Why BRIC MNCs are More Averse to 'Political Risk'

♠ Posted by Emmanuel in at 5/07/2010 02:07:00 PM
Here's an interesting summary from a new report, World Investment and Political Risk 2009, by the Vale Columbia Center on Sustainable International Investment. One of the oft-remarked reasons why Brazil, Russia, India, and China (the BRICs) are a force to be reckoned with in the world economy is their increasing share of foreign investment abroad. However, an interesting finding this new research makes is that multinationals from emerging markets are, if anything else, more sensitive to political risk--threats of expropriation, terrorism, declines in the law & order situation, etc.--than their peers from industrialized countries.

What's surprising to me is that they would be this way considering that they have to live with more political risk at home. Brazil has tensions resulting from world-leading inequality while Russia, India and China all have their respective troubles involving restive minorities and regions. Probably, a reason is that Western MNCs have greater accumulated experience dealing with business environments in foreign lands--where it's acceptable to stay and where not--while the BRIC ones are still getting their feet wet. Hence the stated differences in sensitivity to political risk. In any event, the report's authors here cite higher investment in natural resource sectors and a willingness to go where Western MNCs dare not go (or are restricted by their home governments--think Sudan or Zimbabwe) among the reasons for this increased fear factor:
Hitherto, political risk has worried developed country multinational enterprises (MNEs) investing in developing country markets. But as more emerging market firms invest overseas, they too must grapple with this subject. World Investment and Political Risk 20091 looks at this issue for the first time and finds that Brazilian, Russian, Indian, and Chinese (BRIC) firms appear to worry more about political risk than global counterparts. Though these results are based on a small sample of 90 of the largest BRIC investors,they are thought-provoking nonetheless.

Already, emerging market FDI outflows have tripled from US$100 billion in 2000 to US$350 billion in 2008 says UNCTAD, driven largely by burgeoning investments from Brazil, Russia, India, and China. Although the bulk of this FDI has gone into developed economies, BRIC firms have also stepped up the size and spread of their investments in other emerging markets.

As mentioned earlier, survey data suggests that BRIC firms see political risk as more of a concern than global counterparts when investing in emerging economies. This is not surprising, since BRIC firms invest heavily even in those developing economies they consider among “the world’s five most politically risky,” in contrast to global counterparts who stay clear of the markets they consider most unstable. Brazil, for instance, lists Venezuela as one of its five key emerging markets, even while ranking it as one of the world’s five most high-risk markets. China does the same with Indonesia; India with Russia and Africa; and Russia with Kazakhstan and the Commonwealth of Independent States. Also important is that the BRIC sample also had a higher percentage of natural resource firms, which are more vulnerable to political risk.

BRIC firms, like their global counterparts, worry most about breach of contract and transfer and convertibility restrictions. But Russian and Brazilian firms worry most about breach of contract; Chinese firms about war and civil disturbance; and Indian firms about transfer and convertibility restrictions. Also, while just 9% of Indian firms worry about expropriation, an average of 26% of Brazilian, Russian and Chinese firms do.

BRIC firms, like global counterparts, are confident about their ability to assess political risk and implement existing mitigation strategies. However, they are far less so about anticipating new political risks, evaluating new mitigation strategies and assigning roles for political risk management. They also rely on the same non-formal political risk mitigation strategies as global counterparts, according them different priorities. While global firms rely heavily on engagement with host governments and risk analysis, the Russian firms surveyed rely most on host country engagement, the Chinese on risk analysis and the Indians and Brazilians on local tie-ups. Half the Brazilian sample also relies on scenario planning...
The report also mentions limited takeup of political risk insurance--newfangled financial products designed to guard against such events:
Equally significant, some said that current PRI thinking does not take adequate cognizance of the types of “political” risk challenges they confront. Key among these is the fear of sudden policy and regulatory shift in developed markets which are core to their global competitive strategy, and where they have billions of dollars invested. India’s IT globalizers, for instance, have been hurt by sudden restrictions in US visa and outsourcing-related rules. Earlier, developed markets were completely “safe,” but they are now subject to worrying protectionist pressures. A sudden reversal in established business rules can abruptly disrupt a global business model, causing as much if not more of a loss as expropriation or terrorism in a less strategic emerging market...

Home country governments could respond in two ways. First, they could establish or expand political risk protection for their globalizing firms. While global private sector insurers and international donors offer such protection, many BRIC globalizers find their government agencies more responsive to their needs. They also need to more pro-actively market their PRI offerings, as do private PRI players.

Second is to build local private insurers’ ability to provide PRI cover by permitting them to enter into reinsurance agreements with overseas insurers. As yet, few emerging market insurers have independently offered such protection, given that PRI is a specialized product, their insurance capacity is limited and, in some countries, insurance rules are still restrictive.
There are new players on the world scene, and they aren't the conquistadors of yore.