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World Investment Report 2000 -- Cross-border M&As and FDI flows

G. Srinivasan

ATTRACTING foreign direct investment (FDI) has always been an obsessive and overarching objective among policy-makers and political leaders, even as this has become an arduous exercise to the host governments. No doubt, FDI is the largest source of exter nal finance for many developing countries which, in recent years, especially during financial turmoils, has been found to be more stable than portfolio investment and bank lending. Recognising the importance of FDI, Governments, the world over, are openi ng their economies to encourage the flow of trade, technology, information, investment and financial flows.

In India too, the lure of non-debt creating FDI flows has galvanised successive Governments, post-reform, and only a few years ago, the United Front (UF) Government at the Centre talked about ensuring $10 billion FDI flows into India as the minimum desid eratum if the economy's high growth path was to be paved with a smooth ride to banish the twin dangers of endemic poverty and huge unemployment, and cope with the vast investment requirements of maintaining the rickety infrastructure and creating more am enities. Parallels are always drawn from China's incredible capacity to attract $40 billion by way of FDI in recent years, even as India's best record till date was only a measly $3.7 billion of FDI flows in 1997. China's accession to WTO will make it mo re attractive for FDI as another FDI boom in China may well be forthcoming, reaching an annual level of over $60 billion, Unctad foresees.

That FDI investment has assumed vital significance in the world economy is corroborated by the UN Conference on Trade and Development (UNCTAD) which has just come out with its ``World Investment Report (WIR) 2000: Cross-border Mergers and

Acquisitions and Development''. The Unctad Secretary-General, Mr Rubens Ricupero, in a preface to the report, remarked that cross-border mergers and acquisitions (M&As), including the purchase by foreign investors of privatised state-owned enterprises, a re driving the foreign investment volumes to ``new records'' with FDI inflows by translational corporations (TNCs) being forecast to surpass the one-trillion-dollar level this year, following last year's already impressive $865 billion.

The dramatic feature of recent trends in FDI is the persistently high levels of growth in M&As which have risen at an annual rate of 42 per cent over the past two decades and their completed value in 1999 was about $2.3 trillion, representing about 24,00 0 deals.

A notable feature in most of the growth in international production over the past decade has been via cross-border M&As (including the acquisitions by foreign investors of privatised state-owned enterprise) rather than greenfield investment. Less than 3 per cent of the total number of cross-border M&As is officially classified as mergers; the rest are acquisitions.

Besides traditional bank loans, the recent M&A boom has been facilitated by the increased use of such financing mechanisms as the issuance of common stocks, the exchange of stocks and corporate debt. Venture capital funds have also been significant sourc e of finance, enabling many new firms or small and medium-sized enterprises to engage in M&A activity.

The Unctad rightly turns the spotlight on concerns expressed in political discussions and the media in a number of host countries, that FDI entry through the takeover of domestic firms is less beneficial, if not positively harmful, for economic developme nt than entry by setting up new facilities. At the core of these concerns is that foreign acquisitions do not add to productive capacity but simply transfer ownership and control from domestic to foreign hands. This transfer is also accompanied more ofte n by layoffs of employees or the closing of some production or functional activities (for instance, R&D capacities). It also entails servicing the new owner in foreign exchange.

The Unctad report contends that if the acquirers are global oligopolists, they may well dominate the local market. Cross-border M&As could be used deliberately to reduce competition in domestic markets. They could lead to strategic firms or even entire i ndustries (including key ones such as banking) falling under foreign control, threatening local entrepreneurial and technological capacity-building. The current spate of cross-border M&As is supervening, despite the fact that many M&As have not delivered the anticipated positive results to the acquiring firms in terms of both share prices and `real' economic effects such as profits and productivity. From a foreign investors' perspective, cross-border M&As provide two main gains compared with greenfield investment as a mode of FDI entry: Speed and access to proprietary assets. They often represent the fastest means of building up a strong position in a new market, gaining market power -- and market dominance -- increasing the size of the firm or spreadi ng risks.

Be that as it may, it is also significant to note that some 90 per cent of all cross-border M&As (by value in 1999), including most of the 109 mega deals with transaction values of more than $1 billion, were carried out in developed countries. It was not until the late 1990s that developing countries emerged as important locations for incoming cross-border M&As in terms of value which rose from $3 billion in 1987 to $41 billion in 1999.

In Unctad's perception, most failings of FDI through M&As, as opposed to greenfield FDI, pertain to effects at entry or soon thereafter. In the longer term, when both direct and indirect effects are factored in, many differences between the impacts of th e two modes diminish or vanish. For instance, cross-border M&As are often followed by sequential investments by the foreign acquirers; thus, over time, FDI through M&As could lead to enhanced investment in production just as greenfield FDI does. Similarl y, cross-border M&As could be followed by transfers of new or better technology, especially when acquired firms are recast to enhance the efficiency of their operations.

This is particularly true when there is need for rapid restructuring under intense competitive pressures or overcapacity in global markets might also make host countries find the option of FDI through cross-border acquisitions useful. Unctad also notes t hat differences between the two modes about employment generation tend to diminish over time and depend more on the motivation of entry than on the mode of entry.

Even as it makes a dispassionate analysis of both the modes of FDI entry, Unctad firmly states that there are no a priori solutions to these concerns. Each country needs to make its own judgment in the light of its conditions and needs, and in the framew ork of its broader development goals. It also needs to be conscious of -- and to assess -- the trade-offs involved, whether related to efficiency, output growth, the distribution of income, access to markets for various non-economic objectives. It is int eresting to note that even as Unctad keeps the solutions close to its chest, without revealing what mode of FDI is ideal, given the Hobson's choice of globalisation which many developing countries are trying to grapple with, it said the specific conseque nces of cross-border M&As could be actuated by policy measures: ``Policy matters especially when it comes to the risks and negative effects associated with cross-border M&As'', it said, adding that while cross-border M&As are an alternative to greenfield FDI, the viability of other options such as strategic alliances or public intervention must be weighed warily. There might even be a role for firms in distress owing to developments over which they have no control.

Unctad specifically notes that FDI policies in general could be used to maximise the benefits and minimise the costs of cross-border M&As through sectoral reservations, ownership regulations, size criteria, screening and incentives. Specific cross-border M&A policies can also be used for some of the same objectives, for instance, the screening of cross-border M&As to ensure that they meet certain criteria. Alongside, efforts must be made to foster a culture recognising the need to avert anti-competitive practices of firms through an effective and well-honed competition policy in place. In the end, as the global market for firms is emerging, they need a global approach to competition policy, an approach that takes the interests and conditions of develop ing countries fully into account and on board so that boardroom chaos and dark corporate raids of domestic firms need not erupt to destroy the entrepreneurial elan.