains for some economies, but the benefits could be significantly offset by lower external demand.
The report highlights the importance of the data provided on FDI flows, including information on source and host countries, sectors, and investment purposes. The study analyzed data from 300,000 investments spanning from the first quarter of 2003 to the last quarter of 2022.
Overall, FDI flows declined by 20% during the 2020-2022 period compared to pre-pandemic levels. Asia's relevance as a source and host of FDI diminished in comparison to other regions, with FDI to and from China declining even more than the regional average. The pandemic and prolonged lockdowns may have contributed to the decrease in foreign investment. FDI flows to China decreased from all regions, except for emerging European countries, which increased their investments in China.
The shift towards near-shoring and friend-shoring is evident, as Costa Rica and Colombia became the top two destinations for increased US FDI flows during the 2020-2022 period. India ranked third, followed by Canada, South Korea, and Taiwan. American investment has not only been reduced in China but also in Hong Kong due to increased control by Beijing.
The IMF also introduced a new vulnerability model based on three metrics: geopolitical distance between the source and host countries, the market power of the host country's industry receiving FDI, and the strategic nature of the investment. In this model, India is portrayed as having a relatively neutral measure of geopolitical distance from both the US and China, although the tensions between Delhi and Beijing and the growing strategic convergence between Delhi and Washington challenge this assumption. The report highlights both the opportunities and risks for these countries.
According to the IMF, the impact on non-aligned economies depends on two competing factors. On one hand, the reduction in global activity decreases external demand, affecting net exports and investment. On the other hand, these regions benefit from the diversion of investment flows, which, if significant enough, could boost investment and output.