Risk & Economy » EY: Foreign direct investment still high despite uncertainty

Hanne Jesca Bax, EY Managing Partner Markets & Accounts – Europe, Middle East, India and Africa, discusses why foreign direct investment remains positive

Although interest in Europe’s FDI story has always been high, this is now at levels never seen before. There is a sudden and striking fascination with the day-to-day developments in the continent. This degree of interest can perhaps be explained by the unprecedented transition that the global cross-border investment landscape itself is going through.

Investors in Europe are wrestling with multiple sources of uncertainty, including and not limited to Brexit, migration and refugees, European growth, digital Europe, foreign policies, security concerns and the evolving political picture in Europe. This is not even the entire laundry list of issues – just the ones internal to Europe.

The continent is also dealing with global developments and external issues, ranging from an economic downturn in Brazil to China’s entry into a new phase of slower economic growth and the end of the commodity super cycle. Further, ongoing conflicts in the Middle East and tensions over North Korea and the South China Sea are all contributing to heightened geopolitical uncertainty.

Over the past year, the continent has grappled with the shockwave of the Brexit vote, growing populism and anti-globalization sentiment as well as concerns over the future of the European Union (EU). The recent Dutch and French elections may be a turning point but it is still unclear if the populist tide sweeping Europe has begun receding.

Notwithstanding the current climate of uncertainty, 67% of financial directors, constituting 47% of our overall survey group of 505 international business decision-makers interviewed for the latest EY’s European attractiveness survey 2017, remain confident in the future of the EU.

The time is still right for Europe

The Eurozone economy is picking up speed, with the European Commission forecasting GDP growth of 1.7% this year. In May 2017, the Eurozone Purchasing Managers’ Composite Output Index reinforced other signs of strengthening Eurozone growth with a reading of 56.8, the highest since April 2011.

Improving economic conditions are underpinning optimism over deal activity in Europe. M&A activity in Europe has already seen a strong start to 2017. A stronger growth outlook is also cheering foreign investors into Europe. The EY survey shows that the continent remains one of the world’s top regions for investment – a view also held by financial directors.

Optimism over Europe is also reflected in the reality of foreign direct investment (FDI) into the continent in 2016. Last year, FDI in Europe hit a new record with the launch of 5,845 projects (up 15%) and creating 259,673 jobs (up 19%): that’s twice as many as were being created in the wake of the financial crisis.

Interestingly, European investors provide the majority of FDI in the continent. European companies see more opportunities in their backyard and know their neighbouring markets increasingly well compared to non-European investors. Of equal, if not more interest, to CFOs is that the EU has been strengthening trade and investment relations with fast-growing countries such as China and India in recent years. For instance, Chinese companies launched 297 FDI projects in Europe in 2016, up 25%.

In terms of destinations, what is striking is the inflow of FDI projects to Greater London, Europe’s leading financial hub, which alone recorded 454 projects, ahead of Spain and Poland. In general, three Western European countries i.e. the UK, Germany and France captured half of European FDI inflows in 2016. Central and Eastern Europe (CEE) took the lead in manufacturing FDI, attracting nearly half of the industrial projects in Europe.

Central & Eastern Europe: competitive and attractive

An operation that began as a call centre in CEE may now be broadening out into an IT support function, engaging in sophisticated software development, and even adding R&D capabilities. Many companies seem to have centralized their finance and accounting processes and procedures to improve efficiency, and some of these have set up shared service centers (SSCs) in the CEE.

The region is attracting a wave of SSCs (up 83% for CEE in 2016) and other activities supplying services to companies. CEE offers several advantages such as high availability of English and technical skills, geographical proximity and time zone (close to Western European markets), cultural similarities to Western European countries, decent infrastructure and availability of low-cost office spaces.

Digital everything

FDI trends provide valuable insights into companies’ strategies for the future, and the way they are adjusting to current economic and technology trends. This is something that finance leaders would always be interested in from the standpoint of the investment portfolio. In 2016, a quarter of FDI projects in Europe actually went to software and business services.

Financial services providers and insurers, which have much to gain from digital technologies, continued to make cross-border investments. Though growth in pharmaceutical projects stalled in 2016, the industry remains significant in cross-border investment.

It is a noteworthy development that Europe is already active on the digital transformation front. For CFOs, digitization offers the opportunity for new business models and revenue streams. It also underpins industry convergence i.e. the blurring of two or more previously distinct industries and set of participants.

All this requires CFOs to completely re-evaluate underlying assumptions. They must strategize, plan and allocate investments for future growth while considering industry convergence alongside more traditional market considerations. On the flip side, digitization makes the organization vulnerable to competition from new players and agile incumbents and creates exposure to new risk (such as cyber threats) – a key concern for CFOs.

Imperatives for finance leaders

  1. Learn to live with uncertainty

Geopolitical and policy uncertainty is becoming a permanent feature of a globalized economy – consider how to remain agile for this “new normal”. Invest in scenario-based approaches, monitor changing policies and assess their economic and fiscal impact. Understand how the organization can manage the risks of geopolitical instability, such as diversifying to spread risk and avoiding concentration in one geography. Align risk with business strategy and leverage data and analytics to support real-time decision-making.

  1. Seize the opportunities of the European marketplace

Help the organization to capitalize on the growth and cost-saving opportunities of the European marketplace while managing risks, such as volatility and regulatory compliance. Play their part in training and developing talent in Europe as a means to assure the company’s future labor supply and license to operate. Make bold moves to ensure that the finance function has the right people, with the right skills, to complement the intelligence of smart technologies.

  1. Make the finance function agile – leverage digital

Undertake rigorous and regular portfolio reviews to be strategically nimble and opportunistic. Recalibrate the finance function to take advantage of advances in new technologies – such as in-memory computing, the cloud, analytics, mobility, artificial intelligence, blockchain and robotic process automation. To make the most of new technologies’ abilities, challenge assumptions and encourage experimentation but also manage the risks inherent in each technological innovation.

  1. Take advantage of positive dealmaking outlook, especially in Europe

Ride the M&A wave with near-term dealmaking expected to remain at high levels. Focus on the underlying reasons for pursuing deals: digital disruption, sector blurring, and changing consumer and customer behavior, rather than geopolitical concerns.

 Help overhaul Europe and speak up

Share insights into the EU’s strengths and shortcomings with employees, citizens and policymakers. Engage with policymakers on a range of pressure points for business and government – from digital to data – and help design a Europe that builds on the strengths of the single market.

 

Hanne Jesca Bax, EY Managing Partner Markets & Accounts – Europe, Middle East, India and Africa.

The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.