New Delhi: China and India rival one another and are aggressively challenging the United States as the world's most favored destinations for foreign direct investment, according to the latest Foreign Direct Investment Confidence Index, an annual survey of executives from the world's largest companies, conducted by global management consulting firm A.T. Kearney.

For the first time since 2000, a sizable majority (69 per cent) of executives are more optimistic about the global economy, compared to only one in 10 expressing more pessimism. Corporate investors expressed an increased willingness to make overseas investments compared to 2003 - the first positive year-to-year increase in overall FDI confidence in since 2001. Helping spur likely future FDI, corporate investors see macroeconomic and political risks as less threatening and perceive greater profit opportunities and reduced risk, in the world's leading emerging markets.

Global executives are more likely to invest in China and India than at any time since 1998. China maintained its top ranking as the most attractive FDI destination, while India rose from sixth to third most likely FDI location globally - the country's highest ranking ever, just behind the U.S. Although the United States remained the second most attractive FDI location, the gap between the U.S. and India may be closing. As China and India forge their leading positions in the global economy, the United States and the rest of the world will face severe competitive pressures from these two dynamic and rapidly evolving economies.

India and China spar over FDI like David and Goliath
China and India dominate the top two positions for most positive investor outlook, likely first-time investments, and most preferred offshore investment locations for business processing functions and IT services. Compared to other large emerging markets, China and India are cited by CEOs as the most attractive FDI destinations in the short-term (next three years) and well into the future, beating markets like Brazil, Mexico and Poland for medium-term attractiveness 10 years out.

However, global investors view these two destinations as distinctly different markets: China as the world's leading manufacturer and fastest-growing consumer market and India as the world's business process and IT services provider, with longer-term market potential. When asked what kinds of activities will be offshored to China and India, investors indicated that China leads for manufacturing and assembly, while India leads for IT, business processing and R&D investments. Investors favor China over India for its market size, access to export markets, government incentives, favorable cost structure, infrastructure and macroeconomic climate. However, these same investors cite India's highly-educated workforce, management talent, rule of law, transparency, cultural affinity, and regulatory environment as more favorable than China's. China's FDI flows are larger ($53.5 billion) and primarily capital-intensive, while Indian FDI flows are smaller ($4.3 billion) and skill-intensive, concentrated in information and technology areas.

Growing confidence in China and India challenges long-term U.S. dominance
For a third year in a row, the U.S. lagged China as the second most attractive investment destination in the world, and now India is not far behind. India's rise to the third most attractive market in the world is an all time high. In leading the U.S., China ranks as the number one FDI location across all major sector investors including financial and non-financial services, manufacturing, primary, telecom and utility and wholesale and retail.

For the first time in the Index, India displaced the U.S. to become the second most attractive FDI location among manufacturing investors, while the U.S. fell to third place. Never before has the U.S. been ranked so low among manufacturing investors. Telecom and utility investors upgraded China from fourth to first and India from fifth to second most attractive FDI destination, while dropping the U.S. from first to fourth place - just behind Hong Kong. India's strong performance among manufacturing and telecom and utility firms was driven largely by their desire to make productivity-enhancing investments in IT, business process outsourcing, research and development, and knowledge management activities.

With an $11 trillion economy, more than twice the size of the next largest market, Japan, the U.S. remains a behemoth and may be regaining its former FDI momentum. For the first half of 2004, U.S. FDI inflows are estimated to have reached $42.9 billion, more than the total inflows received for the entire year in 2003. The U.S. also continues to be the dominant outward foreign investor, contributing more than twice the amount of global FDI than France, the next largest FDI exporter in 2003. Nonetheless, the hyper-growth, knowledge-based and lower-cost opportunities unleashed by China and India will continue to challenge the U.S. despite its global economic dominance.

CEOs express the highest levels of optimism in years
Nearly 70 per cent of global investors are more upbeat on the global economy this year. The last time a majority of investors were so bullish on the global economy was in 2000, when global FDI flows reached the all-time high of $1.4 trillion. For the first time since 2001, executives' overall willingness to invest overseas rose. The renewed confidence of CEOs reverses two consecutive years of decline in FDI confidence, coinciding with dramatic declines in actual FDI flows.

Although they remain among the leading corporate risks identified by survey respondents, government regulation and instability (macroeconomic, political and social) appear to be slightly less daunting to global investors than before. Most notably, 51 per cent of global investors view currency and interest rate volatility as a critical risk to operations compared to 63 per cent last year, whereas 46 per cent of global investors cite political and social disturbances as a risk compared to 62 per cent last year. More executives this year expect to achieve profitability targets in the big emerging markets - China, India, Brazil, Mexico and Poland - and aside from Mexico, fewer view these markets as high-risk FDI locations than did last year.

Corporate investors' brighter outlook on the business environment could presage a turnaround in global FDI flows. Yet, investors have heightened concerns over corporate governance, theft of intellectual property, terrorism and threats to employees and assets. FDI decisions will be tempered by the performance of the U.S. economy, the dollar, and the ability of the leadership in Beijing to engineer a soft-landing for Chinese economy.

Roughly a quarter of global investors noted terrorism and volatile energy prices as influencing their overseas investment decisions. A similar percentage of global investors view military conflict in the Middle East - upon which securing Iraq's oil supplies depends - as a critical factor influencing their FDI plans.

"With dampened global risk perceptions, investors who have not overhauled their strategic planning functions, and put in place rigorous risk identification and management systems will be ill-prepared to absorb the next inevitable shock to the global economy," said Paul Laudicina, A. T. Kearney vice president and managing director of the firm's Global Business Policy Council, which conducts the study.

Firms are holding their fire before engaging in cross-border deals
Last year 45 per cent of CEOs selected mergers and acquisitions as their preferred mode of entry into foreign markets, while this year 39 per cent indicated the same. Through restructuring, asset disposals and increased profitability, the largest American and European firms have accumulated over $2 trillion in cash. However, rather than investing abroad, many investors are buying back shares or limiting mergers and acquisitions to their home markets.

Executives remain acutely aware of the negative fallout from overseas mega-deals of the past: huge debt burdens, flawed due diligence, regulatory quagmires and unfulfilled performance expectations. This year global investors also expressed even greater concern over corporate governance issues, with 30 per cent of investors indicating that they will pose a risk to their firms' operations compared to 25 per cent who said the same last year.

"Given the ill-planned expansion strategies of the past as well as lingering concerns over corporate governance, we have entered a period of 'a la carte' M&A, where investors are selectively snatching up complementary strategic assets, with heavy-weight deals the exception," said Laudicina. Although the number of M&A deals rose by 2 per cent last year, the average deal value continued to decline, reaching half the value seen in 2000.

As China's locomotive drives the region, Asia's FDI prospects shine
Five of the six largest jumps in the Index were registered by Asian markets, with Hong Kong, Australia, Singapore, Malaysia and New Zealand enjoying the strongest improvements in investor confidence. Their robust performances were in part driven by North American and European investors seeking to diversify their operations across Asia and anticipating growth opportunities in these markets. Hong Kong, Malaysia and New Zealand received higher confidence nods from Asian investors.

Japan entered the top 10 most attractive investment destinations for the first time, moving from 15^th to 10^th place. With growth levels not seen since the 1980s and progress on reform, Japan is generating renewed investor interest. Unlike previous recoveries, Japanese households are leading the way as traditionally cautious Japanese consumers open their wallets and further support U.S.-China-driven export growth.

Executives overwhelmingly consider China to be the undisputed top FDI destination for the third year in a row. About 40 per cent of global investors expressed a more positive outlook on China's economy compared with last year, vs. only 10 per cent who had a dimmer view. While executives consider the overheating of the Chinese economy to be the third most important factor influencing their FDI decisions, this has not changed the strategic equation, as investors consider the upside benefits to outweigh the risks in China.

India displaced Mexico to become the third most attractive FDI destination worldwide and is increasingly perceived as a R&D hub for a wide range of industries. The country's service-oriented development path is allowing it to bypass obstacles like weak infrastructure. A "wired" India has played to its strengths, which include a well-educated, IT-savvy workforce with English-language proficiency. Yet, according to global investors, bureaucracy, political stability and maintaining a lower-cost advantage will be the principal challenges to India's future competitiveness. These issues will likely require considered attention for the country to translate investor confidence into actual FDI increases. "India is on the cusp of a real FDI take-off. Whether or not it achieves its potential will be powerfully influenced by how the Indian government manages its business policy environment," said Laudicina.

Although corporate reputation is at risk, the offshoring pace quickens
With 10 offshore propositions under debate in the U.S., nearly one in four global investors cited the risk to corporate reputation as an important deterrent to offshoring operations to lower-cost locations. Service sector investors (financial and non-financial) revealed the most concern over perceived reputational risk associated with offshoring. One in five wholesale and retail investors, with greater sensitivity to brand image, noted that a backlash against offshoring would impact their FDI decisions.

Nevertheless, the offshoring impulse has grown, with 66 per cent of global investors expressing a willingness to offshore compared to 50 per cent last year. Investors noted higher labor skills/education, better infrastructure, and proximity to consumers as their top reasons for deferring offshoring. Given their demographic and growth trajectories, many developing countries will become the focus of the world's consumer markets over the next several decades. Expected advances in education and infrastructure in the developing world will likely add momentum to the offshoring pace. The labor arbitrage opportunities presented by offshoring are also expected to remain strong. Only 11 per cent of investors regarded the cost-savings from offshoring to be transitory.

More offshoring traffic is likely headed to emerging markets
For a second year in a row, the United States, the United Kingdom and Ireland ranked among the most preferred offshore locations for corporate investors. Alongside China, India, Malaysia, Singapore, the Czech Republic, Slovakia and Poland, these three developed markets were most frequently cited as offshore destinations for global investors over the next three years.

The U.S., the UK and Ireland are expected to benefit from IT, knowledge management, and business process offshore investments. Ireland was specifically noted as an attractive location for contact centers (call centers, Web centers, etc). From a regional perspective, for instance, Glasgow, Belfast, and Dublin are low-cost service locations in their own right with attractive education levels, infrastructure, financial and political climates, safeguards for intellectual property and quality control - factors that can outweigh the strong cost advantages of a Shanghai or Bangalore offshore destination.

Nevertheless, the offshore wave has just begun to ripple and with effective policy-making and investments in technology, infrastructure and people, emerging markets stand to reap the greatest benefits from offshoring investments. Investors indicate that they will place more than half of their offshore investments in China and India over the next three years.

The transatlantic economy boosts Western Europe's FDI prospects
The United Kingdom jumped from seventh to fourth most attractive FDI destination in the world, driven primarily by increased confidence among U.S. and Asian investors. After dropping out last year, France and Italy re-entered the top 10, climbing from 11^th to sixth and 12^th to ninth place respectively. Germany held steady in fifth place. U.S. and French investors underlie Western Europe's healthy performance.

While the U.S.-led war in Iraq sent transatlantic relations into a tailspin last year, the transatlantic economy was benefiting from a cyclical recovery noted by strengthening FDI flows and foreign affiliate profitability on both sides of the Atlantic. U.S. FDI into the EU 15 rose from $61 billion in 2002 to $81 billion in 2003. Last year, U.S. investors remained the primary source of French FDI inflows and created nearly one-quarter of the new FDI-related jobs in France.

Looking forward, U.S. investors expressed stronger confidence in Europe's largest economies, ranking the United Kingdom second (up from 11^th place), Germany seventh (up from ninth place), France 13^th (up from 19^th place) and Spain 11^th (up from 17^th place). However, a return to positive EU FDI growth will depend on the broadening and strengthening of European economic recovery, since EU inflows are predominantly from other EU members.

UK's Eurozone avoidance impacting FDI decisions
Eurozone countries are more eager to remain under the umbrella of the single currency rather than investing in the UK, ranking it 12^th. This is down from ninth place last year and behind Germany, France, Spain, and Italy and expected Euro members Poland, the Czech Republic and Hungary.

Last year UK FDI inflows dropped by nearly half, from $27.8 billion in 2002 to $14.5 billion in 2003. This was likely driven by fewer investments from and disinvestments by European investors. EU FDI flows to the UK tumbled by an estimated 80 per cent from 2002 to 2003. With the EU accounting for about 47 per cent of UK FDI inflows, the slow recovery and continued corporate restructuring on the European continent are likely undercutting UK FDI inflows.

U.S. investors ranked the UK their second most attractive market in 2004, pouring more cumulative investments into the UK than into any other country, and accounting for 15 per cent of total U.S. FDI outflows. The U.S. corporate asset base in the UK is greater than the U.S. asset base in Asia and the U.S. asset base in Latin America, Africa and the Middle East combined. The UK's innovation and technology-driven economy has made UK firms attractive M&A targets. General Electric (U.S.) acquired the British medical imaging and biotechnology firm Amersham last year for $9.5 billion, one of the largest deals in 2003. The UK economy is expected to have one of the strongest growth rates in Western Europe again this year and well above Eurozone average growth rate.

The EU-FDI dividend fails to materialize as the reality of EU membership sets-in
Despite their entry into the European Union, global investors expressed slightly lower levels of interest in new EU member markets this year. Poland dropped from fourth to 12^th place, the Czech Republic from 13^th to 14^th place and Hungary from 17^th to 19^th place. Now that the novelty of EU membership is fading, corporate investors are anxious to see just how these markets perform, given the challenges that the EU accession process poses.

Among the leading perceived threats to the competitiveness of the 10 new EU members, global investors cited poor infrastructure (67 per cent of investors), corruption (60 per cent), and the erosion of cost advantage (53 per cent). EU reforms are a double-edged sword. While they are expected to bring infrastructure investments and regulatory stability within the EU single market, the economic and social costs of adjustment remain high. EU law will likely add a new layer of bureaucracy and may undermine new members' relative FDI advantages in areas such as favorable tax and labor conditions, which could push investors toward Romania, Bulgaria, the Balkans, Ukraine, and China.

Only one in 10 global investors cited the completion of privatization programs as a risk to the competitiveness of these new EU countries. Nonetheless, the end of privatizations in the Czech Republic and Slovakia in part explain the region's FDI decline last year. According to global investors, among the top 10 countries and regions with the greatest positive outlook, half are in Eastern Europe: Poland, the Czech Republic, Russia, Hungary and the Baltic states.

Russian FDI glow dims amid troubled business climate
Russia tumbled from eighth place last year, its all time high, down to 11^th most attractive market. Kremlin-led legal actions against oil giant Yukos, detention of the company's founder and a series of violent terrorist attacks over the past year have shaken investor confidence. Russian FDI nearly doubled from $3.5 billion in 2002 to $6.7 billion in 2003, driven largely by oil and gas transactions. Oil and gas investors, well-adapted to tough business environments, ranked Russia their second most attractive market in the world, behind Australia.

Mexico and Brazil lose ground among global investors
After maintaining fairly high levels of investor confidence since the late 1990s, Mexico dropped out of the top 10 most attractive markets for FDI, falling from third to 22^nd most attractive destination. Unfulfilled reforms in key areas such as telecom, infrastructure, and energy, and the magnetic pull of China, have led global investors to rethink Mexico. Since the all-time high of $26.8 billion in 2001, Mexican FDI inflows have declined each year, falling to $10.8 billion by 2003, which is the lowest level since 1996. Dampened enthusiasm for Mexico is most apparent among European and Asian investors.

From the end of 2000 to April 2004, roughly one in four maquila enterprises left Mexico, cutting nearly a quarter of a million jobs. Among these firms, about one in three reportedly relocated to China. While Mexico led major emerging markets in 2003 in meeting investors' expected profit targets, this year China, Brazil, India and Poland surpassed Mexico. Mexico ranks dead last compared with China, India, Poland and Brazil in terms of investor short-term (one-three years) and medium-term (ten years) FDI attractiveness.

Currently, Mexico's loss of competitiveness appears to be limited to labor-intensive industries characterized by low cost and large-scale production. But Mexico must continue to move to more complex industrial production activities and services to offset lost manufacturing that is flowing to China and Central America.

This year Brazil ranked the 17^th most attractive market in the world, down from ninth place in 2003 and its lowest ranking ever. Last year Brazilian FDI inflows fell by 39 per cent from $16.6 billion in 2002 to $10.1 billion in 2003, its lowest level since 1995. Greater economic stability, a resumption of growth, and improved investor views on profitability and risk could help turn around the country's FDI slump, but regulatory concerns as well as competing opportunities elsewhere in the developing world may limit the country's ability to boost FDI. Despite the Herculean efforts of the government to secure macro stability, Brazil is still perceived as the most risky country among the five big emerging markets.

About the FDI Confidence Index® and Global Business Policy Council
The FDI Confidence Index is based on an annual survey of CEOs, CFOs and other top executives of Global 1000 companies, conducted by the Global Business Policy Council of A.T. Kearney. Country and sector coverage among the participating companies reveals a normal distribution compared to the Global 1000 population. The results of the FDI Confidence Index study are intended for general information purposes only and do not constitute investment or other business advice.

The Global Business Policy Council is a strategic service of A.T. Kearney that helps chief executives monitor and capitalize on geopolitical, economic, regulatory, technological and social change worldwide. Council membership is limited to a select group of corporate leaders and their companies. The Council's core program includes periodic meetings in strategically important parts of the world, timely analytical products, regular member briefings, regional events and other services.