Investing in emerging and frontier markets can often help investors to diversify equity holdings and provide exposure to growth opportunities not available in advanced economies. But with any opportunity for big gains often comes significant risk, including the potential for political instability, currency revaluation, and government intervention in the private sector. There’s also the issue of corruption in the world’s developing economies. While corruption exists everywhere, it is a way of life in some countries, and has the potential to significantly impact returns on both foreign and domestic investment.
A recent corruption perception index survey from Transparency International ranked countries from least corrupt to the most corrupt, taking into account the results of 13 independent corruption surveys. The top of the list consists of countries such as New Zealand, Denmark, and Singapore (the United States ranked 19th), with countries such as Somalia, Afghanistan, and Myanmar at the very bottom.
One trend is readily apparent: the world’s developed markets dominated the top, with emerging markets lagging behind and “failed states” bringing up the rear. While investment in several of the most corrupt countries isn’t an option for U.S. investors, several that scored very poorly are available through ETFs.
Russia: 146th Out Of 180
Russia has been a notoriously corrupt country since Soviet days, and despite noticeable improvements, general corruption has continued into the Putin/Medvedev era. Russia tied with Sierra Leone and Zimbabwe in this survey, putting the BRIC nation’s corruption in perspective. As just one example, Ikea recently declared that it would halt investment in Russia, due to omnipresent concerns over bribery and other payouts to obtain state services.
Vietnam: 120th Out Of 180
Recent corruption problems in Vietnam have included the use of proceeds for World Bank projects to gamble on European soccer matches, a shocking tale even in the least ethical corners of the world. Revelations like these have helped to set back this dynamic Asian economy, which is still among the fastest growing in the world.
Signs of progress are showing in Vietnam–Intel recently pledged to build a $1 billion factory without corruption–but for the time being the country remains among the most corrupt of the investable frontier markets.
Indonesia: 111th Out Of 180
Indonesia is a vast country both in terms of land mass and people (the nation currently ranks 4th in terms of total population). In its post-dictatorship era, the country has looked to decentralization to better manage the country. The problem is that now instead of having to pay one bribe to the federal government, many smaller bribes are required in order to appease each and every one of the many public officials that may be able to influence a project. This has led to a new kind of bribery bureaucracy that runs lockstep with the Indonesian government.
Mexico: 89th Out Of 180
A major problem in Mexico is drug trafficking, as it becomes increasingly difficult to isolate the crooked cops from those that are being paid of by the cartels. However, President Calderon has led a sweeping campaign to attack the cartels and cut down on corruption since his recent inauguration. This campaign has seen some moderate successes but also some gruesome setbacks, and has called into question the ability of the government to protect its employees and citizens from increasingly defiant gangs.
Thailand: 84th Out Of 180
In addition to the low public official salaries, Thailand has been a relatively unstable country politically, with 15 constitutions between 1932 and 1997 (PDF). These two factors keep Thailand among the world’s most corrupt countries, with little prospect of changes anytime soon. However, the country remains a staunch U.S. ally and the King of Thailand remains personally popular with the Thai people, despite the vast number of changes politically over the years.
India: 84th Out Of 180
Corruption in India is so widespread that there has even been talk of priests taking part in the practice by selling baptism certificates. In years past, companies such as Coca-Cola have pulled out of the country over concerns regarding their product protection laws. India has seen a volatile market over the past four years as many grow concerned over the inability to provide a decent infrastructure and other services for its citizens.
China: 79th Out Of 180
Recent cases in which communist party officials doubling as drug kingpins who amassed fortunes by taking bribes have highlighted the extent of corruption in China. The country has been able to deflect most of the international issues associated with corrupt party officials thanks in large part to its more corrupt neighbors and the country’s growing importance to the global economy.
ETF Results: The iShares FTSE/Xinhua China 25 Index Fund (FXI) is up an impressive 47% over the past year, while the Claymore/AlphaShares China Small Cap ETF (HAO) is up nearly 100% during that period.
Nice Guys Finish Last
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As evidenced by the impressive returns for many of these funds, countries that are perceived as corrupt can still make excellent investment opportunities. Concerns over potential corruption can often push pricing multiples lower, creating the potential for big gains if progress towards developed status is made. Investors must first weigh the risks and costs of corruption with the chance to obtain outsized gains.
Volatility is a double-edged sword that applies on both the way up and way down. During the impressive rally of the last year, many of the world’s more corrupt markets have surged, outpacing the U.S. and other developed, stable economies by a wide margin.
Disclosure: No positions at time of writing.