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Ignore the Political Economy at your own Peril

Rebecca Post's picture

Imagine a conversation. “So, your company is expanding its operations in country x, but I hear there is a lot of frustration among young people about unemployment. Are you worried about the possibility of political upheaval?” And the investor responds, “We’re not very worried about any instability. The current government has been in power for decades and we’re very well connected, so if there are any problems, we’ll be protected.” Without naming names, we can think about how this approach to risk management may have failed investors as of late, but such reversals of fortune predate the days of Twitter and Facebook – take the fall of the Suharto regime in Indonesia. At MIGA’s recent discussion titled “Best Laid Plans? How Ignoring Political Economy Affects Development Outcomes and Increases Risk", this attitude toward risk was aptly labeled “risk myopia.”

So, how are investors and advisors looking at risk more broadly? Two important indicators that risk- management specialists in the World Bank Group are now keeping an eye on are youth unemployment and the percentage of household income spent on food. Although it seems very obvious in hindsight, no matter how stable a country may be perceived on the world stage, a country’s underlying socioeconomic factors should be key elements in any country risk-rating model. But then again hindsight is 20/20 and not myopic.

Seeing risk is one thing, managing risk is another. Panelist Maureen Harrington of Standard Bank noted that the bank is Africa’s largest, operating in 17 countries representing a variety of political regimes and economic challenges. Banks can apply traditional risk-management protocols—country limits, calibrating tenors, deal structuring, etc. But Harrington said something that was particularly compelling: “We have to be relevant in the communities where we work.” She added later that the most difficult situations the bank has encountered have occurred in environments where the bank doesn’t have a presence and an acute awareness of the dynamic on the ground.

Sarah Alexander of the Emerging Markets Private Equity Association looked at the issue from the perspective of private equity investors. Although the business model is different, and a certain amount of risk is what drives the private equity business model, knowing the local angle and ensuring that there is local stake in the game is important. Coinvesting with local funds is a strategy that is often deployed. Of course conducting serious and thorough due diligence on the target company and its people is also important. Alexander also advised “avoiding the crown jewels”—presumably the industries that may be most attractive to the state.

When it comes to infrastructure projects, panelists agreed that government commitment to the deal is essential. This could be problematic in the event of regime change—especially in more autocratic regimes where the balancing power of legislatures and other governing forces is weak or non-existent. And some infrastructure projects create more challenges than others. Power distribution, given its direct relationship with consumers, is likely to be more of a political football than power generation. Certainly we see this pattern in our business as a political risk insurer— the political complexities associated with large infrastructure projects are often cited as the reasons investors and lenders turn to the multilaterals.

If there was a conclusion among the panelists, it was probably this: politics may now trump economics as investors look at risk. As someone who studied political science but spends a lot of time around economists, it’s hard not to feel just a little bit smug.

Comments

Submitted by Myopia on
Another well written article on risk management emphasizing on Political Developments and Economy. Yeah, indeed it be myopic to neglect Political environment while taking any critical business stand, especially opening a new and expanding horizons. One's nearsighted vision can cost an organization fortunes. However, there must be factors other than youth unemployment and the percentage of household income spent on food. like crime rates, consumption rates and importance of location from business perspective etc...Any thoughts on that? Overall very insightful article. Hope to see some more interesting pieces in future.

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