80511 2012 WORLD INVESTMENT AND POLITICAL RISK World Investment Trends and Corporate Perspectives Sovereign Default and Expropriation The Political Risk Insurance Industry © 2013 The International Bank for Reconstruction and Development/The World Bank 1818 H Street, NW Washington, DC 20433 t. 202.473.1000 www.worldbank.org feedback@worldbank.org Some rights reserved 1 2 3 4 15 14 13 12 This work is a product of the staff of The World Bank with external contributions. Note that The World Bank does not necessarily own each component of the content included in the work. The World Bank therefore does not warrant that the use of the content contained in the work will not infringe on the rights of third parties. The risk of claims resulting from such infringement rests solely with you. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. 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ISBN (paper): 978-0-8213-9508-0 DOI: 10.1596/978-0-8213-9508-0 Cover art: Shutterstock Design, cover, and document: Suzanne Pelland, MIGA/World Bank Group MIGA WIPR REPORT 2012 2012 World Investment and Political Risk World Investment Trends and Corporate Perspectives Sovereign Default and Expropriation The Political Risk Insurance Industry TABLE OF Contents FOREWORD ....................................................................................................................................................................1 ACKNOWLEDGMENTS...................................................................................................................................................3 SELECTED ABBREVIATIONS..........................................................................................................................................5 EXECUTIVE SUMMARY. ................................................................................................................................................. 7 CHAPTER ONE World Investment Trends and Corporate Perspectives. ..............................................................................................12 Prospects for Global Growth.................................................................................................................13 Prospects for Private Capital Flows to Developing Countries ...........................................................14 Trends and Prospects for FDI................................................................................................................14 MIGA-EIU Political Risk Survey 2012....................................................................................................17 FDI Outflows from Developing Countries. ...........................................................................................18 Political Risks and Developing Countries.............................................................................................18 Corporate Perceptions of Political Risks in Developing Countries. ...................................................20 Spotlight on South-South FDI.............................................................................................................. 22 Spotlight on the Middle East and North Africa.................................................................................. 24 CHAPTER TWO Sovereign Default and Expropriation ......................................................................................................................... 28 Sovereign Default and Expropriation................................................................................................... 28 Historical Trends of Sovereign Default and Expropriation. ................................................................ 29 Which Countries are Crisis-Prone?........................................................................................................33 Corporate-level Political Risk Perceptions for Sovereign Credit Risk ................................................37 CHAPTER THREE The Political Risk .......................................................................................................................................................... 42 Demand for PRI..................................................................................................................................... 42 Supply of PRI: Capacity, Pricing, and Products................................................................................... 44 Claims and Recoveries.......................................................................................................................... 47 Corporate Approaches to Political Risk Management. .......................................................................49 ENDNOTES ..................................................................................................................................................................52 APPENDICES Appendix 1 FDI Inflows, 2004–2011 ....................................................................................................................... 56 Appendix 2 MIGA-EIU Political Risk Survey 2012....................................................................................................58 Appendix 3 Overview of the PRI Market..................................................................................................................80 BOXES Box 2.1 Impact of Sovereign Debt Restructuring on Financial Flows: The Case of Indonesia.............................33 Box 2.2 Sovereign Risk and Transfer/Convertibility Risk.......................................................................................... 36 Box 3.1 Terrorism Insurance....................................................................................................................................... 48 TABLES Table 1.1 Global Growth Assumptions. ...................................................................................................................... 13 Table 2.1 Joint Distribution of Sovereign Default and Expropriation Events.......................................................... 31 Table 2.2 Frequency of Sovereign Defaults and Expropriations over 1970-2004................................................... 35 MIGA WIPR REPORT 2012 FIGURES Figure 1 Changes in Foreign Investment Plans...................................................................................................8 Figure 2 Primary Reasons for Investing More, or Reinvesting, in the Middle East and North Africa............9 Figure 3 Risk Mitigation Strategies by Foreign Investors..................................................................................10 Figure 1.1 Net Private Capital Flows to Developing Countries. ........................................................................... 15 Figure 1.2 Net FDI Inflows to Developing Countries by Region.........................................................................16 Figure 1.3 Changes in Foreign Investment Plans.................................................................................................19 Figure 1.4 FDI Outflows from Developing Countries...........................................................................................19 Figure 1.5 Ranking of the Most Important Constraints for FDI in Developing Countries. ............................... 21 Figure 1.6 Types of Political Risk of Most Concern to Investors in Developing Countries............................... 21 Figure 1.7 Proportion of Firms that Have Withdrawn Existing Investments or Cancelled New Investment Plans on Account of Political Risk over the Past 12 Months......................................... 23 Figure 1.8 Proportion of Firms that Have Suffered Losses Owing to Political Risk over the Past Three Years...................................................................................................................... 23 Figure 1.9 South-South Outward FDI Stock.......................................................................................................... 25 Figure 1.10 South-South Capital Expenditures in Cross-border Greenfield Projects........................................... 25 Figure 1.11 FDI Inflows into the Middle East and North Africa........................................................................... 26 Figure 1.12 How Have the Developments in the Arab World over the Past Year Affected your Current and Future Plans for Investments in the Middle East and North Africa?....................................... 26 Figure 1.13 Primary Reasons for Investing More, or Reinvesting, in the Middle East and North Africa..........27 Figure 1.14 Increase in Perceived Political Risks on Account of the Political Turmoil in the Middle East and North Africa........................................................................................................27 Figure 2.1 History of Sovereign Default and Expropriation.................................................................................30 Figure 2.2 Changes in International Investment Positions, 1995-2010. .............................................................. 32 Figure 2.3 Inflows of Debt Securities and FDI...................................................................................................... 33 Figure 2.4 Correlation of Sovereign Credit Rating and Transfer/Convertibility Rating...................................... 37 Figure 2.5 Impact of Actual Sovereign Risk Events on Political Risk Perceptions . ..........................................38 Figure 2.6 Sovereign Credit Risk and its Impact on Political Risk.......................................................................39 Figure 3.1 PRI by Berne Union Members and FDI Flows into Developing Countries...................................... 41 Figure 3.2 PRI Issuance by Berne Union Members..............................................................................................42 Figure 3.3 PRI Issuance by Berne Union Members, by Type of Provider...........................................................43 Figure 3.4 Available Private Market PRI Capacity................................................................................................. 44 Figure 3.5 General Insurance Pricing vs. Private PRI Capacity............................................................................45 Figure 3.6 Ratio of Premiums to Average PRI Exposure for Berne Union Members....................................... 46 Figure 3.7 Investment Claims Paid by Berne Union Members.......................................................................... 49 Figure 3.8 Investment Claims Paid by Berne Union Members, by Type of Provider. ....................................... 49 Figure 3.9 Recoveries by Berne Union Members, by Type of Provider...............................................................50 Figure 3.10 Risk Mitigation Strategies by Foreign Investors ................................................................................50 Figure 3.11 Investors Risk Mitigation Strategies, by Risk Type.............................................................................. 51 MIGA WIPR REPORT 2012 MIGA WIPR REPORT 2012 Foreword ingly turning toward PRI as a risk-mitigation tool. The The mission of the Multilateral insurance industry has responded with new products and innovative ways to use existing products as well Investment Guarantee Agency (MIGA) is as substantial capacity to meet the growing demand. to promote foreign direct investment(FDI) World Investment and Political Risk 2011 examined the triggers of expropriation, and found that authoritar- into developing countries to support ian political regimes have been linked to an increased risk of expropriation. This year we look at the risk economic growth, reduce poverty, and of sovereign defaults, typically caused by adverse economic shocks, and how it relates to expropriation. improve people’s lives. As part of this Both the risks of sovereign default and expropriation remain significant issues for foreign investors amid mandate, MIGA seeks to foster a better the global economic slowdown and continued politi- cal instability. understanding of investors’ perceptions of As we continue to gain a deeper understanding political risk as they relate to FDI, as well of political risk through our research, we hope that investors will feel more confident in moving as the role of the political risk insurance forward into new markets. With developing countries becoming the engines of economic growth in today’s (PRI) industry in mitigating these risks. multipolar world, the need for investments that generate jobs, transfer technology, and build infra- structure is greater than ever. As 2012 draws to a close, the economic turbulence unleashed by the 2008 global financial crisis persists. Although FDI inflows to emerging markets began to recover in the years following the crisis, they are ex- pected to decline this year. The continued high growth in developing countries, however, makes them in- creasingly attractive to foreign investors, who remain optimistic about their intentions to invest there. New Izumi Kobayashi challenges, especially the ongoing sovereign debt Executive Vice President crisis and recession in the euro zone, have slowed the flow of FDI from traditional sources. However, FDI outflows from new investors from developing countries have risen significantly in recent years, and are expected to reach a record level this year. This report examines investors’ perceptions and risk-mitigation strategies as they navigate today’s uncertain economic waters. It finds that investors continue to rank political risk as a key obstacle to investing in developing countries and are increas- MIGA WIPR REPORT 2012 | 1 2 | MIGA WIPR REPORT 2012 Acknowledgments This report was prepared by a team led by Daniel the political risk insurance market benefited from the Villar and Conor Healy, under the overall coordination gracious participation of political risk brokers in a of Ravi Vish, and comprising Persephone Economou roundtable discussion in London organized by Exporta and Manabu Nose. Chapter two of the report is Publishing and Events Ltd. Arthur J. Gallagher (AJG) based on the research by Aart Kraay, Maya Eden, International provided data on the private insurance and Rong Qian, as cited in the chapter. Hwee Kwan market. Chow, Professor of Economics and Statistics (Practice) and Associate Dean of the School of Economics Caroline Freund (Chief Economist, Middle East and at Singapore Management University, and Charles North Africa, World Bank), Elena Ianchovichina (Lead Adams, Visiting Professor at the Lee Kuan Yew School Economist, Middle East and North Africa, World of Public Policy, National University of Singapore also Bank), David Rosenblatt (Economic Adviser, World contributed to the report. Rebecca Post and Cara Bank Chief Economist Office), Aart Kraay (Lead Santos Pianesi edited; Suzanne Pelland and Antoine Economist, Development Research Group), Peter Jaoude were in charge of graphic design. Mallory M. Jones (Secretary General, Berne Union), Beat Saleson was the overall coordinator of the editorial and Habegger (Deputy Head of Sustainability and Political production process. Saodat Ibragimova and Vladislav Risk, Swiss Re), Daniel Hui (Director of Credit, Surety, Ostroumov provided administrative support. and Political Risk, Swiss Re), Moritz Zander (Senior Political Risk Analyst, Swiss Re), Theodore H. Moran This year’s World Investment and Political Risk report (Marcus Wallenberg Chair at Georgetown University’s benefitted from comments by MIGA’s senior man- School of Foreign Service), and Gerald T. West (also agement team and we thank Izumi Kobayashi, Michel at Georgetown University as Adjunct Professor for the Wormser, Ana-Mita Betancourt, Kevin Lu, Edith School of Foreign Service) provided peer reviews. Quintrell, Lakshmi Shyam-Sunder, Ravi Vish, and Marcus Williams. Within MIGA, Marc Roex and Gero Verheyen also provided feedback. The World Bank’s Development Prospects Group, under the guidance of Andrew Burns, provided the macroeconomic data presented in the report. The investor survey was conducted on behalf of MIGA by the Economist Intelligence Unit. The analysis of MIGA WIPR REPORT 2012 | 3 4 | MIGA WIPR REPORT 2012 Selected Abbreviations BRIC Brazil, Russian Federation, India, and China EIU Economist Intelligence Unit EU European Union FDI Foreign direct investment GDP Gross domestic product IMF International Monetary Fund MIGA Multilateral Investment Guarantee Agency MNE Multinational enterprise OECD Organisation for Economic Co-operation and Development PRI Political risk insurance UNCTAD United Nations Conference on Trade and Development Dollars are current U.S. dollars unless otherwise specified. MIGA WIPR REPORT 2012 | 5 6 | MIGA WIPR REPORT 2012 Executive Summary Global economic growth estimates for years, and about a quarter of this stock is destined for other developing countries. 2012 indicate a continuing fragile recovery. The findings of the MIGA-EIU Political Risk Survey The ongoing sovereign debt crisis and 2012 underscore that the ongoing weakness and instability in the global economy remain recession in the euro zone, curtailed bank a top constraint for foreign investors’ plans to expand in developing countries in the short term. lending and domestic deleveraging, fluc- Nevertheless, cognizant of stronger economic growth in developing countries, the survey also finds that tuating but elevated commodity prices, foreign investors remain relatively optimistic in their intentions to invest in developing countries in and the ongoing political turmoil in the short term (figure 1). Over the medium term, foreign investors identify political risk as the most the Middle East and North Africa have significant constraint to investing in developing countries. Notwithstanding this, as concerns about slowed the initial rebound that followed macroeconomic stability and access to finance recede, more foreign investors become optimistic the 2008 global financial crisis. This in their intentions to invest in developing countries. Projections of FDI inflows into developing countries slow progress has had an impact on support this finding, with estimates for 2013 indi- cating a rebound to nearly $700 billion. developing countries, which initially fared Despite elevated perceptions of political risk, the well in terms of rebounding growth rates, majority of respondents in the MIGA-EIU Political Risk Survey 2012 have no plans to withdraw or cancel private capital flows, and foreign direct investments in developing countries. Within the range of political risks, adverse regulatory changes investment (FDI). are the foremost concern to foreign investors over both the short and medium term, followed by breach of contract. Among those that do plan to withdraw or cancel investments, it is again mostly due to adverse Having fallen sharply after the onset of the crisis, FDI regulatory changes or breach of contract. These two inflows received by developing countries climbed by political actions are also responsible for the most about $100 billion each subsequent year to reach losses suffered by foreign investors in developing around $640 billion in 2011. In 2012, however, FDI countries, according to the survey. The political risk inflows into developing countries are estimated that increases the most in perceived significance to fall to just under $600 billion. All developing between the short and medium term is expropriation. regions experienced a decline in 2012, except for Latin America and the Caribbean. In contrast to FDI flows into the Middle East and North Africa inflows, FDI outflows from developing countries have been adversely affected by political risk over are estimated to have reached nearly $240 billion in the past couple of years. Investor perceptions of 2012, a new record level. The outward FDI stock of political risks in the region remain elevated across developing countries has risen significantly in recent a range of risks. The Arab Spring countries have MIGA WIPR REPORT 2012 | 7 fared worse than other developing countries in the turmoil unfolded, and estimates of such investment region. The risk perception of civil disturbance and remained subdued in 2012, especially in cases where political violence, but also breach of contract, is significant political instability persists. The MIGA-EIU especially prominent in Arab Spring countries. These Political Risk Survey 2012 shows that the majority of countries saw FDI inflows plummet as political foreign investors are not anticipating big changes in their investment plans at present or in the near future in Arab Spring countries, and a slightly higher proportion of foreign investors plan to divest rather Figure 1 Changes in than invest. As with all FDI, economic factors will Foreign Investment Plans play the most important role in foreign investor re- engagement in the Middle East and North Africa, but Percent of respondents political stability is also crucial. The survey shows that investing or reinvesting in the region is conditional Fig 1.3 first upon more market opportunities, followed by at least one year of political stability, macroeconomic improvements, and reduced corruption (figure 2). Over the next 12 months One of the conclusions in World Investment and Increase substantially Political Risk 2011 was that authoritarian political (20% or more) regimes have been linked to an increased risk of expropriation. Sovereign defaults, often caused by Increase moderately (more than 1% adverse economic shocks, are also linked to the but less than 20%) political risk of non-honoring of sovereign financial Stay unchanged obligations. Both the risks of sovereign default and expropriation remain significant issues for foreign Decrease moderately investors amid the global economic slowdown and (more than 1% continued political instability. This raises the question but less than 20%) of whether and how sovereign defaults relate to other Decrease substantially political risks, in particular expropriation, and this (20% or more) is addressed in chapter two of this report. From a Don’t know historical perspective, these events have occurred in waves and are usually associated with a shift of 0 10 20 30 40 a country’s external liability position in the balance between equity and debt. Following the wave of Over the next three years expropriations during the 1970s, a shift to sov- ereign debt as a source of financing for developing Increase substantially countries culminated in sovereign defaults of the (20% or more) 1980s. Subsequently, as countries that defaulted lost Increase moderately access to international capital markets, FDI became (more than 1% but less than 20%) the major form of foreign capital into developing countries. In recent years, developing countries have Stay unchanged relied more on FDI and portfolio equity than on Decrease moderately sovereign debt, which suggests that the “prize� for (more than 1% expropriating private assets is now larger. but less than 20%) Decrease substantially According to the analysis presented in this report, (20% or more) sovereign defaults and expropriations rarely occur Don’t know in one country in the same year. Sovereign default and expropriation coincided in only five out of 5,360 0 10 20 30 40 cases; the most notable example of these five cases was Indonesia during the Asian financial crisis. Still, there are several systematic patterns in the occur- rences of sovereign default and expropriation events that are worth highlighting. Typically, sovereign Source: MIGA-EIU Political Risk Survey 2012 defaults coincide with adverse economic shocks and 8 | MIGA WIPR REPORT 2012 Fig 1.14 Figure 2 Primary Reasons for Over a longer timeframe, however, sovereign defaults Investing more, or Reinvesting, and expropriations are related in the sense that the majority of countries either consistently refrain from in the Middle East and North sovereign default and expropriation, or engage in Africa both. It is perhaps not unexpected that the same types of countries experience both sovereign defaults Percent of respondents and expropriations, as is evidenced by the clustering of both types of events in two regions, Africa (both North and sub-Saharan) and Latin America and the Caribbean. The perspectives of foreign investors in the MIGA-EIU Political Risk Survey 2012 underline Increased market perceptions of the positive link between sovereign opportunities default risk and more generally elevated perceptions One year of of political risk. The survey finds that more than half political stability of the responding foreign investors believed that an increase in sovereign risk increases broader political Improved risk, particularly for civil disturbance and breach of macroeconomic contract. Even a sovereign credit rating downgrade stability raised concerns for foreign investors about elevated Decrease in corruption risks of expropriation, breach of contract, and transfer and convertibility restrictions—especially when the More favorable new rating was below investment grade and most gov’t regulations clearly in the case when the new grade was a result of Increased access a sovereign default. to financing The fact that political risk is perceived as an Improved infrastructure important constraint to investing in developing capacity countries has been a boon for the political risk Increased access insurance (PRI) industry. New issuance of PRI by to qualified staff members of the Berne Union—the leading asso- ciation of public, private, and multilateral insurance Other providers—increased by 13 percent in 2011, setting a new volume record. Expressed as a ratio of FDI 0 5 10 15 20 25 30 35 40 inflows into developing countries, new PRI has risen to 12 percent on average during 2009-2011, compared with a 10 percent average during 2006- 2008. As of the first half of 2012, PRI issuance was Source: MIGA-EIU Political Risk Survey 2012 still growing strongly, with another record level forecast for 2012. The current main drivers of the increased demand have been the events in the Middle East and North Africa, which have raised the higher debt burdens, while the likelihood of expropri- specter of unanticipated events in seemingly stable ations is explained by the type of political regime. In political regimes; recent expropriations in Latin addition, sovereign default events are less persistent America; contract renegotiations in resource-rich because it is not possible for a country to default economies; and capital constraints and increased on its debt obligations year after year. In contrast, regulation for financial institutions, which make expropriation events do tend to persist because they financing with PRI an attractive option. are often localized, clustered in specific countries or sectors within a country, and may well be repeated Notwithstanding increasing covers, the bulk of FDI multiple times. Since it is not typically the case that remains uninsured against political risk. According a government will expropriate its private sector all to the MIGA-EIU Political Risk Survey 2012, only 18 at once, expropriations occur incrementally. For percent of the responding firms use PRI as a risk- example, from 1970 to 2004, of the 78 countries that mitigation tool, a proportion that has changed only expropriated private assets, 70 percent did so two or marginally over the past four years. The explanation more times. for this rests partly on the perception that some MIGA WIPR REPORT 2012 | 9 political risks (for example, political violence) cannot Figure 3 Risk Mitigation Strategies be effectively mitigated by PRI (figure 3). For other by Foreign Investors risks, informal political risk mitigation prevails. For Fig 3 .9 breach of contract, bringing in local partners through Percent of respondents joint ventures has been the preferred risk-mitigation tool. It is only in the case of expropriations that foreign investors give relatively high marks to PRI; but even for this risk, informal relationships with political Use of joint venture or leaders continue to be viewed as a more effective alliance with approach to risk management. local company Political/economic The increase in demand for PRI has been mostly risk analysis broad-based across all political risks, while both Invested gradually while specialized PRI and broader universal insurance developing familiarity with coverage have tended to move largely in parallel. the local environment Geographically, there has been considerable demand for PRI in developing Asia, reflecting the sizeable FDI Use of third-party consultants received by that region and the existence of many large infrastructure projects. More recently, there Scenario planning has been a marked increase in inquiries for PRI for Engagement with investments in the Southern euro-zone countries due local communities to heightened perceptions of political risks resulting from the sovereign debt crisis. This has gone against Engagement with government in the earlier conventional wisdom that political risks host country are present in developing countries alone. Among Berne Union members, demand for coverage from Develop close public providers has increased at a faster rate than relationships with political leaders for private providers. Demand for South-based public PRI providers (among members of the Berne Union) Political risk insurance has also increased considerably because of the rapid Operational hedging growth in outward FDI from developing countries in (setting up multiple recent years. plants to spread risk) The elevated political risk perceptions of investors Engagement with non-governmental have revived demand for existing products and organizations have given rise to new product offerings. In light of elevated political risk in the Middle East and North Credit default swaps Africa, there has been renewed interest in coverage Provide support for existing investments, while concerns about stress to a well-connected on public finances has led public providers to offer political figure coverage for non-honoring of sovereign financial obli- Other, please specify gations. While the Lloyd’s market has been offering this coverage for some time, the entry of public pro- We don’t use any tools viders has permitted an increase in both capacity and or products to mitigate political risk tenors. Don’t know The claims picture remains volatile and changing in 0 20 40 60 nature and recoveries have been consistently lower over the past five years. Claims rose sharply in both 2010 and 2011, in the latter year as a result of political upheaval in the Middle East and North Africa. Most claims in terms of value were attributed to political Source: MIGA-EIU Political Risk Survey 2012 violence in 2011, while the trend until then for the Note: Percentages add up to more than 100 percent bulk of claims had been for expropriation and breach because of multiple selections of contract. 10 | MIGA WIPR REPORT 2012 Despite the growth in demand, capacity in the PRI framework. The prevailing low interest rate envi- industry has not been a constraint so far. Estimates ronment has put downward pressure on financial place an increase in capacity in the private and returns, which are part of the business model of Lloyd’s PRI market at 19 percent between January and insurance companies, and has led to shifts within the July 2012, mostly on tenors of 10 years or less. New insurance industry into more profitable specialized PRI providers, such as the XL Group and Canopius, lines, such as PRI. All of these developments have have also entered the private and Lloyd’s PRI market, contributed to the increased capacity in the PRI while the public PRI market has expanded with industry and have also led to the perpetuation of a the addition of the Export Insurance Agency of the “soft premium� environment, a trend that does not Russian Federation. appear likely to change in the near term. PRI capacity and pricing are not idiosyncratic, but respond to trends in the broader insurance industry and its cycles. Capacity for the PRI industry is therefore affected by factors that influence the broader insurance industry, such as market devel- opments for other insurance lines and new regu- latory changes, such as the new Solvency II rules in the European Union and the Basel III regulatory MIGA WIPR REPORT 2012 | 11 CHAPTER ONE World Investment Trends and Corporate Perspectives rr Global economic growth estimates for 2012 indicate a continuing fragile recovery with significant downside risks. Private capital flows to developing countries moderated significantly, while foreign direct investment (FDI) inflows declined across all developing regions, with the exception of Latin America and the Caribbean. rr Despite the decline in FDI inflows to developing countries, they continue to account for a substantial share of global FDI: in 2012 they are estimated to be 36 percent of inflows and 14 percent of outflows. rr FDI inflows to developing countries are expected to rebound in 2013 to just under $700 billion and reach close to $800 billion in 2014. MIGA’s survey of corporate investors corroborates this expectation, with the majority of investors in these markets being moderately opti- mistic about their investment intentions over the next twelve months, but more optimistic over the next three years. rr FDI outflows from developing countries reached a new record in 2012, an estimated $237 billion, continuing the upward trend of recent years. About a quarter of the outward FDI stock of developing countries goes into other developing countries (“South-South� investment). rr While economic instability and access to finance continue to be key concerns of companies investing overseas over the next 12 months, mirroring the state of the global economy, political risk features as the most important concern over the next three years. rr Political instability in the Middle East and North Africa has taken a toll on investment intentions and has elevated perceptions of political risk, not only for the Arab Spring countries, but also for other countries in the region. Political and economic stability are inducements for corporate investors to return, but the findings of MIGA’s survey of corporate investors indicate market opportunities are more important over the medium term for encouraging investor re-engagement. 12 | MIGA WIPR REPORT 2012 This chapter presents the highlights of recent earlier monetary tightening in emerging markets to developments in the global economy; an overview combat the threat of inflation. Positive economic of the principal trends in FDI flows into and from developments in the first quarter of 2012 gave way to developing countries; the findings of a corporate headwinds, as the crisis in the euro zone—coupled survey of foreign investors regarding their investment with financial sector stress, ongoing regulatory uncer- intentions over the next twelve-month and three-year tainty, and plunging investor confidence—dampened time horizons; and perceptions of the main con- global economic growth forecasts. As a result, these straints to investing overseas. South-South FDI and forecasts for 2012 have been continuously revised foreign investor perceptions of risks and conditions downward and real GDP growth is not expected to for re-engagement in the Middle East and North experience an uptick until 2013 (table 1.1). Africa are also highlighted in this chapter. Among the high-income economies, despite early signs of growth acceleration, the United States appeared to have hit a soft patch in 2012, with Prospects for Global Growth downward revisions in its real GDP growth rates and number of jobs created, and only marginal progress The world economy weakened in 2011, accentuated in curbing unemployment at a time of falling labor by the sovereign debt crisis in Europe, natural force participation. In Europe, the euro-zone crisis disasters in Japan and Thailand, and the effects of continued to dominate the economic landscape, Table 1.1 Global Growth Assumptions* Real GDP growth in percent 2008 2009 2010 2011 2012e 2013f 2014f World 1.4 -2.2 3.9 2.8 2.3 2.6 3.2 High-income countries 0.1 -3.5 2.8 1.6 1.3 1.5 2.2 Developing countries 5.8 1.9 7.3 6.2 5.1 5.6 5.9 East Asia and Pacific 8.5 7.5 9.7 8.2 7.2 7.6 7.5 Europe and Central Asia 3.9 -6.5 5.4 5.6 3.4 3.9 4.6 Latin America and Caribbean 4.0 -1.9 6.1 4.3 3.2 3.9 4.0 Middle East and North Africa 4.1 3.0 4.1 1.5 0.5 1.9 3.4 South Asia 5.9 5.5 8.1 7.3 6.1 6.1 6.8 Sub-Saharan Africa 5.1 1.9 5.0 4.7 4.8 5.2 5.2 Source: World Bank Global Economic Prospects Group staff estimates Note: e=estimate; f=forecast * As of October 2012 MIGA WIPR REPORT 2012 | 13 with growing challenges due partly to continued In sum, with financial conditions having worsened deleveraging efforts, widening bond spreads, and sharply and increased uncertainty, the global declining equities. In Japan, reconstruction spending economy is estimated to have slowed down in 2012, has contributed to a recovery in economic growth in and growth rates are expected to remain moderate 2012, but prospects going forward indicate a slower over the next couple of years. At the same time, the rate of expansion in light of the country’s fiscal deficit downside risks to the current growth projections and debt problem. have risen, as confidence levels have deteriorated and market turmoil persists. While the effects will be felt In developing countries, real GDP growth is also more strongly in high-income countries, developing expected to slow in 2012 and increase only mar- countries will not remain immune to adverse ginally in 2013-2014 (table 1.1). Although continuing economic fall-out. to grow at rates much higher than for high-income economies, developing countries are facing several challenges: vulnerability to weak global economic growth prospects and curtailed bank lending in high- Prospects for Private Capital Flows income economies; fluctuating commodity prices; to Developing Countries volatile capital flows; and adverse political devel- opments. However, for the most part, the danger of Amidst slow and fragile economic growth prospects, inflation has subsided. New challenges are emerging more stringent regulatory requirements on European in China, the developing world’s largest economy, banks, and intensified deleveraging, capital flows to as it shifts its focus from an export-oriented to a developing countries are estimated to have declined domestic consumption-driven economy. The evo- in 2012 (figure 1.1). This is following another year of lution of the economic and political situation in decline in 2011. Private capital flows have followed China will impact growth prospects in a number the same trend, with volatile portfolio equity inflows of developing countries, particularly commodity- plummeting in both 2011 and 2012. Private bond exporting ones. issuance, mostly by corporate issuers based in developing countries, reached a record level in the first The crisis in the euro zone and intensification of four months of 2012 and is projected to register an the region’s recession in 2012 are having important increase for the year as a whole. FDI continues to be effects on today’s intertwined global economy the biggest source of private capital into developing through various channels. These include trade, countries, but this too is estimated to have declined banking and financial linkages, FDI and the activities in 2012. Official flows (not shown in figure 1.1) from of multinational enterprises (MNEs), and workers’ multilateral institutions declined following peak remittances. Contagion from the euro-zone crisis is levels in 2009 and 2010, when they boosted lending playing an important role in the projected slowdown from multilateral institutions to combat the effects in Europe and Central Asia, especially in Southeast of the financial crisis in 2008. Official development Europe. With an economy more driven by natural assistance to developing countries (not shown in resources, the Russian Federation is an exception and figure 1.1) declined in 2011 by 2.7 percent (in real has maintained elevated real GDP growth projections terms), reaching $134 billion. despite its close economic links with Europe. Economic growth in the Middle East and North Africa—also dependent on Europe for trade and FDI Trends and Prospects for FDI and still marred by considerable political uncertainty and turmoil—is estimated to have decelerated further Having risen by 27 percent to $1.9 trillion in 2011, in 2012 and is now forecast to rebound in 2013. driven primarily by cross-border mergers and acqui- Economic growth in East Asia and the Pacific and in sitions and rebounding growth during the first South Asia is estimated to have also decelerated in half of that year, global FDI inflows declined to an 2012, mainly because of a slowdown in China and estimated $1.7 trillion in 2012. Restrained optimism India. Growth in Latin America and the Caribbean in the second half of 2011, more subdued cross- slowed down as well, mostly due to a sharp decel- border merger and acquisition activity, and curtailed eration in Brazil. In contrast, sub-Saharan Africa is lending all contributed to the decline. FDI inflows to anticipated to continue its recent strong performance developing countries are estimated to have declined and maintain an elevated rate of real GDP growth of by 7 percent in 2012 compared to the previous around 5 percent. year. A variety of factors contributed to the decline, 14 | MIGA WIPR REPORT 2012 including concerns over spillover effects from the Figure 1.1 Net Private Capital Flows sovereign debt crisis in Europe, deleveraging and to Developing Countries reduced bank lending (especially by banks from high-income economies, which continue to be the billion $ Fig 1.1and percent biggest source of FDI for the developing world), and increased economic uncertainty. Developing countries accounted for an estimated 36 percent of global FDI in 2012. 1,400 9 In 2011, high-income economies were at the forefront of the increase in FDI inflows on account of a sharp rise in cross-border mergers and acquisitions,1 and 8 together received $1.3 trillion. That year, developing 1,200 economies saw a 10 percent increase in FDI, alto- gether receiving $639 billion, or 34 percent of global 7 FDI inflows. In 2011, the picture for FDI inflows was mixed, driven by a strong rebound in growth in 1,000 the first half of the year and a sense that the global economy could be on a sustained path to recovery. 6 The Middle East and North Africa experienced the largest decline in light of the political turmoil, while the biggest increase was in Europe and Central Asia, 800 5 where FDI had been severely affected by the 2008 financial crisis and recession in Western Europe. In 2012, FDI inflows to both high-income and 4 600 developing countries contracted as prospects for sustained recovery became more fragile. FDI inflows into developing countries fell to an estimated $594 3 billion (36 percent of the global total), a decline felt across all regions except Latin America and the 400 Caribbean, where there was a marginal increase. For the largest recipients of FDI in the developing world— 2 Brazil, the Russian Federation, India, and China (the BRICs)—FDI inflows remained mostly flat in 2011, 200 with China leading the way with inflows totaling about 1 $220 billion. Together the BRICs accounted for about three-fifths of FDI inflows to developing countries in 2011, a share in line with their proportion of nominal developing-country GDP. Low-income economies 0 0 accounted for an estimated 3.2 percent—a share that has been rising slowly over the past few years and is in 2012e 2014f 2006 2009 2004 2013f 2008 2007 2005 2010 2011 line with their portion of developing-country GDP. -200 FDI inflows into developing countries in the Middle East and North Africa declined marginally in 2012, following a sharp decline in 2011 (figure 1.2). FDI in Private debt the region remains subdued and well below the levels Portfolio equity reached prior to the onset of the Arab Spring events, FDI mostly due to ongoing political instability and uncer- tainty and weakened investor confidence. In Tunisia, Net private capital flows as FDI inflows declined by 14 percent in 2011, while a share of GDP (right axis) inflows to Egypt recorded a net divestment (outflow) of $483 million in the same year. The picture emerging in 2012 is quite diverse: countries with Source: World Bank e=estimate; f=forecast MIGA WIPR REPORT 2012 | 15 continued political instability, uncertainty, or conflict Figure 1.2 Net FDI Inflows to are seeing FDI inflows plummet, while countries with Developing Countries by Region relative stability are seeing investor confidence return and are experiencing strong rebounds.2 Indeed, a $ billion and percent return to stability and reduced uncertainty would con- Fig 1.2 tribute to FDI inflows rising quickly to the pre-turmoil levels (see Spotlight on the Middle East and North Africa on page 24). 900 4.5 FDI inflows into South Asia declined sharply in 2012 by an estimated 27 percent, having risen by 18 800 4.0 percent the previous year. The increase in 2011 was attributed to more investment flowing into India, the region’s largest recipient, in response to the ongoing 700 3.5 but gradual liberalization of the country’s investment policy, some large cross-border acquisitions of Indian firms, and increases in FDI in the services, chemicals, 600 3.0 and pharmaceuticals sectors.3 FDI into South Asia is projected to rebound strongly over the next two years. FDI inflows to East Asia and the Pacific declined mar- 500 2.5 ginally by an estimated 5 percent in 2012, following another small decline in 2011 as inflows into China, the 400 2.0 region’s principal recipient, moderated. The slowdown in China is partly attributed to spending constraints facing investors in high-income economies and mod- 300 1.5 erating global demand, negatively affecting manu- facturing FDI. While inflows into China may adjust permanently to levels below their peak, overall FDI for 200 1.0 East Asia and the Pacific is projected to increase over the next two years. 100 0.5 FDI inflows into sub-Saharan Africa have been on an upward path over the past decade. On average, they 0 0.0 have risen from $13 billion annually during 2000-2005 2012e 2006 2009 2004 2014f 2008 2007 2005 2013f 2010 2011 to $28 billion annually during 2006-2010, and are projected to increase to $38 billion annually during 2011-2014. FDI inflows declined following the financial crisis, but posted a 34 percent increase in 2011 to $36 Sub-Saharan Africa billion. However, they are estimated to have declined South Asia again in 2012, partly due to the adverse economic Middle East and North Africa environment in Europe, historically an important Latin America and Caribbean source of investment, and worse FDI performances Europe and Central Asia in selected key recipient countries. Over the next East Asia and Pacific couple of years, FDI is projected to reach new record levels, underscoring the region’s expected high Share of GDP (right axis) growth as investors seek to take advantage of attractive returns in frontier economies, growing consumer markets, and abundant natural resources. Europe and Central Asia’s close links with euro-zone Source: World Bank members has meant that economies there continue e=estimate; f=forecast to be adversely affected by the sovereign debt crisis and liquidity problems. FDI inflows declined by an estimated 7 percent in 2012, following an increase 16 | MIGA WIPR REPORT 2012 of 35 percent in 2011. The increase in 2011 was 12 months (compared with the previous 12 months) driven by natural resource-seeking investors into and over the next three years (compared with the Central Asia, who helped to boost FDI inflows into previous three years). the Russian Federation, while doubling them into Kazakhstan. In Turkey, FDI inflows shot up in 2011, Overall, MNEs remain relatively optimistic, with and may well remain elevated in 2012, considering half of the respondents expressing the intention to that flows in the first quarter of this year were mar- increase investment in developing countries over ginally higher than in the same period in 2011.4 In the next 12 months, despite the challenges detailed Southeast Europe, where FDI is heavily dependent in this report (figure 1.3). Even though growth on the euro-zone periphery countries, FDI inflows in prospects in developing countries have also become 2011 were a third of their peak level reached prior to subdued, these countries are still projected to grow the 2008 financial crisis. Deleveraging by European about twice as fast as high-income economies. The banks, which has curtailed lending by their affiliates expanding market size implied by the higher growth in the region, led to the introduction of the Vienna rates continues to improve developing countries’ 2.0 Initiative aimed at ensuring orderly credit con- attractiveness to foreign investors, especially when ditions in the region.5 compared with relatively stagnant markets at home. Importantly, one third of the surveyed MNE The Latin America and the Caribbean region was respondents remain cautious; the uncertainty sur- somewhat of a bright spot. FDI inflows into the rounding the global economy is prompting them region are estimated to be marginally higher in 2012, to adopt a “wait-and-see� attitude and leave their following a 26 percent increase in 2011. This was investment plans unchanged or on hold over the next despite moderating growth prospects, deteriorating 12 months. A significant minority of the responding economic conditions in key FDI source countries in MNEs (13 percent) expressed the intention of the euro zone, and concerns over elevated political reducing investments in developing countries. risks in select countries. Although growth slowed sig- nificantly, FDI inflows into Brazil—the region’s largest Similar to the findings of previous MIGA-EIU Political FDI recipient—increased by a third in 2011, attracted Risk Surveys, MNEs are more optimistic over the by the country’s long-term growth potential, the size medium term compared with the short term as of its domestic market, and natural resources. Over seen by responses on investment intentions over the next year, flows into the region are projected the next twelve months compared with investment continue to increase sharply. intentions over the next three years (figure 1.3). The share of MNEs that intend to expand into developing For 2013, FDI inflows to developing countries are countries in the following three years jumps to 70 projected to rebound by 17 percent to $697 billion, as percent compared with 52 percent in the short term, global economic growth is anticipated to accelerate with only 11 percent of them planning to decrease modestly. In the longer term, sustained higher investments over the medium term. The share economic growth in developing countries compared of MNEs that continue to adopt a “wait-and-see� with high-income economies, a large and growing approach over the next three years more than halved consumer base, the availability of natural resources, to 15 percent from those with a cautious stance and ongoing improvements in investment climates over the next year. Clearly, MNEs expect the current will continue to improve the attractiveness of economic uncertainty to decline in the medium term, developing countries as investment destinations. thus removing one of the reasons that has held back additional investment flows. Other surveys reinforce these findings. The 2012 MIGA-EIU Political Risk Survey 2012 A.T. Kearney Foreign Direct Investment Confidence Index6 (based on a survey conducted during July- The anticipated rebound in investment is corrob- October 2011) confirmed that investors are finding orated by the findings of the MIGA-EIU Political Risk developing countries to be promising, particularly Survey 2012 (appendix 2). Now in its fourth year, the owing to their large and growing consumer markets, 2012 survey gauged the investment intentions of 438 and are assigning high priority to them as investment mostly large MNEs with global annual revenues of at destinations. However, FDI inflows to developing least $500 million. The survey, carried out in August countries may be dampened by uncertainty in the and September of 2012, asked MNEs about their near term regarding the speed of economic recovery plans to invest in developing countries over the next and possible downside risks. MIGA WIPR REPORT 2012 | 17 UNCTAD’s World Investment Prospects Survey Other developing countries, notably a small group of 2012-20147 (based on respondents from 174 MNEs middle-income or resource-rich economies (Mexico, and 62 investment promotion agencies during Colombia, Chile, Indonesia, Malaysia, Thailand, February and May of 2012) supported the findings Turkey, and Kazakhstan), also expanded their of investor cautiousness for 2012 and greater overseas investments, together accounting for 30 optimism for investing overseas over the next percent of estimated FDI outflows from developing two years. countries in 2012. As corporate sectors become more sophisticated, domestic firms become global players, and outward FDI Outflows from investment restrictions become more relaxed, FDI Developing Countries outflows from developing countries are expected to continue to increase. In the MIGA-EIU Political Uninterrupted by the slowdown in the global Risk Survey 2012, South-based firms were positive economy, FDI outflows originating in developing about investment prospects in developing countries. countries increased by an estimated 11 percent in Some 62 percent of South-based respondents 2012 to reach a new record level of $237 billion, or conveyed the expectation of investment expansions one percent of their combined GDP (figure 1.4). Since in developing countries over the next three years, FDI outflows from high-income economies declined a smaller proportion than for foreign investors because of a sharp fall in cross-border mergers and overall. Outward investment from China is expected acquisitions, developing countries’ share of global to continue growing rapidly as Chinese companies FDI outflows increased to an estimated 14 percent. seek to become part of international global pro- In line with their share of developing country GDP, duction chains, acquire brands through cross-border the BRICs accounted once more for the lion’s share: mergers and acquisitions, and secure natural an estimated 64 percent of FDI outflows from all resource supplies. developing countries. The acceleration of developing countries’ investment overseas—especially from China, but also from Brazil, which has a longer history of investing abroad—began in the middle Political Risks and of the last decade. This has been in pursuit of their Developing Countries quest to access new markets, natural resources, and technological and management know-how. Strong headwinds facing the world economy, per- sistent uncertainty emanating principally from devel- FDI outflows from the BRICs increased marginally opments in the euro zone, moderating growth, and by an estimated 3 percent in 2012 as MNEs from turbulence in financial markets have exacerbated these countries continued to forge ahead with their foreign investors’ overall concerns regarding gov- overseas investment plans. China’s outflows are ernment actions that could adversely affect the estimated to have reached a new record level in 2012, private sector. While, for the most part, developing having declined in 2011. Chinese MNEs, mostly state- countries continue to introduce measures that owned enterprises, sought to acquire stakes in com- open up domestic markets to FDI and increase panies based in both high-income and developing transparency for investors,10 a number of adverse countries,8 and continued investing in greenfield government actions have amplified concerns about projects in the developing world. China continued political risks. For example: to reinforce its policy of “going global,�9 targeting a greater balance between inward and outward FDI rr The desire for increased regulation in the over the medium term by encouraging the latter. aftermath of the financial crisis has led to the Brazil’s FDI outflows rebounded in 2012 after regis- introduction of national and multilateral rules, tering a net divestment in 2011. Indian MNEs held increased capital requirements under Basel III11 back their overseas investment plans in 2012, with for the banking sector, and Solvency II12 for the estimated FDI outflows declining by nearly two-fifths. insurance industry. More generally, regulatory FDI outflows from the Russian Federation, mostly in changes pertaining to all aspects of a country’s manufacturing and services, declined by an estimated investment climate can cause uncertainty and 11 percent in 2012 to $60 billion from a record level contribute to elevated perceptions of political risk. of $67 billion in 2011. In a recent survey whose findings are reported in Lloyd’s Risk Index 2011,13 changing legislation 18 | MIGA WIPR REPORT 2012 Figure 1.3 Changes in Foreign Figure 1.4 FDI Outflows from Investment Plans Developing Countries Percent of respondents Fig 1.4 $ billion and percent Fig 1.3 250 1.4 Over the next 12 months Increase substantially (20% or more) 1.2 Increase moderately 200 (more than 1% 1.0 but less than 20%) Stay unchanged 150 0.8 Decrease moderately (more than 1% but less than 20%) 0.6 Decrease substantially 100 (20% or more) 0.4 Don’t know 50 0 10 20 30 40 0.2 Over the next three years 0 0.0 Increase substantially 2012e 2006 2009 2004 2008 2007 2005 (20% or more) 2010 2011 Increase moderately (more than 1% but less than 20%) Other developing countries Stay unchanged BRICs Decrease moderately Share of GDP (more than 1% but less than 20%) Decrease substantially (20% or more) Source: World Bank Don’t know e=estimate 0 10 20 30 40 Source: MIGA-EIU Political Risk Survey 2012 MIGA WIPR REPORT 2012 | 19 ranked fifth in importance out of fifty risks related rr While increased government involvement in to operating an international business. the private sector had been viewed as nec- essary at the height of the financial crisis, rr Expropriation—which was an important threat the understanding was that it would be a to foreign investors in the developing world temporary measure to be reversed at a later a few decades ago, but had since abated—is date. Governments have been winding down becoming more prevalent.14 The number of their involvement in private sector companies, direct expropriations (as opposed to indirect though some increased presence remains. and “creeping� expropriations) has been rising While this was a concern at the initial phases since the early 2000s.15 Several new direct of the government involvement, the MIGA-EIU expropriations occurred in 2011-2012, notably Political Risk Survey 2012 found that only a small YPF S.A. in Argentina partly owned by Repsol minority of respondents now consider this to be YMP S.A. (Spain) and Transportadora de a constraint to investing in developing countries. Electricidad, a power transmission company in Bolivia owned by Red Electrica Española The implications of these trends are profound for (Spain), and some local companies in Sri the international production used by many MNEs. Lanka. Contract renegotiations and resource Such production is characterized by interconnected nationalism in the extractive industries regional and global supply chains to which political continue in developing and some high-income events can cause significant disruptions and costly countries, driven by commodity prices that delays because no particular location carries large rebounded quickly following the 2008 financial inventory to sustain a downturn elsewhere. In crisis and have remained elevated since, as Allianz’s ranking of the top 10 business risks based well as the ongoing scramble for resources. on a worldwide survey of risk management profes- Several countries have introduced new royalty sionals, politically determined business interruption regimes or taxation rules for mining companies was second.17 The concern in the business com- (for example, in Australia, Ghana, and South munity about disruption in the global economy Africa), or new mining legislation that requires owing to political risk is also evidenced in the World increased state participation in the extractive Economic Forum’s Global Confidence Index, which industries (as in Guinea and Zambia). In finds a high likelihood of such disruption over the Indonesia, new mining regulations require next 12 months. foreign investors to divest at least 51 percent of the total equity share to local investors over a From a longer-term perspective, political risks are 10 year period. In light of these developments, intertwined and likely to be aggravated by a number it is not surprising that a recent survey by Ernst of global trends. These include rapid population & Young found resource nationalism to be the growth coupled with high shares of youth popu- most important business risk facing the metals lations and few jobs in developing countries, growing and mining sector in 2011-2012.16 income inequalities, urbanization, water and food supply crises, rising demand for arable land and finite rr Political violence and unrest have been on the natural resources, volatile commodity prices, poor rise. Besides damage to assets and business governance, chronic fiscal imbalances, and the like- interruption, political violence can lead to a loss lihood of prolonged austerity.18 Together with more of income for investors not directly affected by widely accessible information and communication it, as other investments may suffer from loss technologies, these factors and others can influence of attraction, as in the case of tourism projects. political risks and impact corporate investment Growing concerns about jobs, social inequality, patterns in turn. elevated food prices, and non-democratic political regimes have given rise to civil distur- bances and political violence, often leading to property damage and business interruptions. Corporate Perceptions of Political This had been accentuated by risk contagion, Risks in Developing Countries where changes in the risk profile in one country can be easily transmitted and affect the risk The MIGA-EIU Political Risk Survey 2012 sought to profile of others. gauge the principal constraints to FDI in developing countries over the next 12 months and over the next three years (figure 1.5). Although concerns about 20 | MIGA WIPR REPORT 2012 Figure 1.5 Ranking of the most Figure 1.6 Types of Political Risk Important Constraints for FDI in of most Concern to Investors in Developing Countries Developing Countries Fig of Percent 1.5respondents Fig 1.6 of respondents Percent Over the next 12 months Adverse Macroeconomic regulatory instability changes Access to financing Breach of Access to qualified staff contract Political risk Transfer and convertibility Infrastructure capacity restrictions Limited market Civil opportunities disturbance Corruption Non-honoring Increased government of government regulation in the aftermath guarantees of the global financial crisis Expropriation/ Other nationalization 0 10 20 30 40 Terrorism Over the next three years War Political risk 0 10 20 30 40 50 60 Macroeconomic instability In the next 12 months In the next three years Access to qualified staff Access to financing Corruption Source: MIGA-EIU Political Risk Survey 2012 Infrastructure capacity Note: Percentages add up to more than 100 percent because of multiple selections Limited market opportunities Increased government regulation in the aftermath of the global financial crisis Other 0 10 20 30 40 Source: MIGA-EIU Political Risk Survey 2012 MIGA WIPR REPORT 2012 | 21 political risks remain elevated, it is the persistent quarter of respondents had to cancel or withdraw fragility and instability of the global economy, the investments. This finding is consistent with his- slow rate of recovery since the 2008 financial crisis torical data on claims payment by the political risk coupled with significant downside risks, and the insurance industry, which indicate that the largest ongoing deleveraging that feature as the most amount of claims paid out to investors is based prominent constraints to FDI. As a result, over the upon expropriation or breach of contract (see chapter next 12 months, macroeconomic instability and three). Additionally, these types of events tend to be access to financing rank in the two top places among highly publicized. The majority of respondents in the the concerns of corporate investors. The weakness survey listed breach of contract and regulatory risks of the global economy and difficulties in accessing as those accounting for the largest amount of losses financing continue to take precedence over political over the past three years (figure 1.8). Thus, risk per- risks and structural constraints such as infrastructure ception and claims data of the political risk insurance capacity and access to qualified staff in developing industry correspond very closely in terms of the types countries. This suggests that political risks tend to of political risks that have the greatest impact on become more important concerns for investors only foreign investors. insofar as the macroeconomic environment is benign and funds are easily accessible. It also suggests that, since growth rates of the global economy and high- income countries in particular are expected to remain Spotlight on South-South FDI subdued at least over the next year, this ranking of constraints is not likely to change significantly. As of 2010, MNEs from developing countries had amassed a stock of overseas FDI valued at some Although the three-year ranking (figure 1.5) confirms $1.2 trillion,19 72 percent of which was attributed the persistent concern of investors about the state to the BRICs. Developing countries often invest in of the global economy and difficulties in accessing other developing countries to take advantage of finance, political risk rises to the top of the list of cultural links, political ties, knowledge of market con- constraints as the most important obstacle for ditions, and familiarity with institutional qualities in investing in developing countries. This highlights countries in near proximity. Examples include MNEs the strong impact that political risk has on the based in Latin America (for example Argentina, investment decision-making process such that it Chile, Colombia, and Mexico), that have acquired overshadows the effects of economic weaknesses or invested in manufacturing and financial services around the world. The fact that this ranking of firms in neighboring countries20 and companies political risk matches the findings of previous based in Asia that have been driving the growth of MIGA-EIU Political Risk Surveys suggests that intra-regional investment flows.21 investors are very cognizant of its presence and view it as a long-term obstacle. As of 2010, the outward stock of South-South FDI(excluding investment channeled through inter- According to the MIGA-EIU Political Risk Survey 2012, mediate jurisdictions) was valued at $302 billion. adverse regulatory activity within developing countries About 56 percent of that stock was accounted for topped investors’ concerns among different types of by the BRICs.22 The Russian Federation, China, political risks (figure 1.6). Regulatory risk—essentially South Africa, Malaysia, and Mexico ranked in the the risks posed by uncertainty regarding regulations top five places in terms of the share of South-South or changes in regulations—has risen in importance investments in their total outward FDI stocks (figure since the first MIGA-EIU Political Risk Survey in 1.9). Much of that investment is intra-regional: 2009. As in 2011, a greater proportion of investors two-thirds of the Russian Federation’s FDI stock ranked this risk in top place, followed by breach of in developing countries is in Europe and Central contract and transfer or convertibility restrictions. Asia (although, as mentioned above, this trend changed noticeably in 2011); just over half of South For the majority of foreign investors, political risks Africa’s stock in developing countries is in sub- have not forced them to cancel or withdraw existing Saharan Africa; and virtually all of Mexico’s stock investments (figure 1.7). In line with the findings of in developing countries is in Latin America and the the earlier surveys, only a minority of investors have Caribbean. been driven to do so because of perceived political risk. Nevertheless, for some types of risks such as regulatory risk and breach of contract, just over a 22 | MIGA WIPR REPORT 2012 Figure 1.7 Proportion of Firms Figure 1.8 Proportion of Firms that Fig 1.7have Withdrawn Existing that have Suffered Losses Owing to Investments or Cancelled New Political Fig 1.8 Risk over the Past Three Investment Plans on Account of Years Political Risk over the Past 12 Percent of respondents Months Percent of respondents Breach of contract Transfer and Adverse convertibility regulatory restrictions changes Breach of Transfer and contract convertibility restrictions Non-honoring of government Civil guarantees disturbance Expropriation/ Non-honoring nationalization of government guarantees Adverse regulatory Expropriation/ changes nationalization War War Terrorism Terrorism Civil 0 10 20 30 40 50 disturbance 0 20 40 60 80 100 Withdraw existing investment Source: MIGA-EIU Political Risk Survey 2012 Cancel planned investments Note: Percentages add up to more than 100 percent Both withdraw and cancel because of multiple selections Neither withdraw nor cancel Don’t know Source: MIGA-EIU Political Risk Survey 2012 MIGA WIPR REPORT 2012 | 23 Based on data from greenfield investments alone, into the Middle East and North Africa do not plan South-South investment flows began to accelerate in to change in their current (low) or planned levels of the second half of the last decade, coinciding with investments in both Arab Spring countries and in the the acceleration of all FDI outflows from developing rest of the region (figure 1.12). On a more positive countries. On average, the number of South-South note, 14 percent of respondents plan to invest in projects rose from 590 during 2003-2005 to 996 Arab Spring countries, a share that is the same as for during 2009-2011. The value of cross-border the rest of the region. These findings highlight that investments also followed an upward trend, although political and economic instability have taken a toll on it has yet to recover from its post-financial crisis the region’s investment prospects, especially in the decline (figure 1.10). Arab Spring countries, and investors appear likely to continue with a “wait-and-see� approach before re- engaging. Spotlight on the Middle East The MIGA-EIU Political Risk Survey 2012 also sought and North Africa to gauge the importance of different factors that would induce investors to re-engage in the Middle FDI inflows into the Middle East and North Africa East and North Africa (figure 1.13). Stability—both were on an upward path during the past decade, but political and economic—scored high, as did better declined initially due to the 2008 financial crisis and governance. However, investors’ re-engagement subsequently in the aftermath of the political turmoil appeared to be driven primarily by the presence of that began at the end of 2010. Data from greenfield investment opportunities. This suggests that despite investments show that the decline was dramatic: in the “wait-and-see� approach adopted by many 2008 capital expenditures in cross-border greenfield investors, lucrative opportunities could induce them investment projects were $116 billion; in 2011 that to re-enter. figure was only $11 billion and in the first half of 2012 it declined further to $2 billion.23 The high score registered for “one year of political stability� suggests that political risk has been an In 2012, FDI inflows into the region remained important factor in the decision of investors to subdued and well below recent historical levels. For withdraw or not to engage in new investment in the many of the region’s economies, dependence on FDI Middle East and North Africa. As expected, political from Europe24 has meant that the recession and dele- risk perceptions increased more for the Arab Spring veraging in the euro zone continue to adversely affect countries than for the rest of the countries in the the flow of investment. Developing oil-importing region. Political violence, in particular civil dis- economies, which had enjoyed a rapid increase in turbance, but also war and terrorism, were the risks FDI inflows (figure 1.11), saw these plummet because that registered major increases in negative risk per- of the financial crisis and later due to political insta- ceptions for the majority of foreign investors. These bility, civil disturbance, security challenges, and were more pronounced for the Arab Spring countries other negative effects stemming from the political across all political risks (figure 1.14), but they also events that have unfolded in the region. In Egypt, increased in importance for countries in the rest of for example, FDI inflows reached only $218 million the region. This suggests that, with regard to political during July 2011-March 2012, compared with $2.1 risk perceptions, the ongoing instability in the Arab billion during July 2010-March 2011.25 For developing- Spring countries has spilled over to the rest of the country oil exporters in the region, the increase in region, with potentially ongoing negative effects on investment was less steep earlier on, and in fact investment. flows have largely remained flat. There are some early signs that in countries where In the short term, the dearth of FDI flows into the political stability is returning and uncertainty is Middle East and North Africa is likely to continue, abating, FDI prospects are becoming more positive. especially in those countries where there is still For the Middle East and North Africa overall, FDI significant political instability. Nearly 20 percent of flows are projected to stay largely flat in 2013 and the foreign investors in the MIGA-EIU Political Risk begin to rebound only in 2014. In Tunisia, for Survey 2012 plan to withdraw existing investments example, during the first five months of 2012, FDI from the Arab Spring countries. Around half of that inflows increased by 41 percent compared with the share also plan to do so in the rest of the countries same period in 2011.26 The Central Bank of Tunisia in the region. However, the majority of investors has forecast FDI inflows in 2012 to reach $2 billion, 24 | MIGA WIPR REPORT 2012 the same level as in 2009.27 Countries in the region Figure 1.10 South-South Capital are also implementing new measures to attract Expenditures in Cross-border investment, as well as measures to enhance the con- tribution of FDI to the local economy. For example, Greenfield Projects* Libya issued a decree in May 2012 allowing foreign Fig 1.11 firms to enter into joint ventures with local firms $ billion and number of projects while requiring them to set up and carry out training programs for their local workforce to facilitate the transfer of know-how and skills.28 Tunisia is drafting a new investment incentives code aimed at boosting 120 1,200 the contribution of foreign investment to employment and regional balance.29 However, for the region as a whole, uncertainty remains about the longer-term effects of ongoing political and economic instability 100 1,000 on investment. 80 800 Figure 1.9 South-South* Fig 1.10 60 600 Outward FDI Stock Percent of total outward stock of reporting country 40 400 24% Russian Fed. 20 200 19% China 11% South Africa 10% Malaysia 0 0 2012H1 2006 2009 2004 2008 10% Mexico 2007 2003 2005 2010 2011 9% Brazil 7% Others 5% Thailand Number of projects 4% India Capex Source: IMF * Outward South-South FDI stock of 29 countries as reported by the IMF’s Coordinated Direct Source: fDi Markets database * Investment Survey Capital expenditure (capex) on new projects and expansions of existing investments. Capex data are not recorded for all projects (total amounts reported are based on only projects for which figures are recorded) MIGA WIPR REPORT 2012 | 25 Fig 1.12 1.11 FDI inflows into Figure Figure Fig 1.13 1.12 How Have the the Middle East and North Africa Developments in the Arab World $ million over the Past Year Affected your Current and Future Plans for Investments in the Middle East and 25 North Africa? Percent of respondents 20 15 Current investments: Arab Spring countries 10 Current investments: All other countries 5 in the region 0 Planned/future investments: 00 01 02 03 04 05 06 07 08 09 10 11 Arab Spring countries Oil-importing countries Planned/future Oil-exporting countries investments: All other countries in the region Source: World Bank 0 20 40 60 80 100 Note: Oil importers: Djibouti, Egypt, Jordan, Lebanon, Morocco, Tunisia Oil exporters: Algeria, Islamic Republic of Iran, Increase Syrian Arab Republic, Yemen No change Data for Iraq and Libya are not available Withdrew Don't know Source: MIGA-EIU Political Risk Survey 2012 26 | MIGA WIPR REPORT 2012 Fig 1.14 Fig 1.15 Figure 1.13 Primary Reasons for Figure 1.14 Increase* in Perceived Investing More, or Reinvesting, in Political Risks on Account of the the Middle East and North Africa Political Turmoil in the Middle East and North Africa Percent of respondents Percent of respondents Increased market opportunities Expropriation One year of Breach of contract political stability Transfer and Improved convertibility restrictions macroeconomic stability Non-honoring of Decrease in corruption sovereign financial obligations More favorable gov’t regulations Adverse regulatory changes Increased access to financing War Improved infrastructure Civil disturbance capacity Terrorism Increased access to qualified staff 0 10 20 30 40 50 60 70 Other Arab Spring countries All other countries in the region 0 5 10 15 20 25 30 35 40 Source: MIGA-EIU Political Risk Survey 2012 * Major or minor increase Source: MIGA-EIU Political Risk Survey 2012 MIGA WIPR REPORT 2012 | 27 CHAPTER TWO Sovereign Default and Expropriation rr As uncertainty remains elevated because of the global economic slowdown and continued political instability, both sovereign default risk and other political risks (in particular expropriation) remain sig- nificant issues for foreign investors deciding their investment plans. rr This chapter looks at the links between sovereign default and expro- priation. It presents the finding that—over longer time horizons—sov- ereign default and expopriation are likely to occur in a similar set of countries. However, sovereign default and expropriation are different in nature and rarely occur in the same year. rr The determinants of sovereign default and expropriation differ. While political regimes marked by poor governance and under the control of political parties conventionally described as “left-wing� explain a higher likelihood of expropriations, transitory economic shocks and debt burdens tend to better predict sovereign default. rr Expropriation is more likely to happen multiple times in countries that have expropriated private assets in the past, whereas sovereign default is a less persistent event. rr From a historical perspective, sovereign default and expropriation have occurred in waves and are usually associated with a shift of a country’s external liability position. Based on trends in the international investment position of countries since 2000, developing economies seem to have higher risks of expropriation compared to sovereign defaults given the composition of their external liabilities. rr Despite differences in the determinants of sovereign default and expropriation, foreign investors in the MIGA-EIU Political Risk Survey 2012 are more likely to identify them as related. In this sense, political risk insurance (PRI) coverage for sovereign credit risk could poten- tially have a positive spillover effect to alleviate broader political risk concerns. 28 | MIGA WIPR REPORT 2012 This chapter offers an empirical analysis of the There has been little academic research on how the relationship between sovereign default and expro- determinants of these two events differ from each priation over a long and a short time horizon, by other. This is particularly important because the risk using data from 1970-2004.30 Additionally, it looks of loss for insurers is materially different for the two at how investors perceive these risks and how this broad branches of PRI coverage—traditional con- might differ from the observed reality. fiscation, expropriation, and nationalization covers and the broader coverage related to non-honoring Currently, there is a growing demand for political of sovereign financial obligations, which deals with risk cover for non-honoring of sovereign or sub- sovereign default risk. While the private market has sovereign financial payments. This is a reflection been offering non-honoring coverage for a long of the constrained financing environment following time, public PRI providers have only recently begun the 2008 global financial crisis. A key conclusion to offer this coverage. of the last four MIGA-EIU Political Risk Surveys is that “macroeconomic instability� is a top short-term Analysis in later sections will show that sovereign concern for cross-border investors in developing default and expropriation are different in nature, but countries. However, “political risk� remains a larger finds several systematic patterns for understanding structural concern for foreign investors in the the relative risk of the two events occurring. The medium term. MIGA-EIU Political Risk Survey 2012 also provides corporate-level evidence about how multinational MIGA’s World Investment and Political Risk 2011 enterprises (MNEs) perceive the correlation report highlighted that the political regime of a between sovereign default risk and political risk host country is the major driver of expropriation, when they make investment decisions. which is a key risk concern for investors in many developing countries. Moreover, as discussed in that report, an adverse economic shock, such as the Asian financial crisis in 1998, raised the number of Historical Trends of Sovereign investment disputes and increased expropriation Default and Expropriation losses. In terms of sovereign default risk, there is rich empirical literature that outlines how sovereign There was a large spike of expropriation events defaults are caused by negative economic shocks,31 for investors from the United States in the 1970s, macroeconomic factors,32 and institutional quality.33 followed by an increase in sovereign default events in the 1980s, as shown in the upper panel of figure However, the causes of expropriation are less 2.1. Defaults were more common during the global explored. In previous studies, Kobrin34 found depression of the 1930s and during the economic that the likelihood of expropriation is explained crises in developing countries in the 1980s. Such by economic shocks, the size of foreign direct historical patterns of expropriation events is also investment (FDI), and the sector concentration of confirmed based on the Berne Union’s PRI claim FDI. Li35 looked at political factors such as chief payments to investors outside of the United States executive turnover and political regime type. Guriev over 1971-2011, as shown in the bottom panel of et al.36 studied higher oil prices and weak political figure 2.1.38 The claim payments are clustered in the institutions as determinants of expropriation in 1970s and late 2000s. The trend of expropriation oil-exporting countries. The only major study that events is consistent between two the different data looks directly at the relationship between sovereign sources. default and expropriation is by Tomz and Wright.37 MIGA WIPR REPORT 2012 | 29 Fig 2.1 part 1 As discussed in World Investment and Political Risk Figure 2.1 History of Sovereign 2011, events of expropriation reached historical Default and Expropriation peaks in the 1960s and 1970s. In these decades, two distinct processes were converging. On the one hand, FDI was a greater proportion of foreign capital transactions compared to portfolio investment Number of countries or debt securities; on the other hand, the period coincided with the post-colonial emergence of new 30 nations eager to assert greater national control over economic activity. As such, the number of outright nationalizations by host governments was par- ticularly high. Furthermore, in the aftermath of some developing-country revolutions (for example, Bolivia 20 in 1952, Cuba in 1959, The Congo in 1960, Indonesia in 1964, Chile in 1970, Iran in 1979), developing countries saw an increase in political pressures that supported government takeovers. During this time period, nearly two thousand expropriations occurred 10 worldwide, and a significant portion of FDI origi- nating in high-income countries was lost. However, expropriation cases declined dramatically for the 15 years after 1980 as FDI levels reached 0 a plateau. By the early 1990s, with the so-called Washington Consensus in full swing and the state- 1930 1940 1950 1960 1970 1980 1990 2000 centric development model in decline, there was a growing sense that expropriations were a thing of Expropiation the past. In the second half of the 1990s, a backlash Default against the Washington Consensus accompanied by incomplete deregulation of domestic markets Source: Tomz and Wright (2010) and transitions in political systems led to a higher incidence of expropriation cases. These expropri- ations were clustered in Latin America and Central Total claims of expropriation/breach and Eastern Europe. However, they were no longer of contract (in millions) predominantly associated with widespread national- 100 izations (although there were still a few such cases), but mostly associated with contractual disputes over regulated sectors of the economy (that is, regulatory- 80 type risks). Public utilities, such as power and water, were the most affected by governments reneging on commitments. It was the period between these two expropriation waves (the major one in 1970s and 60 the minor one after 1996) that was characterized by a high incidence of sovereign defaults, to the point that the 1980s are remembered as the decade of the 40 “developing-country debt crisis.� These historical trends indicate that both expro- 20 priations and sovereign defaults tend to be clustered, but they do not tend to occur in parallel; in fact they rarely occur in the same year. There were only five 0 cases among a total of 5,360 (for the pooled obser- 1970 1980 1990 2000 2010 vations of 191 countries over the 1970-2004 period) when these two events coincided in a single year in the same country (see upper panel of table 2.1). Source: Berne Union 30 | MIGA WIPR REPORT 2012 Sovereign default events are less persistent, partly Table 2.1 Joint Distribution because it is technically difficult for a country to of Sovereign Default and default consecutively on its debt obligations—since default involves action against all debts and there Expropriation Events tends to be no additional outstanding debt on which to default after the first wave of defaults has taken place. Sovereign defaults typically coincide Pooled Observations (1970-2004) with adverse economic conditions, such as shocks to commodity prices and interest rates and have No Expropriation Total been sensitive to the global capital flow cycle.39 expropriation However, expropriation events are found to be more No persistent over time, partly because such events 4,967 275 5,242 default are specific to certain strategic sectors (such as water or energy) and they are clustered in specific Default 113 5 118 countries. Expropriation tends to be sectoral and it is rare to find cases of wholesale nationalization Total 5,080 280 5,360 of private enterprises. While this raises the risk of expropriation in other sectors of the economy (in fact, this is the main indicator that foreign investors look at in assessing political risk, according to the Per-country Observations (1970-2004) MIGA-EIU Political Risk Surveys), it does not follow that all foreign assets will necessarily be subject to government takeover. No Expropriation Total expropriation Despite the lack of correlation between expro- No priation and sovereign default in the short term, it 75 34 109 default is instructive to further investigate why these two events seem to arrive in waves. One hypothesis by Default 20 62 82 Tomz and Wright is that the two events are related, with certain time lags that are distinct to each type Total 95 96 191 of event and specifically to the changing compo- sition of the country’s external liabilities. In other words, the composition of foreign investments, that Source: Eden, Kraay, and Qian (2012) is, the weight between debt and equity, has been Note: The upper panel considers 5,360 pooled altered in a systematic manner. For example, in observations of 191 countries during this time the decades following the spike of expropriation in period. The lower panel observes those same the 1970s, countries relied more on debt financing, 191 countries, highlighting where either event culminating in the debt crisis of the 1980s. After occurred during this time period. the economic crises of 1980s, developing countries broadly lost their access to capital markets, partly in response to this, direct investment and equity investment reemerged as a major financing source for developing countries. An interesting exception would be a case where sovereign default and expro- priation coincided, as was the case in Indonesia Figure 2.2 shows a recent shift of external liability with the 1998 Asian financial crisis. As highlighted positions (that is, the change in FDI and portfolio in Box 2.1, 40 there were immediate drops in debt investment flows consisting of debt and equity flows and FDI inflows after 1998. However, in this financing) for advanced economies versus developing exceptional context, the weight between debt and economies41 and shows a clear contrast between the equity recovered to the pre-crisis level after the debt two. Since the mid-1990s, FDI inflows have increased crisis ended. Despite such exceptions, the historical in developing economies, peaking in 2007, while evidence suggests that a country’s external liability new FDI inflows to advanced economies continued position can be useful in assessing the host country’s to shrink. Recently, there has been a clear shift relative riskiness to sovereign default. toward equity financing developing economies, while MIGA WIPR REPORT 2012 | 31 Figure 2.2 Changes in International Investment Positions, 1995-2010 In millions Fig 2.2b Net FDI Position Net FDI Position Advanced Economies Emerging and Developing Countries 800 800 600 600 400 400 200 200 95 00 05 10 95 00 05 10 0 0 -200 -200 -400 -400 -600 -600 -800 Fig 2.2 b -800 -1,000 -1000 Net debt investment position Net debt investment position Advanced Economies Emerging and Developing Countries 1400 1400 1200 1200 1000 1000 800 800 600 600 400 400 200 200 0 0 95 00 05 10 95 00 05 10 -200 -200 Source: IMF, balance of payment statistics 32 | MIGA WIPR REPORT 2012 high-income economies have relied more on debt Latin America and the Caribbean. The expropriations financing. After the 2008 financial crisis, net debt are also clustered in Africa and Latin America in the flows for advanced economies dropped sharply, and Berne Union data based on self-reported PRI claim the weight of equity investments (on shares, stocks, payments (by year of payment, not year of occurrence and participations) has increased dramatically. of the event). Thus, the long-term coincidences of the data suggest a real underlying pattern, even This figure also shows that developing countries bearing in mind that one of the major difficulties in have continued to rely more on FDI and portfolio any empirical analysis of expropriations is the lack of equity liabilities. In the medium term, despite reliable and consistent aggregate data. the reputational cost of expropriation, the shift toward FDI also implies that the “prize� for expro- In addition to the regional concentrations of expro- priating private assets is getting relatively bigger in priations, an empirical study (Li 2009) shows that developing countries. However, in the short term, the political institutions of the host government the ongoing sovereign debt crisis in European are correlated with the likelihood of expropriation. countries is a fresh concern, and the adverse Another study, commissioned by MIGA42 looked at spillover impact to developing countries seems to whether two political indicators—the policy envi- be the larger worry for foreign investors. This is ronment of the country and the country’s political supported by the MIGA-EIU Political Risk Survey ideology (“right-wing� vs. “left-wing,� as defined in 2012, which found that macroeconomic instability the same study)—are also important determinants of and access to financing are the top constraints for the two events. Using Country Policy and Institutional foreign investors over the next 12 months, while Assessment (CPIA) aggregate scores, a general political risks are the prominent concern for them measure of policy soundness developed by the World over the next three years. Bank, the study found that countries with lower CPIA scores (that is, more challenging governance environments) are more likely to expropriate private assets, although this relationship becomes statis- Which Countries Are Crisis-Prone? tically insignificant when controlling for other factors. The study found a stronger relationship with the gov- Although defaults and expropriations rarely coincide ernment’s political ideology, reinforcing the conven- in the same year, they are historically related in tional wisdom that foreign investors who operate in the sense that the same types of countries seem countries with governments described as “left-wing� to engage in both over the long term. This section need to be more concerned about the risk of expro- gathers the empirical findings of past studies to priations. This finding is also consistent with World understand the country-specific factors that make the Investment and Political Risk 2011, which found that two risk events more likely. the type of political regime could be a major driver of expropriation. The lower panel of table 2.1 uses the dataset con- structed by Tomz and Wright (2010), and presents There is also a tendency that expropriations will a joint distribution of 191 countries showing those repeat multiple times, while sovereign defaults that experienced sovereign default and expropriation are much rarer events. Among 78 countries that events during 1970-2004. Countries in the upper- expropriated private assets at least once in this left quadrant neither defaulted nor expropriated at time period, about 70 percent experienced expro- any point in the time period (75 cases), whereas priation two or more times, as shown in the upper countries in the lower-right quadrant both defaulted panel of table 2.2. A country is more likely to have and expropriated (62 cases). Nearly 70 percent of expropriation events as the number of past expro- countries occupy one of those two quadrants, versus priation events increases. It suggests the possibility 30 percent that experienced only one of the events of reputational spillovers, leading to the conclusion during this time period. This indicates there is a that governments lose incentives to preserve a good strong positive correlation between the two events in reputation by honoring their obligations once they the long term. have revealed themselves to be unreliable. As the reputation loss is a critical cost of expropriation, By looking at the regional distribution of 62 countries governments that have expropriated private assets that experienced both events over 1970-2004, about in the past (and have therefore already incurred this half of the expropriation acts occurred in Africa reputation cost) are more likely to engage in further (North and Sub-Saharan) and a third of them in expropriation. MIGA WIPR REPORT 2012 | 33 Box 2.1 Impact of Sovereign Debt Restructuring on Financial Flows: The Case of Indonesia Public debt levels of most Asian countries ended. Undoubtedly, better macroeconomic prior to the 1997-98 financial crisis were conditions such as the narrowing of fiscal relatively low. Government debt as a per- deficits and higher yields on domestic centage of GDP in 1996 for China, India, currency investments during the post-crisis Indonesia, Malaysia, the Philippines, period acted as pull factors that attracted and Thailand were at 16, 69, 23, 41, 47, capital flows into the country. Nonetheless, and 4 percent respectively. Out of the six the quick recovery of debt and FDI inflows countries, only Indonesia experienced a suggests that the retaliation was modest sovereign external debt crisis during this and does not support the joint retaliation period. Meanwhile, Indonesia, Malaysia, hypothesis. It attests to the short-term the Philippines, and Thailand suffered memory of foreign creditors and investors from currency and banking crises when as regards the sovereign debt restructuring the financial crisis hit the region. This box event that took place in Indonesia during focuses on the case of Indonesia to inves- the financial crisis. tigate the impact, if any, of its sovereign external debt restructuring on financial flows to the country. This is related to the joint retaliation hypothesis raised in Tomz and Wright concerning whether the non- Fig 2.3 honoring of debt contracts spills over to Figure 2.3 Inflows of Debt spoil relations with other types of investors. Securities and FDI If there is cross-retaliation between debt and equity contracts, the government will be excluded from FDI after the outbreak of As percentage of GDP a sovereign default event. Annual data from 1981 to 2010 on inflows of debt securities 4 and FDI into Indonesia expressed as per- 3 centages of GDP are displayed in Figure 2.3, along with the bar that indicates the onset 2 of the debt crisis. 1 0 81 85 90 95 00 05 10 It is clear from the figure that both debt and FDI inflows tumbled at the onset of -1 the sovereign debt crisis, which in this case -2 also coincided with the expropriation events. -3 The precipitous drop of debt inflows shows that the impact of the debt restructuring -4 on debt securities seems more immediate compared to FDI inflows. Interestingly, both FDI inflows types of capital inflows started to recover Debt Inflows when Indonesia was still in the midst of the debt crisis. Indeed, debt and FDI inflows exceeded their pre-crisis levels only two and three years, respectively, after the debt crisis 34 | MIGA WIPR REPORT 2012 The case of sovereign defaults is quite different. Table 2.2 Frequency of Sovereign The bottom panel of Table 2.2 shows that sovereign Defaults and Expropriations over defaults occurred only once or twice in 90 percent of the countries. In the MIGA-commissioned empirical 1970-2004 study, it was found that the country is less likely to experience another sovereign default episode if it Expropriation experienced a default in the previous five years. As mentioned previously, it is technically difficult for Frequency Number of % a country to consecutively default on its debt obli- of events countries gations, as debt has to be built up again prior to the next default opportunity. 1 24 30.77 This finding on the persistence of expropriations 2 16 20.51 provides a good signal for foreign investors that the loss probability of expropriation tends to be higher 3 13 16.67 for countries that experienced the event in the past. 4 10 12.82 If sovereign default is a more isolated event, how can the risk of sovereign default risk be assessed? 5 9 11.54 In the empirical study (Eden, Kraay, and Qian 2012), which defines sovereign defaults as a country’s 6 4 5.13 failure to make required payments to foreign private creditors, the sovereign default event coincided 7 1 1.28 with idiosyncratic economic shocks. In this regard, economic indicators such as higher external debt 8 1 1.28 burden and lower real GDP growth are good pre- dictors of sovereign default. Kraay and Nehru Total 78 100 (2006) also found that sovereign defaults with official creditors are determined by the quality of policies and institutions, in addition to debt burden Sovereign Defaults and economic shocks. Frequency Number of In summary, sovereign default and expropriation % of events countries have occurred for somewhat different political and economic reasons and they are different in 1 62 70.45 nature. Expropriations tend to repeat and are more determined by political factors. Sovereign defaults 2 19 21.59 tend to be determined by temporary economic shocks. In the short term, the two events rarely occur 3 4 4.55 in parallel. In the long-run perspective, however, the relative riskiness of the two types of events can be 4 3 3.41 understood by looking at the external liability position of the host country.43 This correlation is unique and Total 88 100 more complex in comparison with a perhaps more obvious correlation between sovereign risk and transfer/inconvertibility risk (in box 2.2). ote: Among 191 countries in the total sample, N there are 78 countries with expropriation events Given that the same countries engage in both sov- and 88 countries with sovereign default events ereign defaults and expropriations in the long term, during this time period. the same country-level expertise that is useful for underwriting traditional PRI may also be relevant for Source: Tomz and Wright (2010) providing non-honoring of sovereign financial obli- gations. MIGA WIPR REPORT 2012 | 35 Box 2.2 Sovereign Risk and Transfer/Convertibility Risk Besides expropriation, a perhaps more default. According to Fitch (2004) of the obvious correlation is that between 12 emerging-market sovereign crises, nine sovereign risk and transfer and convert- resulted in a default but only two resulted ibility risk. The two risks are highly cor- in some form of transfer and convertibility related. Based on Standard &Poor’s (S&P) event.45 This makes a simple “sovereign ratings on the long-term foreign currency ceiling� approach less realistic. (LTFC) and transfer and convertibility as of September 2012, a simple correlation Based on the reduction of transfer and between the two is 0.83. Figure 2.4 plots convertibility risk relative to sovereign risk, 128 countries with different LTFC rating rating agencies view transfer and convert- (x-axis) and transfer and convertibility rating ibility risk as lower. As a result, the transfer (y-axis). The fitted line shows this high cor- and convertibility rating exceeds sovereigns’ relation between these two types of risk. LTFC ratings in 68 percent of sovereigns that are rated by S&P (2009), while another Historically, sovereigns suffering from 32 percent have the same rating for both political and economic pressures have LTFC and transfer and convertibility. In tried to safeguard falling foreign reserves figure 2.4, countries with a transfer and by restricting the ability of residents to convertibility rating higher than the LTFC convert from local to foreign currency. Fitch rating are plotted above the 45 degree line. previously operated a “sovereign ceiling� Countries in monetary or currency unions approach, whereby LTFC was automatically are assigned the same transfer and con- regarded as the ceiling on the transfer vertibility rating as other union member and convertibility rating. This is based on countries, and dollarized economies have experiences of sovereign debt crises in the the same transfer and convertibility rating 1970s and 1980s, when governments facing as the United States.46 In such cases, their default imposed moratoriums or exchange transfer and convertibility ratings tend to be controls and/or took other restrictive overrated compared with their LTFC rating, measures, such as impeding access and which weakens the correlation between the transfer of foreign currency by private two risks. entities. However, as private capital flows and trade have become more globalized, the number of countries that impose capital controls has decreased dramatically. In addition, the experience of sovereign default events since the mid-1990s (for example, the Dominican Republic in 2005) provides some support for the view that governments are less likely than in the past to impose foreign exchange controls and private-sector mora- toriums in order to prevent a sovereign 36 | MIGA WIPR REPORT 2012 In the next section, firm-level observations are Figure 2.4 Correlation of provided to further analyze this issue based on the Fig 2.4 Sovereign Credit Rating and MIGA-EIU Political Risk Survey 2012, which asked how MNEs’ risk perception of political risks change Transfer/Convertibility Rating in response to future sovereign default events. Corporate-level Political Risk T&C rating Perceptions for 100 Sovereign Credit Risk 80 As discussed in chapter one, in the MIGA-EIU Political Risk Survey 2012, macroeconomic instability Linear projection (r=0.83) and access to financing emerge as the top two con- 60 straints for FDI over the next 12 months. It is clear that the euro-zone sovereign debt crisis and recent financial deleveraging have created severe business 40 obstacles for firms and affected corporate-level risk perceptions for FDI. Given the weak economic 20 conditions in the euro area, the survey further inves- tigates how the current sovereign debt crisis affects firms’ general perceptions on political risks, comple- 0 menting the country-level analysis in the previous 0 20 40 60 80 100 sections. LTFC rating Based on the survey, it is clear that multinational investors perceive traditional political risks (expro- priation/breach of contract, transfer restriction and inconvertibility, and war and civil disturbance) as significant, alongside the risk of a sovereign’s Source: Standard & Poor’s non-honoring of financial obligation, because of Note: Rating is rescaled in a range of 0-100 in which current sovereign credit events. Figure 2.5 illus- “D� corresponds to 0 and “AAA� corresponds to trates the answer to the question of how firms’ 100 general perception of political risks change due to an increase in sovereign risk through events (for example, euro-zone sovereign default episodes, debt restructuring of the investing country, and com- modity price shocks). For all political risks, over 50 percent of firms consider that actual sovereign risk events will increase the risk of each political event. credit events. This suggests that foreign banks in There is a strong perception that an increase in emerging economies currently face a serious funding sovereign risk will lead to major increases in war constraint because of the weak global economy and and civil disturbance (37 percent of respondents), limited funding resources. This tends to make them breach of contract (31 percent), transfer and convert- more risk averse and therefore seek risk-mitigation ibility restrictions (26 percent), and expropriation instruments more actively than firms in other sectors. (24 percent). Firms that invest in the Middle East and North Africa are especially likely to see higher The MIGA-EIU Political Risk Survey 2012 also asked risks that the sovereign crisis could trigger political whether changes in sovereign credit rating would instability, host government’s expropriatory actions, affect a firm’s business risk of expropriation/breach and restrictions on foreign exchange. Another inter- of contract, transfer restriction/inconvertibility, and esting finding from the survey is that firms that non-honoring of sovereign financial obligations. work primarily in the financial sector perceive a Figure 2.6 shows the results for the first two types of major rise in political risks due to these sovereign political risks. Similar to figure 2.5, over half of firms MIGA WIPR REPORT 2012 | 37 expressed their concerns about the rise in expro- to weak external liability positions), those with poorer priation and contract violation, as well as foreign governance, or countries that experienced multiple currency transfer restriction in the event sovereign political risk events in the recent past. These topics debt default should occur. Even under the more too need to be the subject of further research. realistic situations where the sovereign credit rating would be downgraded below investment grade, they perceive higher risks of both political risk events. Figure 2.5 Impact of Actual This seems to be somewhat contradictory to the Sovereign Risk Events on country-level evidence, which shows a lack of cor- relation between actual sovereign default and Political Fig 2.5 Risk Perceptions expropriation events in the short term as well as no spillover effect between two events. As discussed in Percent of respondents previous sections, in the past decades there are rarely cases where two extreme events (sovereign default and expropriation) coincide as shown in table 2.1. Although actual events tend not to happen at the same time, this firm-level survey makes clear that the two events are generally perceived by MNEs as Expropriation strongly correlated in the sample. The survey does not explicitly ask the time period over which the Breach of contract risk was being assessed, but investors tend to have a forward-looking view on political risk, especially Transfer for expropriation (figure 1.4 and 1.5). If they have and convertibility a longer-time horizon when indicating their per- restrictions ceptions on political risk, this survey result would be compatible with long-run evidence that a similar set War and of countries eventually engages in both sovereign civil disturbance default and expropriation. 0 20 40 60 80 100 As investors’ risk perceptions of sovereign default are positively correlated with their perceptions of the Major increase in perceived risk risk of expropriation, this implies that the provision Minor increase in perceived risk of PRI for non-honoring of sovereign financial obli- No impact gation could have some positive spillover effects Minor decrease in perceived risk in mitigating investors’ broader political risk per- Major decrease in perceived risk ceptions for FDI. Don’t know Finally, based on the survey, the sensitivity of political risk perceptions to sovereign risk seems to be higher for specific types of firms—those investing in certain Source: MIGA-EIU Political Risk Survey 2012 countries in the Middle East and North Africa (such as Egypt) and Latin America (such as Argentina, Note: In this question, “sovereign risk� includes events Brazil, and Mexico). In addition, such region-specific such as default episodes in euro-zone, debt responses by firms could be partly explained by restructuring, and commodity price shocks already-elevated perceptions of political risk after the Arab Spring in the Middle East and North Africa, but this should also relate to the country typology dis- cussed in the previous section. Although this requires a more systematic analysis, foreign investors’ political risk perceptions might be more sensitive to a sov- ereign crisis in certain countries. As noted in this section, investors’ risk perceptions might also be more sensitive in countries that face higher con- tagion risks from the global crisis (for example, due 38 | MIGA WIPR REPORT 2012 In conclusion, this chapter examined the empirical Figure 2.6 Sovereign Credit Risk and relationship between sovereign credit risk and its Impact on Political Risk political risk over time and highlighted some empirical regularities between the two types of risk. Percent of respondents At the country level, it found that the two types of events rarely coincide in the short term, but seem Fig 2.6 to occur in waves. Because of the current global economic crisis in the advanced economies, foreign Expropriation/breach of contract investors’ political risk perceptions seem to be elevated for emerging and developing economies. As Sovereign the emerging economies have relied more on FDI debt downgrade (staying above as a substantial source of foreign currency in recent investment grade) years, expropriation risk seems to be relatively higher. Sovereign This is in sharp contrast to advanced economies, debt downgrade which are perceived to be more susceptible to sov- (below investment ereign debt default risk. Amidst the global economic grade) crisis, PRI for sovereign credit risk seems to play a Sovereign role in encouraging investments by managing the risk debt default of non-honoring of sovereign financial obligations, Sovereign but it could also alleviate investors’ broader concerns debt upgrade (staying above for other political risks. investment grade) Sovereign Finally, this chapter suggests that a similar set of debt upgrade (below countries with weak policy environments and gov- investment grade) ernments conventionally described as “left-wing� 0 20 40 60 80 100 have a more persistent risk of expropriation. In terms of PRI coverage for expropriation risks, this finding suggests that it is important to accumulate Transfer restriction/inconvertibility knowledge of political and economic conditions for a similar set of countries that faced a persistent expro- Sovereign debt downgrade priation risk in the past. For PRI providers, this infor- (staying above mation is useful for providing traditional political risk investment grade) insurance as well as relevant for providing coverage Sovereign for non-honoring of sovereign financial obligations. debt downgrade (below investment grade) Sovereign debt default Sovereign debt upgrade (staying above investment grade) Sovereign debt upgrade (below investment grade) 0 20 40 60 80 100 Major increase Minor increase No impact Minor decrease Major decrease Don’t know Source: MIGA-EIU Political Risk Survey 2012 MIGA WIPR REPORT 2012 | 39 CHAPTER three The Political Risk Insurance Industry rr Between 2008 and 2011, issuance of political risk insurance (PRI)47 has increased by 29 percent for Berne Union members, an increase that has exceeded that of foreign direct investment (FDI) flows into developing countries over the same time period. However, aggregate premium rates have remained remarkably stable. rr Capital availability in PRI, just as in other specialty insurance lines, has increased over the past four years. This trend is driven mainly by devel- opments in the broader insurance market and by the growing demand for PRI. rr As a relatively small specialty line, the PRI market is influenced by developments in the general (property/casualty) and life insurance industry. The capital position of general and life insurers remains strong and new capital requirements contemplated by Solvency II are expected to be met easily. Premium income in general and in life insurance has remained flat. rr At least partially due to trends in the general insurance market, capital has been allocated to specialty lines such as PRI in search of higher income. The growth in PRI has involved both public and private pro- viders, with the proportions of issuance from each roughly stable. In the private and Lloyd’s market, capacity has increased 19 percent in the first half of 2012, with new providers entering the market and existing providers increasing their capacity. rr Claims have increased sharply over the past two years and have tended to be paid out more by private providers than by public ones. Reported recoveries from claims paid by both public and private pro- viders of the Berne Union have been low, though interpretation of this is complicated by the unpredictable lag between claim payments and recoveries. 40 | MIGA WIPR REPORT 2012 The PRI industry expanded in 2011 and evidence Figure 3.1 PRI by Berne Union from the first half of 2012 indicates that this trend Members Fig 3.1 and FDI Flows into is continuing. The PRI industry, as a specialized line of insurance, is affected by the demand for PRI Developing Countries itself, as well as by changes in capital availability in the broader insurance market. This chapter explores both of these trends by first focusing on the potential Ratio of PRI to FDI to developing countries reasons why demand for PRI grew over the past in percent four years and then exploring how trends in the broader insurance market affected PRI’s availability of 14 coverage and pricing. 12 In 2011, the members of the Berne Union issued $75 10 billion in investment insurance,48 which represented an increase of 13 percent over the previous year.49 For 8 the first half of 2012, issuance reached $47 billion, 6 with trends suggesting that the uptick could well continue into the second half of the year. Private PRI 4 members outside of the Berne Union have reported 2 similar trends, although the exact amount of issuance is more difficult to determine because of confiden- 0 00 01 02 03 04 05 06 07 08 09 10 11 tiality and other legal reasons. While volume of new PRI issued by Berne Union Growth of new PRI vs. FDI flows members in 2011 is over twice the volume issued in 2005, this needs to be viewed in the context of 700 growing levels of FDI flows into developing countries, 600 including FDI from developing countries themselves. 500 Despite an upward trend, the rate of growth has not been smooth, with a fall-off occurring in 2008. 400 However, since 2009, the cumulative growth rate of 300 PRI issuance has been greater than that of FDI into developing countries (part 2 of figure 3.1). For this 200 reason, on average, new PRI as a proportion of FDI 100 inflows into developing countries has increased from 9.5 percent during 2006-2008 to 11.6 percent during 0 00 01 02 03 04 05 06 07 08 09 10 11 2009-2011 (part 1 of figure 3.1). Most of this increase took place in 2009 in the aftermath of the global financial crisis and has remained constant since New PRI then at 11.6 percent.50 The increase may be a result FDI into developing countries of either higher global political risk perceptions, or more capital scarcity in the financial sector (as PRI in some cases may relieve capital charges in financial Sources: Berne Union Secretariat; World Bank MIGA WIPR REPORT 2012 | 41 institutions), or a combination of both. It should be Figure 3.2 PRI Issuance by Berne noted that the figures also underscore that the bulk Union Members of FDI is not covered by PRI. Fig 3.2 $ million Demand for PRI 80,000 With trends largely pointing to growth in investment into developing countries and heightening awareness 60,000 and perceptions of political risk among investors, demand for PRI has increased sharply since 2005. The year 2011 showed the strongest increase in 40,000 absolute terms since the onset of the financial crisis, with new investment insurance issued by members of the Berne Union reaching a new record (figure 3.2). 20,000 By the first half of 2012, the Berne Union issuance level was still growing strongly and is expected to reach an even higher level than in 2011. Issuance for 0 the first half of 2012 alone was near the level for the 2012H1 2000 2006 2009 2004 2008 2002 2007 2003 2005 2001 2010 2011 full year in 2009 and higher than the level of each year prior to 2007. The main developments driving the demand for PRI have been: Source: Berne Union Secretariat rr Unexpected events in the Middle East and North Africa have raised the profile of risks associated with seemingly stable regimes. The growing demand for PRI is taking place in the context of the current financial market turmoil and rr Expropriations in Latin America and contract deleveraging by financial institutions in Europe and renegotiations in the mining sector in several other high-income economies that are facing new resource-rich economies over the past few years regulatory requirements to bolster their positions. have brought political risk into the forefront of With limited funding available and banks especially investors’ consideration. cautious, PRI for investment projects is in demand to enable financing to go forward, particularly to obtain rr Capital constraints and more regulation in capital relief. financial institutions (for example, Basel II-III, Solvency II) have limited the financing options As foreign investors look for higher returns, they for foreign investment. PRI may be able to are turning increasingly to frontier markets where mitigate the perceived risks by regulators and political risks can be significant. New actors in the offer capital relief for financial institutions, which field of FDI who are less familiar with developing- makes financing with PRI more attractive. country environments—especially frontier markets— also look to PRI as a tool to mitigate risks. Demand rr In the financial sector, a drop in demand for PRI for PRI is increasing from investors interested in by banks for shareholder loans to their affiliates countries that are beginning to encourage FDI, such has been offset by increased demand from as Myanmar, or those that have seen a substantial project finance. influx of investment in recent years, like Mongolia in natural resources. Finally, events in the Middle East and North Africa contributed to greater awareness More generally, after a rather benevolent period with of the need to manage political risk by underscoring low levels of political claim losses, there is a growing that investors are not always in a position to take into realization that political risk events are not easily account unanticipated events in their current risk- predictable and can adversely affect FDI projects and mitigation strategies. supply chains. 42 | MIGA WIPR REPORT 2012 Fig 3.3 Figure 3.3 PRI Issuance by Berne since 2005, while total cover provided by private and Union Members, by Type of Provider multilateral providers was more volatile, actually declining in some years (figure 3.3). In 2008 and $ million 2009, the growth in total cover provided by public providers increased much faster than for private providers that are members of the Berne Union, but this trend is reversing. Among investment insurers based in developing countries that are members of 80,000 the Berne Union, total cover provided also increased 70,000 considerably in parallel to the growth in outward FDI from developing countries. 60,000 Anecdotal evidence among public issuers confirms 50,000 this picture of higher than historical growth compared to that of private providers, for which 40,000 growth in issuance has not been significantly higher than historical trends. These observations, however, 30,000 exclude Lloyd’s market participants, meaning the relative growth rates and relative shares of public 20,000 and private issuance may not be as marked as the figure suggests. In a July 2012 roundtable of private 10,000 insurers and brokers from the London insurance 0 market (Lloyd’s syndicates and other private insurers) hosted by the Exporta Group on behalf of MIGA, 2012H1 2006 2009 2008 2007 2005 2010 2011 participants noted an increase in demand for PRI across all political risks. While noting that regulatory Multilateral requirements such as Solvency II (the revised capital Public requirements and risk-management standards for Private the insurance industry in the European Union) and Basel III (a comprehensive set of reform measures to strengthen the regulation, supervision, and risk management of the banking sector) are increasing Source: Berne Union Secretariat the cost of insurance, the broad consensus was that demand is still strong for both specialized and general lines of coverage. In fact, most private market While the increase in demand for PRI has been participants noted the overall stability in the market broad-based, demand (in absolute terms) has been over the past 20 or so years, in the sense that both particularly strong for investments in Asia. This specialized PRI and broader universal coverage have probably reflects the continued growth in infra- tended to move in parallel. While there have been structure projects in the region into 201251 as well periods when one or another type of coverage has as attractive opportunities in countries with large been preferred by clients, over the long term the domestic markets that are also continuing to see relative share of both types of coverage has remained real GDP growth. However, in relative terms, smaller broadly constant. In the current period of issuance, countries have seen a disproportionate rise in PRI this growth pattern continues to hold. The expec- issuance. An interesting development in the market tations of market participants are that demand for is that—while historically demand for PRI has PRI will continue to increase at rates slightly typically been focused on investments in developing above those for FDI and that, in the near term, the countries—in the past two years there has been a Solvency II regulatory requirements will not pose a marked increase in inquiries and issuance in some barrier to the pattern of continued growth, at least high-income countries, reflecting heightened political in the PRI market. As an insurance regulator told risk perceptions there due to the financial and sov- MIGA, the capital position of insurers in the United ereign debt crisis. Kingdom at this time is significantly stronger than what will be required under the new regulatory According to the Berne Union, total PRI cover framework, so this should not act as a barrier to provided by public providers increased every year further growth. MIGA WIPR REPORT 2012 | 43 Fig 3.31 Supply of PRI: Figure 3.4 Available Private Market Capacity, Pricing, and Products PRI Capacity Total maximum per risk in $ million Capacity In terms of capacity, the private PRI industry appears 1,000 well-positioned to respond to the ongoing rise in demand. Arthur J. Gallagher & Co. London brokers estimated in their July 2012 market update52 that capacity in the private market increased by 24 800 percent since July 2011, of which about 19 percent represented an increase in the first six months of 2012 (figure 3.4). Single providers have tended to 600 increase available line sizes and tenors. The increase in capacity in the private and Lloyd’s markets is occurring at tenors of 10 years or less. For 15-year tenors, Arthur J. Gallagher & Co. estimates that 400 capacity stands at some $440 million. Over the past year, it has not only been the expansion of availability in the PRI market that has increased capacity, but 200 also the entry of new players. XL Group has recently received approval from Lloyd’s to underwrite political risks and trade credit risks as a Lloyd’s syndicate 0 and has also expanded its underwriting capability.53 01 02 03 04 05 06 07 08 09 10 11 Canopius also began underwriting political risks in Private January 2012, and in February 2012, Ironshore Lloyd’s Lloyd’s Pembroke Syndicate began to offer PRI coverage to the United States market.54 Capacity in the public sector is typically funded by Source: Arthur J. Gallagher & Co. governments, and PRI capacity ceilings in many public providers can be high. Exogenous factors and requirements also shape the supply of public sector PRI to investors.55 In the public market, new entrants include the Export Insurance Agency of the Russian Federation, which will offer investment insurance to There are two broad trends currently occurring Russian firms investing abroad starting in 2013.56 in the insurance industry. The first relates to the Recently, the African Development Bank approved an environment facing the property/casualty and life equity investment into the African Trade Insurance insurance markets. While the post-2008 crisis has Agency allowing it to increase its capital base.57 negatively impacted the insurance industry’s income in developed countries, the industry appears to be To some degree, capacity in the PRI market is also on the verge of new growth in developing countries driven by the situation of the broader insurance where insurance penetration remains relatively low. market. Over the past couple of decades, insurance Thus, the future outlook for private capacity in the firms have entered and exited the PRI market— insurance market remains positive. The second driven by the dynamics of the broader insurance trend is the new regulatory regime under Solvency market—adding or subtracting capacity. Therefore, II and Basel III. As mentioned earlier, in discussions it is useful to review some of the broader issues MIGA had with insurance regulators in the United affecting the property and casualty insurance industry Kingdom and the European Union, it was clearly to understand these historical dynamics, since these stated that capital adequacy is not a major concern in are the business lines typically shifting into the PRI the insurance industry generally. Broadly, most of the market. Solvency II quantitative requirements are in place and in these two significant jurisdictions insurance com- 44 | MIGA WIPR REPORT 2012 Figure 3.5 General Insurance not change in the short term. What this means is Pricing Fig 3.5 vs. Private PRI Capacity that financial returns have been falling. One of the corporate responses to this has been to shift capital $ million per risk into specialized lines, including PRI. This explains to a large degree why capacity in PRI has been growing at rates above those of FDI flows. Pricing 1,000 160 As noted earlier, PRI is often managed as a specialty 140 line by general insurance companies, so liquidity 800 120 and pricing of PRI correlate somewhat with the insurance market. Further, as the PRI portfolio is 100 600 dwarfed by that of general insurance, the supply 80 of PRI also closely follows trends in the insurance 400 cycle. Consequently, notwithstanding the very rapid 60 growth in demand for PRI, capital supply in this line 40 of business has increased equally rapidly leading to 200 continued soft premiums. How much insurance pro- 20 viders in any business segment are willing and able 0 0 to underwrite is also determined by the availability of 01 02 03 04 05 06 07 08 09 10 11 reinsurance, which by all accounts remains strong. According to Aon Benfield, reinsurance capacity has Private been ample, returning to its previous record high of Lloyd's $470 billion at the end of the first quarter of 2012.60 ADVx Composite Index Indeed, PRI market capacity and general insurance pricing have trended together over the past 10 years (figure 3.5). There are several ways to measure the Sources: Gallagher London; Advisen58 softness of the insurance market, including insurance Note: The Advisen ADVx™ Composite Commercial pricing indexes and the available amount of policy Lines Pricing Index shows the change in the holder surplus (the difference between insurers’ average commercial lines premium in the United assets and liabilities). Figure 3.5 tracks capacity in States by quarter beginning the first quarter of the PRI market since 2001 against Advisen insurance 2001 (Q4 2000 = 100) consultants’ ADVx composite index of general insurance pricing, a pricing benchmark used in the insurance industry. For 2012, and looking at the same issue in terms of year-on-year growth rather than absolute dollar panies are currently well-capitalized. Specialized and figures, Advisen also compared the property and general and life firms, as well as major reinsurers, casualty policy holder’s surplus growth with GDP have concluded that Solvency II requirements are not growth and estimated that policyholders’ surplus is expected to negatively impact capital availability in still growing ahead of GDP61 and, in fact, ahead of the next few years. Because of these trends, market historical growth averages. This would indicate that conditions in the broader insurance market are “soft� the forces contributing to premium softness remain and liquid.59 in place, and that policyholders’ surplus continues to grow to historic highs. An important ongoing concern in the broader insurance industry has been the protracted low- The current soft insurance market has persisted interest environment. Given regulatory limits on throughout the credit crisis. Despite the temporary assets classes allowed for investment, returns rise in claims in the aftermath of the global financial from investments have remained low by historical crisis and the political turmoil in the Middle East standards with expectations that the situation will and North Africa, premium levels have remained MIGA WIPR REPORT 2012 | 45 stable as capacity has increased in both the general Figure 3.6 Ratio of Premiums to insurance and PRI markets. Thus the market was Average PRI Exposure for Berne confronted with the seeming paradox that benign insurance market conditions held up despite the Union Members unfavorable environment in financial markets. It is unclear how long the current soft state of the global insurance market will persist. If predictions of continued sluggish growth in the industrialized world materialize, interest rates and investment 1.0 income will likely remain subdued for some time. However, lower economic activity will also reduce the real demand for insurance services, although 0.8 some product lines may experience growing demand in developing countries as insurance penetration 0.6 increases. In the PRI market, risk appetite, pricing, and capacity 0.4 will depend as much on loss events outside the narrow PRI industry as on financial losses within the PRI industry from significant political events. Large 0.2 92 94 96 98 00 02 04 06 08 10 11 catastrophe losses, for example, directly influence reinsurance availability, requiring private insurers to deploy capital across business lines. The PRI industry’s supply cycle therefore also depends as much on events such as natural disasters as it does on political events. Source: Berne Union Secretariat Note: Average rates; weighted average rates are likely Historically, the ratio of premiums to average PRI higher exposure has fluctuated within a band. Plentiful capacity in both the general and PRI markets as well as greater flexibility in setting premium rates by pro- viders in the public market helped to hold premiums relatively steady in 2011 (figure 3.6), but it is not certain that this will continue. Potentially, the drivers Products of the demand for PRI outlined earlier will exert upward pressure on premiums. There are also signs The increased risk perception by investors and con- that premiums in some risk categories of the broader sequent increase in demand for PRI has resulted insurance market are increasing,62 which would also in innovative ways to use existing products and exert upward pressures on PRI pricing. increased product offerings. Some public members of the Berne Union (including MIGA) have expanded In conclusion, in the private sector, PRI is often a their offering to respond to different investor needs. specialty line offered by general insurance companies For example, the events in the Middle East and and, as such, developments in the PRI market are North Africa region have engendered an interest influenced by developments in the broader insurance for coverage of existing investments, despite the business.63 In recent years, capacity in the general historical requirement of many public providers to insurance market has increased. At the same time, cover only new investments. Additionally, the more demand for insurance has been sluggish because constrained financing environment since 2008 has of the slow economic recovery following the global resulted in greater need for sovereign or sub-sov- financial crisis. Insurers’ capital has continued to ereign support or direct engagement in financing of grow to new records and currently there appears to projects. This has led to greater interest in coverage be a sufficient supply of reinsurance globally.64 This of risks such as the non-honoring of sovereign is reflected in the current soft market, though going financial obligations. Additionally, the growing stress forward, increased demand may drive prices higher. on public finances in some parts of the world as a result of the crisis has led to an increase in interest 46 | MIGA WIPR REPORT 2012 by investors in sovereign non-payment insurance. violence (figure 3.7) and were mainly as a result of The entry of public providers into these product the turmoil in the Middle East and North Africa. markets has permitted an increase in volume as well This represents a significant shift in the pattern up as tenors for these covers. until 2010, when most claims were attributed to expropriation or breach of contract. To illustrate this, Overall, risk-mitigation strategies and product during 1995-2010, claims resulting from expropriation mixes within the PRI industry have not changed or breach of contract accounted for 68 percent of dramatically. The increase in PRI issuance in the all claims in terms of amount paid, but the share of Lloyd’s market this year has not tended to favor any losses under these coverages was only 5 percent in particular coverage. Lloyd’s market participants at 2011. Typically the size of claims for expropriation or the MIGA-sponsored roundtable in July 2012 exten- breach of contract tends to be larger than those for sively discussed the issue of guarantee product mix. political violence because expropriation claims tend One of the main conclusions was that the relative to be associated with the total loss of an investment, share of different types of coverage has not changed while political violence claims reflect replacement or significantly over the past two decades. While in the repair costs and are only infrequently related to the short term there may be an increase of one type of total abandonment of the project. coverage—say, non-honoring of sovereign financial obligations—over the longer term the relative shares Because there are no data available for claims and of different products have remained broadly constant. recoveries in the Lloyd’s market, the discussion in This impression was reinforced in MIGA’s discussion this section will center on the experience of Berne with reinsurers, who tended to see a broad picture Union members. However, in the yearly roundtable of the PRI industry. Discussants observed that the that MIGA sponsors, the impression was that the mix of products may also reflect the relative liquidity claims experience in the Lloyd’s market over the past position of equity investors and financial institutions, couple of years has mirrored that of the Berne Union, as both tend to favor different insurance products. although the share of political violence in 2011 was This would account for short-term differences in the not as large. mix of PRI products, but over the medium term the mix has remained remarkably stable. In contrast to previous years, among Berne Union members, private PRI providers bore the brunt of in- Guarantee types have also tended to evolve in a vestment claims in 2010, accounting for 54 percent of somewhat distinct way. On the one hand, events the total value of investment claims paid by all Berne such as those in the Middle East and North Africa Union members in that year (figure 3.8). That picture have increased investor interest in some specialized became less pronounced in 2011, when private pro- lines, like civil unrest and terrorism coverage (box viders were responsible for about 46 percent of Berne 3.1) And some investors are expanding the use of Union claims for investment insurance. The ratio of investment insurance products for assets such as oil cumulative claims to cumulative new investment PRI rigs, mobile equipment, and personal assets.65 A new from 2005 to the first half of 2012 was 0.15 percent for development in the realm of specialized war coverage public PRI providers, compared with 0.34 percent for is the emergence of new products covering piracy.66 private. While claims paid in a particular year are also On the other hand, there has also been an increase in response to claims registered at any point in the in demand for global policies that encompass past, these ratios indicate that there is some differ- all risks. With uncertainty as to where the next ence between public and private providers. political risk “event� will occur, there seems to be an increased interest in global PRI coverage. Reported recoveries have been consistently lower over the past five years (figure 3.9), but this pattern may be due to the unpredictable lag in recovery fol- Claims and Recoveries lowing a claim. Furthermore, recoveries differ by type of claim, with no recoveries typically associated with Political risk claims, in terms of value, have shown political violence claims. considerable volatility from year to year. They increased sharply in 2010 to $312 million and declined in 2011 to about $191 million. Claims in 2011 resulted overwhelmingly from acts of political MIGA WIPR REPORT 2012 | 47 Box 3.1 Terrorism Insurance Following the events of September 11, and have been renewed following periodic 2001 in the United States, there has been reviews. In some countries (for example, increased awareness of the risk of ter- Belgium and the United States) insurers are rorism, which has been accompanied by required to provide coverage against ter- a retrenchment in the private provision rorism, while in others (like Germany and of insurance for it. In the aftermath the United Kingdom) insurer participation is of September 11th, about 20 countries voluntary. In the case of the United States, worldwide established terrorism insurance the Terrorism Risk Insurance Program schemes as public-private partnerships (Reauthorization Act of 2007), which has to help insurers offer adequate capacity, been extended to December 2014, offers especially in the case of large-scale terrorist up to $100 billion in government-backed events. The aim has been to minimize terrorism coverage to the private sector. the impact of a withdrawal of terrorism However, it is limited. Certain forms of insurance on businesses and to protect terrorism are exempted (like nuclear or them against losses associated with ter- chemical attacks and bioterrorism) and it rorism and business interruption resulting does not apply to international operations from it. of companies based in the United States. Terrorism risk is difficult to insure because In general, excluding government-sponsored it is not easily measureable and historical terrorism insurance schemes, capacity for data may not be relevant. There is a great terrorism insurance remains limited—at potential for vast losses from large-scale around $2-3 billion, according to one terrorist attacks, especially in urban centers, estimate. Recent developments regarding which reduces the ability of the private the provision of terrorism insurance include sector to offer insurance. This is why a Denmark’s Terrorism Insurance Act 2010, public-private insurance partnership can a public-private partnership to provide help create an insurance system that is coverage for damages to property, trains, resilient to the threat of terrorism. cars, and ships caused by nuclear, chemical, biological, and radiological terrorist acts; To date about 20 countries have some Xin, a new insurance consortium launched kind of government-backed terrorism by Amlin, Market, Canopius, and Argenta insurance scheme in place. These include (all Lloyd’s syndicates) to offer terrorism Australia, Austria, France, Germany, India, insurance to businesses in Asia; and the Netherlands, Spain, Switzerland, United U.S. subsidiary of Bermuda-based insurer Kingdom, and the United States—among Ironshore, which is bringing Lloyd’s political others. Most schemes were implemented as risk coverage to companies in the United a temporary measure in response to market States. failure following the September 11th events Sources: Swiss Re. “The Economic Case for a Private-public Terrorism Insurance Partnership.� Insights. March 2007; Terrorism Insurance Act Review 2012 (licensed from the Commonwealth of Australia under a Creative Commons Attribution 3.0 Australia License); Lloyd’s. “New Terrorism Consortium to Protect Under-insured.� March 26, 2012; Rick Friedl, “Ironshore Brings Political, War, and Terrorism Coverage to U.S.� The Royal Gazette, April 17, 2012; Wells Fargo Insurance Services.“The Terrorism Risk Insurance Act is Set to Expire in 2014 - What’s Next?� July 2010. 48 | MIGA WIPR REPORT 2012 Corporate Approaches to political leaders, could be becoming less effective as Political Risk Management relationships and established historical ties weaken. This implies that formal tools, such as PRI, could This section seeks to explore how investors perceive become more popular. the responsiveness of the PRI industry to their risk concerns. Building on the survey responses in Two of the findings of this chapter—that the same chapter one on risk perceptions, this section expands risk-mitigation tools and product mix within the PRI on the strategies used by investors to manage and industry have been used over the past four years mitigate political risk. —may seem puzzling on the surface. If risks have increased, why have strategies to deal with them not According to the MIGA-EIU Political Risk Surveys changed dramatically? Partly the answer rests in a over the past four years, the choice of risk-mitigation more disaggregated view (figure 3.11) that allows a tools used by foreign investors does not seem to better understanding of how risks are mitigated by have changed radically. Thus, the answer to the different tools. question of how firms mitigate political risk (figure 3.10) is not significantly different, even though The picture that emerges from this disaggregated political risks seem to have increased. Over the past view is that for some types of risk, mostly associated couple of years the proportion of investors interested with political violence, there does not seem to be in in PRI has changed only marginally. However, non- the view of international investors an effective risk formal tools, such as engagement with host-country mitigating tool. Since some of the increase in risk Fig 3.6 and developing relationships with governments Figure 3.8 Investment Claims Paid Figure 3.7 Investment Claims Paid by by Berne Union Members, by Type of Berne Union Members Provider $ million Fig 3.8 $ million 350 200 300 150 250 100 200 150 50 100 0 05 06 07 08 09 10 11 12H1 50 Unspecified 0 05 06 07 08 09 10 11 12H1 Transfer restrictions Political violence Expropriation Multilateral Breach of contract Public Private Source: Berne Union Secretariat Source: Berne Union Secretariat MIGA WIPR REPORT 2012 | 49 perception is associated with an increase in political Figure 3.10 Risk Mitigation violence risks, this can explain why PRI’s favorability Strategies Fig 3 .9 by Foreign Investors among investors is little changed. However, those investors who have purchased PRI cover for political in percent violence stand a greater chance of compensation should a covered event occur. Given the recent unpredictable events in the Middle East and North Africa, it is possible that investor perceptions of the Use of joint venture or value of political violence cover may change. For alliance with breach of contract, engaging with local officials has local company consistently been the preferred strategy of investors Political/economic over the past four years. Given the rise in regu- risk analysis latory takings, it is reasonable to assume that this will remain the case. However, risk of expropriation Invested gradually while presents an opportunity for the PRI industry, given developing familiarity with that investors see PRI as being relatively effective in the local environment controlling that risk (figure 3.11). Use of third-party consultants Scenario planning Fig3.9 3.9 Recoveries by Berne Engagement with Figure local communities Union Members, by Type of Provider Engagement with $ million government in host country Develop close relationships with political leaders 150 Political risk insurance 120 Operational hedging (setting up multiple plants to spread risk) 90 Engagement with non-governmental 60 organizations Credit default swaps 30 Provide support to a well-connected political figure 0 2012H1 2006 2009 2008 2007 2005 2010 Other, please specify 2011 We don’t use any tools or products to mitigate Public political risk Private Don’t know 0 20 40 60 Source: Berne Union Secretariat Source: MIGA-EIU Political Risk Survey 2012 50 | MIGA WIPR REPORT 2012 In summary, the past four years would appear to Figure 3.11 Investors Risk have been good years for the PRI industry. The Mitigation Strategies, by Risk Type industry’s countercyclical nature has been on display in terms of the return of higher risk perceptions among foreign investors and financial institutions. This has permitted a four-year increase of 29 percent in issuance,67 leading to an aggregate increase in portfolio. While premium rates have remained soft, Transfer and convertibility in aggregate terms, premium income has increased restrictions because of increased volume. The availability of Breach of contract capital in the broader commercial insurance market Non-honoring of has meant that more has been available to support government specialized insurance lines such as political risk. guarantees Therefore, even though issuance has grown rapidly Expropriation/ and a somewhat higher proportion of new FDI is nationalization being insured compared to five years ago, the soft Adverse premium environment in PRI persists at least in the regulatory changes short term. Furthermore, as non-life insurance seems War poised to grow in developing countries, it may yet be Terrorism that policyholders’ surplus will continue increasing Civil disturbance from its record levels, thus further perpetuating these price levels. Although there have not been sufficient Other losses in PRI to date to alter this general picture, caution is needed since political risks—real, as well 0 20 40 60 80 100 as perceived—remain significant. Engage with local public entities Joint venture with local enterprises Risk analysis/monitor Relationships with key political leaders Political risk insurance Risk is not significant for my projects No existing tool can alleviate this risk Source: MIGA-EIU Political Risk Survey 2012 MIGA WIPR REPORT 2012 | 51 endnotes 1 19 OECD. “International Mergers and Acquisitions Estimate based on outward stock data for 29 Surge in 2011.� Investment News Issue 16. October developing countries reported in IMF’s Coordinated 2011. Direct Investment Survey. China as estimated by 2 Global Arab Network. “Foreign Direct Investment Ken Davies, “Outward FDI from China and its and Tourism Receipts Pick Back Up in Tunisia.� Policy Context, 2012,� Columbia FDI Profiles. June 7, October 7, 2012. 2012. 3 20 The Hindu. “FDI in 2011-12 Rises 34%, a New Institute of International Finance. Capital Flows to High.� October 20, 2012. Emerging Market Economies. June 7, 2012. 4 21 Central Bank of Turkey. Balance of payments sta- Anita Prakash and Ikumo Isono. “ASEAN in the tistics. Global Economy–An Enhanced Economic and 5 IMF. Statement at the Conclusion of the European Political Role.� ERIA Policy Brief. No. 2012-01. Bank Coordination “Vienna 2.0� Initiative’s Full January 2012. 22 Forum. Press Release No. 12/80. March 13, 2012. These shares are likely higher since a portion of 6 A.T. Kearney FDI Confidence Index 2012: Cautious outward investment is channeled through inter- Investors Feed a Tentative Recovery. mediate jurisdictions, which do not constitute 7 UNCTAD. World Investment Report 2012. Chapter 1. the ultimate destination of the investment. For 8 In one of the biggest acquisitions in Brazil, Sinopec example, for China, Hong Kong, SAR China purchased a 30 percent stake in Petrogal Brasil. accounts for 63 percent of its outward stock and 9 Ken Davies. “Outward FDI from China and its for the Russian Federation, Cyprus accounts for 42 Policy Context.� Columbia FDI Profiles. June 7, percent of its outward stock. 23 2012. fDi Markets database. 10 24 OECD and UNCTAD. Seventh Report on G20 The European Union accounts for 80 percent of Investment Measures (covering the period between FDI flows in Morocco and 58 percent in Tunisia. October 7, 2011 and May 3, 2012). See De Bock, Reinout, Florea, Daniel, and Toujas- 11 A global regulatory standard on bank capital Bernate Joël, “Spillovers from Europe into Morocco adequacy, stress testing, and market liquidity and Tunisia,� IMF Working Paper No. 10/238, risk agreed upon by the members of the Basel October 1, 2010. 25 Committee on Banking Supervision. It is scheduled Central Bank of Egypt. “BOP Performance in July/ to be introduced from 2013 until 2018. March 2011/2012.� 12 26 The Solvency II Directive codifies and harmonizes Tunisia’s foreign investment promotion agency. See EU insurance regulation, primarily as it concerns also “Foreign investment in Tunisia recovers to pre- the amount of capital that EU insurance companies revolt levels,� Reuters, August 2, 2012. 27 must hold to reduce the risk of insolvency. Solvency Central Bank of Tunisia. 53rd Annual Report: Fiscal II is expected to come into effect on January 1, 2014. Year 2011. August 2012. p. 49. 13 28 Lloyd’s Risk Index 2011. Tripoli Post. “Decree Allows Foreign Investors to 14 Clifford Chance. “Resource Nationalism II: Enter Joint Ventures in Libya.� June 8, 2012. 29 Expropriation – Any Rights or Remedies?� Briefing AllAfrica.com. “Tunisia: New Investment Code to Be Note. May 2012. Submitted to NCA Late December.� 15 30 MIGA. World Investment and Political Risk 2011. Eden, Kraay, and Qian. “Sovereign Defaults and Chapter 2.Washington DC. Expropriations: Empirical Regularities.� Policy 16 Ernst & Young. Business Risks Facing Mining and Research Working Paper 6218. The World Bank. Metals 2011-2012. 2012. 17 Allianz Risk Pulse. December/January 2011-12. 18 World Economic Forum. Global Risks 2012. 52 | MIGA WIPR REPORT 2012 31 38 Michael Tomz and Mark L. J. Wright. “Do Countries Berne Union dataset covers the expropriation and Default in ‘Bad Times’?� Journal of the European breach of contract claims paid to non-U.S. foreign Economic Association. 5(2–3): 352–60.2007. direct investors from insurers that are the member 32 William R. Cline. “International Debt: Systemic of the Berne Union. The Berne Union is the inter- Risk and Policy Response.� Institute for national organization and community for the global International Economics. 1984. See also Daniel export credit and investment insurance industry. 39 McFadden, Richard Eckaus, Gershon Feder, Carmen Reinhart and Kenneth Rogoff. This Time Vassilis A. Hajivassiliou, and Stephen O’Connell. is Different: Eight Centuries of Financial Folly. “Is There Life after Debt? An Econometric Princeton University Press. 2009. 40 Analysis of the Creditworthiness of Developing This box is prepared in collaboration with Chow Countries.� International Debt and the Developing Hwee Kwan, Singapore Management University. 41 Countries.179–209. World Bank.1985. See also The group categorization of advanced economy and Andrew Berg and Jeffrey Sachs. “The Debt Crisis: emerging and developing economy aligns with the Structural Explanations of Country Performance.� IMF’s World Economic Outlook. The definition is Journal of Development Economics. 29(3):271-306. found on the website (http://www.imf.org/external/ 1988. pubs/ft/weo/2012/01/weodata/groups.htm). 33 42 Aart Kraay and Vikram Nehru. “When Is External Eden, Kraay, and Qian. “Sovereign Defaults and Debt Sustainable?� World Bank Economic Review. Expropriations: Empirical Regularities.� World Bank 20 (3): 341-365.2006. See also Daron Acemoglu, Policy Research Working Paper #6218. 2012. 43 Simon Johnson, James A. Robinson, and Yunyong Net FDI flow includes direct foreign investment Thaicharoen.�Institutional Causes, Macroeconomic flows (inward minus outward investment) and net Symptoms: Volatility, Crises and Growth.� Journal of re-invested earnings. Net debt investment is the Monetary Economics 50: 49-123. 2003. net portfolio investment of debt securities, such as 34 Stephen J. Kobrin. “Foreign Enterprise and Forced bonds, notes, and money market instruments. 44 Divestment in LDCs.� International Organization, This chapter focuses on the sovereign default event Vol. 34, No. 1, pp. 65-88. 1980. and does not consider the sub-sovereign default 35 Quan Li. “Democracy, Autocracy, and Expropriation event. According to Moody’s (2009), sub-sovereign of Foreign Direct Investment.� Comparative Political defaults rates are found to be heavily concentrated Studies. vol. 42 no. 8. 2009. during the first two years of sovereign crisis in the 36 Guriev, Kolotilin, and Sonin. “Determinants of emerging markets. Given this evidence, we expect Expropriation in the Oil Sector: A Theory and that sub-sovereign default event is similarly cor- Evidence from Panel Data.� CEPR Discussion Paper related with the country’s expropriation events. 45 no. 6755. Centre for Economic Policy Research. During 1998-1999 Russian crisis, the government 2008. tightened capital controls and imposed a formal 37 In “Sovereign Theft: Theory and Evidence about 90-day moratorium on servicing external debt. Sovereign Default and Expropriation� (2010) Tomz Also, during Argentina’s financial crisis in 2001, and Wright study the effect of two political risks the central bank was very selective in granting per- (default and expropriation) on foreign investments mission to transfer foreign currency and imposed (debt and FDI). They provide a theoretical model to exchange control regulations. understand how a government’s incentives to take two political actions (repudiate debt contract and/ (cont’d) or expropriate private assets) are determined by the state of economy, the nature of punishments from investors, and the type of political leaders. Their empirical analysis highlights the historical pattern that two events have occurred in alternating waves which seemed to accompany the shifts in the com- position of external liabilities between equity and debt. MIGA WIPR REPORT 2012 | 53 46 54 Transfer and convertibility of monetary or currency Ironshore. “Ironshore enters war, political violence union members are rated based on the past and stand-alone terrorism business to meet pro- and current policy soundness of those union’s tection needs of U.S. companies�, April 16, 2012. 55 monetary authorities. For example, all members For an extensive discussion of the drivers of of the European Economic and Monetary Union capacity in the private, public, and multilateral PRI have a transfer and convertibility rating of “AAA.� market, see Gerald T. West and Kristofer Hamel, All members of the Central African Economic and “Whither the Political Risk Insurance Industry?�, Monetary Community, the West African Economic in Theodore H. Moran and Gerald T. West, eds. and Monetary Union , and the Eastern Caribbean International Political Risk Management: Looking to Currency Union have “BBB-�. Transfer and con- the Future (Washington, DC: World Bank). 56 vertibility ratings for dollarized economies are the See Export Insurance Agency of Russia website same as those for the United States (for example, http://www.exiar.ru. 57 Panama is rated “AAA�). African Trade Insurance Agency. “A Strategy to 47 For the purposes of this report, PRI refers to Dampen Effects of the Global Downturn Sees investment insurance. African Development Bank Invest Ksh1.2 billion in 48 Investment insurance figures are for both ATI.� Press release. August 2, 2012. 58 developing and high-income economies and might Advisen. “State of the Market April 2011: Is a include business that does not fit into any other Market Shift on the Horizon?� 59 category. Advisen, ibid. 49 60 This figure includes a large amount of issuance in Aon Benfield, Reinsurance Market Outlook. June 2009 to support Japanese investor activities in the and July 2012 Update. 61 United States at that time. Advisen, op. cit. 50 62 It is important to realize that this figure understates Marsh. Global Insurance Market Quarterly Briefing: the actual level of PRI coverage as it only refers to Q1 2012. 63 Berne Union members who report PRI issuance. MIGA. World Investment and Political Risk 2011. However, MIGA’s consultations with Lloyd’s market Chapter three. 64 participants (the major private player, whose Aon Benfield, op. cit. 65 activities and figures are not reported in Berne Michael D. Nolan, Frederic Gilles Sourgens, and Union data) and underwriters have confirmed that Christina Totino. “Recent Trends in Public Political the trends the Berne Union faces are similar to the Risk Insurance Coverage.� Corporate Finance ones they face. So while the actual amount of FDI Review. May/June 2011. 66 covered may be somewhat higher (estimates place Insurance Daily .“Beazley Unveils Combined War/ it between the 16 percent and 18 percent) the story piracy Cover.�July 11, 2012. 67 of issuance growth and level of coverage remains This data are only available for Berne Union valid. members, but a similar trend holds for the Lloyd’s 51 Marsh. “U.S. Insurance Market Report 2012: market. Political Risk and Structured Credit.� February 2012. 52 Gallagher London. Credit and Political Risk – PRI Report and Market Update. July 2012. 53 Insurance Journal. “XL Political Risk, Trade Credit Unit Gets Approval for Lloyd’s Expansion.� June 11, 2012. 54 | MIGA WIPR REPORT 2012 MIGA WIPR REPORT 2012 | 55 AppendiCES Appendix 1 FDI Inflows, 2004–2011 $ billion 2004 2005 2006 2007 2008 2009 2010 2011 World 767 1,175 1,565 2,320 1,924 1,366 1,500 1,904 Developed countries 551 869 1,167 1,761 1,287 938 917 1,265 Developing countries 216 307 398 559 637 428 583 639 Latin America and 66.8 74.8 74.4 126.4 137.2 84.9 125.3 158.3 the Caribbean Argentina 4.12 5.27 5.54 6.47 9.73 4.02 7.06 7.08 Brazil 18.17 15.46 19.38 44.58 50.72 31.48 53.34 71.54 Chile 7.17 6.98 7.30 12.53 15.15 12.89 15.37 17.30 Colombia 3.02 10.25 6.66 9.49 10.18 7.14 6.90 13.23 Costa Rica 0.79 0.86 1.47 1.90 2.08 1.35 1.47 2.18 Dominican Republic 0.91 1.12 1.53 2.25 2.73 1.70 2.09 2.30 Mexico 24.83 24.41 20.12 31.49 27.14 16.12 20.71 19.55 Nicaragua 0.25 0.24 0.29 0.38 0.63 0.43 0.51 0.97 Panama 1.02 1.10 2.94 2.02 2.53 1.09 2.18 3.26 Peru 1.60 2.58 3.47 5.49 6.92 6.43 8.45 8.23 Uruguay 0.33 0.83 1.51 1.36 2.14 1.60 2.19 2.18 Venezuela, R.B. de 1.48 2.71 0.20 2.59 0.41 (3.05) 0.78 5.32 East Asia and the Pacific 77.6 129.1 153.0 196.4 211.2 154.5 290.0 274.9 China 62.11 104.11 124.08 156.25 171.53 131.06 243.70 220.14 Indonesia 1.90 8.34 4.91 6.93 9.32 4.88 13.77 18.16 Malaysia 4.62 3.92 7.69 9.07 7.57 0.11 9.17 10.78 Philippines 0.69 1.66 2.71 3.25 1.44 2.71 1.64 1.87 Thailand 5.86 8.06 9.45 11.33 8.54 4.85 9.68 9.52 Vietnam 1.61 1.95 2.40 6.70 9.58 7.60 8.00 7.43 South Asia 7.8 10.9 25.8 32.4 50.8 39.3 30.4 35.7 Bangladesh 0.45 0.81 0.70 0.65 1.01 0.73 0.92 0.80 India 5.77 7.27 20.03 25.23 43.41 35.58 26.50 32.19 Pakistan 1.12 2.20 4.27 5.59 5.44 2.34 2.02 1.31 Sri Lanka 0.23 0.27 0.48 0.60 0.75 0.40 0.48 0.96 Source: World Bank Note: Figures in parentheses represent negative numbers 56 | MIGA WIPR REPORT 2012 Appendix 1 FDI Inflows, 2004–2011 (cont’d) $ billion 2004 2005 2006 2007 2008 2009 2010 2011 Europe and Central Asia 42.6 55.8 101.3 148.4 169.0 90.4 88.0 118.7 Azerbaijan 3.56 4.48 4.49 4.36 3.99 2.90 3.35 4.49 Belarus 0.16 0.31 0.36 1.81 2.19 1.88 1.39 4.00 Bulgaria 2.66 4.10 7.87 13.88 10.30 3.90 1.94 1.98 Georgia 0.49 0.45 1.17 1.88 1.59 0.65 0.87 1.15 Kazakhstan 4.16 2.55 7.61 11.97 16.82 14.28 6.63 13.23 Romania 6.44 6.87 11.45 10.29 13.85 4.93 3.20 3.04 Russian Federation 15.44 12.89 29.70 55.07 75.00 36.50 43.29 52.88 Serbia 1.03 2.05 4.97 3.43 3.00 1.94 1.34 2.70 Turkey 2.79 10.03 20.19 22.05 19.50 8.41 9.04 15.87 Turkmenistan 0.35 0.42 0.73 0.86 1.28 4.55 3.63 3.19 Ukraine 1.72 7.81 5.60 10.19 10.70 4.77 6.45 7.21 Uzbekistan 0.18 0.19 0.17 0.71 0.71 0.84 1.63 1.40 Middle East and 9.7 16.9 27.3 28.1 29.6 26.3 22.3 15.4 North Africa Algeria 0.88 1.16 1.84 1.83 2.68 3.05 2.33 2.72 Egypt, Arab Rep. 1.25 5.38 10.04 11.58 9.49 6.71 6.39 (0.48) Iran, Islamic Rep. 2.86 3.14 1.65 2.01 1.91 3.05 3.65 4.15 Jordan 0.94 1.98 3.54 2.62 2.83 2.41 1.65 1.47 Lebanon 1.90 2.62 2.67 3.38 4.33 4.80 4.28 3.48 Morocco 0.79 1.67 2.46 2.83 2.47 1.97 1.24 2.52 Syrian Arab Republic 0.28 0.50 0.66 1.24 1.47 2.57 1.47 1.06 Tunisia 0.59 0.71 3.24 1.52 2.60 1.53 1.33 1.14 Sub-Saharan Africa 11.4 19.1 16.1 27.8 39.1 32.5 26.7 35.7 Angola 1.45 (1.30) (0.04) (0.89) 1.68 2.21 (3.23) (5.58) Botswana 0.75 0.49 0.75 0.65 0.90 0.82 0.26 0.59 Chad 0.47 (0.10) (0.28) (0.07) 0.23 1.11 1.94 1.85 Congo, Dem. Rep. 0.41 0.17 0.24 1.79 1.67 (0.28) 2.73 1.60 Congo, Rep. (0.01) 0.80 1.49 2.64 2.53 1.86 2.21 2.93 Ghana 0.14 0.14 0.64 1.38 2.71 2.37 2.53 3.22 Liberia 0.08 0.08 0.11 0.13 0.28 0.13 0.45 0.51 Madagascar 0.05 0.09 0.29 0.77 1.17 1.07 0.86 0.91 Mozambique 0.24 0.12 0.19 0.42 0.56 0.90 1.01 2.08 Niger 0.03 0.05 0.04 0.10 0.28 0.63 0.94 1.01 Nigeria 1.87 4.98 4.85 6.03 8.20 8.55 6.05 8.84 Seychelles 0.04 0.09 0.15 0.13 0.13 0.12 0.17 0.14 South Africa 0.70 6.52 (0.18) 5.74 9.64 5.35 1.22 5.72 Sudan 1.51 2.30 3.53 2.43 2.60 1.82 2.06 1.94 Tanzania 0.44 0.94 0.40 0.58 1.38 0.95 1.02 1.10 Uganda 0.30 0.38 0.64 0.79 0.73 0.84 0.54 0.80 Zambia 0.39 0.36 0.62 1.32 0.94 0.69 1.73 1.98 MIGA WIPR REPORT 2012 | 57 Appendix 2 MIGA-EIU Political Risk Survey 2012 The data provided herein are based on a survey conducted on behalf of MIGA by the Economist Intelligence Unit (EIU). The survey, which was carried out in July/August 2012, contains the responses of 438 senior exec- utives from multinational enterprises investing in developing countries. Quota sampling was used to ensure that the industry and geographic composition of the survey sample approximates the composition of actual FDI outflows to developing countries: following a first round of responses to the questionnaire, additional email campaigns targeting respondents in specific industries or geographic locations were conducted until all demographic quotas were met. For some questions, percentages add up to more than 100 percent because of multiple selections. Question 1. In which 1. In are you are which country country you personally personally located?located? Percent of respondents Question 1 United States United Kingdom Canada India Italy Germany Spain China Singapore Switzerland France Russian Federation Turkey Australia Belgium Finland Portugal Denmark Hong Kong, SAR China Netherlands 0 5 10 15 20 25 Others: Poland, Greece, Malaysia, Nigeria, Sweden, United Arab Emirates, Austria, Czech Republic, Ireland, Japan, South Africa, Angola, Brazil, Chile, Colombia, Croatia, Cyprus, Egypt, Hungary, Indonesia, Kenya, Oman, Pakistan, Peru, Romania, Saudi Arabia, Slovenia, Tanzania, Thailand, Azerbaijan, Bahrain, Belarus, Brunei Darussalam, Bulgaria, Ecuador, Estonia, Gibraltar, Guadeloupe, Islamic Republic of Iran, Isle of Man, Kazakhstan, Malawi, Malta, Mexico, Morocco, Mozambique, Norway, Paraguay, Sri Lanka, Ukraine, Vietnam 58 | MIGA WIPR REPORT 2012 Question 2. What industry? 2.primary What is your is your primary industry? Percent of respondents Financial sector Business activities Other services Mining, quarrying, and petroleum Utilities, transport, storage, and communications Food, beverages, and tobacco Electrical and electronic equipment Other manufacturing Electricity, gas, and water Machinery and equipment Chemicals and chemical products Construction Rubber and plastic products Metals and metal products Agriculture, hunting, forestry, and fishing Health and social services Motor vehicles and other transport equipment Trade Hotels and restaurants Education Wood and wood products Textiles, clothing, and leather Coke, petroleum products, and nuclear fuel Public administration and defense Community, social, and personal service activities Publishing, printing, and reproduction of recorded media Precision instruments Non-metallic mineral products 0 10 20 30 40 50 MIGA WIPR REPORT 2012 | 59 3. What are your organisation’s global annual revenues in US dollars? Question 3. What are your organization’s global annual revenues? Percent of respondents $500m or less $500m to $1bn $1bn to $5bn $5bn to $10bn $10bn or more 0 10 20 30 40 50 In In Question 4a. which which region region is your is your company company headquarters located? headquarters located? Percent of respondents Western Europe North America Asia-Pacific Middle East and Africa Eastern Europe Latin America 0 10 20 30 40 50 60 | MIGA WIPR REPORT 2012 In which region is your company headquarters located? Question 4b. In which country is your company headquarters located? Percent of respondents United States United Kingdom Canada Germany India Italy Switzerland France Spain Netherlands Singapore Belgium Sweden Denmark Finland Portugal China Hong Kong, SAR China Japan Malaysia 0 5 10 15 20 25 Others: Russian Federation, Australia, Greece, United Arab Emirates, Austria, Chile, Cyprus, Ireland, Poland, Turkey, Brazil, Croatia, Czech Republic, Indonesia, Islamic Republic of Iran, Nigeria, Norway, Oman, Pakistan, Romania, South Africa, Algeria, Azerbaijan, Bahrain, Belarus, British Virgin Islands, Brunei Darussalam, Cape Verde, Ecuador, Estonia, Isle of Man, Israel, Jamaica, Kenya, Luxembourg, Malta, Mauritius, Mexico, Monaco, Peru, Saudi Arabia, Seychelles, Slovenia, Sri Lanka, Tanzania, Thailand MIGA WIPR REPORT 2012 | 61 5. Which of the following best describes your job title Question 5. Which of the following best describes your job title? Percent of respondents Board member CEO/President/Managing director CFO/Treasurer/Comptroller CIO/Technology director Other C-level executive SVP/VP/Director Head of business unit Head of department Manager Other 0 10 20 30 40 50 6. What are your main functional roles? Choose up to three. Question 6. What are your main functional roles? Choose up to three. Percent of respondents General management Strategy and business development Finance Risk Operations and production Marketing and sales IT Information and research Customer service Legal R&D Supply-chain management Procurement Human resources Other 0 10 20 30 40 50 62 | MIGA WIPR REPORT 2012 7. In which developing countries is your firm presently investing? Question 7. In which developing countries is your firm presently investing? Percent of respondents China India Brazil Russian Federation Turkey Mexico South Africa Indonesia Vietnam Thailand Malaysia Argentina Philippines Chile Ukraine Saudi Arabia Romania Colombia Egypt, Arab Rep. Nigeria Peru Kazakhstan Pakistan Bulgaria Serbia Ghana Tanzania Morocco Kuwait Algeria Bahrain Tunisia Others* 0 10 20 30 40 50 * Others receiving five or more responses include: Iraq, Jordan, Angola, Bangladesh, Cambodia, Lebanon, Uruguay, Oman, Dominican Republic, Georgia, Guatemala, Panama, Lithuania, Belarus, Costa Rica, Jamaica, Albania, Honduras, Montenegro, Turkmenistan, Uganda, Bosnia and Herzegovina, El Salvador, Democratic Republic of Congo, Sudan, Uzbekistan, Armenia, Islamic Republic of Iran, Zambia, Yemen, Republic of Congo, Syrian Arab Republic, Madagascar MIGA WIPR REPORT 2012 | 63 Question 8. In your opinion, which of the following factors in the next 12 months and in the next three years will pose the greatest constraint on investments by your company in developing countries? Percent of respondents Q8 on constraints to FDI rankings 12 months Macroeconomic instability Access to financing Access to qualified staff Political risk Infrastructure capacity Limited market opportunities Corruption Increased government regulation in the aftermath of the global financial crisis Other 0 10 20 30 40 three years Political risk Macroeconomic instability Access to qualified staff Access to financing Corruption Infrastructure capacity Limited market opportunities Increased government regulation in the aftermath of the global financial crisis Other 0 10 20 30 40 64 | MIGA WIPR REPORT 2012 Question 9a. How do you expect your company’s planned investments in emerging markets 9a. How do you to change expect your company’sthis year planned compared investments with last in emerging year? markets to change this year compared with last year? Percent of respondents Increase substantially (increase 20% or more) Increase moderately (increase more than 1% but less than 20%) Stay unchanged Decrease moderately (decrease more than 1% but less than 20%) Decrease substantially (decrease 20% or more) Don’t know 0 10 20 30 40 50 Question 9b. How do you expect your company’s planned investments in 9b. How do you expect your company’s planned investments in emerging markets to change over emerging markets to change over the next three years compared with the the next three years compared with the previous three years? previous three years? Percent of respondents Increase substantially (increase 20% or more) Increase moderately (increase more than 1% but less than 20%) Stay unchanged Decrease moderately (decrease more than 1% but less than 20%) Decrease substantially (decrease 20% or more) Don’t know 0 10 20 30 40 50 MIGA WIPR REPORT 2012 | 65 Question 10. In your opinion, which types of political risk are of most concern 10a. In yourto yourwhich opinion, company when types of risk are ofin investing political emerging most concern tomarkets in the your company next when 12 months investing the next and in markets in emerging three in the years? next twelve months? Select up to three. Percent of respondents 12 months Adverse regulatory changes Breach of contract Transfer and convertibility restrictions Civil disturbance Non-honoring of government guarantees Expropriation/nationalization Terrorism War 0 20 40 60 80 100 three years Adverse regulatory changes Breach of contract Transfer and convertibility restrictions Civil disturbance Non-honoring of government guarantees Expropriation/nationalization Terrorism War 0 20 40 60 66 | MIGA WIPR REPORT 2012 11. In your opinion, in the developing countries where your firm invests presently, how do each of the risks listed below affect your company? Rate each risk on a scale of 1 to 5 where 1=Very high impact and 5=No impact Question 11. In your opinion, in the developing countries where your firm invests presently, how do each of the risks listed below affect your company? Percent of respondents Transfer and convertibility restrictions Breach of contract Non-honoring of government guarantees Expropriation/nationalization Adverse regulatory changes War Terrorism Civil disturbance 0 20 40 60 80 100 1 (Very high impact) 2 3 4 5 (No impact) MIGA WIPR REPORT 2012 | 67 losses due to any of the following risks? Select all that apply. Question 12. In the past three years has your company experienced financial losses due to any of the following risks? Percent of respondents Breach of contract Adverse regulatory changes Transfer and convertibility restrictions Civil disturbance Non-honoring of government guarantees Expropriation/nationalization War Terrorism 0 10 20 30 40 50 68 | MIGA WIPR REPORT 2012 13. To your knowledge, have any of the following risks caused your company to withdraw an existing investment or cancel planned investments over the past 12 months? Select one answer for each risk. Question 13. To your knowledge, have any of the following risks caused your company to withdraw an existing investment or cancel planned investments over the past 12 months? Percent of respondents Transfer and convertibility restrictions Breach of contract Non-honoring of government guarantees Expropriation/nationalization Adverse regulatory changes War Terrorism Civil disturbance 0 20 40 60 80 100 1 (Very high impact) 2 3 4 5 (No impact) MIGA WIPR REPORT 2012 | 69 Question 14. What tools/mechanisms does your company use to mitigate political risk when investing in developing countries? Select all that apply. Percent of respondents 14. What tools / mechanisms does your company use to mitigate political risk when investing in developing countries? Select all that apply. Use of joint venture or alliance with local company Political/economic risk analysis Invested gradually while developing familiarity with the local environment Use of third-party consultants Scenario planning Engagement with local communities Engagement with government in host country Develop close relationships with political leaders Political risk insurance Operational hedging (setting up multiple plants to spread risk) Engagement with non-governmental organizations Credit default swaps Provide support to a well-connected political figure Other We don’t use any tools or products to mitigate political risk Don’t know 0 20 40 60 70 | MIGA WIPR REPORT 2012 15. In your opinion, in the countries where your company invests, what are the most effective tools / mechanisms available to your firm for alleviating each of the following risks? Select one tool for each risk. Question 15. In your opinion, in the countries where your company invests, what are the most effective tools/mechanisms available to your firm for alleviating each of the following risks? Percent of respondents Transfer and convertibility restrictions Breach of contract Non-honoring of government guarantees Expropriation/nationalization Adverse regulatory changes War Terrorism Civil disturbance Other 0 20 40 60 80 100 Engage with local public entities Joint venture with local enterprises Risk analysis/monitor Relationships with key political leaders Political risk insurance Risk is not significant for my projects No existing tool can alleviate this risk MIGA WIPR REPORT 2012 | 71 16. How would the following events affect your business’s risk of expropriation/breach of contract? Question 16. How would the following events affect your business’s risk of expropriation/breach of contract? Percent of respondents Sovereign debt downgrade (staying above investment grade) Sovereign debt downgrade (below investment grade) Sovereign debt default Sovereign debt upgrade (staying above investment grade) Sovereign debt upgrade (below investment grade) 0 20 40 60 80 100 Major increase Minor increase No impact Minor decrease Major decrease Don't know 72 | MIGA WIPR REPORT 2012 transfer restrictions/inconvertibility? Question 17. How would the following events affect your business’s risk of transfer restrictions/inconvertibility? Percent of respondents Sovereign debt downgrade (staying above investment grade) Sovereign debt downgrade (below investment grade) Sovereign debt default Sovereign debt upgrade (staying above investment grade) Sovereign debt upgrade (below investment grade) 0 20 40 60 80 100 Major increase Minor increase No impact Minor decrease Major decrease Don't know MIGA WIPR REPORT 2012 | 73 18. How would the following events affect your business’s risk of non-honouring sovereign financial obligations? Question 18. How would the following events affect your business’s risk of non-honoring of sovereign financial obligations? Percent of respondents Sovereign debt downgrade (staying above investment grade) Sovereign debt downgrade (below investment grade) Sovereign debt default Sovereign debt upgrade (staying above investment grade) Sovereign debt upgrade (below investment grade) 0 20 40 60 80 100 Major increase Minor increase No impact Minor decrease Major decrease Don't know 74 | MIGA WIPR REPORT 2012 19. How 19. Question does How doesin an increase an increase sovereign risk in sovereign through risk(eg, other events through other events (such as default default episodes episodes in in euro-zone, euro debt zone, debt restructuring, restructuring, commodity price shocks, commodity etc,) affect your perception of the following political risks? When sover- price shocks, etc.) affect your perception of the following political risks? eign risk increases through other events (eg, default episodes in euro- When sovereign risk increases through other events (such as default zone, debt restructuring, commodity price shocks, etc,), how does it episodes in euro-zone, generally debt restructuring, affect your perception commodity of risk in each of the price shocks, etc.), following areas? how does it generally affect your perception of risk in each of the fol- lowing areas? Percent of respondents Expropriation Breach of contract Transfer and convertibility restrictions War and civil disturbance 0 20 40 60 80 100 Major increase Minor increase No impact Minor decrease Major decrease Don't know MIGA WIPR REPORT 2012 | 75 20. How have the developments in the Arab World over the past year affected your current and future plans for investments in the andHow Middle East20. Question North Africathe have (MENA) region? Select one developments in for the each World over the past Arab year affected your current and future plans for investments in the Middle East and North Africa region? Percent of respondents Current investments: Arab Spring countries Current investments: All other Middle East and North Africa Planned/future investments: Arab Spring countries Planned/future investments: All other Middle East and North Africa 0 20 40 60 80 100 Increase No change Withdrew Don't know 76 | MIGA WIPR REPORT 2012 Question 21a. How have the developments in the Arab World over the past year changed 21a your perception of the following types of political risk in the Arab Spring countries? Percent of respondents Expropriation Breach of contract Transfer and Inconvertibility restrictions Non-honoring of sovereign financial obligations Adverse regulatory changes War Civil disturbance Terrorism 0 10 20 30 40 50 60 70 80 90 100 Major increase in perceived risk Minor increase in perceived risk No impact Minor decrease in perceived risk Major decrease in perceived risk Don't know MIGA WIPR REPORT 2012 | 77 Question 21b. How have the 21b developments in the Arab World over the past in percentage year changed your perception of the following types of political risk in the Middle East and North African region? - All other Middle East and North African Countries Percent of respondents Expropriation Breach of contract Transfer and convertibility restrictions Non-honoring of sovereign financial obligations Adverse regulatory changes War Civil disturbance Terrorism 0 10 20 30 40 50 60 70 80 90 100 Major increase Minor increase No impact Minor decrease Major decrease Don't know 78 | MIGA WIPR REPORT 2012 Question 22. Which of the following would be your primary reason for 22 investing more or reinvesting in the Middle East and North Africa? Percent of respondents Increased market opportunities One year of political stability Improved macroeconomic stability Decrease in corruption More favorable gov't regulations Increased access to financing Improved infrastructure capacity Increased access to qualified staff Other 0 5 10 15 20 25 30 35 40 MIGA WIPR REPORT 2012 | 79 Appendix 3 Overview of the PRI Market The PRI market includes three broad categories of providers and covers both export or trade credit and investment insurance. For the purposes of this report, PRI refers to investment insurance. The public PRI market comprises both national and multilateral PRI providers. The private market’s PRI falls into two main categories: (i) political risk activities similar to those of public and multilateral insurers, such as coverage for investments in developing countries against expropriation, political violence, and other such risks; and (ii) developing-country non-payment insurance covering contract frustration and default by governments. Public PRI Providers: They comprise national export credit agencies and investment insurance entities. They focus on cross-border trade and investment, generally for constituents in their own countries. Multilaterals: These include the African Trade Insurance Agency, the Asian Development Bank, the Inter- American Development Bank, the Inter-Arab Investment Guarantee Corporation, the Islamic Corporation for the Insurance of Investments and Export Credit, and MIGA. The World Bank, the Asian Development Bank, and the Inter-American Development Bank also provide risk-mitigation instruments, such as partial risk guarantees.a Private PRI Providers: The majority of private insurers are based in three insurance centers—London, Bermuda, and the United States (primarily New York City)—and several of the larger insurers have offices in Singapore; Hong Kong SAR, China; and Australia (Sydney), among other places. As well as traditional PRI for equity investment, the private market offers protection for a wide variety of payment risks in developing countries, either for political perils alone, or comprehensive non-payment cover. Brokers play an important role in pro- moting and sourcing PRI for the private market. This market segment is dynamic: over the past year, some players have exited the PRI market, while new entrants have appeared. The Reinsurers: Reinsurance companies write PRI-related coverage for both trade and investment. Reinsurance is an underlying factor driving both pricing and capacity in the private market. Some of the top reinsurers include Munich Re and Hannover Re of Germany, Swiss Re of Switzerland, and Berkshire Hathaway/General Re of the United States. Export credit agencies and multilaterals also participate as reinsurers of PRI, although on a smaller scale. The Berne Union: The Berne Union was founded in 1934 in order to promote international acceptance of sound principles in export credit and investment insurance and to exchange information relating to these activities. Today, the Berne Union has 86 members, including Prague Club members, comprising mainly export credit agencies, multilateral organizations, and private insurers. The Berne Union plays an important role in bringing together the public and private insurers to enhance coop- eration and information sharing. Members meet on a regular basis to discuss industry trends and challenges. In recent years, there has been a concerted effort on the part of the Berne Union Secretariat to promote trans- parency and disclosure in the industry and to represent member interests in order to promote global trade and investment. Lloyd’s: An insurance “marketplace� where members join together to insure political risks for cross-border investment, such as confiscation of property, inconvertibility of currency, and political violence. Only a small number of Lloyd’s syndicates offer investment insurance. a A partial risk guarantee covers private lenders against the risk of government failure to honor contractual obligations relating to private projects. b The Berne Union’s Prague Club was started in 1993 with funding from the European Bank for Reconstruction and Development. It is an information exchange network for new and maturing insurers of export credit and investment. The Prague Club supports members’ efforts to develop their export credit and investment insurance facilities by hosting technical discussions at twice-yearly meetings, as well as ad hoc information exchanges. A number of Prague Club members have gone on to meet the requirement for full Berne Union membership. Sources: Berne Union; Lloyd’s 80 | MIGA WIPR REPORT 2012 Berne Union and Prague Club Members Berne Union Members Year Year Company Country Company Country joined joined ASEI Indonesia 1999 Private ASHRA Israel 1958 CESCE Spain 1972 ATRADIUS Netherlands 1953 COFACE France 1948 CGIC South Africa 1958 COSEC Portugal 1977 AIG United States 1999 ECGC India 1957 ECICS Singapore 1979 ECIC, SA South Africa 2004 EH GERMANY Germany 1953 EDC Canada 1947 FCIA United States 1963 EFIC Australia 1957 HISCOX Bermuda 2008 EGAP Czech Republic 1996 SOVEREIGN Bermuda 2001 EKF Denmark 1997 ZURICH United States 2001 EKN Sweden 1947 EXIMBANKA SR Slovak Republic 2004 EXIM J Jamaica 1983 FINNVERA Finland 1964 Multilateral GIEK Norway 1951 HKEC Hong Kong SAR, China 1969 ICIEC Multilateral 2007 KSURE Korea, Rep. of 1977 MIGA Multilateral 1992 KUKE Poland 1999 ATI Multilateral 2012 MEHIB Hungary 2000 MEXIM Malaysia 1985 NEXI Japan 1970 ODL Luxembourg 2011 OEKB Austria 1955 ONDD Belgium 1954 OPIC United States 1974 PWC Germany 1974 SACE Italy 1959 SBCE Brazil 2001 SERV Switzerland 1956 SID Slovenia 1998 SINOSURE China 1996 SLECIC Sri Lanka 1984 TEBC Taiwan, Rep. of China 1996 THAI EXIMBANK Thailand 2003 TURK EXIMBANK Turkey 1992 US EXIMBANK United States 1962 UK Export Finance United Kingdom 1934 MIGA WIPR REPORT 2012 | 81 Berne Union and Prague Club Members (cont’d) Prague Club Members Year Year Company Country Company Country joined joined Public Private AOFI Serbia 2007 LCI Lebanon 2009 BAEZ Bulgaria 1997 BECI Botswana 2005 Multilateral ECGA Oman 2000 ECGE Egypt, Arab Rep. 2003 ATI Multilateral 2002 ECIC SA South Africa 2002 DHAMAN Multilateral 2000 ECIE UAE 2009 ICIEC Multilateral 2001 ECIO Greece 2011 EGAP Czech Republic 1993 EGFI Iran, Islamic Rep. of 1999 EXIAR Russian Federation 2012 EXIM R Romania 1993 EXIMBANKA SR Slovak Republic 1993 EXIMGARANT Belarus 1999 HBOR Croatia 1997 IGA Bosnia & Herzegovina 1999 IE Singapore 2011 JLGC Jordan 2001 KECIC Kazakhstan 2004 KREDEX Estonia 1999 KUKE Poland 1993 LGA Latvia 2011 MBDP Macedonia, FYR 1999 MEHIB Hungary 1993 NAIFE Sudan 2007 NZECO New Zealand 2010 PHILEXIM Philippines 1997 SEP Saudi Arabia 2000 SID Slovenia 1993 TASDEER Qatar 2011 THAI EXIMBANK Thailand 1997 UKREXIMBANK Ukraine 2008 UZBEKINVEST Uzbekistan 1996 82 | MIGA WIPR REPORT 2012 Lloyd’s Syndicates Lloyd’s Syndicates Company ACE Global Markets Amlin Ark Ascot Aspen Beazley Canopius Catlin Chaucer Hardy Hiscox Jubilee Kiln Liberty Syn. Mgmt. Markel Marketform MAP Novae Starr PFR Consortium O'Farrell Pembroke Talbot XL MIGA WIPR REPORT 2012 | 83 Insuring investments r Ensuring opportunities 84 | MIGA WIPR REPORT 2012 Multilateral Investment Guarantee Agency World Bank Group 1818 H Street, NW Washington, DC 20433 USA t. 202.458.2538 f. 202.522.0316 www.miga.org/wipr