Operating in new regions brings risk for construction

11 September 2018

There are several factors that construction businesses must consider as they look to operate in new, high-growth regions.

Ambitious infrastructure development programmes in emerging markets across Asia, Sub-Saharan Africa (SSA) and the Middle East and North Africa (MENA) will drive construction sector growth in the coming years, as governments look to plug infrastructure gaps and private investors seek higher yields.

According to BMI Research, sector growth in emerging markets is expected to average 4.9 per cent annually between 2018 and 2022, compared with just 2.4 per cent in developed markets.

As construction firms look to enter these high-growth regions, often for the first time, they must contend with an array of risks in unfamiliar operating environments. Here, we outline considerations for companies across the security, trading and investment environments when entering new regions.

Global operations, local opposition

Construction firms operating internationally often bring expertise to projects that is not available locally. However, foreign participation in major projects can also be a source of grievance among local populations, elevating security risks.

This has been seen across Asia in response to outbound Chinese investment under the Belt and Road Initiative.

For example, nationalist groups opposed to Chinese investment in Pakistan have routinely targeted construction projects in the China-Pakistan Economic Corridor with improvised explosive device (IED) attacks and kidnapping for ransom.

Local grievances could also result in protests that prevent access to construction sites, cause damage to site equipment or pose injury risks to employees.

Consideration 1:

Construction businesses should assess the broader impact of their operations when entering a new region, engaging where possible with local communities and implementing adequate crisis management procedures to protect people and assets.

Look below the surface

While elevated growth rates are commonplace in emerging markets, they often mask structural economic imbalances, potentially exposing construction firms to a rapid deterioration in the economic outlook after entering a new region.

Across SSA, governments have incurred elevated fiscal deficits to fund infrastructure development programmes, pushing up sovereign credit risks and increasing the likelihood that payments to construction companies will not be fulfilled.

In Kenya, general government debt is forecasted to reach 60 per cent of GDP by the end of 2018, up from 40.8 per cent in 2010. There are growing concerns about the government’s ability to meet its payment obligations while maintaining current spending levels on infrastructure.

Firms are also likely to experience significant challenges operating in any country that is heavily leveraged to a single commodity in the instance of a price downturn.

Falling commodity prices can deplete foreign exchange reserves as export revenues drop. This can often lead to hard currency shortages, limiting the ability of foreign companies to repatriate earnings denominated in the local currency.

Governments may also introduce stringent capital controls to limit currency outflows.

Consideration 2:

Construction businesses should look beyond headline economic growth when entering a new region. Consider whether government investment in infrastructure is sustainable and how operations may be affected by a rapid deterioration in economic conditions.

Construction implementation challenges

Governments across SSA, MENA and Asia are keen to encourage foreign participation in ambitious construction projects. However, legal and regulatory systems in emerging markets are often underdeveloped, generating a number of risks.

Construction companies should pay particular attention to the bureaucratic hurdles associated with participating in a project.

In many countries, approval procedures for construction permits can be cumbersome and inefficient, causing significant project delays.

Construction projects can also be highly politicised and a change in government can result in the cancellation of projects supported by previous administrations.

In Sri Lanka, the election of a new president in 2015 resulted in the suspension of the Colombo Port City project, as the new government looked to roll back Chinese influence.

As a result, while the project pipeline has grown across frontier and emerging markets, there has also been a rapid uptick in the number of cancelled projects.

Between January 2016 and October 2017, the global number of cancelled and suspended projects doubled: a reflection of the challenges that construction firms may face when entering a new region.

Consideration 3:

Construction firms entering a new region should consider the likelihood that projects will be delayed or cancelled, and assess whether the legal and regulatory environment offers effective investor protections or contract enforcement measures in the case of cancellation.

Managing risk when entering a new region

It is clear that firms looking to capitalise on global opportunities in the construction sector will increasingly look to emerging markets.

With growing numbers of construction companies entering new regions, they must grapple with unfamiliar risks.

To help firms manage a disparate range of country risks, JLT has developed World Risk Review, an online country risk ratings platform. Providing ratings for 197 countries across nine perils, World Risk Review enables users to monitor dynamic risk environments over time in a portfolio of countries.

World Risk Review can support a broader risk management strategy. Our Credit, Political and Security Risks team works with clients to secure insurance solutions, covering perils such as kidnap for ransom, terrorism, political violence, expropriation, licence cancellation, contract frustration and currency inconvertibility, among others.

For more information, please contact Eleanor Smith, Senior Political Risk Analyst on +44 121 626 7837