A World of Risk

In emerging markets, the clash between politics and profits poses multiple threats.

Even as specialty chemical products manufacturer H.B. Fuller grew sales in Europe, India, the Middle East, and Africa to 30% of its total revenue last year, it also had to deal with growth of a different kind — the groundswell of political opposition to Egyptian leader Hosni Mubarak.

That turmoil forced the $1.4 billion company to shut down a Cairo adhesive-manufacturing facility for two weeks, driving up its expenses as it sourced products for its Mideast customers from plants elsewhere. The operational disruptions were minor, but the increased costs to ship product into Egypt hurt profit margins (although Q1 growth in that region topped 13%).

While the Middle East uprisings have yet to produce infamous investment-destroying incidents like the seizure of an elevated private expressway in Bangkok (1993) or the cancellation of a privately funded power plant in India (1994), they have placed political risk on management’s watch list again.

Indeed, this year the severity of political risk rose in 19 countries, according to the 2011 Aon Risk Solutions political-risk map. In a 2010 report by the Multilateral Investment Guarantee Agency (MIGA), a part of the World Bank, executives cited political risk, macroeconomic instability, and weak government institutions as the biggest challenges facing foreign direct investment (FDI) in the next three years. Breaches of contract, sudden regulatory changes, and transfer and convertibility restrictions were the three most worrisome political risks.

Despite dangers, companies aren’t turning isolationist. After falling during the financial crisis, FDI in developing countries is growing again. MIGA forecasts 20% FDI growth in 2011 and 13% in 2012, by which time inflows will reach $575 billion. Much of the capital will target the growing middle-class economies in Russia, India, and China, as well as natural-resource investments in sub-Saharan Africa, North Africa, and the Middle East.

The problem is that some of the most politically risky countries offer the most enticing prospects. Russia is an example. In Transparency International’s 2010 corruption-perceptions index, Russia ranked as one of the worst 20 countries for government commitment to accountability, transparency, and anticorruption. But the country’s private-sector boom is hard to ignore — gross domestic product is expected to grow 4.8% this year and 4.5% in 2012.

Brightpoint, a provider of supply-chain solutions to the wireless telecom industry, exited Russia during the financial crisis because its credit insurers pulled in-country coverage and, subsequently, customers couldn’t get letters of credit, says Anthony Boor, Brightpoint’s former CFO. But now that insurers are starting to go back, Boor, who left the company last month, says that Brightpoint “is looking at reentering.”

Most commonly cited political risks in developing countries over the next three years.

Protect Yourself

Political risk can be mitigated, but it’s not easy. One way is to buy political-risk insurance (PRI). Policies can cover brick-and-mortar assets, net investment values (investment plus retained earnings), and sales and supply contracts.

The market for PRI has been flat over the last five to seven years, as companies either glossed over or downplayed emerging-market risks and the recession squeezed risk managers’ budgets. But insurers say that is now changing. “Companies realize there is more risk than they thought there was in emerging markets,” says Evan Freely, global head of political risk and trade credit at Marsh. Their co-investors and lenders also want indemnification.

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