Political Risks in Emerging Markets
Emerging market countries offer tantalizing rewards. High growth rates, untapped resources, and burgeoning middle classes can make for attractive investments. But amidst this allure lies an unpredictable nemesis: political risk. From the abrupt twists of military coups in West Africa to nationalization policies in Latin America, and from regulatory upheavals in Asia to geopolitical tensions in Eastern Europe, we have in the last decade (and before) seen political shifts turn golden opportunities into perilous ventures overnight. Understanding and anticipating political risks in emerging market countries is more than just a strategy—it’s a survival skill.
Political risks can make or break investments in emerging markets. These risks necessitate robust strategies to safeguard business interests. This post will analyze the costs of political instability, provide real examples across emerging market countries, regions and sectors, and outline actionable measures investors can take to navigate the tricky terrain of emerging market investments.
Political risk encompasses non-economic events influenced by political dynamics, which can drastically alter the business landscape of a country. These shifts are often abrupt and unforeseen, impacting foreign investments significantly.
For example recent upheavals in Mali saw transitional authorities reevaluating mining contracts made by prior governments. In Niger, the new administration has rattled foreign companies involved with the country’s uranium mining. Such shifts can change the economic calculus for foreign investors overnight, necessitating robust mitigation strategies.
The Real Toll of Political Upheaval
1. Direct and Indirect Financial Impacts
There’s the tangible loss from geopolitical events. Things like damage to assets, production halts, and potential legal repercussions. But there are subtler, long-lasting impacts too. Things like diminished reputation due to adverse media coverage, reduced investor confidence, and broader economic ramifications. The recent predicament of the French nuclear company, Orano, in Niger exemplifies the intertwining of political decisions, global sanctions, and business operations.
2. Humanitarian Concerns
Beyond economic implications, the manifestation of political risk can endanger personnel, sometimes resulting in tragic losses. Such events have profound impacts, from emotional trauma to monetary costs related to repatriation and more.
Focused Risk Management Strategies
In navigating the intricate political terrains of emerging market countries, investors should adopt a multi-pronged approach, that includes some or all of the following:
1. Engage with Local Expertise
Collaborating with local partners can offer a dual advantage – gaining insights into the local socio-economic situation and creating a favorable image that the business is inclusive and not merely extractive.
2. Champion Corporate Social Responsibility (CSR)
Effective CSR policies can bridge the gap between foreign businesses and local communities, positioning the company as an entity that gives back.
3. Continual Political Risk Assessment
Regular and thorough evaluations can provide a more accurate lay of the land, enabling businesses to adapt to changing dynamics.
4. Customized Risk Management
Since every African nation has its own distinct political nuances, tailor-made strategies should be devised.
5. Harness Bilateral Investment Treaties
When aligned, these treaties can offer an additional layer of security and confidence.
6. Consider Political Risk Insurance
Political risk insurance can act as a financial cushion, protecting businesses against sudden political upheavals.
Past Cases Provide Future Lessons
The below cases studies are instructive regarding the need to monitor and prepare for local situations and to be prepared to quickly pivot when they occur.
1. Venezuela’s Oil Industry Crisis
- Case Study: Venezuela has experienced significant political crisis that severely impact its oil industry. The government’s actions, including nationalization and mismanagement, have led to a decline in oil production and to foreign companies exiting from the country, many without recovering their investments.
- Lessons Learned: This case illustrates the importance of assessing political risks in resource-rich but politically unstable countries.
2. South African Mining Sector
- Case Study: South Africa, a resource-rich nation, has faced labor strikes, regulatory changes, and political instability affecting its mining sector. The government’s push for increased black ownership and stricter regulations has impacted foreign mining companies.
- Lessons Learned: This case highlights the need for adaptability in the face of changing regulations and the importance of engaging with local communities and governments.
3. Russian Oil and Gas
- Case Study: Russia’s energy sector has been susceptible to political risks, including sanctions and geopolitical tensions. Companies like ExxonMobil and BP had to reassess their investments due to evolving political dynamics.
- Lessons Learned: This case underscores the necessity of a flexible risk management strategy that considers geopolitical developments and global politics.
4. China’s Africa Investments
- Case Study: China’s substantial investments in African countries have sparked debates about political influence and debt sustainability. Projects like the Djibouti-Ethiopia railway have faced criticism over their potential long-term political implications.
- Lessons Learned: This case emphasizes the importance of understanding the geopolitical dimensions of foreign investments and conducting comprehensive due diligence.
5. Middle East and North Africa (MENA) Region
- Case Study: The MENA region has experienced various political upheavals, including the Arab Spring. These events disrupted businesses, particularly in sectors like tourism and hospitality, impacting companies like Marriott and Accor.
- Lessons Learned: This case highlights the need for contingency planning and risk diversification, especially in regions prone to political volatility.
6. Nigeria’s Oil Industry
- Case Study: Nigeria’s oil sector has faced ongoing challenges related to political instability, corruption, and militant attacks. Companies like Shell have had to navigate complex political landscapes.
- Lessons Learned: This case demonstrates the significance of engaging with local communities, addressing social issues, and having crisis management plans and high-level security in place.
7. China’s Supply Chain Vulnerabilities — COVID
- Case Study: The COVID-19 pandemic exposed vulnerabilities in global supply chains, particularly in industries reliant on Chinese manufacturing. Lockdowns and disruptions in China led to shortages of critical goods worldwide, affecting industries like healthcare, electronics, and automotive.
- Lessons Learned: This case emphasized the risks of overreliance on a single country, highlighting the need for diversification and robust contingency plans in supply chain management.
8. China’s Supply Chain Vulnerabilities — Geopolitical Tensions
- Second Case Study: As geopolitical tensions between China and various countries, including the United States, have increased, businesses have had to deal with export restrictions, increased tariffs and random arrests, all of which have disrupted and compllicated supply chains and impacted companies relying on Chinese manufacturing and exports.
- Lessons Learned: This case underscores the importance of ongoing risk assessment and adaptability in supply chain management. Businesses need to be ever mindful of geopolitical factors when making sourcing decisions and have contingency plans in place for sudden disruptions.
These case studies underscore the profound impacts of political risks on businesses in emerging markets.
Conclusion
The political shifts described above emphasize the need for vigilance and preparedness in emerging market investing. Unforeseen events can disrupt business plans, but by understanding past challenges and employing risk mitigation strategies, investors can improve their chances for success in emerging markets. With in-depth risk assessments, strategic partnerships, and contingencies, companies can build resilience. While risks are inherent, informed investing can lead to significant returns.
The ripple effects of major political events extend far beyond their immediate occurrence. Drawing from historical lessons helps investors craft bespoke mitigation strategies. The key message: preparedness and vigilance are paramount in the ever-evolving landscape of emerging market investments.
In this dynamic arena, the well-informed and ready will prosper.
