Not surprisingly, the pandemic triggered a decline in FDI flows into emerging markets in 2020. However, even prior to the pandemic, aggregate FDI flows into emerging markets as a share of GDP had almost halved in the prior decade.

Why have FDI inflows declined so significantly? One of the most notable trends has been the decline on FDI returns in emerging markets. Before the global financial crisis, FDI in major EMs offered higher rates of return compared to developed markets, helping compensate investors for the additional risks associated with EM investments, such as more challenging regulatory and business environments and higher political risks. However, since 2009, returns on FDI across EMs have declined significantly, while returns on FDI in developed markets have remained relatively stable.

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Weaker FDI inflows could weigh on long-term growth potential for emerging markets, given that FDI has been a key source of knowledge and technology transfer, supporting total factor productivity growth. While some countries with high domestic savings rates may be better placed to manage the impact of a decline in FDI on fixed investment, those with lower domestic savings and weaker capital markets access, such as smaller countries in Latin America and Africa, are more likely to be affected as a result of lower FDI flows.

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Moreover, a protracted and uneven recovery across emerging markets, coupled with deglobalisation and growing interest in shortening supply chains to address some of the vulnerabilities laid bare by the trade tensions between the US and China, and more recently the pandemic, are among the significant headwinds that may prevent a reversal of this decline.

The emergence of the Omicron coronavirus variant poses new risks to the global economic growth and inflation outlook, as concerns mount about the variant's health risks and several countries have imposed new travel restrictions in recent days. However, the risks to emerging markets are particularly acute: should the new variant lead to another rising wave of COVID-19 infections, the hardest-hit economies will be those with lower vaccination rates, higher dependence on tourism and lower capacity to offer additional fiscal and monetary policy support to offset the growth impact of the resurgence in infections.

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Macroeconomics – Global

Vaccination rates vary across emerging markets but remain on average lower than developed markets

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Amongst emerging market countries, the economic impact from the outbreak will not be homogenous, and will depend on a mix of government restrictions, public comfort with social interactions, and the capacity of governments and central banks to provide additional policy support to the private sector, if needed.

Even prior to the outbreak of the latest coronavirus variant, emerging markets were already coping with more rapid than anticipated increases in inflation and persistent supply chains disruptions. High food and energy prices, which account for a large share of emerging market’s disposable income, has led to rapid increases in headline inflation in major emerging markets including Turkey, Brazil, Mexico and Russia, increasing the risk of government mandated price controls, which could weaken corporate profitability.

The latest outbreak could also have implications for the easing of supply chain bottlenecks. Over recent months, high-frequency alternative trade indexes, which reflected base effects earlier in the year, suggested an ongoing but uneven recovery across emerging markets (EMs).