Businesses’ political risks used to be fairly simple. If a foreign firm invested in an unconstrained autocracy, the government might just seize its assets. Think about Venezuela expropriating General Motors in 2017 or ExxonMobil back in 2007. Investing in democracies with strong, independent courts, on the other hand, was relatively safe.
No longer. Since the 1980s, outright expropriation has declined. In its place, a subtler, but equally costly, form of political risk has emerged: transfer risk.
Transfer risk means the risk that a government might limit investors’ ability to freely move funds out of a country or to convert funds from local to foreign currency. That’s what happens, for example, if a U.S. company invests in Argentina, earns income in Argentine pesos, and then is barred from converting those pesos to dollars or is forced to do so at an artificially low exchange rate.
The governments that impose transfer restrictions are not just left-wing populists and autocracies. For instance, just now, China is considering removing transfer restrictions at the same time Britain is considering implementing them. It’s the world turned upside down.
Here are four things every investor needs to know:
1. Subtle government theft can still be costly.
In a headline-grabbing expropriation, in 2012, the Argentine government seized shares worth roughly $10 billion in the oil firm YPF from Repsol, a Spanish firm. At the same time, with much less public attention, the Argentine government was collecting more than $225 million a day from transfer restrictions that forced firms to convert pesos to U.S. dollars at an artificially suppressed exchange rate. At that pace, it took Argentina only weeks to seize more from foreign investors through transfer restrictions than from the YPF nationalization.
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While the full effect of an expropriation is visible immediately, the costs of transfer restrictions accrue over time. Firms’ costs increase the longer restrictions stay in place. Over time, costs can rise to a level that drive foreign firms out of business or out of the country.
2. Transfer restrictions are easy for governments to justify.
When a government expropriates a mine or a factory, it is clearly violating the rule of law. Investors punish the government by withdrawing investments; the International Monetary Fund and World Bank are likely to protest; and the expropriated firm can usually sue the government in international tribunals to get back some or all of its lost assets.
Transfer restrictions are different. In times of crisis, governments may need to impose short-term restrictions on investors’ ability to move money out of the country. Ever since the Asian financial crisis in 1999, the IMF has acknowledged that such temporary restrictions can be sound policy.
This makes it difficult to tell when a government is imposing temporary restrictions to prevent a currency crisis and when it is imposing restrictions that will last a long time and extract significant wealth from foreign investors.
As summarized to us by one prominent international investor who wished to remain anonymous, “transfer risk is very benign: It happens in banks, under the table on dark Saturday nights, and there are no headlines.”
3. Democracy doesn’t prevent transfer restrictions.
Democracies rarely expropriate; generally, voters want governments to uphold the rule of law. Further, in democracies, courts can usually block the government from unjustly seizing assets.
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But transfer restrictions are entirely different — and elections and strong courts are no protection.
Our research finds that countries with more independent checks and balances expropriate two times less often than countries without these constraints. But constrained governments are just as likely to impose costly transfer and convertibility restrictions. In fact, as a formerly unconstrained country becomes more institutionalized, its government becomes more like to impose transfer restrictions.
The most recent evidence comes from Britain, where politicians have discussed imposing transfer restrictions to prevent investors from removing their capital as Britain separates from the European Union.
4. For investors, transfer risk is the political risk of the future.
International trade and investment treaties have been quite successful in reducing the risk of expropriation that overseas investors used to face. Many of these treaties, however, allow governments to impose transfer restrictions.
In its most recent report, the IMF identifies 43 countries with some type of transfer or convertibility restriction in place. Our research suggests that this number is unlikely to decrease anytime soon.
Benjamin Graham is assistant professor of international relations at the University of Southern California and co-founder of the Security and Political Economy (SPEC) Lab.
Noel Johnston is assistant professor of political science at the University of California, Riverside.
Allison Kingsley is assistant professor of strategy at the University of Vermont Grossman School of Business.