FDI drivers and political stability

Political stability encompasses many things, including corruption, the strength of institutions and the rule of law. It therefore must be carefully assessed by multinational enterprises while selecting an FDI destination. By Viola Caon for Investment Monitor.

A potential foreign direct investment (FDI) destination’s political stability can be a deal-breaker for a multinational enterprise (MNE) looking to establish a presence in a new region.

The importance of this driver is linked to its broad and multifaceted implications, which touch on the various aspects of the political, financial and economic features of a country.

Political stability can indeed be looked at through various filters. Investment Monitor has selected a few that it believes would help MNEs to make the best assessment of a potential FDI destination, including corruption, terrorism, strength of institutions and rule of law.

“Investors will be more comfortable investing in a location that has a similar (or more favourable) environment to their own country,” says Investment Monitor chief economist Glenn Barklie.

“The government is responsible for the rule-setting of many factors that encourage or discourage FDI. Having trust in the host country’s government may be a given in some cases (for example, a US company investing in Germany); however, in some less-developed countries, government instability – and in turn a lack of strong FDI policymaking – can be a turn off,” he adds.

Case studies of FDI drivers being affected by political instability

The table below shows a list of ten countries that scored very differently according to the parameters mentioned above.

Among them, Venezuela is an interesting example of a country that on paper has great potential but is struggling to attract FDI due to its political instability, which has also involved high levels of social unrest, corruption, poverty, violence and inflation.

Despite its petroleum reserves, the size of its national market and the wealth of its natural resources, Venezuela ranked unfavourably across all the indices Investment Monitor has collected data from.

It came 173^rd in the Corruption Perception Index 2019 out of 180 countries; it scored 25.7 in a scale to 100 in the World Economic Forum’s Global Competitiveness Report 2019 for strength of institutions; and it was last in a list of 128 countries in the World Justice Project’s Rule of Law Index 2020.

The country’s interventionist government and strongly politicised judiciary have actively been rejecting FDI in recent years.

US multinational General Motors left the country in 2017 after alleging that the Venezuelan government seized its plant. Other MNEs have done the same in recent years, either selling their assets in the country at a low price or giving them up completely.

Similarly to Venezuela, the Democratic Republic of the Congo (DRC) performed badly across these political stability tracking indices. To draw a direct comparison, the country came 168^th in the Corruption Perception Index 2019; it scored 32.8 in a scale to 100 in the World Economic Forum’s Global Competitiveness Report 2019 for strength of institutions; and came third to last in the World Justice Project’s Rule of Law Index 2020.

The DRC also has great potential. It has abundant mineral resources that could and should see it thriving in sectors such as mining, energy and infrastructure. So far, mining is the sector that attracts most FDI in the country, followed by telecommunications.

However, foreign investors in the DRC have to contend with corruption, heavy bureaucracy and administrative fees to establish business there. In 2018, the mining code was amended, which led to increased taxes and royalties, requiring that at least 10% of the capital of mining companies be owned by indigenous citizens, and severely restricting the export of unprocessed minerals under a new mining permit.

On top of that, the ongoing humanitarian crisis and conflict in the east of the country and troubled relations with neighbouring Rwanda, Uganda and Angola have contributed to persistent insecurity.

M&A impact of political instability

When looking at the same ten countries as above, but with regards to M&A activity, the impact of any political instability is clear. According to data from the UN Conference on Trade and Development, both Venezuela and the DRC attracted zero cross-border M&A in 2019.

On the other side of the coin, Germany, which ranks high across the political stability indices analysed, attracted 349 cross-border M&A deals worth $12.9bn in 2019.

M&A activity was also healthy in other countries that showed high levels of stability. Finland came second among the ten countries, with $11.1bn across 83 deals in 2019. Sweden, another country that has a strong reputation when it comes to political stability, the strength of its institutions and levels of corruption, came in third position with $6.8bn in M&A volumes across 133 deals.

Are all stable countries equal?

It is worth noting that the FDI world has its dark side too. In the rankings above, political stability was assessed across various metrics including the strength of institutions, transparency and the rule of law.

Sometimes, however, political stability exists because of authoritarian regimes that do not abide by the rule of law nor guarantee high levels of transparency for their institutions. Yet, they are, technically speaking, politically stable and some of them attract impressive levels of FDI, especially of the greenfield variety.

While data overall shows that FDI still flows into these countries, albeit not as much as it might were they under democratic regimes, it has also emerged that this investment varies according to the sector and type of investor.

If an MNE invests in the oil and gas sector, for instance, it might find it easier to do so in an illiberal country because the sector tends to come under greater scrutiny and is the target of strong criticism in more liberal countries.

By the same token, sometimes it is the investing country’s regime that automatically rules out activities in certain OECD countries due to incompatibility. When investing in construction, for instance, China ties its lending to state-owned construction companies delivering the project. This is illegal in the EU and within OECD countries, which means China goes for other regimes that are often less liberal and not as transparent.

However, even in the countries widely considered to be stable, political events can still affect how investors behave, according to Barklie.

“Even in more established economies such as the US and the UK, events such as the recent US elections and Brexit have the potential to cause companies to reconsider basing operations there,” he concludes.

This is the third in a series of articles on FDI drivers. An overview can be found here, and an article on FDI drivers and barriers in the business environment is located here.

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