Planting Seeds on Rocky Ground

October 18, 2010—Security, rule of law, good infrastructure, and a healthy, educated workforce. These are just some of the conditions that investors consider when looking at an investment prospect, according to Patrick Garver, a former executive of Barrick Gold Corporation. However, when looking at a country affected by conflict, Garver notes, an investor is likely to see very little of this and more likely to encounter indebtedness, limited human capital, shaky if any rule of law, and pervasive corruption.

Garver and other distinguished panelists discussed the challenges investors face in conflict-affected and fragile states during a seminar at the recent Annual Meetings of the World Bank and International Monetary Fund. Also participating on the panel organized by the World Bank’s Multilateral Investment Guarantee Agency (MIGA) were Habiba Sarabi, Governor of Afghanistan’s Bamyan Province—the first female governor in the country’s history—and Desha Girod, Assistant Professor in the Department of Government, Georgetown University. James Bond, MIGA’s Chief Operating Officer, moderated the panel.

Avoiding the Poverty and Conflict Trap

Evidence points to economic growth, rising income, and integration into the global economy as critical factors in helping countries emerge from conflict and avoid the somewhat high risk of relapse. Foreign aid can bolster a country in the immediate aftermath of conflict, but eventually these flows decline as other trouble spots emerge across the globe. So how can countries attract sustainable investment in difficult circumstances? And why should investors bother?

When asked about her experience in Afghanistan’s rebuilding process, Sarabi noted that inadequate infrastructure and a lack of clarity on how to tackle the country’s long list of priorities were both significant impediments to bringing in much-needed investment. She particularly noted that the country is grappling with its nascent democracy. “Democracy is ideal, but people don’t understand the value of democracy and they don’t know the laws. Democracy and education need to go hand-in-hand.”

Girod underlined that while there is no conclusive answer on how countries can avoid a vicious circle of poverty and conflict, her research points to some important factors. First, solid domestic leadership can provide a strong signal to the investor community by adhering to the agreements made with international financial institutions. Second, the prior existence of democratic institutions provides a mechanism for addressing grievances.

Natural Resources – Blessing or Curse?

Much has been made of the “resource curse” and it is true that some of the countries with the red flags that Garver noted are rich in resources. But, he argued, the resources and the curse are not inseparable; the onus is on government and investors alike. “If you’re going into a country with a long history of corruption, it’s inevitable that you will be exposed to it, but not that you will participate,” he said. Sarabi also implored investors to walk the talk on corruption. “If you want us to be transparent, then you need to be too.”

Panelists noted that a combination of conflict, valuable natural resources, unsavory government officials, and investors out for a quick profit can quickly negate any positive impact accruing from an investment. Squabbles over resource rents can play a role in precipitating a conflict and they can also help push a recovering country back into conflict. High commodity prices can exacerbate the problem as the allure of easy money raises the stakes. Instead of attracting responsible investors committed to the long-term success of a project, countries with weak leadership and endemic corruption end up with junior and speculative companies that are hoping to flip their assets.

Unfortunately, Girod said her research shows that resource-rich states tend not to recover well from conflict. This is evidenced by key development indicators, such as infant mortality rates, that do not improve. On the other hand, states that are committed to reform and interested in attracting the support of international financial institutions tend to fare better. Here, she provided the examples of El Salvador and Mozambique. One hypothesis is that donors have less leverage in states rich in natural resources, and this can prevent the critical building blocks of good governance from being put into place.

License to Operate

When it comes to investment destinations that show opportunity with a reasonably committed—if somewhat weak—government, what can investors do to mitigate risks? Garver enumerated a number of important factors, stressing that all must be addressed. “You need to understand the country and the nature of the conflict so that the investment meets the country’s needs. Don’t create big winners and losers. Address the concerns of local communities and understand their context.” Investors should also avoid cutting deals with governments that seem too good to be true. “You need to enter into fair and transparent deals that can withstand changes in government.” He also stressed the importance of choosing strong local partners and staff. In addition to addressing these “soft” issues, investors can seek political risk insurance or limited recourse project finance to add a layer of “hard” protection.

Moderator James Bond made the point that MIGA’s political risk insurance straddles both “hard” and “soft” protection. MIGA’s risk-mitigation product is available in the marketplace, but the fact that host governments are also members of MIGA, an entity within the World Bank Group, also gives the agency a solid footing and room to resolve disputes when disagreements arise between foreign investors and governments.

Coming Attractions

While this Investment in Conflict-Affected and Fragile States seminar offered rich insight on the behavior of investors and host countries in very difficult environments, MIGA is exploring this issue in even greater depth with its upcoming World Investment and Political Risk 2010 report. The report will be launched this December in London at the Financial Times summit: Managing Global Political Risk: Cross-Border Investment in Conflict-Affected and Fragile States.

Note: A video of the entire session is available on the Program of Seminars website. Click on “video links” under Announcements.