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Saturday, June 15, 2024

FDI attraction amidst global minimum tax policy

By Phan Dinh Manh

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Foreign direct investment (FDI) has been rising strongly even though global economic uncertainties have negatively affected this capital flow. Many factors are taking a toll on FDI activity and Vietnam can hardly stay unscathed.

The global FDI flow amounted to US$1,580 billion in 2021, up a staggering 64% over 2020 when this capital channel dropped to a new low. The recovery was attributed to a strong rebound in mergers and acquisitions (M&A) activity and the fast growth of international project financing due to loosened financial conditions and major infrastructure stimulus programs.

However, the global environment for international trade and cross-border investment underwent radical changes in 2022. The Russia-Ukraine military conflict and the lingering aftermath of the Covid-19 pandemic have triggered food, fuel and financial crises in many countries. These may lead to a sharp reduction in global FDI.

Major changes

In 2021, multinational corporations (MNCs) from developed economies doubled their outbound investment year-on-year to over US$1,300 billion, accounting for 75% of the global FDI. The strong growth was attributed to a record reinvestment of their earnings and the vibrant M&A activity.

The total outbound investment by European MNCs strongly bounced back in 2021 to US$552 billion. U.S.-based MNCs also boosted their overseas investment by 72% to US$403 billion. FDI from other developed economies also surged by 52% to US$225 billion, backed by strong investment activity of MNCs in Japan and South Korea.

The FDI amount from MNCs in developing countries also grew 18% to US$438 billion.  Though the outbound FDI from a developing Asia was still growing, MNCs based in Asia conducted fewer M&A deals in 2021.

Investment in areas related to sustainable development has increased substantially of late. Inbound investment in developing countries increased by 70% in 2021. However, most of the additional investment has been channeled into renewable energy.

The FDI flow into developing Asian economies increased for the third year in a row in 2021 and hit an all-time high of US$619 billion in 2021, accounting for 40% of the global FDI. The FDI capital was evenly distributed in the continent except South Asia. Six major economies, from China, Hong Kong, Singapore and India to the United Arab Emirates and Indonesia, accounted for over 80% of the FDI flow into Asia.

The FDI flow might undergo changes as the Organization for Economic Cooperation and Development (OECD) in February detailed the final guidance for governments on how to collect the new global minimum corporate tax of 15% next year. Major MNCs with annual revenue of over 750 million euros will be subject to the tax. The primary aim of the tax is to prevent MNCs from transferring their earnings to tax havens and reduce the tax incentive competition among countries. The global minimum tax is believed to have strong impact on investment policies and international investment activity as tax incentives are among the major factors behind FDI decisions.

Over two-thirds of new FDI projects in the past five years have reported consolidated revenue above the 750-million-euro threshold, or even a bigger amount in developed economies. While many companies may find themselves unaffected by the tax initially, an increasing number of MNCs will boost FDI down the road. But as the threshold is gradually lowered, most FDI projects would be subject to this tax later.

Lowering the competition among low-tax countries may benefit developing economies. However, when the competition shifts from tax incentives to other alternatives to attract investment, many countries would find themselves at a disadvantage as they are financially incapable of providing necessary infrastructure facilities or subsidies.

Vietnam facing new reality

Vietnam has been widely known for its low-cost labor. However, its labor quality may not be a near-term advantage in comparison to other neighboring economies. A report by Manpower Group shows that the average salary of Vietnamese workers is US$275 a month, far lower than the world’s average of US$2,143. The Philippines has a slightly higher monthly pay, at US$283, but its labor quality is higher, with 18.3% of the workforce possessing high skills, compared to 11.6% in Vietnam.

However, with a sizeable population, Vietnam is a highly potential market. According to McKinsey, the number of Vietnamese consumers who spend at least US$11 a day in terms of purchasing power parity will increase by 36 million people in a decade. In 2010, less than 10% of Vietnam’s population had disposable income higher than this threshold, but the proportion has now exceeded 40%, and can border on 75% by 2030. The purchasing power is on the rise, not only from those people first entering the consumption group, but also from the higher disposable income among consumers in the income pyramid. The two top ladders of the pyramid (comprising those consumers who spend at least US$30 a day) are expanding quickly and may account for 20% of the population by 2030.

Urbanization is a factor behind the income surge. The number of urban dwellers is expected to increase by 10 million in the next decade when the proportion of urban residents increases to 44% in 2030 from 37% in 2020. However, a higher land rent and impacts from the tax policy can erode Vietnam’s attractiveness to investors.

It is assumed that foreign investors choose Vietnam as an FDI destination due to better benefits in comparison to other countries. These benefits include direct economic and trade benefits like tax deduction, low-cost labor, and a sizeable market, as well as other strategic advantages like cultural similarities, reciprocal partnerships and nation-to-nation cooperation. Therefore, Vietnam needs to maintain its competitive advantages, both economic and strategic benefits, to compensate for other benefits for FDI enterprises that may evaporate when a higher tax rate applies.

Vietnam can help MNCs cut input costs via indirect assistance measures like cutting machinery acquisition and R&D costs, and improving infrastructure. The most important factor to benefit MNCs is to develop original equipment manufacturing (OEM) facilities to build up a complete value chain in the country. Vietnam can also offer direct support in terms of capital, science and policy to help upgrade technology and reduce product costs for OEM enterprises, and build up them into a production network.

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