Political risk insurance in a shifting landscape for foreign direct investment

Foreign direct investment (FDI) has been, and continues to be, an important driver of growth for developing countries. Yet FDI into these economies has been on a downward slope for more than a decade. Subdued global economic growth, external shocks, and structural changes in investment and supply chains have contributed to this trend. 

Although developing countries account for a larger share of FDI than they did years ago—because developed countries have fared even worse— the picture is still discouraging: Emerging-market FDI as a share of gross domestic product (GDP) has dropped from just under 3 percent of GDP in the early 2010s to around 1.6 percent in the 2020s.

FDI into developing countries remains concentrated in a handful of economies, with six countries—China, Brazil, India, Mexico, Indonesia, and Vietnam—accounting for nearly 70 percent of inflows during 2019-23. And while many low-income economies receive only small amounts of FDI, these are often substantial compared with their GDP.

There is some good news. Greenfield investment, when a parent company establishes operations in a foreign country and which is one part of overall FDI, is rising in developing countries. This brings new and additional resources, capital, and assets to an economy. Although most greenfield investment still goes to middle-income countries, lower-income markets are seeing a jump in mining-related FDI, potentially the result of the global push to find minerals critical for the green-energy transition.

Beyond these shifts in the amount and composition of cross-border investment, the global FDI landscape is undergoing a significant transformation driven by near-shoring, friend-shoring and reshoring. Geopolitical competition and the quest for resilience have led companies to increasingly prioritize investments in countries that are geographically closer or politically aligned with their home markets (near-shoring and friend-shoring) or to relocate investment and production from abroad back to their home country (reshoring).  

To investigate recent trends in the relocation of FDI and to evaluate the prospects of near-shoring, friend-shoring, and reshoring, the World Bank Group’s Multilateral Investment Guarantee Agency (MIGA) commissioned a survey of investment promotion agencies (IPAs) in 2024, with support from the World Association of Investment Promotion Agencies. The survey results raise the expectation that friend-shoring and near-shoring will significantly influence the transformation of the FDI landscape in the coming years, especially in manufacturing.

Reflecting the views of foreign investors, nearly 80 percent of all IPAs—and almost 90 percent of those based in developing countries—said friend-shoring would be very important or moderately important over the next three years. A large majority of IPAs were also optimistic about the advantages of friend-shoring and near-shoring for their countries, highlighting their compatibility with FDI source countries and the integration within supply chains of multinational enterprises. Yet all countries cannot benefit simultaneously from FDI relocations driven by friend-shoring or near-shoring, and some are certain to lose out.

For countries that are unlikely to benefit from near-shoring and friend-shoring, the best course of action is to refocus on the long-standing drivers of FDI: a conducive regulatory environment, a supportive business climate, access to skilled labor, moderate taxation, and good infrastructure, among other factors. These countries, and potentially others, should consider political risk insurance (PRI) to mitigate political risks and strengthen foreign investor confidence. 

Surprisingly the evidence shows that despite a rise in political instability, fragility, violence, and conflict, a very small—and declining—portion of FDI to emerging markets is covered by PRI. Although higher in absolute terms, the portion of FDI in low- and lower-middle-income countries covered by PRI is also declining. Greater investor awareness of how these risks can be insured, as well as new products tailored to investor needs, including in the context of the green transition, can support FDI, especially in challenging environments.

Multilateral insurers may be particularly well-positioned to address political risks due to their perceived neutrality and ability to leverage their convening power to de-escalate disputes. New products under development, such as PRI covering carbon credits and fair and equitable treatment in bilateral investment treaties, may also contribute to the development of new markets and better align with investor needs.

This is where MIGA and the World Bank Group Guarantee Platform can help. MIGA began hosting the new platform in July 2024, consolidating guarantee products and experts from across the World Bank Group. The goal is to make guarantees more accessible for clients by simplifying offerings, processing guarantees faster, and developing innovative products to support private-sector investments and lending. With the heightened political risk now evident in many countries, and near-shoring and friend-shoring potentially leaving some countries behind, concerted steps to make guarantees more readily available can be a valuable tool to promote FDI in riskier environments.

Source: blogs.worldbank.org