There was a significant slowdown in foreign direct investment (FDI) in Australia during 2020. Gross inbound transactions fell from nearly $60 billion in the year-ended 2019 to only $33.6 billion for the year-ended 2020, about half the average pace seen in recent years.
Uncertainties related to the pandemic weighed on investment decisions and cross-border capital flows globally. In Australia, the government instituted a temporary zero-dollar screening threshold for foreign acquisitions, fearing the opportunistic acquisition of distressed Australian businesses by foreign interests.
The government also rolled out a new national security test to sit alongside the already expansive ‘national interest’ test to ensure greater scrutiny of transactions that might otherwise fly under the radar of the existing test.
Exclusive reports in the Australian Financial Review suggested there was a de facto ban in place for high-profile acquisitions from China. Chinese cross-border acquisitions slumped to just $1 billion in 2020 from $2.6 billion in 2019 according to one database.
Earlier this year, the treasurer blocked the Chinese government-owned China State Construction Engineering Corporation’s proposed acquisition of an Australian-based, South African-listed building company.
The transaction was deemed a risk to national security, although this view was only communicated privately. It was just one of several potential Chinese acquisitions quietly rejected by the government.
I have developed a Foreign Investment Uncertainty Index to better track policy uncertainty in relation to foreign investment and its economic effects over time. The indexed is based on a search for keywords relating to uncertainty and foreign investment in Australian newspapers.
My index finds that foreign investment uncertainty nearly doubled for the four quarters of 2020 compared to the average for 2019.
The increase in 2020 is attributable in part to the government’s reduction in the screening threshold to zero dollars in response to the pandemic and the introduction of a new national security test.
In previous years, uncertainty was mostly driven by specific high-profile transactions that tested the operation of Australia’s foreign investment framework.
The single biggest increase in the index occurs in the context of the Australia-US bilateral investment relationship due to the treasurer’s rejection of Archer-Daniels-Midland’s (ADM) bid for Graincorp in 2013.
The index shows little change in the decade from 1997 to 2007, punctuated only by Treasurer Costello’s rejection of the acquisition of Woodside Petroleum by Royal Dutch Shell in 2001.
However, the influx of Chinese FDI from around 2008 and the regulatory response leads to a significant pick-up in both the level and the volatility of the index over subsequent years.
The industry sectors most affected by foreign investment uncertainty in Australia are the energy and resources sector, reflecting their high levels of foreign ownership and high-profile cross-border acquisitions that are more likely to become politicised.
Applying the same methodology to the United States suggests the United States has much lower levels of foreign investment uncertainty historically due to a more narrowly focused regulatory review process.
However, the United States also shows a dramatic rise in foreign investment uncertainty more recently due to changes in legislation expanding the scope of its FDI screening process in 2018, as well as the effect of the Trump administration’s policies on business investment.
An increase in the Foreign Investment Uncertainty Index for Australia has a negative effect on private investment spending, although the effect is smaller and less persistent than for the broader Economic Policy Uncertainty Index originally developed by Stanford University’s Nick Bloom.
Around 19 per cent of capital expenditure in Australia is on the part of firms with at least 10 per cent foreign ownership, including around 2000 US-owned businesses. To the extent that restrictions on foreign investment devalue the stock of domestic equity capital, they can also increase collateral and borrowing constraints for Australian-owned firms, reducing their investment spending too.
In our 2018 report, Deal-Breakers? I argued for an increased focus on national security in the regulation of cross-border investment at the expense of the more parochial and non-security related issues that have traditionally dominated the screening process and motivated interventions by the treasurer.
That study also highlighted the need for the government to articulate the reasons clearly and transparently for rejecting foreign acquisitions to minimise uncertainty and its economic effects.
Given the close security relationship between Australia and the United States, the increased prominence of national security concerns in FDI regulation is expected to drive further growth in the already strong bilateral investment relationship with Australia’s largest investment partner.
But as the ADM-Graincorp episode illustrates, even a mature investment relationship is not immune to political uncertainty and is perhaps even more vulnerable to surprise decisions.