Investors want to place their money where they are guaranteed a high return for their high risk not where they are more likely to experience continual losses.
FDI is the most prevalent source of external finance in developing countries. This is due to the relatively immense market for development and production in developing countries. The presence of refined financial markets also makes developing countries with an emerging economy an attractive hub for foreign investment. Additionally, FDI is able to withstand most economic risks that come with investing in a developing country– economic risks in developing countries are less likely to have a global macroeconomic effect. Therefore investing in an emerging economy serves as a good risk diversifier. As a result of their ability to yield higher returns and accelerating growth emerging economies receive superior levels of FDI inflows.
In 2019, Ernest and Young reported that South Africa after Egypt was the second largest recipient of FDI in 2018. South Africa (SA) has been able to set itself apart as a leading African emerging economy by joining B.R.I.C.S, this affiliation made SA more palatable to foreign investors. SA is regarded as one of the most attractive investment havens in Africa. This is largely due to its ability to avoid fatal social and economic conflict after attaining democracy post-Apartheid. It has also been able to create compensation and unity centred policies that have calmed any possible socioeconomic outbreaks. Additionally, South Africa has been progressive in terms of openness to trade, developing a sophisticated financial market and privatising entities. These developments have made the country’s economy appealing to potential foreign investors. Although the country has maintained a good public reputation record as an attractive FDI hub, it faces dire challenges that have the potential to alter the rational opinions and expectations potential investors have formed over the years. The most prominent challenges being political instability and corruption- both are worryingly linked to the government.
South Africa has experienced a substantial amount of political instability dating back to 2007. Over a decade later the country still finds itself battling against political instability which has translated into economic instability as well. Lucas (1990) concludes that political instability increases capital flows into a country which would then positively affect FDI. However, in the case of South Africa this is incorrect given that the country has a severe problem of political instability that affects the exchange rate which can inversely affect capital inflows and expected profitability. In March 2017, the Rand depreciated from R12.80/$ to R13.60/$ as a result of the political instability caused by the reshuffling of the then Finance Minister Pravin Gordhan. This kind of response is most likely to discourage potential investors from investing in SA. This assertion is consistent with Alesina and Perotti (1996) findings that political instability reduces investment which then hinders economic growth.
The most prevalent kind of corruption in the country is the mismanagement of funds and resources. The former is guaranteed to run a firm dry since funds become depleted when unaccounted for and mismanaged. In March 2018, it was discovered that Steinhoff under its previous board allegedly had traces of fund mismanagement and this obviously resulted in disinvestment which saw its share price hit an all-time low of R1.60. This disinvestment was a direct response to the alleged corruption. The most recent record of resource mismanagement is the government’s distribution of Personal Protective Equipment (PPE) and sanitisers- which are both vital for protection against COVID-19. This mismanagement of resources in the middle of a pandemic exposes how far gone our troubles with corruption are.
How has COVID-19 affected FDI in South Africa?
FDI took a massive dip in 2020 as expected due to COVID-19. UNCTAD (2020) estimated that FDI flows to Africa would fall by (25% - 40%) in 2020 as a result of the pandemic. Prior to COVID-19 directly affecting the country, South Africa was already experiencing unpleasant economic conditions such as being downgraded to junk status credit rating and entering into a recession - both these factors negatively impact economic growth. As a result of this, FDI inflows were expected to underperform due to the severity of the country’s economic climate. The arrival of COVID-19 significantly reduced any chances of revival the country had for FDI inflows. The pandemic exacerbated an already dire situation. Following suit to the rest of Africa, SA experienced a decline in FDI inflows in the last year. This follows the 15% decrease to $4.6 billion in FDI inflows that occurred in 2019. These figures were initially unanticipated given the fact that the South African government had made attempts to increase and attract FDI to the country by making collaborations with German car manufacturers such as BMW and Mercedes Benz. These collaborations saw SA pulling in FDI inflows valued at $5.4 billion in 2018. Unfortunately, the government’s endeavours were not enough to counteract the effect of the pandemic.
Other Factors affecting FDI
Other factors that negatively impact FDI in the country are crime, regular episodes of loadshedding, lack of accountability for mismanagement of funds and/or misconduct and institutions not upholding their mandates. This can result in stock market and exchange rate volatility which can then discourage foreign investors from pursuing Greenfield and Brownfield projects locally as well as discourage foreign portfolio investment in the country.
South Africa can attract FDI by:
· Increasing privatisation to protect investors’ assets from being looted. Privatised firms have a mandate to maximize the shareholders’ profits;
· Improving its quality of government and promoting a culture of accountability in government organisations or government-affiliated projects in hopes of obtaining political stability;
· Creating policies that promote free capital flows between SA and the rest of the world this will attract more investors to the country because the barriers to trade will be reduced;
· Ensuring that the legislative system is effective in apprehending parties involved in defrauding corporations;
· Finding a sustainable supply of energy that will not hinder production and labour productivity;
· Maintaining an investor-attractive corporate tax rate i.e. keep corporate tax low and stable;
· Maintaining a stable exchange rate to decrease investor uncertainty created by currency volatility;
· Introducing the use of technology at fundamental levels of education to promote a technologically savvy society that will be able to make use of advanced technology for future production purposes.
What other avenues can South Africa explore to attract foreign direct investment?
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Yours in Thoughtful Learning