Corruption, governance risks: The cost of doing business in emerging markets?

Beyond a governance issue, corruption is a major deterrence to capital flows, undermines long-term development and carries crippling social costs. Seasoned investors, though, are quick to challenge the notion that corruption and governance risks are not bound by geography.

Transparency International policy manager Rebecca Mackinnon says corruption "significantly" distorts emerging market economies.

"Foreign investment and corruption have this deeply intertwined relationship, especially in emerging economies. Essentially, a high-corruption environment deters legitimate interest, and it crowds in illicit capital instead," she told Financial Standard.

This dynamic is particularly evident in resource-rich economies with weak governance frameworks. Countries like the Democratic Republic of Congo, she said, has vast mineral wealth, but struggles to translate natural resources into sustainable economic growth.

"For somewhere with unbelievably rich mineral wealth but no governance or oversight over licensing and permits, what that means is you get someone who's very corrupt coming along and paying for that licence," Mackinnon said. "You're not getting ethical operators - you're getting exploitation."

Out of the 182 countries in this year's Corruption Perceptions Index (CPI), only 30 improved their corruption scores in the last year. About 100 stagnated, with Asia-Pacific countries showing only marginal gains.

Denmark took the top spot for the eighth time in a row with the highest score of 89. Finland (88), Singapore (84), Australia (76) and New Zealand (81) also score highly - countries perceived to be the least corrupt or "clean" countries.

Weak governance and limited accountability were key themes among lowly ranked countries. The Philippines scored 32 points, while Indonesia and Laos received 34 points each.

MSCI has threatened to strip Indonesia its emerging market status due to "structural issues in the opacity in shareholding structures and concerns about coordinated trading."

For these reasons, MSCI froze Indonesia's stocks in early 2026. Such issues "materially limit international institutional investors' ability to assess true free float and to rely on observed market prices for portfolio construction and index replication," the index provider said.

MSCI this week announced it will extend its review of Indonesia to further investigate if it is deserving of emerging market status or else downgrade it as a frontier market.

Mackinnon points out that when corruption is endemic, it raises the cost of doing business through bribes, unpredictable regulatory environments and weak rule of law.

"This, in fact, effectively acts as a significant barrier to transparent foreign direct investment that developing economies need to grow," she said.

Rather than take blanket exposure to countries or indices, active managers are selectively allocating capital to companies and management teams they trust, while avoiding those where governance risks outweigh potential returns.

The recent Stockbrokers and Investment Advisers Association (SIAA) Conference heard emerging markets often lack the same depth of regulatory backstops as developed economies, placing greater emphasis on assessing management integrity and alignment with shareholder interests.

As a result, valuation discipline becomes critical as investors must factor governance risk directly into what they are willing to pay.

J. P. Morgan Asset Management Asia head of investment specialists for emerging markets and Asia-Pacific equities Alexander Treves sees a wide range of governance standards at the individual corporate level and across governments of emerging markets. Governments also play varying and sometimes outsized roles.

"For example, the Chinese government is much more interventionist in capital markets than in some other places. Sometimes that causes issues. At other times, it can be a tailwind. China's ability to build infrastructure and get things done is directly correlated with the role the government plays," he said.

More importantly, Treves said, it would be amiss to believe that developed markets are immune to governance issues and shortcomings.

"I've been doing this job for 30 years, and many of the biggest corporate scandals during that time have actually occurred in the West - think Lehman Brothers, Enron and so on," Treves said.

"I'm a bit wary when people say governance is shaky in emerging markets but assume it's robust in developed markets. That's simply not true."

Apart from economic costs, the social costs stemming from corruption tend to be far-reaching.

Mackinnon said the social costs are "equally stark."

"Corruption enables human rights abuses, strengthens the influence of elites and organised crime, and diverts public funds away from essential services," she said.

"It diverts resources from infrastructure, education and healthcare into private pockets. That weakens the very foundations of an investable economy."

Some argue that corruption can be described as a type of "tax".

It's a useful starting point, Mackinnon said, but describing it as a tax "significantly undersells" the damage that corruption does.

"Taxes, while they have lots of flaws and can be unequal or regressive, at least fund public services and are somewhat accountable. Corruption has none of that," she said.

"Unlike tax, corruption is random, destructive and regressive. It falls heaviest on those least able to pay, including small businesses, citizens and communities that depend on public infrastructure and services."