Whether it occurs in a small developing economy, a petrostate or a G20 nation, corruption is a costly problem, writes Rafael Docavo-Malvezzi, AXA XL’s Global Head of Risk, Political Risk Credit and Bond Insurance.

 

Allowed to continue unabated, corruption develops deep roots and threatens a nation’s future growth.

Corruption resides at the intersection of power and money, and it is inversely related to the strength of a country’s institutions. For example, corruption is generally low, or at least contained, in nations with strong functioning governments, where the rule of law is applied consistently and respected. In places where governments are weak or ineffective, and where the judiciary branch has little independence, corruption soars.

The Corruption Perceptions Index by Transparency International is an annual ranking of countries, scoring them on a scale from 0 to 100. The closer to 100, the cleaner the country – that is, the less corrupt it is thought to be. In the Americas, the highest rated country is Canada, with a 2018 CPI score of 81. The country considered least corrupt in the entire world is Denmark, with a score of 88. Compare that with Venezuela, at 18; North Korea, with a score of 14; and the very bottom of the CPI list, Somalia, at 10. The United States scores 71, among the 25 nations with the least corruption.

 

Cautionary tales

Venezuela offers a stark lesson in how a combination of bad ideas and profound corruption can dismantle a country. Decades of authoritarian rule, which advanced policies of nationalising key industries and expropriating private assets, initiated a downward spiral into an economic and humanitarian crisis. Venezuela’s downfall was compounded by a vast patronage system that siphoned government funds and made corruption in the country systemic.

In 1997, the year before Hugo Chavez was elected president, Transparency International ranked Venezuela 44th in the world for corruption. By 1999, it had fallen to 75th. In 2014, one year into the regime of current President Nicolas Maduro, Venezuela plummeted to 161st, and was deemed the most corrupt nation in the Americas.

How did things go so wrong? A major part of Venezuela’s problems stem from what would otherwise seem like a building block for growth: it has the world’s largest oil reserves. The country’s dependence on oil makes it highly vulnerable to volatility in crude oil prices. Unfortunately, oil wealth also tempted Venezuela’s rulers to consolidate their power to capture oil profits and support patronage. When crude oil prices dropped after peaking in June 2008, Venezuela’s fortunes followed, leading to unrest and hyperinflation, which eroded wages. Maduro responded with strong-arm tactics: political repression, strict currency controls, and a 96% currency devaluation in 2018 – all of which made the country’s problems even worse. A tenth of the nation’s population has fled, and those who remain face persistent shortages of the most basic commodities.

Despite the severity of Venezuela’s current situation and Maduro’s ability to withstand international pressure to step down after an election in May 2018 that was widely criticised as rigged, change seems inevitable. With time, new leadership and better fiscal policies, the country can recover. Opportunities for foreign investment will emerge, and Venezuela can rise again.

Another object lesson in the costs of corruption is South Africa. Once one of the leading emerging market economies as a member of the so-called BRICS, South Africa was widely seen as a frontier for development, with great market potential. Times have changed. Patronage under several administrations led to mismanagement of the public utility, Eskom, which provides 95% of the country’s electricity.

As a vertical monopoly that controls power generation, transmission and distribution, Eskom has suffered from a lack of transparency that facilitated the diversion of its funds. Burdened with debt, Eskom now is unable to supply enough power to keep South Africa’s lights on. The South African power supplier has had to take one-third of its plants offline due to maintenance issues, forcing periodic blackouts. Observers estimate that continuing power outages will cut into South Africa’s GDP. The International Monetary Fund projects South Africa’s GDP growth rate in 2019 at 1.2%.

In the Corruption Perception Index, South Africa has steadily appeared more corrupt. It ranked 34th in the world in 2000, nearly on par with developed nations in western Europe. By 2009, South Africa’s corruption ranking fell to 55th. In 2018, it was 73rd of 180 countries in the ranking.

There remains great opportunity for infrastructure development, mining and other sectors in South Africa. Sadly, opportunities have been lost because of unreliable institutions and undue influence over private-sector businesses. Like Venezuela and other nations that suffer from corruption, South Africa has a choice to make. It can continue on the path that has led to stagnation, or it can choose to implement reforms that make the country more attractive to foreign investment.

Nations that have high levels of corruption are often in dire straits, with few prospects of sustainable growth and difficulty in attracting investment. Corruption not only deprives citizens and businesses of economic opportunities but also translates into heightened risk profiles for political and credit risks. Even in otherwise strong countries, corruption hurts productivity and economic health.

Experience teaches us that there is always a risk of systemic problems, even in countries that appear robust.

For example, Brazil previously had acceptable marks for institutional strength and corruption, but a major corruption scandal erupted in 2014, implicating hundreds of political figures and executives at global companies as well as top management of the national oil company. The ensuing investigation, called Lava Jato, or ‘Operation Car Wash’, is still going, having, along the way, forced the removal of the Brazilian President as well as the resignation of Peru’s president. Brazilian conglomerate Odebrecht S.A., which was one of the largest companies involved in the Lava Jato scandal for paying bribes to win public works contracts, recently filed for bankruptcy protection. Its former CEO, a grandson of the company’s founder, was sentenced to 19 years in prison for corruption and barred from any role with the company.

Even Denmark, the lowest perceived level of corruption, is still grappling with a €200bn money-laundering scandal uncovered in 2017 at its largest bank’s Estonian branch. Disclosing results of a lengthy investigation, Danske Bank said it found evidence that some employees in the branch had assisted and colluded with customers in the money laundering. Money and power can make for dangerous crossroads, no matter where they occur. As Brazil, Venezuela, South Africa and other cases demonstrate, the unintended consequences of corruption can affect lives in many countries.

 

Not all bad news

Despite cases of rampant corruption and financial crisis in countries – Venezuela is a textbook example – the outlook is not bad everywhere. Good outcomes are possible for development projects in risky countries. Keys are to understand and analyse the risks, using a long-term perspective, and take advantage of insurance solutions to mitigate financial losses.

Conducting exhaustive due diligence is critical, not only for underwriting organisations like ours, but also for project lenders, investors and developers alike. It is important to understand the interplay of local, regional and national political and economic dynamics before committing capital. A big part of that involves partnering with the appropriate customers – our insureds. For example, institutions such as the World Bank and other multilateral development agencies play a pivotal role in enabling the financing of critical infrastructure projects in developing markets; they conduct exhaustive due diligence, diligently monitor project execution to avoid delays and can influence a recipient government’s continued commitment to the project.

Here is a small sampling of riskier geographies where AXA XL has successfully provided financial protection to our key customers for strategically important projects:

  • Development of basic transport infrastructure in Angola
  • Road infrastructure development in Azerbaijan
  • Energy infrastructure in Kenya
  • Power generation projects in Indonesia
  • Liquified natural gas export infrastructure in Nigeria
  • Power generation project in the Philippines

 

AXA XL is one of the global leading providers of political risk, credit and bond insurance. Political risk, credit and bond insurance can play a critical role in mitigating financial risks in a changing world. Our ongoing monitoring and analysis of geopolitical, country and credit risks, allows us to selectively underwrite risks with tenors of up to 20 years. Complex risks abound, but our global underwriting footprint and commitment to risk analytics enable our key customers to navigate difficult venues with confidence and bring projects to life that make long-term growth possible.