How to encourage investments in fragile states

Facilitating investments into Fragile and Conflict-Affected States (FCS) is one of the most important strategic pillars in MIGA’s Strategy. In an effort to further expand MIGA’s support in FCS countries, I recently visited Burundi, South Sudan, and Afghanistan and met with investors, government agencies, and donors. Although the investment climate varies in these FCS countries, I observed the following four common threads during my visit.

First, despite the deteriorating security situations, there are still investors seeking business opportunities in FCS countries, as long as the expected return on investment is sufficiently high to cover a required level of return plus risk premium.[1] When it comes to the investors actively operating in FCS countries, their concerns appeared to be more focused on unexpected and arbitrary changes in government policies against their investments, rather than the security issue itself. Most aspects of the government-related procedures are risks beyond the control of investors, for example, renewal of licenses and permits, taxation, and various contracts signed with the government. Investors usually go through several political cycles during their investment horizon. An approval from the current government does not guarantee the same approval would be obtained from the succeeding government. A foreign investor I met in Afghanistan cemented this notion by telling me that “when we made a decision to invest in Afghanistan, we were already well-aware of the security issue in the country. For us, the security was a foreseeable risk that could be mitigated to some extent, if not entirely avoidable. We can take care of security risks as well as commercial risks; but what concerned us the most was the risks related to uncertainties in the government’s regulation and policy.”

This observation is also in line with the findings of MIGA’s 2010 Report, in which key risk factors were identified by investors operating in FCS countries. In the report, 62 percent of respondents identified ‘regulatory changes’ as the top political risk concern, whereas only 15 percent and 4 percent responded that war and terrorism were the main concerns for their investments.

Second, diaspora investments are notably playing important roles in recovery and reconstruction of FCS countries. More than half of my meetings in Afghanistan were with diaspora businessmen, who had left the country during the conflict period mostly in 1980s. After having been educated and then operated their own businesses in countries such as the Netherlands and the USA, they came back to Afghanistan for business purposes with dual citizenship. Diaspora investors usually bring back to their home countries ample resources such as finances, entrepreneurship, new business, operational efficiencies, and new technology. Diaspora investors, compared to other foreign investors, uniquely position themselves in the investment community with exclusive strengths, such as familiarity with the country politics, knowledge of the market, and existing business networks. In 2014, MIGA helped facilitate a small diaspora investment into the Afghani dairy sector by providing political risk insurance against the risks of transfer restriction, expropriation, and war and civil disturbance. Although it was an investment into their own home country, the diaspora investors’ concerns were still based on the policy uncertainties and possible damages on their investments caused by political violence. The investment was based on a partnership with a Dutch company, which combined diaspora investors’ business experiences and network in Afghanistan, and a Dutch company’s proven technology in setting up and operating a dairy processing factory.

Third, in FCS countries, prospects of new foreign investments into the countries are usually limited, and existing investors sometimes want to exit the country. However, there are also a group of existing investors that try to find ways to stay in the countries given their long investment horizon and high rate of return they have earned in the country. Considering this, the provision of appropriate protection measures for existing investors[2] is important to minimize capital flight and to avoid negative signals to the new potential investors. Three existing foreign investors I met in South Sudan and Afghanistan have been in operation in the countries over a decade. During South Sudan’s civil conflict in 2014 and a Taliban attack in Afghanistan in 2012, their investment assets were severely damaged.  Despite these unfortunate incidents, they resumed operations and were looking for measures to protect their assets against this type of political violence in order to stay on in the countries.

Fourth, a good mix of small/medium size[3] investments, and large infrastructure investments should be pursued in parallel in FCS countries. The majority of private companies in FCS countries are small and medium-sized enterprises (SMEs), usually in agribusiness, construction, trade, manufacturing and service sectors. SMEs in FCS countries are playing crucial roles to rebuild the local economy. MIGA-supported SME investment projects in places such as Afghanistan, Sierra Leone, and West Bank and Gaza have shown that the projects, although small in size, facilitated the transfer of advanced technologies to local producers, helped to reduce dependence on imported products, generated employment and upgraded working conditions for workers. SME investment, if proven successful, can be a bellwether, which would usher in larger investments into the countries down the road.

There is also a strong need to reconstruct basic infrastructure such as power and roads for economic recovery in FCS countries. Given the large investment size and required technologies, the participation of private investors is essential to fill the financing gap and to provide necessary technologies in infrastructure development. However, private investors tend to be hesitant to participate in the large/long-term infrastructure and power projects in FCS countries unless a certain level of legal/regulatory/institutional framework isin place. In addition, the fact that the investments are often made on the basis of contractual obligations of the government (or government agencies) also means strong needs of hedging the risk of possible breach of contract by the government. In Côte d’Ivoire where the government showed a strong commitment to attracting private sector investment in infrastructure after a prolonged conflict, MIGA was able to help mobilize over $2 billion in foreign direct investment.

In an effort to further encourage investments into FCS countries, MIGA is now operating Conflict-Affected and Fragile Economies Facility (CAFEF), a multi-country, donor-funded facility. CAFEF will help MIGA extend its capacity to cover investments into countries such as Afghanistan, Burundi, and South Sudan.

This post first appeared on The World Bank Political Risk and Emerging Markets Blog.

Publication does not imply endorsement of views by the World Economic Forum.

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Author: Kyoo-Won Oh is an Underwriter at the Multilateral Investment Guarantee Agency (MIGA), the political risk insurance and credit enhancement arm of the World Bank Group. 

Image: An Afghan boy sets up items for sell at his makeshift shop on the outskirts of Peshawar. PAKISTAN-AFGHANISTAN/REUTERS/Fayaz Aziz