For every international investor there is always the unknown variable of political risk that cannot be modeled by traditional statistical models. Growth, inflation and interest rate forecasts all help in painting a picture of a country, but it is an appreciation of the political and economic ideology of a government and its people that completes it. At times of crisis, such as the current economic downturn, uncertainty about the decisions that politicians will make is accentuated. Which assets in a portfolio are most at risk from expropriation is a question that is being pushed higher up the agenda and appearing on it for the first time for many. However, fears and reality are hardly ever the same thing. In this article we aim to examine the effect the credit crunch has had on expropriation risks and what the outlook is going forward for the four most talked about emerging markets: Brazil, Russia, India and China (the BRICs).
Despite President Lula’s left-wing political orientation, his government has not espoused nationalization policies. It has not challenged the privatization program that Brazil undertook in the 1990s either. Such a divestment program netted the country $87 billion; nearly half of the assets were acquired by foreign investors. Foreign investors’ interest in the country has grown rapidly; the global crisis resulted in a 50% decline in FDI (spell out) to $26 billion during 2009. However, as the country gets out of recession FDI is bouncing back, with estimates of $45 billion inflow of FDI for 2010. President Lula is eagerly promoting the country abroad; bilateral investment treaties like a technological and military cooperation accord with France are advancing.
Factions of left-wing parties and social movements, however, strongly campaign for a reversal of privatization. Vale, which has grown to become the world’s largest iron ore miner after being privatized in 1997, has turned out to be the main focus of this campaign. In 2007, labor unions, student groups and the Landless Workers Movement (MST) organized an informal plebiscite to call for its renationalization, managing to collect three million votes. President Lula rejected the proposal out of hand, but in 2009, as a concession to left-wing quarters, he put pressure on Vale to increase domestic investment to minimize job losses. Lula used this anti-privatization sentiment during his re-election campaign in 2006 to discredit his main opponent. That same strategy is likely to be used by Dilma Rousseff, Lula’s handpicked candidate for his successor, in the 2010 presidential race.
Yet the election will probably lead to delays in the passage of a constitutional amendment allowing for the seizure, without any compensation, of farms that condone the use of slave labor. The bill was originally proposed in 2001, but lawmakers sympathetic to farmers have stalled the process. They say the bill’s definition of slave work opens the door to arbitrary decisions, and that the supposed slaves are just part of the estimated 59% of Brazilian workers who are unregistered. Brazil’s 1943 labor legislation does not recognize seasonal and temporary work, which farmers say are essential to make their businesses viable.
The government is stepping up efforts to get a new oil law approved. Although the new law is not expected to lead to nationalization, it is likely to introduce changes to contractual conditions to secure increased state revenue via taxation and royalties. Moves to boost royalties on mining are being considered and industry executives fear that their nationalistic tone may scare new investment. Although President Lula will continue facing strong pressure from radical left-wing constituencies, particularly within the ruling party, to nationalize companies operating in sectors deemed strategic, he is very unlikely to heed those calls.
Expropriation of private property in Russia is limited primarily to the extractive sector in Russia. The takeover of assets owned by energy giant Yukos in 2003, following the arrest of its owner, Mikhail Khodorkovsky, was the last example of outright expropriation – without compensation – of a major business venture in Russia. In order to achieve its goal of state dominance in strategic extractive sectors, the government now prefers to exert influence indirectly: by imposing back-taxes, threatening environmental fines or exploiting its powerful presence in the energy sector. For example, in 2007, UK-Russian oil firm TNK-BP was forced to sell its stake in the Kovykta field to Gazprom after the latter had threatened to deny TNK-BP access to the gas pipelines that carry exports to western Europe. In July 2007, Russian authorities were also able to engineer the sale of the oil major Russneft to Oleg Deripaska, after initiating a criminal investigation against the firm’s then owner Mikhail Gutseriev, a figure considered to be politically unreliable by the siloviki faction within Russia’s ruling elite. Similarly, large environmental fines were threatened against the Sakhalin-2 consortium to force the project participants to cede a controlling stake to Gazprom in the autumn of 2006.
It is likely that expropriation risks across all sectors will decline in Russia over the next three years, with the exception of the extractive industries, for two reasons. First, a division between the Prosecutor General’s Office, controlled by the so-called liberal faction, and the Investigative Committee, controlled by the siloviki, ensures that no single political faction is able to press bogus charges against business entities with the same ease as before. Second, the Law on Foreign Access to Strategic Sectors that came into effect in May 2008 clarifies the rules of operation in strategic sectors and limits the state’s ability to discriminate against investors. However, because of the highly lucrative nature of extractive projects, indirect pressure on foreign investors holding a majority stake in these will be significant despite legislative changes. That said, the state will likely compensate those forced to surrender their economic interests, albeit potentially at a lower than market price.
The two main national parties in India – the Congress (currently in power) and the opposition Bharatiya Janata Party (BJP) are both in favor of economic reform, trade liberalization, and progressive de-regulation of key sectors. The current government, under Prime Minister Manmohan Singh, is encouraging privatization and foreign direct investment to reduce its fiscal deficit, divest itself of stakes in loss-making public sector enterprises and raise funds for large-scale infrastructure construction across the country. In 2010, the government further facilitated foreign investment by simplifying administrative procedures for foreign companies purchasing stakes in Indian firms, for instance reducing the number of forms required from more than 30 to just one. The government’s policy of attracting foreign investment means that the risks of government expropriation are minimal.
However, foreign investors in India do face issues concerning regulatory uncertainty. The legal system puts a number of restrictions and imposes a stamp tax on the transfer of land. Land titles lack clarity, making it difficult to buy and sell land. Moreover, in India, state governments possess broad regulatory powers and important issues such as zoning, land-use and environment can vary from one state to another. Opposition from labor unions and political constituencies has also slowed reform in such areas as land and labor. For instance, middle-income farmers who have gained economic leverage through agricultural subsidies exert political pressure on the land reform process. These farmers are strongly opposed to land reform and are likely to lobby state governments to reject major industrial projects that they perceive as damaging their livelihood. A recent example of this concerns the $12 billion investment by South Korean steel-maker Posco in a steel mill and port in Orissa in eastern India. Although backed by the central government, the Posco project was delayed from 2005 until mid-2010 due to land protests and legal challenges in the Orissa courts but has now gone ahead. Such delays, accompanied sometimes by protests, characterize the risks that foreign investors face for their Indian projects rather than outright government expropriation.
Since 1978, when the country officially launched its so-called ‘open door’ policy, there have been no incidences of expropriation of foreign assets in China. The World Bank reports that the transparency of transactions in China is higher than the OECD average, although the ability of shareholders to sue officers and directors for misconduct and the level of director liability, are, respectively, five and three times lower than the OECD average. Nevertheless, the legal environment for doing business in China can be expected to become more aligned with international practices as the economy is further liberalized.
With respect to property ownership, all land belongs to either the state or local collectives. The state owns all mineral resources, waters, forests, mountains, grasslands and beaches, as well as all urban land, while local collectives own all rural and suburban land, except specific portions that belong to the state. In March 2007, the government approved a landmark private property law that strengthens primarily the legal protection for rural land worked on by farming communities. The new law is aimed to tackle the growing problem of illegal land requisitions by property developers and local officials. While landownership cannot be transferred, real estate property above the land and land-use rights may be transferred without affecting the ownership of the land. Land-use rights entitle the individual to the right to possess, use and profit from the land, but only under the conditions stipulated in the land grant contract or allocation certificate. Chinese law now allows foreign businesses to hold long-term land-use rights.
While the process of changing the conditions of a land grant contract can be lengthy, the registration of personal property is more straightforward due to the limited level of ownership of private property. According to the World Bank, it takes three steps and 32 days to secure rights to property, which is, in fact, quicker than the OECD average. Nevertheless, China still lacks a comprehensive system of real estate registration, and the government only published its first complete registry of ownership in 2004. In addition, as land ownership rests exclusively with the state, it has the legal right to confiscate land on the grounds of national security and public interest. However, the government is again unlikely to confiscate foreign assets unless the asset in question specifically compromises China’s national security. ■
Philip Skinner, consultant at Exclusive Analysis, Ltd., looks at the risk of expropriation in these important investment sites. Exclusive Analysis is a specialist intelligence company that forecasts commercially relevant political and violent risks worldwide.