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The potential impact of the current financial crisis and slowdown of foreign direct investment (FDI) could be devastating for emerging economies, according to the Multilateral Investment Guarantee Agency (Miga), the political risk insurance arm of the World Bank Group.

Miga’s acting executive vice- president and chief operating officer James Bond believes emerging markets have so far been spared the worst from the turmoil.  But the crisis is far from resolved. “The danger is the crisis will reduce growth and impact some particularly vulnerable countries,” says Bond. “I would be very surprised if FDI in developing and emerging economies didn’t slow down this year and next.  A 10% decline is significantly underestimating what we’re seeing.” he says.

This fear is echoed by the United Nations Conference on Trade and Development (Unctad), which also expects FDI flows to fall by at least 10% this year and continue to decline next year. Although the slowdown in flows is expected to affect developed countries first, it will also affect flows to developing economies. Banks around the world will find it difficult to provide financing for projects, while slower growth will make international expansion less attractive to businesses.

The picture was very different only last year. Unctad said in its World Investment Report that inflows of FDI rose by 30% in 2007, to US$1.8tn, exceeding the previous record high of US$1.4tn in 2000. FDI inflows into developing countries reached their highest level ever at US$500bn – a 21% increase over 2006.

The least developed countries attracted US$13bn worth of FDI in 2007, a record high according to the report. And developing countries continued to gain in importance as sources of FDI, with outflows rising to a new record level of US$253bn, mainly as a result of outward expansion by Asian transnational corporations. These so-called South-based investors may turn out to be the savior of many of the world’s most vulnerable countries.
At a recent panel discussion organised by Miga around the World Bank Group annual meetings in Washington, DC, Carlos Contreras, the executive managing director of Caja Madrid, also noted this shift in the structure of the world economy. “South-south investment will attract more sovereign wealth funds into infrastructure projects,” he said.
Unctad also noted the emergence of sovereign wealth funds as a new feature of global FDI in its report. “These funds with US$5tn assets under management tend to have a higher risk tolerance and higher expected returns than traditional official reserves managed by monetary authorities.”
At the same panel discussion the minister of finance and economic empowerment from Mauritius, Ramakrishna Sithanenm argued that growth in Africa is still strong. “We have to be able to diversify our markets and accelerate the process of regional integration and take advantage of south-south FDI.”

Miga’s Bond also sees potential in nurturing and harnessing south-south FDI. “We expect these investors to reshape the trajectory of FDI flows in the near and medium term, especially in the wake of the financial crisis in the OECD countries. This is an important trend and we want to leverage these investments as much as possible for the sake of those at most risk of being mowed down under this crisis.”
Even before the financial crisis, Miga had been actively promoting south-south investments. In fiscal year 2008 alone the agency issued US$520mn in guarantees for such investments, an increase of US$271mn from the previous year. Now Miga is focusing on adapting its products to attract more clients from emerging markets, including sovereign wealth funds particularly from Asia and the Gulf states.
As a result of the global financial crisis, the World Bank expects to see a setback in poverty reduction worldwide; lost learning potential for children and adults; destruction of the natural environment; and increased tension due to persistent high poverty and large gaps in income between rich and poor countries.

“At times like this, supporting the private sector becomes even more critical, because of its capacity to generate wealth, create opportunities and employ more people than any other sector,” says Bond. “Our strategy and priorities are based on where we are needed the most and how we can leverage the maximum resources to add real value.  We are modernising our product and reducing the hassle factor for investors so that we can work together to stop this financial crisis from turning into a human crisis.”
Miga was created in 1988 to promote FDI into emerging economies to support economic growth, reduce poverty, and improve people’s lives. It does this by offering political risk insurance to investors and lenders, covering risks including expropriation, breach of contract, currency transfer restriction, and war and civil disturbance. Miga issued US$2.1bn in guarantees to underpin developmentally beneficial FDI in emerging markets in the year ending June 30, 2008.