Political Risk in Post-Crisis Asia
July 2000
Although the worst is over, genuine political
and economic reform has yet to take root in Asia to ensure the recovery will
last.
by Daniel
Wagner
AIG
It is tempting to declare the economic and political crisis in Asia over
when many of the economies in the region are, to one degree or another, on the
rebound. Regional stock markets have largely recovered, economic restructuring
has been addressed in some fashion by most regional governments, and most governments
appear to have made an effort to dilute the linkage between big business and
government. If one compares these indicators to where they were in late 1997
and 1998, progress has indeed been made. But is the nature of this progress
sufficient to sustain the recovery?
Although it is legitimate to believe that the worst is over, too little appears
to have been done to address some of the root causes of the crisis. Despite
the best efforts of some of the region's governments, genuine reform of economic
and political structures has in most cases not materialized. For this reason,
many analysts question whether the recovery will last. The majority of ordinary
people in the region still suffer the consequences of the crisis in terms of
increased poverty and unemployment. The result has been a corresponding increase
in sectarian and political violence, a rise in the number of separatist movements,
and greater boldness on the part of some of the region's fringe political elements.
In addition, an increasing wealth gap exists between northern Asia, which
is enjoying an economic boom, and southern Asia, which continues to struggle
over issues associated with structural reform. With a recession looming in the
United States and Europe, where most Asian exports are consumed, the short-to-medium-term
prospects for sustained growth in the region are questionable.
The issue of where Asia is heading—economically, politically, and socially—is
an international concern fueled by newspaper headlines that focus on issues
such as kidnappings, allegations of corruption, the pressure on local currencies,
and constant political change. The result is that for many businesses operating
in Asia, the crisis is not over.
The Impact on Banks
Since 1997, equity investors generally have become hesitant to commit new
funds to projects, and many of the region's banks—having adopted conservative
lending policies as a result of the crisis—are treading cautiously when considering
the commitment of new funds to trade and investment transactions. Two trends
have compounded the impact of the crisis on banks. The first is the absence
of a steady flow of transactions that banks can feel good about. In the early
and mid-1990s, when times were good, many banks jumped on the infrastructure
bandwagon, lending to dozens of toll roads and power and water projects. Many
of these projects encountered problems servicing their debt, and the banks were
left holding the bag. As a result, most banks have tightened their internal
lending procedures.
Second, not only do they fund fewer projects, but the projects must be of
a particularly high quality to generate their interest. This has led to greater
competition for high-quality projects among financial institutions. It has also
eroded profit margins. Whereas previously a bank may have commonly factored
in profit margins of 150 to 250 basis points (or higher) when determining its
lending rates, it is now common for banks to work with margins of 100 basis
points or lower. The new trends have narrowed the range of options that banks
consider when addressing risk management issues. When considering whether to
include political risk insurance in a transaction, for instance, banks may be
forced to choose between protection and profit. Many banks will therefore lend
without coverage, taking their chances on the political risk question rather
than cutting into the margin.
The Impact on Political Risk Insurance
For political risk insurers, the fallout from the crisis has also been pronounced.
A number of significant claims arose as a consequence of having insured some
of the same infrastructure transactions that got the banks into trouble. The
most significant of these was a $290 million claim that impacted a number of
insurers. For an industry with a small level of premiums generated in a given
year (when compared with mainstream lines of insurance), these types of claims
can have a considerable impact on this tiny industry.
Fortunately, however, even at the height of the crisis, only some of the
pending claims materialized. Many of the investment disputes that arose were
resolved through diligent effort on the part of project sponsors and insurers.
Still, enough damage was done to cause underwriters to adopt an underwriting
philosophy similar to that of the post-crisis banks. Yet, although now more
conservative in their approach, there are few countries in which underwriters
will not consider reviewing trade and investment transactions at all. The issue
is one of aggregation of exposure. Investors, traders, and lenders seem to be
focused on the same countries as sources of concern over political risk-related
issues. This presents a challenge for underwriters, who naturally want to limit
the amount of exposure in any one country.
The playing field for political risk insurers has become crowded, by the
industry's standards. The arrival of new players since 1996 has made the PRI
business more competitive than ever at a time when the insurance market is soft.
PRI providers thus find themselves in the same boat as banks, dealing with smaller
margins and chasing fewer desirable deals. This environment is favorable for
buyers of PRI, but that means that underwriters face the dual challenge of accepting
business that makes sense while generating premiums that justify the risk assumed.
The Bottom Line
The bottom line is that Asia is not yet out of the woods. Banks will continue
to search for transactions that make sense while yielding an adequate margin
to justify participating in loan syndications; and political risk insurers will
continue to provide coverage for transactions that fit their risk profile and
include a sufficient risk-to-premium reward. The challenge for businesses seeking
loans and insurance for their trade and investment transactions will be to obtain
financing at an affordable level while adding a level of protection that makes
moving forward sensible.
Asian governments will continue to face difficult choices concerning the
completion and maintenance of the reform process. This may translate into unpopular
decisions, but in consideration of the long-term well-being of each country,
the region, its people, and its businesses, these decisions must be made. Ultimately,
it will yield the perception among the international business community that
Asia is a safer place to do business.
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