Chapter

5 Investment Guarantees: The Role of the Inter-Arab Investment Guarantee Corporation

Author(s):
Saíd El-Naggar
Published Date:
March 1990
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Author(s)
Abdel Rahman Taha

The objective of this study is to highlight the salient features of the regional scheme of investment guarantees managed by the Inter-Arab Investment Guarantee Corporation (IAIGC)—an institutional offshoot of joint Arab economic effort—and to review the experience acquired by the Corporation since it commenced operations in 1975. Before proceeding with this, however, we should consider the concept of investment guarantees against non-commercial risks and briefly discuss international guarantee schemes, which provide a useful point of entry into the subject of inter-Arab investment guarantees.

Role of Guarantees in Promoting Foreign Direct Investment Flows

Three basic elements govern the decision-making process over direct investments in a country other than the investor’s country. First is the existence of favorable investment opportunities in the country under consideration, namely, satisfying the investor’s expectation of greater returns than could otherwise be obtained in another country or from international financial markets; this requires proof of project feasibility in every respect—technical, financial, managerial, and marketing.

Second is the need for a favorable investment climate; “investment climate” means the totality of political, economic, institutional, and legal conditions that may affect the success of an investment project in a given country. Here the political factor is paramount; it includes the extent of political stability enjoyed by the country, the philosophy governing its economic imperatives, its efficiency in managing the national economy, and the policies pursued in regulating private domestic and foreign investments, foreign exchange, and credit. Also included are the degree of development of international financial markets, the stability of international relations, the various legislations for promoting or regulating or monitoring foreign investments, and the efficiency of the instruments on which they are based, in addition to the degree of development of infrastructure and its efficient performance.1

The third basic element governing direct investments is an evaluation of the noncommercial risks at work in the host country. These risks are essentially political, and in general they arise from those state-adopted measures that have a bearing on the political, economic, or security situation. These measures are invariably beyond the control of the investor, who normally cannot influence them or evade their consequences and repercussions on his investment project. The principal risks are the threat of nationalization and confiscation, war or political unrest in general, and the fear of being unable to transfer the invested capital or earnings accrued outside the host country into a convertible currency.2

If a good investment opportunity is found and the climate proves conducive for investment, the investor’s evaluation of the noncommercial risks at work for the duration of the investment, whether real or imagined, becomes a decisive factor in his decision to invest. He cannot possibly proceed if his evaluation shows that the potential risks are greater than he can handle. By and large, the investor will use every legal (and perhaps illegal) means available to mollify the effects of the noncommercial risks. He may, for example, select investments that would accrue the greatest profit in the shortest time; these are unlikely to have a positive effect on the development of the host country. As a result, it comes as no surprise to find some investors’ actions creating an opposite effect on the government of the host country, prompting it to impose precisely those restrictions that the investor seeks to avoid.

It follows that a certain degree of legal protection, or insurance against political risks, would improve the investor’s outlook and evaluation of the noncommercial risks surrounding a given project. This protection would tend to reduce the rate of investment return applied in the measurement of the net present value—which is the measure of the financial feasibility of a project—and thus increase the chances of the investor taking a positive decision toward entering into the project, without resorting to other, unwholesome, and possibly illegal, practices to curb the risks. Providing protection against noncommercial risks may therefore be the decisive factor in deciding to invest within foreign countries.

Evolution of the Concept of Investment Guarantees

There are, arguably, two principal methods of guaranteeing foreign investments. One is legal guarantees. These come in many forms, such as bilateral agreements between capital exporting and importing countries and national legislation designed to promote or regulate the inflow of foreign investments, provide protection, and safeguard such investments against all forms of political risk. There are also special agreements on specific investments, referred to as concession agreements; these agreements are between the host country and the investor, whereby the former grants the latter the right to invest in a specific area and awards certain privileges, incentives, and guarantees established by the state, which may be undertaken within the framework of prevailing investment laws or outside it.3

Most Arab countries (15 of them) have enacted laws to encourage or regulate investment.4 Much of the legislation stipulates guarantees on foreign capital investments against nationalization, confiscation, seizure, or expropriation, except when, for reasons of public interest, it is so decided by specific legislation or by court order. Normally, such legislation requires that the state provide fair compensation and permit transfer of the value of that compensation abroad if the same sum is found to have been previously transferred from abroad to the recipient country, in conformity with the prevailing currency laws. Moreover, it often stipulates that the state guarantee the transfer of net earnings accrued from the invested capital as well as the re-export of capital in the event of project liquidation, and in the same currency with which imports were obtained.5

Despite the importance of such state legislation and special concession agreements in encouraging and reassuring the foreign investor, their effect is undermined by the fact that the authorities of the host country are both the litigant and the judge where such guarantees are concerned. Furthermore, such legislation does not usually provide the foreign investor with a guarantee against political risks arising from the vulnerability of his investment’s material assets to losses sustained during war or revolution or civil strife in general.

This leads to the second method of guaranteeing foreign investments, whereby institutions from the exporting countries or regional institutions or, more recently, multilateral institutions undertake to insure foreign investments against the noncommercial risks engendered.

Briefly, the concept of “investment guarantee” is the insurance against noncommercial risks provided for an investment outside the investor’s own country as compensation for losses sustained by his investment, against pre-designated guarantee premiums. Though investment guarantees that are normally provided by public institutions are similar to business insurance in certain respects, there is a fundamental difference between the two. The latter applies the principle of the “law of large numbers”; through this law the insurer can calculate the probability of the risk to be insured against and thus the projected profit or loss when adopting a specific insurance plan. Naturally, this principle does not apply to investment ventures, as the number of projects here is relatively small, making it difficult to predict the incidence of noncommercial risks. Consequently guarantor institutions have relied on administrative and legal methods to diminish the effect of the risks to their financial status and to strengthen their capacity to redeem financial compensation. One should add that these institutions do not normally pursue profits as a basic objective. Rather, they provide a general service, which is the provision of protection for an investment outside the investor’s country. Thus, the institutions’ vulnerability to loss—which is frequent—does not necessarily lead to their liquidation or phasing out, for they receive continuous government support from the public treasury on grounds of protecting the national interest that these guarantor institutions were in fact established to promote. The same can perhaps be said for multilateral guarantor institutions. Ultimately, they seek to help realize general development objectives, and the states that own them will certainly spare no effort to support and protect them whenever necessary.

Guarantee Schemes Outside the Arab World

National Guarantee Schemes6

There are 15 industrialized states that possess investment guarantee schemes.7 Some are managed by the existing institutions themselves. This is the case in the United States, where the Overseas Private Investment Corporation (OPIC) provides insurance services in addition to funding. Other schemes evolved from within public agencies or ministries and were charged initially with managing export credit insurance plans; examples are the Export Credits Guarantee Department of the United Kingdom and Japan’s Ministry of International Trade and Industry.

All such schemes are designed basically to guarantee their citizens’ foreign investments against noncommercial risks; by and large, they revolve around three sets of risks: nationalization and confiscation, wars and civil strife, and the inconvertibility of the currency of the host country into a free currency. The programs differ in varying degrees as to underwriting policies, conditions of eligibility, the investment’s gestation period and amount of coverage, guarantee premiums, and types of projects and investments eligible for guarantee or for precedence. Some of these schemes provide guarantees only in those countries with which they have agreements protecting investments, such as in the case of the United States.

Multilateral Schemes: The Multilateral Investment Guarantee Agency (MIGA)8

The idea of an international scheme for investment guarantees is nothing new and can be traced back to 1948. However, it did not materialize until quite recently, when the Multilateral Investment Guarantee Agency (MIGA) was formed in April 1988 as an institutional offshoot of the World Bank Group, and began its operations in mid-1989.

This Agency aims essentially at promoting the flow of investment funds (slanted toward development objectives) to the developing countries by insuring long-range investments against political risks, more specifically the risks surrounding currency convertibility, the threat of nationalization, confiscation, war, revolution or civil strife, and the failure of the state to honor its legal commitments. Promotion is achieved through the provision of ancillary consultancy services. The Agency’s guarantees cover pioneer investments only and are restricted to its member countries. Pioneer investments include fresh financial infusions for project expansion, renewal, or financial restructuring, as well as for purchase of public institutions through privatization and the reinvestment of earnings open to transfer abroad.

The Agency insures a specific percentage of the investment; it may reach as much as 90 percent of the par value or about $50 million per project. Premiums on guarantees are determined on a per project basis, following the Agency’s appraisal of several elements, including the nature of the risks to be covered and the project itself. The Agency also provides, in cooperation with the International Finance Corporation (IFC), consultancy services and technical assistance to member countries to help improve the investment climate in these countries and develop their capacity to attract direct foreign investments. However, the Agency has not been able to conclude any investment contracts up to the date of issuance of its 1989 annual report although it has been providing consultancy and technical services.9

Arab Investment Guarantees

Objectives of the IAIGC

The Inter-Arab Investment Guarantee Corporation is an autonomous regional organization whose membership comprises all the Arab countries. Its main office is in the State of Kuwait and it commenced its activities in mid-1975.

The Corporation aims at promoting the flow of investments between the Arab countries by (a) providing the Arab investor with insurance coverage in the form of reasonable compensation for losses resulting from noncommercial risks; (b) carrying out activities that are ancillary and complementary to the Corporation’s main purpose, in particular, research related to the identification of investment opportunities and the conditions of investment in the Arab countries.10

The Corporation’s objectives crystallized from specific activities and programs, and it has developed an inter-Arab scheme for investment guarantees against noncommercial risks. The Corporation has also pursued intensive research to identify the investment climate and opportunities of the Arab countries and has provided services to promote these opportunities within Arab investment circles. It has also extended technical support services to member countries, in an effort to develop the legal and institutional facets of the investment climate therein and to upgrade the manpower of the institutions concerned with financing and promoting investment.

The Corporation has succeeded, over the past 15 years, in inculcating an indigenous technique for investment guarantee. The technique is new to the Arab world and developing countries in general, as it used to be confined exclusively to the industrial countries. By preparing and developing various model guarantee contracts, as well as contractual and coverage procedures, the Corporation was able to lay the groundwork for the first regional, multilateral scheme for Arab investment guarantees. We shall now highlight the main features of this scheme and the most salient features of its application.

Which Investor Is Eligible for Coverage?

To obtain IAIGC coverage, the Corporation’s Convention requires the investor to be a national of a member state other than the host country, if he is a natural person (individual); if a juridical person, his stocks or shares must be substantially owned by nationals of member states, and his seat of control must be situated in one of these states.

Substantial ownership does not necessarily imply ownership of most of the capital; it is sufficient if a part of the capital of the juridical person enables its owners to influence the operation and management of the juridical person. In this case no condition is laid as to proof of nationality of the juridical person in the member state in the legal sense; it is sufficient if the company’s headquarters is located within that state.

In addition to Arab individuals and companies that own substantial shares and are located in the Arab states, the Corporation’s Convention permits the extension of its guarantees to firms outside its member states, provided that no less than half the capital of these firms is Arab owned. The rationale behind this stipulation stems from the conviction that Arab interests in such companies are large enough to warrant their falling under the aegis of Arab sovereignty, and so they are afforded the same treatment as private Arab companies. Extending coverage to such companies creates an opportunity to benefit from the technical capability needed in development and constitutes an incentive to reinstate to the Arab world Arab investments employed in international markets.

Investments Eligible for Guarantee

The IAIGC requires that, before providing guarantees for an investment project, two conditions be met:

  • (a) The project must be a pioneer enterprise, and investments employed prior to application for coverage are regarded as old and do not qualify for guarantee. The rationale behind this requirement is to render the guarantee an incentive for investors to explore new avenues of investment, as well as its being a contributing factor in the making of investment decisions. On the other hand, the reinvestment of earnings accrued from a previous investment are eligible for guarantee, as is the purchase of existing assets and projects so long as they involve foreign currency transfers to the host country.
  • (b) Prior approval must be obtained from the government of the host country for both implementation of the investment and its guarantee by the IAIGC.

There are no other conditions of eligibility for the IAIGC investment guarantee. All investments, whatever their type, are eligible for guarantee. This eligibility applies equally to direct and indirect investments (that is, full or part ownership of enterprises and their branches or agencies, ownership of shares, stocks, and bonds), and even to loans directed to financing a development project—provided the project’s duration exceeds three years. The Corporation does not distinguish between private and public investments so long as the latter are managed according to business principles.

The IAIGC gives special priority—“subject to all operations being conducted on a sound basis and with the object of serving the interests of its investors”—to the following investments:

  • Investments that promote economic cooperation between the Arab countries, in particular joint Arab projects and projects that promote Arab economic integration.
  • Investments proved to the Corporation to be effective in the development of the productive capacities of the host country’s economy.
  • Investments in which the guarantee of the Corporation is considered to be an essential consideration in the decision to make them.

Types of Guarantee Contracts

The IAIGC provides guarantees through various contracts, each of which is designated for a specific type of investment.

Direct investment guarantee contracts cover investments consisting of total or partial ownership of the capital of a project, the overall and unlimited liability of which falls upon the guaranteed party, whether the party is a juridical person or not.

Equity participation guarantee contracts cover investments consisting of total or partial acquisition of shares or bonds of a company not subject to the control of the guaranteed party, who is thus not accountable for its obligations except within the limits of his participation. The rationale behind separating this type of contract from the previous one lies in the nature of the relationship between the applicant for the guarantee (investor) and the investment project, which differs in scope and nature in each case.

Loan guarantee contracts cover loans for financing investment and development projects, with the condition that their maturity should exceed three years and the loan be obtained from an Arab bank; the bank may be a joint Arab-foreign bank located outside the Arab world, in which case Arab participation must be at least 50 percent.

Contractors’ equipment guarantee contracts were designed (in view of the importance of the contracting sector for the implementation of investment projects) to cover contractors’ equipment used in the host country by the guaranteed party to implement a project, provided that this equipment is imported or purchased within the host country with foreign currency transferred from abroad for that purpose.11

The Risks Eligible for Insurance

The Convention of the Corporation (Article 18) drew up the general framework of the risks eligible for insurance by stipulating three generally agreed upon categories of noncommercial risks (expropriation and nationalization, inconvertibility, and wars and civil disturbance), thus rendering the IAIGC comparable with other guarantor institutions.

The guarantee contracts include detailed descriptions of these risks. The direct investment guarantee contract (as well as the equity participation guarantee contract) describes certain aspects of the measures taken by the public authorities in the host country to restrict substantially the ability of the guaranteed party from exercising his fundamental rights with respect to his investment; it also clarifies confiscatory measures, nationalization, sequestration, expropriation, and seizure of the investment.

As for the loan guarantee contract, its definition of risk concentrates on those risks that infringe upon the rights of the investor as a creditor. Its coverage is against any action taken by the public authorities of the host country that results in preventing the investor from exercising his fundamental rights as a creditor, such as preventing him from receiving his rights or disposing of his rights, or imposing a rescheduling of the loan, delaying repayment of principal and interest, or introducing any measure to the project that results in a failure to repatriate the creditor his due as stipulated in the loan contract.

As for the risk of inconvertibility, guarantee contracts define it as those measures introduced by the public authorities of the host country that prevent the investor from repatriating the principal of his investment or the remission of his earnings therefrom or the investment amortization installments. It includes delay of approval of the transfer and the imposition at the time of transfer of a clearly discriminatory exchange rate falling below 99 percent of the prevailing exchange rate.

The risk of war includes any armed foreign intervention, or armed violence or civil disturbance from within the host country, such as revolutions, coups d’état, insurrections, and other acts of violence that have a detrimental effect on the material assets of the investment project if it is a direct investment, on the equipment covered by the guarantee if it is a contractors’ equipment guarantee, or on the creditor’s material assets if it leads to inability to repatriate a loan, as in a loan guarantee contract.

Guarantee Premiums

The Corporation charges, against its commitment to guarantee, a standard guarantee premium applied in all Arab countries. However, the rate of the premium varies according to type of contract. For direct investment and equity participation guarantee contracts, it amounts to 0.6 percent (6 per thousand) of the current amount of the guarantee for each risk covered by the contract. For loan and contractors’ equipment guarantee contracts, the premium is 0.45 percent (4.5 per thousand) of the amount of the guarantee. The Corporation also charges a “commitment fee” of 0.45 percent of the total amount of the guarantee for investment, equity, and equipment contracts, 0.25 percent for loan contracts, against the Corporation’s commitment to guarantee the maximum amount throughout the contract period.

The Corporation refunds the guaranteed party 25 percent of the total guarantee premium paid at the end of the contract if no claim (compensation) takes place during the contract period.

Compensation

The Corporation compensates the guaranteed party on the basis of 85 percent of the incurred loss where the risk is one of infringement on the investor’s fundamental rights or one of war, and 90 percent of the incurred loss if the risk is inconvertibility. The guarantee contracts require that the guaranteed party always bear the percentage not covered by the guarantee against loss and refrain from insuring it or transferring it to a third party. The reason for this is to keep the guaranteed party, through his bearing part of the loss, cautious in his dealings, giving him a vested interest in avoiding or reducing losses. The Corporation may also suspend payment of compensation in cases where such payment requires issuance of a final court ruling, and until such time as the ruling is issued. In this case the investor is entitled to receive 50 percent of the total compensation charged against provision of adequate insurance. The Corporation is also subrogated, within the limits of the compensation provided, to the rights of the investor whom it compensates.

Limits of Insurance

The Corporation applies a number of ceilings when paying compensation during implementation of guarantee operations; these ceilings are necessary to maintain the Corporation’s financial position, as it has commitments and obligations of its own.

  • There is a maximum amount for the total cover that is fixed by the Corporation; this total may not at any time exceed five times the Corporation’s total capital plus reserves. (This maximum reached approximately 215 million Kuwaiti dinars ($762 million) by the end of 1988.)
  • There is also a national maximum, imposed by the necessity of spreading operations among the various member states, which the Corporation’s Council set at 50 percent of the total insurance transactions, provided that the amount of insurance in every case does not exceed the Corporation’s paid-up capital of KD 22 million ($78 million) or the total capital plus reserves of KD 43 million ($152 million), in those special cases requiring the Corporation to make new estimates.
  • The third ceiling is the maximum amount of insurance in respect of any single transaction. The Corporation’s Convention sets this maximum at about 10 percent of the total amount of capital plus reserves, or KD 4.3 million ($15.2 million). This limit may be doubled, that is, increased to 20 percent, for investments to which the IAIGC gives special priority, and to which attention was drawn earlier in this paper (see section on investments eligible for guarantee, above).

The Experience of the IAIGC

Guaranteed Investments

Total Arab investments guaranteed by the IAIGC through the various types of guarantee discussed earlier amounted to about $293 million for the period 1975–88. Eighty guarantee contracts have been concluded, of which 48 (about 50 percent of total contracts), valued at $140 million (about 48 percent of the total amounts insured), were direct investment and equity participation guarantee contracts. Loan guarantees for investment projects amounted to $123 million or about 42 percent of the total value of contracts (see Table 1). The sectoral distribution of the guaranteed investments shows that most of the guarantees went to the tourism sector, which received 35 percent, followed by industry at 25 percent and services at 24 percent (Table 2). Most of the guaranteed investments were in seven host countries, namely, Egypt and the Yemen Arab Republic (each 20 percent), Morocco (15 percent), Iraq (13 percent), the Syrian Arab Republic (10 percent), Sudan (6 percent), and Mauritania (4 percent) (see Table 3).

Table 1.Guarantee Contracts Concluded up to December 31, 1988
Total value of Contracts
Type of ContractNumberKuwaiti dinarsU.S. dollars
Direct investment2330,898,640109,569,645
Equity participation188,733,83330,971,039
Loan2834,654,951122,889,897
Contractors’ equipment118,397,80329,779,443
Total8082,685,227293,210,024
Table 2.Investment Guarantee Contracts by Sector, Concluded up to December 31, 1988
Total Value of Contracts
SectorNumberKuwaiti dinarsU.S. dollarsPercent
Industry1420,562,40272,916,31924.87
Agriculture81,421,9445,042,3551.72
Tourism2128,976,096102,752,11335.04
Animal wealth and fisheries1410,365,25136,756,20912.53
Real estate21,447,5005,132,9781.74
Infrastructure2119,912,03470,610,05024.10
Total8082,685,227293,210,024100.00
Table 3.Geographical Distribution of Operations as at December 31, 1988
Total Value of Contracts
CountryKuwaiti dinarsU.S. dollarsPercent
Bahrain86,700307,447
Egypt17,578,63762,335,59221
Iraq11,020,51639,079,84413
Jordan430,0001,524,823
Kuwait785,9532,787,0671
Mauritania3,447,55112,225,3584
Morocco11,983,12942,493,36515
Somalia844,3932,994,3011
Sudan6,690,00323,723,4158
Syrian Arab Republic8,094,54428,704,05710
Tunisia731,7272,594,7771
United Arab Emirates2,422,0008,588,6523
Yemen Arab Republic17,420,44061,774,61021
Yemen, People’s Democratic Republic of1,149,6344,076,7162
Total82,685,227293,210,024100

Risk Realization

To date, no risks relating to direct investment or equity participation guarantees have eventuated, so that the Corporation has not paid out any compensation in terms of these two types of guarantee contracts. The Corporation did receive notification of the risk of seisin by a host country over a piece of land intended for a guaranteed project, but the Corporation interceded, and the authorities subsequently canceled the measure, thus averting payment of compensation.

However, for loan guarantees, inconvertibility risks were realized in the case of two loans from Arab financial institutions to investment projects in two Arab countries. The amount of compensation paid was $7.6 million, or 90 percent of the total amount guaranteed, but the Corporation was subsequently able to receive that sum. The IAIGC also paid compensation for another loan valued at $3 million; its retrieval is in process.

Summary

Arab investment flows guaranteed by the Corporation since it began operations are very modest when compared with the figures for unofficial investment flows12 between the Arab countries, which were estimated at $9.88 billion at the end of 1988.13 In our opinion, the smallness of the investments guaranteed in relation to total flows should not detract from the importance of these investments, for they constitute what are called “additional” flows; that is, they appear over and above the natural flows resulting from the presence of good investment opportunities and a conducive investment climate. Their owners do not see the noncommercial risks accompanying the project as so large that they should forgo the investment or seek out ways by which to reduce the risks. This concept is called the concept of “additionality.”14

Like natural flows, additional flows are essentially products of a good investment opportunity and a reasonable investment climate. But the investor believes there are noncommercial risks, such as the threat of nationalization or confiscation or inconvertibility, that are high enough to warrant his refusal to proceed with the investment. In other words, the high risks raise the net present value, which is the ratio utilized in appraising the financial feasibility of a project, so that all other alternative opportunities appear more attractive to the investor; as a result, the investor decides not to enter the project.

However, if guarantees are provided against the possible realization of these risks, the investor’s calculations would change. The net present value would then be lower, increasing the chances of a decision to proceed with the investment. From this we can infer that guarantees against noncommercial risks are not in fact the decisive factor in direct investment flows between countries; the principal catalyst to these flows is in fact the availability of good investment opportunities within a conducive investment climate. International experience bears out this thesis, for we find that most direct investment flows during the eighties were to the newly industrializing countries of southest Asia, where good investment opportunities have emerged and economic and financial policies are conducive to such investment.15 The same is apparent for the Arab world, where the greatest unofficial direct investments are in those countries that have sought to improve their investment climate by applying more liberal economic and financial policies and by reducing state control of economic activity or in general allowing market forces greater leeway in the determination of prices and the distribution of resources.16

From what has been discussed thus far, it is apparent that the promotion of direct investment flows between countries is not a function of guarantees alone. Guarantees should be part of a complete and integrated package of services including, in addition to guarantees against noncommercial risks, the following:

  • Helping the investor to identify available investment opportunities in a host country and to determine a suitable project for investment.
  • Helping the parties to the investment process, whether promoters, investors, or official agencies, to become acquainted with one another during the promotion of investment opportunities and the determination of sources of finance.
  • Describing for the investor the various aspects of the investment climate in a host country, including project licensing measures, incentives, and exemptions stipulated in the country’s investment laws.
  • Helping the host country to improve its investment climate (especially its legal and institutional aspects) by providing it with technical assistance in these areas.

Perhaps the officials who drew up the Corporation’s Convention had this broad concept of service in mind, for the provision of guarantees to Arab investors is closely tied to the provision of these very services. The Convention expressly states that, “for the purpose of promoting investments among member countries, the Corporation shall undertake activities that are ancillary to its main purpose and in particular the promotion of research relating to the identification of investment opportunities and the conditions of investment in the said countries.”

The Corporation has been very active, especially in the last few years, in providing services ancillary to guarantees. It has researched and published studies on all facets of the investment climate in the Arab countries and held conferences and training seminars on various issues and instruments of investment. It has also initiated a promotion service that seeks, within the means available, to acquaint Arab investors with investment opportunities open for financing. The Corporation has also provided technical assistance to member states to help improve the legal and institutional aspects of their investment climate and enhance the efficiency of cadres responsible for foreign investment promotion and administration in the Arab countries.

It is difficult to evaluate the impact of all these services on inter-Arab investment flows, especially over the short run. Being support services, their impact takes place through other measures. However much one may speak of specific achievements in the areas of promotion, legal consultation, or general foreign investment policies, they have had a direct effect on the achievement of specific flows and have contributed positively to improving the investment climate in general. No doubt, intensifying these services and pursuing them with professional competence, in addition to providing comprehensive, flexible, and reasonably priced guarantees, will prove most fruitful over the long run and will improve the investment climate within the Arab countries and thus lead to greater direct investment flows between these countries.

As a postscript, there are a number of objective causes pertaining to the nature of Arab investment flows and the process of developing guarantees that have contributed to reducing the size of guaranteed investments. The first cause is that the most outstanding direct Arab investments in the Arab countries came from public sources.17 Some were in the form of joint Arab projects, where government participation did not need any guarantees to encourage such participation. Also, it was during the heyday of the Corporation (the latter part of the seventies), when investments were at their peak, that the foundations of the Corporation were laid, its financial status consolidated, and its services defined. Finally, unofficial direct investment flows at both the international and Arab levels became tighter during the eighties. There were a number of reasons for this development, most of which go back to the deteriorating economic situation in most host countries, which, as suggested earlier, has a direct bearing on the weakening demand for guarantees.

To sum up, the role played by guarantees in attracting investments is an ancillary or complementary one, and an improved investment climate, in all its various political, economic, and institutional aspects, is really the key factor in attracting direct foreign investments to the Arab world. It cannot be overemphasized that the process of improving the climate of investment is extremely complicated and fraught with difficulties over the short run. But there are encouraging signs, not the least of which is that this question is a leading topic of discussion in international talks on development problems in general and on the debt question in particular. The prevailing view appears to be that improving the investment climate, through restructuring and readjustment of ailing economies toward greater liberalization, can help to attract resources, especially direct investments, that will not fetter the state with additional debts yet introduce new techniques and useful managerial experience; that is, greater commercial investment flows are a major avenue for resolving the debt problem and, ultimately, the problem of underdevelopment. There is no doubt that greater effort and assistance from the international and regional donor communities, embodied in their states and institutions, are central to achieving tangible progress in this area. But, ultimately, it is the indigenous initiatives of the countries concerned that are the determining factor.

Comment

Nour El-Din Farrag

The following remarks on the subject of investment guarantees bring together a number of points that seemed worth highlighting, some personal opinions, as well as certain clarifications that can only serve to complement Mr. Abdel Rahman Taha’s excellent study on “Investment Guarantees: The Role of the Inter-Arab Investment Guarantee Corporation.” Consequently, what follows is more an “annotation” than a “commentary,” but one that will hopefully stimulate further discussion.

First, the subject of investment guarantees is tied up with protecting the rights of the investor, as these guarantees are considered a form of property rights protection. In the advanced industrial countries, this matter is not in contention. There, property rights are protected by the nation’s constitution; the exercise of them is regulated by laws that acknowledge international conventions, and their application is supervised by fair judicial systems and preserved by impartial executive agencies, before whom the national investor and the foreign investor are equal. This broad system of regulation achieved its stability, permanence, and following after a long time, but it has generated confidence for the investor and has won his trust.

The advanced industrial countries have also instituted political, economic, and social liberties—shaped by the prevailing forms of government—and have adopted the market approach to managing their economies, intervening only in cases of infringement or breakdown resulting from progress and growth. They have long since abandoned the planned form of economy.

For these reasons, international investment capital moves freely between these countries, influenced only by traditional economic and financial considerations, and it excludes from its accounts what has come to be termed “political risk.” As the latter is the principal motivation behind the quest for investment guarantees, we do not observe in the developed countries provisions for guaranteeing investments against political risks, nor are there any known bilateral or collective agreements for protecting foreign investment, since there is no need for them. There are, however, regulations designed to encourage investment, both domestic and foreign, and to secure attractive returns commensurate with the extent of economic and commercial risk engendered in certain economic sectors or specific geographic areas that market forces do not reflect to the desired degree. But the investment’s source and its adjusted returns are surer than the political risk. This situation is not limited to the developed countries, for certain developing countries, albeit few, have been actively engaged in this process, especially those that have become, or are on their way to becoming, newly industrializing economies.

The question of investment guarantees, particularly foreign investment guarantees, in the sense of protecting foreign investment from political risk, is essentially one of the mobility of investment capital between capital exporting states (mostly the developed countries and a few developing countries) and the developing countries receiving these transfers.

One of the most important economic policy objectives for Arab countries hosting foreign capital is to reach a stage where this capital no longer needs defending against political risk, that is, a stage at which investment guarantee schemes can be dispensed with; and let our starting point be Arab investments within the Arab world.

Second, the importance of foreign investment guarantee schemes against political risk, especially the risk of currency inconvertibility, appeared shortly after the Second World War in response to the call for the reconstruction of Western Europe, whose economies had been ravaged by the war.

The capital exporting states of Western Europe became much more interested in these schemes following the breakup of their colonies in Third World countries, the recovery by these countries of their political independence and legal sovereignty over their own natural resources, the wave of nationalization of foreign investments that ensued in their territories, as well as the apprehensions and political disturbances that accompanied the first stages of independence, and the damage sustained by those foreign investments not subjected to nationalization.

The need of the advanced industrial countries for sustained flows of primary materials from the newly independent countries became intertwined with the corresponding need of the latter for financial resources to develop their economies. This need led to the creation of legal and financial schemes designed to restore confidence in foreign investment for the exploitation of these natural resources, or at least to narrow the margin of distrust prevailing. A series of bilateral international agreements to protect foreign investments were concluded between the capital exporting industrial countries and the developing countries with their sought-after natural resources. At the same time that these agreements were being concluded, national institutions were established to guarantee foreign investments against political risks in the developing countries.

Certainly, the goals of foreign investment guarantee schemes have developed considerably with the accelerating economic growth and prosperity of the advanced industrial countries during the second half of this century. Promoting the economic development of developing countries has become an objective of investment guarantee schemes in these countries. But fear and apprehension over the future of foreign investment in developing countries remain, because their political and judicial systems have not inspired much confidence. Legal and executive instruments are the two principal driving forces of foreign investment in most of these countries.

The profuse literature on the subject of foreign investment guarantees abounds with definitions of political risk, varying in length, limit, detail, and range according to the purpose of the study. But the studies all agree on the inclusion of three conventional categories of risk: (1) seizure, nationalization, and expropriation; (2) nonnatural catastrophes such as wars, civil violence, rioting, and insurrection; and (3) the inconvertibility of currencies or prohibition of transfers abroad. The convention establishing the Multilateral Investment Guarantee Agency (MIGA) introduced another category of risk—the breach of contractual obligations by the state toward the foreign investor where “travesty of justice” is in question, in either one of three forms: the absence of a legal or arbitration board to which the investor may appeal his case; the agency’s default in issuing its decision within a reasonable span of time; and the inability of the investor underwritten to implement the decision issued in his favor.

Considering the contemporary history of the Arab world, it is difficult to contend that a period rife with seizures, nationalization, and forced expropriation did not in fact occur in a number of Arab countries influenced by extremist doctrines, doctrines that proved in time to be hollow. On the other hand, it is not difficult to see the beginnings of a new phase within these countries, signaling a fundamental change in political and economic philosophies toward respect for the rule of law and the inviolability of property. Reflecting the roots of the new phase, this category of political risk is bound to wane and eventually disappear.

The remaining three categories of political risk vary in degree and importance from one Arab country to another. But there is no doubt that the risk of currency inconvertibility—in spite of its present inflated importance among many investors—is the least difficult to resolve and the closest to being abandoned in a number of Arab countries that have begun to adopt new structural reform policies for their economies. Moreover, this risk applies mainly to investment in import-substituting industries; no problem arises where the investment is in export-oriented industries—those industries to which capital importing countries are giving priority.

Legislation encouraging investment has been promulgated in a large number of Arab countries hosting such investments, or is presently being promulgated on the basis of the principle of protecting investment from the risks of seizure, nationalization, or expropriation, as well as the threat of currency inconvertibility, already incorporated in their clauses. Thus, legal guarantees against these risks have either already found their way into the legal system governing foreign investment in these countries, or are in the process of doing so.

As for the state’s breach of contractual obligations in travesty of justice, it is difficult to find any examples of this in the Arab countries. It is one of those risks that will automatically disappear with the spread of the current drive to respect the rule of law and preserve rights, and with the growing recognition of the need for greater foreign investment flows and of the positive, perhaps even central, role that Arab investments may play in building a new Arab economy.

That leaves nonnatural catastrophes—a political risk of which Arab investment is wary. These risks are without doubt concrete, but they are also limited to a few Arab countries, and their elimination is tied to the success of the current and rapid efforts being waged to restore peace and political stability and to renormalize the path of economic development in these countries.

To sum up, the risks of seizure, nationalization, and forced expropriation are no longer real threats in our contemporary Arab world. The other forms of political risk, though waning, remain, and vary in importance from one Arab country to the next, thus requiring some investment guarantee. However, in my opinion, this requirement is transitory and relates in an inversely proportional way to those long-term political and economic developments that are taking place now in Arab countries hosting Arab and foreign investments, which will be positively affected by the current developments among our neighbors to the north and east, as they are similar in nature and follow a parallel course.

Third, despite the voluminous studies and specialized research conducted on foreign investment guarantees and their role in the economic development of developing countries, one is hard pressed to find a single cogent quantitative study on the impact of the presence (or absence) of these guarantees on investment capital flows to these countries.

On the other hand, a number of recent studies on the subject, based on about two decades of experience in underwriting investments, including Mr. Abdel Rahman Taha’s valuable research for this seminar, have, through a qualitative analysis of this experience, reached the following conclusion: That investment guarantees are perhaps mostly a necessary condition for initiating investment flows to developing countries but are insufficient to sustain, increase, or develop these flows.

These studies summarize by stating that “guarantees against noncommercial risks are not in fact the decisive factor in direct investment flows between countries; … the role played by guarantees in attracting investments is an ancillary or complementary one, … [and that] the principal catalyst to these flows is in fact the availability of good investment opportunities within a conducive investment climate … [or] an investment climate that is on the whole reasonable.”1

The focusing of attention on the importance of familiarity with favorable investment opportunities, their identification and promotion, and improvement in the investment climate in developing countries that host investments led to initiatives taken in these two fields being assigned a prominent place within the basic objectives of investment guarantee corporations, which were also charged with providing technical assistance and consultancy services in these areas.

It is worth mentioning that as much as these corporations have improved the investment climate in host countries, the need of the foreign investor for guarantees before investing has correspondingly lessened; demand for them is decreasing or has ceased, and this is perhaps the ultimate measure of the success of these corporations in achieving the goals for which they were established.

This conclusion on the role of investment guarantees against political risks, irrespective of the natural financial attraction for the foreign investor that receives direct and effective compensation for material losses sustained, apparently led researchers to argue that the importance of providing investment guarantees through national or international specialized institutions lies more in the positive psychological effect they create for the investor when deciding whether to invest. Moreover, the provision of investment guarantees by multilateral institutions in which both capital exporting countries and recipient host countries participate serves to reinforce this psychological effect, if the host country shares the responsibility of guaranteeing investments against political risk and is committed to showing encouragement and sympathy when dealing with foreign investments.

Fourth, efforts by the advanced industrial countries—and a few newly industrializing countries—to provide protection against political risk for their foreign investments in developing countries led to the formation of a network of investment guarantee schemes comprising bilateral investment agreements that offer legal guarantees for foreign investments, and national institutions that provide financial (compensatory) guarantees against political risks to these investments.

The absence of corresponding schemes, especially financial compensation against political risks endured, for inter-Arab investments, and the dire need to promote these visible investments, were behind the formation in the early seventies of a multilateral Arab scheme to guarantee inter-Arab investments and the delegation of the task of applying it to the Inter-Arab Investment Guarantee Corporation (IAIGC).

This Arab scheme for underwriting investments is important because (1) it is the first such multilateral scheme joining together capital exporting countries and investment-receiving countries in one institution; (2) all its founding states are developing countries belonging to a single regional association; and (3) its objective is to serve as one of the pillars of joint economic development by encouraging the transnational movement of Arab capital for investment in productive projects, with decisions to invest subject solely to economic and financial considerations (that is, remaining free of political risks). Mr. Abdel Rahman Taha has highlighted the broad features of this inter-Arab investment guarantee scheme, as applied by the IAIGC since 1975, and his presentation was outstanding.

He also appraised the experience of this inter-Arab investment guarantee scheme in terms of the extent of its success in promoting visible Arab investments. He summarized: “Arab investment flows guaranteed by the Corporation since it began operations are very modest when compared with the figures for unofficial investment flows between the Arab countries, which were estimated at $9.88 billion at the end of 1988.”

Actually, the investment flows guaranteed by the Corporation were not only modest in proportion to total flows; they were small even in absolute terms. The total value of direct investment guarantee contracts and equity participation, as well as loan guarantees for financing investment projects, did not exceed $112 million at the end of 1988; this figure is divided between 7 countries out of a total of 20 participating countries.

The modesty of what has been achieved to date compared with what was sought in inter-Arab investment schemes, which Mr. Taha attributes to “objective causes,” may also be due to the following:

  • The discrepancy between the financial resources made available to start the Corporation (10 million Kuwaiti dinars in capital) and the requirements that it play an influential role in promoting investment capital flows needed to finance many new projects that are by their nature large scale, such as in petroleum and petrochemicals, energy, mining industries, and agroindustrial complexes.
  • National investment guarantee institutions in capital exporting countries ultimately rely on the financial capacities of their countries; the guarantees they issue are covered by their own governments, which is not so with the IAIGC.
  • The Corporation works alone in an extremely complicated field, for there are no country investment guarantee institutions with which to dovetail when providing supplementary financial resources to a disguised insurance cover that can affect the investments needed to implement major projects.
  • National investment guarantee institutions are permitted, within limits, to increase their financial resources by obtaining long-term loans guaranteed by their governments; the IAIGC was permitted no such opportunity.
  • As a result of all these factors, and in the interests of economy and caution, the figures for all available project guarantees during the first several years of the Corporation’s operations were greatly dampened. This situation no doubt affected the institution’s image before investors. Although the Corporation was later able to double its capital and achieve the same in reserves, the figures for guarantees available for each project continue to range between $15 million for conventional projects and $30 million for joint projects, which are still modest when considering the investment requirements of large-scale Arab projects.
  • A few years ago the Corporation began guaranteeing Arab export credit facilities against political risks, and the total value of contracts concluded reached $350 million by the end of 1988. This figure represents about 76 percent of total contracts concluded up to that time; other contracts amounted to $113 million, thus making the overall total $463 million.

If the figures for operations under consideration for the same period are included (and these total $381 million, with $106 million in investment guarantees and $275 million in export credit facilities), a total of $844 million is obtained. But this amount exceeds the upper ceiling set by the Corporation’s Convention for total guarantees—five times the capital reserve, or $762 million. It is also indicative of the constraints imposed by the Corporation’s financial center on the potential expansion of its operations, and suggests that a re-examination of its own financial resources and operational priorities is in order. They should be balanced against the desired growth rate for its operations.

  • It may be advisable when conducting such a re-examination for the Corporation to examine the potential financial (and technical) benefits of cooperation with MIGA, now that seven Arab countries have become signatories to the Convention establishing the Agency and thus wield significant voting power—slightly over 11 percent of the total voting power of all member countries—which will doubtless increase, as three other Arab countries are also preparing to endorse the Convention.
  • Positive comment is also in order here. The Corporation is to be commended for the great efforts it has made to provide ancillary services, especially in the two areas of identifying available investment opportunities in host countries and specifying the types of projects open for investment, and in providing technical assistance to help host countries improve their investment climate, particularly from the legal and institutional sides. The Corporation has also contributed much to developing human resources in these fields and to promoting and attracting Arab investments to their own countries.

Mention has already been made of the paramount importance attached by research on foreign investment to the question of improving the investment climate, as it is the principal criterion for external investment flows to the developing countries.

In summary, the Inter-Arab Investment Guarantee Corporation has confirmed the operational viability of an Arab system for investment guarantees and its capacity to develop within the available financial means. It therefore truly deserves to pursue these capacities at a level commensurate with contemporary Arab requirements for investment guarantees and thus expand its means and its effectiveness in channeling more Arab investments back into the Arab world.

1For a detailed examination of the concept of “investment climate,” see “The Elements of the National Investment Climate,” Training Seminar on Financial Markets and Sources of Finance, Khartoum, Sudan, March 7–12, 1987 (Kuwait: Inter-Arab Investment Guarantee Corporation).
2See Charles Kennedy, Jr., Political Risk Management: International Lending and Investing Under Environmental Uncertainty (New York: Quorum Books, 1987).
3A detailed discussion of legal protection for foreign investments may be found in Chapter 2 of Zouhair A. Kronfol, Protection of Foreign Investment: A Study in International Law (Leiden: A.W. Sijthoff, 1972).
4See Arab League and IAIGC, Investment Legislation in the Arab Countries, a series on the laws governing investment in 15 Arab countries (Kuwait, 2nd ed., 1987).
5For a typical case, see “Law No. 18 for 1975 Regarding Promotion and Regulation of Investment in the Yemen Arab Republic,” in Chapter 2, “State Guarantees for Investment Projects,” Articles (3) and (7), Investment Legislation in the Arab Countries (Kuwait: Arab League and IAIGC, 1987), pp. 9–10.
6Alan C. Brennglass, “Investment Guarantee and Political Risk Programs,” Chapter 17, in Political Risks in International Business: New Directions for Research, Management, and Public Policy, ed. by Thomas L. Brewer (New York: Praeger, 1985).
7The United States, Japan, the Federal Republic of Germany, France, Canada, Australia, the United Kingdom, Austria, Belgium, the Netherlands, Finland, Norway, Italy, Sweden, and Switzerland.
8Ibrahim F.I. Shihata, MIGA and Foreign Investment: Origins, Operations, Policies and Basic Documents of the Multilateral Investment Guarantee Agency, Part II (Dordrecht, Netherlands: Martinus Nijhoff Publishers, 1988).
9MIGA, Annual Report, 1989 (Washington).
10Article (2) of the Convention Establishing the Inter-Arab Investment Guarantee Corporation. The Convention was subsequently modified to incorporate commercial risk associated with export-import credit facilities between the member countries (Corporation Council Decision No. 9 for 1987). The Corporation has developed a scheme for guaranteeing exports, which went into effect in 1986.
11The Corporation plans to issue a new guarantee contract for services; it would include a guarantee for contracting in addition to transportation and consultancy services.
12Includes public sector investments managed according to business principles.
13See IAIGC, “Inter-Arab Investments: Their Progress, Successes and Failures,” research report presented at Eleventh Conference of the Arab Economists Union, Casablanca, October 3–5, 1989, Table (1), p. 6.
14A good discussion of this concept may be found in a report by Arthur Young & Co., dated May 28, 1982, to the Overseas Private Investment Corporation (OPIC) as to the impact of OPIC’s activities on U.S. investment flows to developing countries. The report defines “additionality” as the net increase in investment flows resulting from the guarantee of a given project.
15See article by David Goldsbrough, “Foreign Direct Investment in Developing Countries,” Finance and Development, Vol. 22, No. 1 (March 1985), pp. 31–34.
16For a description of the distribution of Arab investment flows between the Arab countries specifically, see IAIGC, Report on the Investment Climate in the Arab Countries, 1988 (Kuwait, May 1989), pp. 50–51 (Table 2).
17The government share in investment flows managed according to business principles in the seven major Arab countries receiving investments amounted to nearly 87 percent. See IAIGC, “Evaluation of Arab Investment Projects,” paper presented at Seminar on Performance Evaluation of Arab Investment Projects, Amman, Jordan, May 22–23, 1989.
1Abdel Rahman Taha, “Investment Guarantees: The Role of the Inter-Arab Investment Guarantee Corporation,” above.

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