Whats in a number? If its an official statistic on foreign direct investment, the answer might be misleading. For example, China recently reported $10.76 billion in FDI receipts for January, a 16.1 percent increase from the same month a year earlier. A government spokesman told media that this number underscores the countrys economic stability when many are questioning it. In fact, a good chunk of what appears to be FDI flowing into China is domestic investment wrongly categorized: Chinese investors often route money through a tax haven first, a practice called round-tripping. This explains how the British Virgin Islands is officially the second-biggest investor in mainland China after Hong Kong.
Using a long-standing reporting method from the Organization for Economic Cooperation and Development, most governments compile FDI statistics according to the country that served as the moneys most recent home, even if its a tax haven where the investor in question has a holding company. But the Paris-based OECD recently switched to a method that should soon bring more accuracy to FDI numbers, which are often enlisted to support opinions about global economic trends and country competitiveness.
This change, which comes as revenue-hungry governments seek to close tax loopholes, will provide more data for their endeavors. At a June 2013 meeting in Moscow, the Group of 20 approved an OECD initiative to address erosion of the tax base and profit shifting; this effort will likely dovetail with other recent reforms, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act and the U.K. Bribery Act. The OECD has developed a plan that starts with boosting the reporting obligations of FDI investors to their tax authorities to better elucidate where profits are coming from and where theyre accounted for.
Martin Murenbeeld, chief economist with Toronto-based investment dealer Dundee Capital Markets, welcomes more clarification on FDI flows. As an economist, you always want more and better data, Murenbeeld says. But a lot of this depends upon proper and timely compliance. Companies will do what the law requires.
The OECD established a new way to tabulate FDI in 2008 and agreed with member states to start using it in 2013. These changes will apply only to its 34 members, though China and other countries can adopt them. The new approach mandates following money back to its country of origin rather than settling for its latest stopover. Thats a more useful measure when it comes to developing well-informed government policy, says OECD economist Michael Gestrin.
Because the update will require statisticians to overhaul some collection methods, the OECD doesnt expect a complete picture of FDI based on the new standard until late 2015. Take Canada, where the government reports that Chinese interests spent just $12.04 billion on acquisitions and other investments in 2012, versus Dealogics total of $22.95 billion for takeovers alone. Statistics Canada, which relies on surveys of Canadian businesses, anticipates a break-in period as it adjusts those documents and helps people understand and comply with the changes, an agency spokesman says.
FDI stats will still be published according to the old method as well. The International Monetary Fund mandates it for nations reporting their balance of payments, and the numbers are also useful for foreign exchange and other investors tracking currency flows. Though its impossible to predict with any precision how FDI stats will change, the total pool of capital will appear to shrink once round-tripped funds are stripped out. More important, the new rules will remove or at least minimize distortions of country-to-country investment flows. The main beneficiaries may be governments looking to protect their tax bases, but anyone who participates in the global economy will see the playing field in a new light.