Investments in least developed countries: a risky bet?

Ravi Vish, Director and Chief Economist at the World Bank's MIGA (Photo Credit: Suzanne Pelland, World Bank)

MediaGlobal’s Maroussia Klep interviews Ravi Vish, Director and Chief Economist at the Multilateral Investment Guarantee Agency (MIGA) of the World Bank Group

MG: With the exception of a plunge in 2009 because of the financial crisis, foreign direct investments in the least developed world have increased steadily in the last decade (from $7.1 billion in 2001 to $24 billion in 2010). However, many investors are still reluctant on placing their money in these countries traditionally considered as “highly risky.” Are these apprehensions justified?

RV: In surveys conducted by MIGA, a member of the World Bank Group and a provider of investment guarantees to foreign investors, over the past couple of years, we have noticed that investors in LDCs are more worried about political risks than investors in other emerging markets. More importantly, these risks go beyond political violence – expected to be present in conflict-affected countries – and entail structural and institutional weaknesses or adverse changes in the regulatory framework. Besides, being low-income economies, LDCs tend to have small market sizes, infrastructure bottlenecks or a workforce that does not always provide the level of skill/productivity needed by today’s corporations.

MG: Although there may still be risks linked to the political or economic situation of LDCs, these countries present also significant investment opportunities thanks to abundant natural resources (oil and minerals), cheap labor and a booming middle-class. Returns on investments are expected to be higher there than in most other countries in the world. How can investors mitigate the risks you mentioned for taking full advantage of these opportunities?

RV: LDCs are the new ‘frontier’ markets whose potential has not yet been tapped fully by foreign investors and where returns can be high for those willing to take on the risks.

The economic environment may take longer to improve, but political risks can be mitigated through a variety of tools, one of which is political risk insurance. MIGA is particularly suitable to address the needs of corporations seeking to invest in LDCs, because a focus on investors seeking to establish projects in low-income economies is one key pillar of our strategy.

Even in developed countries, investors are not always aware of available instruments to mitigate such risks, for example political risk insurance, and rely instead on informal measures, such as building relationships with the host country, which may not always be effective in preventing losses. One measure to alleviate investor concerns about political risk would be to encourage the provision of political risk insurance for LDCs through national export credit agencies. Because many LDCs are perceived to be risky destinations, the cost of political risk insurance can be prohibitively high for some types of investors. Where the development impact of a project is significant, there may be a case for lowering that cost.

MG: Attracting foreign direct investments is crucial for LDC’s economic development. Governments in these countries are increasingly aware of that and take measures to create safer and attractive investing environments. How can these efforts reassure foreign investors?

RV: For LDCs, foreign direct investment is the biggest external private capital flow, which can bring into the host country technological know-how, spillovers, training, and improvements in infrastructure, as well as new capital and employment.

While regulatory frameworks have been strengthened and become more open over time, ensuring that investors feel protected from adverse political actions is crucial.  Making sure that the country has strong foreign investment protection legislation and an appropriate dispute resolution mechanism is therefore important. This is particularly relevant for projects in which the investor has to work together with a government entity, for example, in the case of Public-Private Partnerships (PPPs) in infrastructure. Equally significant are measures to promote good governance and strengthen institutions, the benefits of which apply across all sectors.

MG: Based on these encouraging observations, could you give an example of a foreign direct investment in a LDC that proved very successful both for the host country and the investor?

RV: MIGA supported the Mozal project, an aluminum smelter production facility in Mozambique. This project benefited Mozambique by helping to catalyze additional investment, particularly important given that the country had emerged from a civil war. It also contributed about 3 percent to its GDP and it is one of the country’s biggest exporters. The project made contributions to employment creation, public revenue and foreign exchange generation, infrastructure development and environmental, social and health initiatives through a special trust fund set up to serve local communities.

The project was also a South-South investment in that the investor was the Industrial Development Corporation of South Africa. South Africa also benefited, as the project offered employment to an estimated 800 workers, as well as training for assembly line operations and maintenance in aluminum production at the Hillside smelter in Richards Bay, South Africa. MIGA also supported Mozambique through a guarantee to Eskom, South Africa’s electricity company, which provides not only critical energy supply to Mozal, but also low-cost and reliable power to South Africa.