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The Perils of Investing in New Democracies

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It is natural for foreign investors to get excited about the prospects that await them in newly democratized countries -- particularly in places where the ability to invest was either closed or severely restricted by the host country itself, or through sanctions by the international community. Soon after a country's 'liberation,' an investment conference usually draws prospective bankers and investors together, exploring the country's possibilities and extolling its seemingly endless opportunities. However, it is important for investors to temper their enthusiasm, for it is often the case that the risks associated with investing in new democracies either exceed or may not justify the potential reward.

We must first bear in mind that the investment regime that existed just prior to a country's liberation took many years to put in place and may be extremely restrictive to foreign investors. Entrenched economic and political interests do not simply disappear because of a change in the country's political structure. An excellent example of this is what is occurring now in Myanmar, where the previous military government had extensive business interests and a new foreign investment law is in the process of being drafted and approved by the country's legislature.

The draft legislation contains many protectionist provisions among its nearly 100 parliamentary amendments -- many inserted by politicians with links to the country's former military government, which require foreign investors to partner with politically-connected local partners. The draft law also includes more than a dozen investment sectors where vague wording leaves investors to wonder whether venturing there would be a good or bad idea.

Myanmar's president is so uncomfortable with the existing draft that he sent it back to parliament for revision when it reconvenes more than a month from now. Until the new law is passed, the existing investment law, adopted in 1988, will continue in force. Some foreign investors believe that the existing law may be preferable to the new, highly politicized draft law, given its vagueness, particularly given the amount of leeway the country's foreign investment regulating agency has in interpreting the new law.

In reality, whatever version of the new investment law is adopted, the first foreign investors to take the plunge will be diving into an abyss of unknowns -- even if they partner with well connected business interests. For U.S. investors, such an alliance could lead to potential conflicts with respect to the Foreign Corrupt Practices Act, depending on what is required to satisfy their partners.

Last week's events in Libya are a reminder that it, too, is another newly democratized country where there are many unanswered questions. The 2012 Investment Law bars foreign investment in 12 economic areas, including importation, and wholesale and retail sales. In Tunisia, foreign investors are denied national treatment in the agricultural sector, and until recently, foreign investment was actively discouraged in a number of service sectors, such as restaurants and retail sales.

In March of this year in Egypt, the outgoing military government implemented two amendments to the 1997 investment law which allowed investors that were accused of corruption, embezzlement or graft to be able to return the stolen assets at face value (at the time they were taken) in exchange for being prosecuted. In essence, 'if' someone is caught, he/she will escape prosecution and punishment if the money or asset is returned. These amendments - designed in particular to protect members of the previous government -- have not been formally challenged by the new government. Egypt's General Authority for Investment -- not a court of law -- rules which assets were stolen, their value, and how they should be returned, thereby completely bypassing the judicial process. Welcome to the 'new', democratic Egypt.

Inevitably, each newly democratized country will tell a similar story. Entrenched political, business, or military interests will remain entrenched. In Egypt's case, the military is thought to own up to 40 percent of the country's businesses. That will not change overnight or perhaps ever. If ongoing democratic change has taught investors anything, it is to expect the unexpected. The landscape will surely change at a moment's notice, often with unpleasant surprises.

The best advice any potential investor in a newly democratized country should heed is to be wary, cautious, and acutely focused on protecting your interests. Hire a knowledgeable local business lawyer, try to ensure that your joint venture partner can get things done without getting you into trouble, monitor changes in the investment and other laws to ensure your business is in compliance, and try not to invest in sectors that are deemed 'strategic' to the government unless you are highly experienced in doing so and have your feet firmly planted on the ground. The introduction of democracy can create new problems for businesses and politics alike.

Daniel Wagner is CEO of Country Risk Solutions and author of Managing Country Risk.