Conventional wisdom on capital flows holds that foreign direct investment is for the long-term, while securities and other flows may be more volatile. However, as Olivier Blanchard and Julien Acalin conclude, a large proportion of measured foreign direct investment can be flows going in and out of a country on their way to a final destination. What explains this? The answer is special purpose entities (SPEs).
SPEs are legal entities set up to obtain specific advantages from a host economy, in which they have little to no employment, physical presence, or production. They are usually set up to benefit from low taxes but can be established for other reasons such as easier access to capital markets, financial services, and skilled workforces. Because they have little to no impact on the economy, these financial flows can distort the true picture of economic activity provided by foreign direct investment numbers. Directly measuring flows from SPEs helps resolve this.
A new IMF database for the first time measures cross-border flows and positions of SPEs resident in 26 participating economies, based upon an international definition. Using the database our Chart of the Week breaks down foreign direct investment in these economies. Foreign direct investment positions channeled through resident SPEs in some places are remarkably high, in Luxembourg they are 45 times the size of its economy, it’s 30 times in Mauritius, and 28 times in Bermuda.
As outlined in a recent IMF Blog, some of the world’s top recipients of foreign direct investment have large financial stocks that include those channeled through SPEs. To this end, this new database is a major step toward improving the transparency and comparability of external sector statistics by filling the data gaps, including to better understand the prospective changes due to the new global corporate tax agreement.
The database reflects an internationally-agreed methodology as endorsed by the IMF Committee on Balance of Payments Statistics in a 2018 report. It complements SPE statistics disseminated by the Organisation for Economic Co-operation and Development (OECD) and the European Union statistical office, Eurostat, for their member countries.
This database release will be followed by annual updates featuring increased country coverage, including for EU economies where reporting of SPE data will become mandatory this year.