The role of politics in investment climate: Some thoughts from the Bolivian experience

Wednesday, July 19, 2006 12:40 PM by Massimiliano Cali

It was quite surprising to read in yesterday's Financial Times that the Bolivian government is set to approve a US$ 2.3bn bid by two Indian companies (Jindal Steel and Power of India) to extract of one of the world's largest untapped iron ore deposits. The numbers are even more impressive considering this would be the first Indian investment in Bolivia and the largest Indian investment in the whole Latin America.

This news comes shortly after the Bolivian government's decision to nationalise the natural gas sector (the most important commodity in the country), which broke the contracts signed with multinational oil companies a few years before by a different government (see ODI Blog: At what price gas? Bolivian energy policy and nationalism). Quite interestingly, the country has also recently attracted expressions of interest from Russia (Gazprom announced last month an interest in investing up to US$ 2bn in Bolivia's gas sector) and Australia (Republic Gold could shortly start producing in a large gold mine in the southern part of the country). This news may provide some interesting food for thought on Bolivia and on the relationship between politics and markets in developing countries.

To the extent that a firms' expected profitability (on the basis of which investment decisions are made) is negatively affected by political risk, one would be tempted to interpret these investment decisions as a sign that markets do not seem to consider the Bolivian political situation particularly unstable or insecure for investment. Or at least, the boom in commodity prices provides a greater incentive than the disincentive given by Bolivian political risk.

To be sure, the nationalisation of the gas reserves has already made a direct impact on Bolivia's attractiveness to foreign capital. The fact that the traditional economic partners of Bolivia (Brazil, US, Spain, France) are not involved in the new investments' plans may be a direct consequence of nationalisation hitting their companies hard. Moreover, by slowing down the operations due to the uncertainty in the contracts, nationalisation is likely to pose potentially serious constraints to the development of the Bolivian gas sector.

However, it is intriguing to notice that one of the most explicit actions against the creation of a good investment climate (as the breakage of public contracts is) seems to be producing effects hardly explicable by conventional wisdom. In order to reconcile the Bolivian facts with this wisdom, it is tempting to consider a third, somewhat paradoxical option: the renegotiation of the gas contracts in Bolivia has not hindered the investment climate of the country. This may be the case if investors considered the terms of the old gas contracts as very favourable to multinational companies; therefore, the re-negotiation of contracts would not undermine investors' profitability, and it would be appropriate on the ground of fairness. But economists don't tend to believe in paradoxes...