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Foreign direct investment (FDI) flows are forecast to increase to US$1.5trn in 2011, but will not return to the pre-crisis highs of US$2.3trn recorded in 2008, according to an annual report published by the World Bank’s Multilateral Investment Guarantee Agency (Miga).

In its annual review of FDI flows launched at a conference in London this week, Miga revealed that FDI flows hit US$1.3trn in 2010, with flows into developing countries increasing by 30% in 2010 to US$507bn. However, a much smaller increase is expected in 2011, and the report suggested that the rebound following the 2008 crisis was losing momentum as the Eurozone crisis worsens.

The political turmoil in the Middle East and North Africa (Mena) has also played a role in denting investor confidence in the short-term.

The report goes on to suggest that investors are more optimistic about developing markets, including the Mena region, over the medium term.

According to Miga’s survey of multinational executives, carried out in conjunction with the Economist Intelligence Unit, nearly 75% of respondents have plans to expand in developing countries over the next three years, as these countries grow faster than their European counterparts.

“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.”

Developing countries now attract two-fifths of global FDI and originate close to one-fifth of overseas investment.

Identifying risks

Investor concerns differed in the short-term and the long-term. Over the next 12 months, survey respondents reported that some of the biggest constraints for FDI are access to finance and macro-economic instability, reflecting the fact that the commercial banking sector, particularly in the Eurozone, are reducing their lending capacity as a reaction to internal debt problems and impeding regulatory issues.

In the medium to long-term, the survey found that concerns surrounding access to finance diminished whilst political risk issues became more important.
To mitigate these increasing risks, the survey found that the use of political risk insurance (PRI) is growing.

Ravi Vish, director and chief economist, economics and policy group, at Miga, told conference delegates that there had been “significant growth” in the use of PRI.
The report found that the rate of growth of PRI has exceeded that of FDI, meaning that a higher proportion of FDI is now insured for political risk. In 2010, 14% of all FDI flows were covered by PRI, this is the highest level seen since the early 1990s.

Catherine Aubert, managing director and head of trade credit and political risk insurance at Société Générale, reflected that there is strong demand for comprehensive political risk insurance, commenting that banks would “rather pay higher premium rates than have loopholes in the cover”.

However, there are some companies that do not prioritise the use of PRI.

Vicky Bowman, global practice leader, external affairs, at international mining company Rio Tinto, said that PRI was not the company’s first port of call, explaining that Rio Tinto aims to reduce the political risks related to its mining projects through various methods including working closely with the local communities, presenting the company as the “developer of choice” that can help set up local supply chains and generate local jobs.

Almost 60% of survey respondents told Miga they opted to use a joint venture or an alliance with a local company to mitigate political risk in a developing country. Only one in five firms surveyed used investment insurance to protect themselves from political risk.

Resource nationalism and the risk of expropriation were highlighted by the report as key risks for global investors and insurers.

A number of developing and high income countries such as Brazil, Guinea, Indonesia, and Australia have revised or are in the process of revising their mining legislation, raising mining taxes or carrying out contract renegotiations to carve out a larger share of revenues. The difficulties of underwriting indirect or creeping expropriation as opposed to outright nationalisation of assets were highlighted by the conference panellists.

Investors continue to remain cautious about the emerging new democracies in North Africa, the report suggests, with FDI flows into Egypt and Tunisia declining in the first quarter of 2011. The ongoing turmoil in Europe is set to cause FDI flows into North Africa to slump further before rebounding slowly.

New products

The changing risk environment has led to the need for different types of insurance products.

Demand for means of mitigating against business disruption was highlighted by panellist Mark Gubbins, executive director, political, project and credit risks at Arthur J Gallagher.

“In the same way that lenders have focused on the effects of political risks events on a borrower’s ability to repay loans we are also seeing an increased trend by companies to seek to insure against the disruption of their business by political risks events as much, if not more, than the loss of assets,” he tells GTR after the conference.

He refers to the political violence seen after the elections in the Cote d’Ivoire in early 2011 where mining companies did not see any loss or permanent abandonment of their assets.

“[This] prompted the commercial insurance market to launch new products such as mining disruption insurance,” he explains.
Gubbins reflects that there are further gaps in the market for insurance coverage.

He suggests that although insurers are working to develop “as comprehensive a political risks insurance product as possible”, the market is still very wary of covering infrastructure project developments that rely on a government offtaker, such is often the case in the power industry.

“This is particularly apparent in the strong demand from developers of renewable power projects for protection against changes to Feed-in-Tariffs,” he observes. Feed-in-Tariffs are a form of subsidy for renewable energy projects.

Gubbins remarks that the lack of insurance appetite in this sector is a “true market gap that the like of Miga needs to fill”.