In an ideal world, investors want their deals to be risk-free and ripe for guaranteed, juicy returns. But it isn’t an ideal world. Instead, those countries that have been long regarded as investor safe-havens are losing their sheen. The UK, the world’s largest financial centre, has been downgraded by credit rating agencies and lost its treasured triple A rating because of the amount of government debt it is carrying. Investors are also worried about the prospect of a hung parliament in the forthcoming general election. Before Christmas Greece was downgraded to BBB+ with a negative outlook, the first time in 10 years a ratings agency has put the nation below the A investment grade, and some may say there’s still time for more.
While the world’s major markets such as the US and Europe have taken a bump, there are signs that they are on the road to recovery, though it may take longer than expected to bounce back. But other countries, particularly in emerging economies that may not have been adversely affected by the banking and financial crisis that engulfed much of the developed world, are showing worrying signs of corruption and government interference that might make investors think again about dipping their toes into these markets.
Here are some of the key markets that have stoked investor interest over the past few years, and an indication of the risks inherent in them.
Laos
Laos, with its abundant natural resources, has often been touted as one of Asia’s final frontiers for mining companies and the sector has been a major contributor to Laos’ increased growth of approximately six percent per year, largely due to FDI. But there are problems. According to the World Bank, the judiciary is vulnerable to interference by the government due to judicial appointments being made by the government and corruption is also common with the most powerful able to influence decisions. Furthermore, Laos has a poor record for protecting investors (ranked 180th out of 181 countries) and has an only slightly better record for enforcing contracts (ranked 111th out of 181 countries), according to the World Bank’s recent Doing Business report.
Laos adopted its Anti-Corruption law in 2006 and is now making attempts at more transparency and working towards reducing corruption in state departments. The reality, however, is that corruption continues to be a normal everyday practice affecting business and everyday life. Transparency in business transactions is low, according to Transparency International, which ranks the country 158th out of 180 countries in its Corruption Perceptions Index 2009 – the lowest rating in Asia after Burma. Government sectors involved with revenue collection and foreign investment are deemed to be particularly vulnerable to corruption.
Having the government as a partner seems to be the accepted way of moderating discretionary government actions. The level of fairness of the regulatory system appears to largely depend on if an investor is willing to allow the Laos government to take an option for, or an initial equity stake in the project, usually 10-20 percent, as can be witnessed with other mining operations in the country, such as Banpu’s Hong Sa coal mine and coal fired power plant, which is currently due for completion in 2012. In addition to joint ventures between the government and the private party, the Laotian government can be offered what is effectively an exercisable equity option to acquire a portion of a mining business. It has exercised these options with two large mining companies in 2008 (Oxiana and PanAust).
Vietnam
Vietnam has weathered the global economic crisis relatively well, but the country is still seen as a risky and relatively opaque investment destination. Corruption is endemic in Vietnam at all levels of government, and acts as a major barrier to foreign investment. Transparency International ranks the country 120th out of 180 countries in its latest Corruption Perceptions Index. The authorities had announced aggressive plans to fight corruption, and encouraged the media to act as a watchdog, but these efforts lost steam after several journalists were detained for reporting on major corruption scandals. As a result, progress on corruption will remain a key determinant of investment attractiveness.
In fact, investors say that the lack of accountability and transparency, and burdensome bureaucracy all impact the effectiveness of the government in formulating and implementing policy. Furthermore, recent history has shown that economic reform and the restructuring of inefficient state enterprises are vulnerable to being undermined by entrenched interests and conservative elements in the government more focused on security.
While the government stimulus package has boosted the economy, there are questions over how the budget deficit can be financed, how inflationary pressure can be contained, and how the crowding out of private investment can be avoided. Hanoi has embarked on a plan to trim bureaucratic procedures in government, but how that scheme plays out will be something to watch.
Vietnam’s fixed exchange rate policy also frequently causes economic pressures to build. The authorities are expected to widen the currency’s trading band or devalue it again gradually in coming months, and this has prompted hoarding of dollars. For now, the risk of a sudden big devaluation is considered small.
Vietnam has seen a rising number of strikes, protests and land disputes, often affecting foreign businesses.
Disturbances have erupted in rural areas due to state expropriations of land and the corruption of local officials.
But there remains no evidence for now that wider unrest is likely, or that there is any imminent risk of the regime being challenged from below.
India
India has attempted to improve investor sentiment by beefing up its corporate governance regime. Indian companies will have to raise their boardroom practices to comply with a new corporate governance code aimed at reforming corporate India after the Satyam scandal. The new code, produced by the Ministry of Corporate Affairs last December, tells listed companies to separate the role of chairman and CEO, change their external auditor every five years, and conduct an annual review of internal control effectiveness. The code also cuts the number of directorships one person can hold from 15 to seven.
To enhance the independence of non-executive directors, the code says they should be appointed on fixed, six-year contracts, after which they would not be able to hold any role at the company for three years.
Companies should change their audit firm every five years, so they get a “fresh outlook”, and rotate their audit partner every three years, the code says.
The code is voluntary, with listed companies expected to comply with its recommendations or explain to shareholders why they have not done so.
India launched a review of corporate governance practices a year ago after the exposure of a massive fraud at Satyam, one of the country’s largest IT companies. That fraud has so far led to charges against several partners at Satyam’s audit firm, PricewaterhouseCoopers, as well as Satyam’s now-former CEO.
But investors may have more concerns with India’s current security situation and its relationship with nuclear neighbour Pakistan. The bomb blast in Pune in western India on February 13 this year, which killed 15 people, has underlined India’s vulnerability to terrorism in spite of the authorities’ best efforts to improve security after the November 2008 Mumbai attacks. The latter severely strained relations between New Delhi and Islamabad after it emerged that the attacks were planned in and launched from Pakistan. But while the Indian government refrained from taking any retaliatory action after the Mumbai attacks (apart from cancelling the tentative peace talks between the two countries), political and public pressure would be considerably stronger for New Delhi to act in a more forceful manner if another high-profile terror attack with clear links to Pakistan were to occur.
Indeed, Indian frustration over the perceived unwillingness of Pakistan to take action against Lashkar-e-Taiba (widely believed to have been behind the Mumbai attacks) and Pakistani ire over India refusing to take up negotiations on Kashmir have seen goodwill between the two governments evaporate.
Pakistan
The fragile position of President Asif Ali Zardari remains a substantial political risk and there is a real possibility that he will be ousted before his term runs out in 2013. Zardari has failed to impress since taking office in September 2008 and is deeply unpopular both among the ruling elite and the wider public.
Constrained by a narrow political base, he has appointed former business cronies to key government positions, which has further alienated him from the powers-that-be in Pakistan – the army and the judiciary. The opposition has already demanded that Zardari and his cabinet resign on the back of corruption charges against him, leaving his fate in the hands of the Supreme Court, which may deem him unfit for the presidency. Zardari has sought to appease his critics by yielding powers to Prime Minister Yusuf Raza Gilani, but this has arguably undermined his position further and created confusion over who is really in power. The removal of Zardari, by the opposition, the judiciary, or the army, could cause serious political upheaval as competing factions fight for executive power. Any extended uncertainty about who is in control would be severely destabilising for the fragile Pakistani state and the wider region, while also having a negative impact on the economy.
The country has also been experiencing a series of home-grown terrorist attacks and the government seems unable to predict which areas, buildings, or organisations might be targeted. On December 7, 2009 three attacks took place in Lahore, Peshawar and Quetta. Two explosions in the Moon Market area of Lahore killed 49 people and injured 130. In Peshawar it is estimated that 10 people were killed and 45 injured in a suicide attack at the entrance to the Sessions Court. Ten people were injured when a remote controlled Improvised Explosive Device was detonated in Quetta. On January 1, 2010 an attack at a volleyball match in Lakki Marwat, NWFP killed at least 93 people. On March 8, 2010 a bomb exploded in the Model Town area of Lahore, Punjab. Reports said that at least 11 people have been killed, and 60 injured.
Japan
The new Democratic Party of Japan (DPJ) government of Prime Minister Yukio Hatoyama is rapidly losing support, with its approval rating having fallen to 37 percent in February from more than 70 percent last September. A key reason for this is public dissatisfaction with a funding scandal centred on DPJ Secretary-General Ichiro Ozawa, who has refused to resign. He is a key campaign strategist and political fixer for the DPJ, and his departure would be a major blow for the party ahead of Upper House elections due in July. While the DPJ has an overwhelming majority in the Lower House, an Upper House majority would allow it greater freedom in policy implementation. Although Japan is officially out of recession, its recovery is looking very shaky, and any further deterioration in economic conditions could further undermine the DPJ’s popularity.
But there are some positive points, particularly in terms of business and investor appetite. At the end of February the country’s financial services regulator announced that companies with a listing in Japan will have to disclose more information about their corporate governance practices and how much they pay directors. The new disclosures, released by the country’s FSA, are aimed at giving investors more of the information they need to hold companies to account. Currently, Japanese companies are allowed to withhold information that is taken for granted in the US.
Companies will have to reveal the names of any directors earning more than $1m and give a breakdown showing salary, bonus, stock options, and pension payments. The same applies to “statutory auditors,” who are the Japanese equivalent of non-executive or supervisory directors. Companies will also have to disclose the roles of their independent directors, whether they have any financial or accounting expertise, and the details of their relationship with the company’s internal audit function.
The FSA also wants to make companies report more about the outcome of resolutions put to their annual shareholder meetings. Currently, Japanese companies only have to report if a resolution was passed or not. In the future, they will have to reveal the number of votes cast for or against and the number of votes withheld. More detailed voting disclosures, “will give a clearer picture of the decisions made by shareholders, which will entail a better functioning of the market pressure over the management,” the FSA said. The proposals will take effect on March 31.
In December, the Asian Corporate Governance Association (ACGA) said that Japan’s corporate laws should be reformed to make the country’s rules on independent directors clearer. The lobby group used a new position paper on governance reform to argue that Japan’s current legal definition of what constitutes an “outside director” is “weak and often confusing to foreign investors and others.”
The ACGA called for listed companies to bring independent voices into the boardroom and to enable their boards to play more of a strategic oversight role.
Brazil
Brazil has signalled that it wants to collect a much bigger chunk of the profits from the oil that it produces. The country, which produces about 2.4 million barrels of oil a day, currently requires oil companies that do business on its soil to pay around 50 percent of their profits to the government in either royalties or corporate taxes.
That’s in line with the rates paid in other “low-tax” countries like the US and Canada. But a major new discovery off of the country’s coast, estimated to contain as much as 50 billion barrels of oil and natural gas, could change all that. With this new resource in mind, Brazilian lawmakers are considering a bill that would push the effective tax rate for outside oil companies north of 80 percent, terms similar to countries like Iraq or Norway.
The legislation would require that international energy outfits get the majority of the materials used to extract oil from Brazilian suppliers, and would give the government final say over which projects get developed. The new law would also require any oil firm operating in the country to partner with Brazil’s state oil company Petrobras, which would be solely responsible for laying the infrastructure required to extract oil and ultimately overseeing all the production. International oil firms would be relegated to providing funding and technical know-how in exchange for a share in the profits.
While oil firms may not be reluctant to offer praise for the proposed legislative change, they are still interested in operating there. But the problem is working with Petrobras. Analysts and industry experts believe that by requiring Petrobras to be involved in every Brazilian project, the whole country’s oil production process could be slowed down as the firm would not have the resources or manpower to carry out the work as the new oil and natural gas fields cover thousands of square miles of ocean.
Nigeria
Like Brazil, Nigeria is considering hiking its royalty rate and requiring much of the material used in construction projects to be locally made. It also wants its state oil firm to have a bigger role in projects. The major difference is that Nigeria, unlike Brazil, lacks both a technically advanced state oil company and a major industrial base to make home-grown equipment for the industry. Another problem is that Nigeria may very well introduce these new oil-producing terms despite the major shortcomings within its domestic industries.
The proposed law has prompted one major oil firm operating in the country to call it “a cumbersome document that lacks insight into the very basics of our industry”, adding that the royalty provisions are some of the “harshest in the world.”
But other oil producing countries are moving in a similar direction. Kazakhstan, a lucrative spot for a consortium of international firms including British Gas and Italy’s Eni, may also tighten its tax policy. Venezuela, which is experiencing a decline in oil production, has made more fields available for the international oil firms to bid on, although the terms remain tough.
