Washington: Foreign direct investment from the US to China dipped 40 percentage points between 2020 and 2022 compared to investments between 2015 and 2020, even as India emerged as the third-largest destination for US FDI flows in the same period, with an increase of 20 percentage points in new investments.

In a paper on geo-economic fragmentation published last week, the International Monetary Fund has shown that US FDI flows increased to countries of emerging Europe by 19.4 percentage points, to the rest of Americas by 9.2 percentage points, and to the rest of Asia (excluding China) by 2.3 percentage points.

FDI flows from advanced European countries to China declined by 19.7 percentage points and to the rest of Asia by 9.8 percentage points, while increasing to the US by 7.5 percentage points. China’s FDI flows to the US declined by 22.1 percentage points and to Europe by 17.8 percentage points.

Based on these trends, the IMF warned that FDI fragmentation, “modeled as a permanent rise in cross-bloc barriers to importing investment inputs”, could reduce global output by about 2% in the long term. FDI was likely to become more concentrated “within blocs of aligned countries”. The chapter was published in the backdrop of intensifying US-China tensions and ahead of the spring meetings of the IMF and the World Bank this week.

On average, the IMF suggested that emerging and developing economies were more vulnerable to this fragmentation. At a time when India is positioning itself as a possible destination for capital seeking investment outlets beyond China — and has been a net beneficiary as the data from US suggests — the fund warned that the diversion of investment inputs could allow some economies to gain, but such benefits could be “significantly offset by spillovers from lower external demand”.

It added that while “non-aligned regions” — within which category the report counted India — could have some negotiating power vis-à-vis the geopolitical blocs, uncertainty regarding their alignment could restrict their ability to attract investment.

But the richness of the paper lies in the data uncovered about the current trajectory of FDI flows, including information on the source and host countries and on the sector and purpose of the investment. The study was based on an examination of data of 300,000 investments from the first quarter 2003 to the last quarter of 2022.

Pointing out that FDI flows in general declined by 20 percentage points in the 2020-22 period compared to the pre-pandemic average levels, the IMF said: “Asia became less relevant both as a source and host, losing market share vis-à-vis almost all other regions. Notably, FDI to and from China declined by even more than the Asian average, although the persistent effect of the pandemic and prolonged lockdowns could also have contributed to the fall in foreign investment.” Barring countries of emerging Europe, which invested more in China, FDI flows to China decreased from all corners of the world — the US, advanced Europe, rest of Americas, rest of Asia.

In a sign that near-shoring and friend-shoring is becoming a preferred route for foreign capital, the top two destinations for increased US FDI flows in 2020-22, in comparison to 2015-20, were Costa Rica and Columbia. India ranked third. Canada, South Korea and Taiwan came next. American investment has reduced not just in China, but also Hong Kong as Beijing’s writ has increased over the territory.

The IMF also came up a new model of vulnerability based on three metrics — the geopolitical distance between source and host countries based on their voting records at the United Nations; the degree of market power each host country has in the industry that is receiving the FDI; and the strategic nature of the FDI.

In this model, it posits India as a country with “relatively neutral measure of geopolitical distance” from the US and China, a questionable premise given the tensions between Delhi and Beijing and the increased strategic convergence between Delhi and Washington. The report then points to the opportunity and risk for these countries.

“For the non-aligned economies, the impact depends on the outcome of two competing channels. On the one hand, the substantial reduction in global activity reduces external demand, weighing on net exports and investment,” it said. “On the other hand, these regions also benefit from the diversion of investment flows, which— if sufficiently large—could boost investment and output.”

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