New Report Examines Investment and Political Risk in Emerging Markets
December 03, 2009—While political risk is a top concern for corporate foreign investors, the allure of business prospects in the developing world means that these markets are likely to continue to attract a growing share of global foreign direct investment (FDI). These findings and others are revealed in a new MIGA report, World Investment and Political Risk 2009.
To gauge how the current global financial crisis has colored the outlook of the investment community and insurance industry when it comes to long-term investments in developing countries, MIGA commissioned independent agencies to conduct several corporate surveys. The research revealed three key findings that are examined in depth in the report.
Political Risk Remains a Key Concern,
but Emerging Markets are Expected to Attract a Growing Share of FDI
The report found that political risk remains one of the main obstacles to foreign investment in emerging markets, and that it is likely to remain so over the medium term. Investors surveyed for the report ranked political risk among their top three concerns when investing in developing countries more often than any other consideration, including macroeconomic stability and access to financing. Even though overall risk appetite seemed to be on the rise leading up to the financial crisis and risk premiums were flattening in a time of abundant liquidity, political risks had been deteriorating in a number of areas. Contract renegotiations in the extractive industries and a resurgence of “resource nationalism” served to heighten concerns over expropriation and breach of contract, while decentralization to sub-sovereign entities led to increased concerns about such entities being able to meet contractual and financial obligations – particularly in infrastructure projects.
Although a majority of investors surveyed didn’t believe that the economic downturn itself resulted in higher political risks in their main investment destinations, the crisis did have a more pronounced impact in the most vulnerable destinations. Analysts commissioned for the report agree that in environments where liquidity is severely undermined and there is pressure on local currency, there is a heightened risk that governments may impose transfer and convertibility restrictions. Strained budgets could also make it more difficult for governments to fulfill their contractual or guarantee undertakings and of course economic hardship could weigh on the risk of social unrest.
Despite these risks, the developing world remains an attractive destination for FDI as many economies have fared better in the economic crisis than the industrialized economies and represent untapped opportunities for investors. Investor surveys undertaken for this report confirm a robust appetite for investment in developing countries with FDI to emerging markets expected to rebound as early as 2010, although it will most likely remain directed at a handful of countries.
Concern about Political Risk and Sustained FDI into Emerging Markets Point to Need for Political Risk Mitigation Instruments
As concerns over political risk converge with an increased interest in emerging market investments, there is a need for risk-mitigation instruments. Although the use of political risk insurance (PRI) as a risk-mitigation instrument has been relatively small, with the majority of investors relying on their own risk management capacity, 40 percent of respondents indicated they would consider using insurance for future investments.
The PRI industry itself has grown from a minimal presence 20 years ago to a well-established market today, generating annual premiums of about $1 billion. Exposure is diversified across a number of well-capitalized and informed carriers, underwriting standards and processes have been strengthened, and reinsurance has grown exponentially. The financial crisis has demonstrated the value in a balance of public and private insurers as the private insurance market has experienced capacity constraint in some countries. The crisis points to a need for continued cooperation between public and private insurers through coinsurance, reinsurance, and information sharing.
South-Based Investors are Shaping
the Global FDI Environment
From 2003-2008, FDI outflows from developing countries increased more than seven fold reaching an estimated $198 billion in 2008, 73 percent of which came from Brazil, the Russian Federation, India, and China. And while South-based investors surveyed appeared bullish in their investment plans, they also are concerned about political risks. As with North-based investors, political risk is ranked first among concerns when investing in emerging markets.
This emergence mirrors a trend seen in MIGA’s portfolio over the past several years. Although the size of the investments was relatively small, South-based investors represented 50 percent of the share of projects insured by MIGA in fiscal year 2009. MIGA, like other PRI providers, has responded by tailoring its product to meet the needs of this emerging market segment, including offering Shariah compliant cover. Some South-based national insurers, such as China’s Sinosure, have ramped up their investment coverage. New regional insurers such as the African Trade Insurance Agency have also experienced tremendous growth in the past few years. While this represents important steps in meeting the needs of South-based investors, the report suggests that PRI providers need to step up their efforts in promoting awareness of their services and adapting their product offerings.
While PRI is likely to main a niche product, in part because insurable risks are a subset of the total spectrum of political risks, it does play a key role in facilitating large and complex projects and channeling investment into underserved markets including the world’s poorest countries and conflict-affected environments. As a development institution, MIGA is focused on serving investors where PRI can make a difference by helping to bring jobs and resources that improve the lives of people living is some of the world’s most challenging environments.