When Corruption is Low, Your Profits are High

By Martin Hutchinson
Director of Global Equity Research

Transparency International last week published its Corruption Perceptions Index, ranking 180 countries around the world according to their level of corruption. That sounds like boring goody-goody stuff, suitable only for one of the less-interesting World Bank seminars.

But that's not the case: The level of corruption in a society is a measure of the leakage from that country's economy. In other words, if you've invested in a corrupt country, a portion of the profits that should be going into your pocket is being siphoned off somewhere else.

This is a particularly important consideration for international investors, since many of the markets abroad are nowhere near as efficient as ours.

When you're investing internationally you need to consider this issue; it's available at: http://www.transparency.org/news_room/in_focus/2007/cpi2007/cpi_2007_table

The CPI isn't the only thing you must consider: If it were, you'd plunk the entire bundle down in Denmark, Transparency International's #1 country (the truth is, you could do much worse). You can't learn much in general from the small differences between the countries at the top of the list; after all, the United States is only 20th, and we're all presumably pretty satisfied that this market is a safe-enough place to invest.

Differences between emerging markets, and between different regions, are much more illuminating, however. You'd expect Scandinavia and northern Europe to rank high, and they do, but there are East Asian countries scattered among the Scandinavian nations, a remarkable tribute to places that were very poor only 40 years ago. Singapore, for example, is at #4 - ahead of Britain, Germany, the United States and everywhere else, except for New Zealand and a couple of the Scandinavians.

Hong Kong and Japan are both higher on the list than the United States, while Taiwan is at #34 and South Korea at #43, both pretty respectable levels.

The major bad news for Asia from Transparency International's list is the position of its two great growth stories, China and India. Tied with Brazil and Mexico at #72, they are one place below Senegal. While a mid-table position isn't disastrous, it indicates that corruption is a very serious problem in both countries. Typically, this corruption is worst in the public sector, and in the banking system as a whole - both areas in which a modest bribe can secure an altogether disproportionate benefit. In India, it means that any company dealing with the public sector is likely to get in trouble - think, for example, of the disastrous investment Enron made in the Dabhol power plant a few years back. In China, pretty well all quoted companies are majority controlled by the public sector, and so is the banking system, while price-earnings ratios are above 30. However brilliant are its growth prospects, China is thus a very dangerous place to invest.

Some other Asian countries are even worse - Burma brings up the bottom of the table at #179. But you presumably wouldn't put money there anyway; nor probably in Iraq (#178), Afghanistan (#172), or Bangladesh (#162). However, Indonesia and the Philippines are surprisingly low, at #143 and #131 respectively, and if you're an experienced emerging markets investor I'm sure your broker has shown you investments from those countries. Both countries are at a level where, as a foreign investor, not only are your investments unsafe, but so are everybody else's. In the long term, or even in the medium term, growth from such a base is impossible unless the government produces drastic and long-lasting reforms.

Outside Asia, Transparency International's table is generally bad news for Latin America. Some countries are okay - Chile and Uruguay are both well ranked at #22 and #25 respectively, pretty well up with European levels (but there's little for a U.S. investor to buy in Uruguay). However, Mexico and Brazil are down with China and India, where corruption is a real problem, and Colombia (#68) is only a little better. Even worse are Argentina, at #105, and Venezuela, at #162. The Middle East is also pretty tough, though the Gulf States of Qatar and Bahrain seem OK.

Africa doesn't rank as badly as you might think, though very poor African countries make up most of the bottom-feeders. Botswana at #38 and South Africa at #43 both have perfectly respectable ratings, comparable with Italy (#41) for example, a country you'd presumably be fairly happy to invest in. If you're interested in natural resources investments, some of Africa should thus not be ruled out.

Southern and Eastern Europe, finally, are a bit iffy but not really disastrous. Greece at #56 and Turkey at #64 are both at levels where corruption is a problem, but they shouldn't be ruled out as investments. Most of the Eastern European countries that were formerly communist are more or less OK too - Bulgaria at #64 and Romania at #68 bring up the tail. However, with the exception of the Baltic States, if a country was in the old Soviet Union, you should worry. Ukraine is at #118, which probably doesn't surprise you, but the richer and more investable countries of Russia and Kazakhstan are worse, not better (#143 and #150.) I should avoid both.

To summarize, Transparency International's Corruption Perceptions Index is useful mainly as a check for investments that may otherwise seem attractive. If a country is above #50 on the list, then corruption probably isn't a major problem, except in particularly problematic areas like government contracting. Between #50 and #100 or so, corruption is endemic in the society and a risk to you as a foreign investor. While it may not prevent the country enjoying good economic growth, it may prevent you as an investor or a foreign company as a direct investor from enjoying the fruits of that growth. If a country ranks below #100, it is very unlikely that it will enjoy any kind of economic takeoff, although with good natural resources (Russia, Kazakhstan, Venezuela) it may have a few good years if resources prices are high.