The Georgian Co-Investment Fund: Can it increase FDI by reducing Political Risk?
Georgia has seen a constant inward flow of FDI over the last decade, contributing substantially to economic growth. However, growth has recently slowed while many investment opportunities remain unrealised. To increase FDI and revive economic growth, the former Georgian prime minister and several local and foreign investors have set up a $6 billion fund. The Georgian Co-Investment Fund (GCF) is meant to act as a private investor in FDI projects in Georgia. It can hold 25% to 75% of the equity in a project. Its main investors are former Georgian prime minister Bidzina Ivanishvili as well as some of the biggest foreign investors in Georgia. Over the next five years it plans to invest $3 billion in the energy and infrastructure; $1.5 billion in the manufacturing; and $1 billion in the tourism sector, with smaller amounts for agriculture and other activities.1 This essay examines how the GCF can help increase FDI by mitigating political risk.
Political risk can be defined as a possible negative impact from political activity on a business operation.2 A 2010 survey of executives conducted by the World Bank’s Multilateral Investment Guarantee Agency (MIGA) and the Economist Intelligence Unit (EIU) names Georgia among the most attractive destinations for FDI among conflict affected countries. At the same time, respondents named political risk as the main obstacle for FDI over the medium term.3
This essay’s structure is as follows: the first section takes a look at how the fund can reduce risk by spreading it; section two examines the fund’s role in predicting and preventing regulatory changes; this is followed by section three which deals with the fund’s impact on expropriation and breach of contract risks; section five highlights some reasons why the fund might fail to fulfil it’s purpose and the last section concludes.
An Opportunity to Spread Risk
One way in which the GCF could reduce political risk is due to the nature of risk itself. Risk is the possible amount lost multiplied by the probability of the loss. By gaining the GCF as a co-investor, a potential foreign investor can reduce his or her amount of investment in a project and thus his or her possible losses.
Assuming that the full control of the project remains with the original investor and not the GCF, it would also be possible to split control from ownership. Ownership can be an especially sensitive issue when it comes to natural resources, monopoly industries or the provision of basic services. Investments in the energy sector most likely fall into one or more of these categories.
To decrease possible complications arising from ownership, the GCF enables an investor to leave the ownership of projects, for example hydro power stations, in the hands of Georgian nationals while keeping control of major decisions and ensuring a sufficient return on his or her invested capital.4
Anticipating and Mitigating Regulatory Changes
While spreading risk is a strategy not uniquely applied to political risk, finding a local partner with good government connections and influence can also help mitigate more specific political risks. Take regulatory risk as an example. Regulatory risk refers to unexpected regulatory changes that might have a negative impact on an investment project’s profitability. In the 2010 MIGA/EIU survey, respondents stated regulatory changes as the second biggest concern when investing in developing countries, after breach of contract risk.5
Recent regulatory changes in Georgia include politically motivated changes in electricity tariffs and changes in visa requirements for Iranian citizens. These changes can have a negative impact on investments in the energy and tourism sectors.6 7 8 They demonstrate that regulatory risk is of possible concern for foreign investors in Georgia.
The GCF can help anticipate regulatory changes and create opportunities to influence them by opening a communication channel to the government and by creating allies among the most influential businesses in Georgia. These allies can further help reduce other major political risks like the risk of expropriation, breach of contract or contract renegotiation.
1 Georgian Co-Investment Fund, ‘Strategy and Objectives’. http://www.gcfund.ge/en/strategy-objectives [accessed 23 December 2013]
2 Robert McKellar, A Short Guide to Political Risk, Farnham and Burlington: Gower Publishing, 2010, p. 3.
3 Multilateral Investment Guarantee Agency, ‘World Investment and Political Risk 2010’ Washington DC, p. 20, 36 http://www.miga.org/documents/WIPR10ebook.pdf [accessed 22 December 2013]
4 Louis T. Wells, Jr.,’God and Fair Competition: Does the Foreign Direct Investor Face Still Other Risks in Emerging Markets?’ in Moran, Managing International Political Risk, Oxford and Malden, MA: Blackwell Publishers, 1998, pp. 15- 43 (p.36).
5 Multilateral Investment Guarantee Agency, ‘World Investment and Political Risk 2010’ Washington DC, p. 20, 36 http://www.miga.org/documents/WIPR10ebook.pdf [accessed 22 December 2013]
6 Democracy and Freedom Watch, ‘Georgia cuts electricity price by a quarter’, Tbilisi 2012 http://dfwatch.net/georgia-cuts-electricity-price-by-a-quarter-57407 [accessed 22 December 2013]
7 Jay Solomon, ‘Georgia Says It Froze Iranians' Accounts’ The Wall Street Journal, 2013 http://online.wsj.com/news/articles/SB10001424127887323300004578559863908220032 [accessed 23 December 2013]
8 Molly Corso, ‘Georgia: Is Tehran Trying to Use Tbilisi to Evade Sanctions?’ EurasiaNet 2013 http://www.eurasianet.org/node/67253 [accessed 23 December 2013]