Global investors still optimistic on emerging market prospects

Heightened global risk perceptions in the aftermath of the financial crisis, fuelled by sovereign credit risk in the developed world and political crises in the Middle East and North Africa, have increased investors’ concerns, according to a new report by the World Bank’s Multilateral Investment Guarantee Agency. However, the report, World Investment and Political Risk, notes that investors are more optimistic over the medium term.

A survey of global investors conducted for the report finds they are “cautiously optimistic” about their investment plans in the next 12 months. They are more confident over the next three years: nearly 75 per cent of corporate respondents have plans to expand in developing countries over this period.

MIGA’s survey shows that events in the Middle East and North Africa have had a negative effect on foreign direct investment (FDI), but a significant majority of global investors said they have not changed their investment plans. However, while investors appear willing to ride out this period of turmoil and uncertainty, they are also ready to downsize plans should political instability intensify and become prolonged.

Overall, the report notes that the recorded growth of private capital flows to developing countries, including FDI, is moderating, but is expected to regain speed in the medium term— corroborating the sentiment found in the investor survey.

“This uncertain economic landscape aside, developing countries are expected to grow more than twice as fast as high-income economies over the next few years,” notes MIGA’s Executive Vice President Izumi Kobayashi. “This continued growth, together with stronger and more business-friendly environments, should enhance their appeal to savvy investors worldwide.”

The report notes developing countries now attract two-fifths of global FDI and originate close to one-fifth of overseas investment. Nonetheless, political risk remains a significant constraint to investment in these countries, becoming more prominent over the next three years as current concerns about the global economy subside.

The survey found that heightened global risk perceptions have prompted investors to employ a wide variety of risk-mitigation tools, including political risk insurance (PRI). PRI issuance has grown, not only in absolute terms, but also relative to FDI. Over the past five years, the rate of growth of PRI has exceeded that of FDI, meaning that a higher percentage of FDI is now insured for political risk. In 2011, this trend appears to be continuing.

Concerns about expropriation remain elevated and the report provides an in-depth analysis of this risk. It found that the probability of disputes between governments and foreign investors is materially increased by an economic shock and/or significant political shift. Evidence also shows that investor disputes are more likely to be resolved — avoiding outright expropriation — by democratically elected governments rather than non-democratic regimes.

“In today’s turbulent world, we hope that this report sheds light on different dimensions of political risk and the role of investment insurance in fostering an environment conducive to attracting FDI and promoting development,” says Kobayashi.