POLITICAL RISK

POLITICAL RISK

ARISES FROM THE UNCERTAINTY OVER THE

CONTINUATION OF A GOVERNMENT AND POLICIES

THAT IMPACT FOREIGN INVESTORS’ PROFITABILITY.

Moreover...

POLCIES, THAT ARE UNPLEASANT, DO NOT

CONSTITUTE RISK AS LONG AS THEY ARE TRANSPARENT

AND ENFORCED WITH CONSISTENCY.

POLITICAL RISKS

INSTABILITY RISK

OWNERSHIP RISK

OPERATIONS RISK

TRANSFER RISK

INSTABILITY RISK

ARISES FROM THE UNCERTAINTY ABOUT

STABILITY OF A GOVERNMENT.

OWNERSHIP RISK

ARISES FROM THE UNCERTAINTY ABOUT A GOVERNMENT’S DECISION

TO REDUCE FOREIGN INVESTORS’ OWNERSHIP IN THEIR INVESTMENTS

IN THE COUNTRY.

CONFISCATION

IMPOUNDING OF THE PROPERTY OF FOREIGN INVESTORS BY THE HOST

GOVERNMENT WITHOUT COPENSATION.

EXPROPRIATION

PURCHASE OF PROPERTY FROM FOREIGN INVESTORS.

NATIONALIZATION

PURCHASE OF PRIVATE BUSINESSES BY HOST GOVERNMENT.

DOMESTICATION

PLANNED REDUCTION OF EQUITY HELD BY FOREIGN INVESTORS.

OPERATIONS RISK

ARISES FROM THE UNCERTAINTY ABOUT HOST GOVERNMENT’S

POLICIES THAT MAY CONSTRAIN FOREIGN INVESTORS’ OPERATIONS

IN THE COUNTRY.

They can change policies regarding...

• PRICES

• TERMS OF COMPETITION

• TAXATION

• PRODUCT SPECIFICATIONS

MEASURES CAN BE HIGHLY VARIED AND UNLIMITED

AND

THEY CAN BE AS DEVASTATING AS EXPROPRIATION

TRANSFER RISK

ARISES FROM THE UNCERTAINTY ABOUT GOVERNMENT POLICIES THAT MAY RESTRICT FOREIGN

INVESTORS’ ABILITY TO TRANSFER PROFITS OR CAPITAL OUT OF THE

COUNTRY.

HOW TO ANALYZE POLITICAL RISKS

POLITICAL

SOCIAL

ECONOMIC

EXTERNAL THREAT

QUESTION:

HOW LIKELY IS IT THAT AN OUTSIDE FORCE WILL DESTABILIZE THE GOVERNMENT OF A COUNTRY?

THINGS TO LOOK FOR:

THE WORDS AND ACTIONS OF THE LEADERS OF THE ENEMY

COUNTRIES

INTERNAL THREAT

QUESTION:

HOW LIKELY IS IT THAT THE GOVERNMENT WILL REMAIN

STABLE (ASSUMING THERE IS NO EXTERNAL THREAT)?

A COUNTRY WHERE TRANSITION OF POWER FOLLOWS A FIXED

SCHEDULE AND IS PEACEFUL IS MORE STABLE .

SUCH A COUNTRY ALLOW ITS PEOPLE TO CHOOSE THEIR RULERS AND

SPEAK THEIR MINDS.

POLITICAL FREEDOM(ACCORDING TO FREEDOM HOUSE-99)

FREE PARTLY FREE NOT FREE

Argentina Armenia China

Bulgaria Brazil Egypt

Czech Rep Ghana Indonesia

Hungary Malaysia Nigeria

Taiwan Russia Saudi Arab

S. Africa Turkey Vietnam

EXISTENCE OF DEMOCRATIC POLITICAL PROCESS DOES NOT

ALWAYS ENSURE POLITICAL STABILITY.

OTHER EXAMPLES INCLUDE:

INDIA, ISRAEL, ITALY, TURKEY

LIKEWISE, EXISTENCE OF AN AUTOCRATIC GOVERNMENT DOES

NOT NECESSARILY IMPLY INSTABILITY.

LOOK AT THE SIX ASIAN TIGERS

• CHINA IS A COMMUNIST COUNTRY.

• INDONESIA HAD MILITARY DICTATORSHIP & ONE PARTY RULE UNTIL RECENTLY.

• TAIWAN & SOUTH KOREAWERE AUTHORITARIAN STATES UNTIL RECENTLY.

• SINGAPORE HAS ELECTED AUTHORITARIAN GOVERNMENT

HONG KONG’S COLONIAL GOVERNMENT WAS

UNDEMOCRATIC.

SIGNALS TO LOOK FOR:

• SEPARATIST MOVEMENTS

• POLITICAL MOVEMENTS

• RADICAL MOVEMENTS

• ETHNIC TENSIONS

• DISCONTENT

OWNERSHIP RISKS

QUESTION:

WILL THE GOVERNMENT ACT IN A WAY THAT WILL DEPRIVE A

FOREIGN FIRM FROM CONTINUING ITS OWNERSHIP IN THE COUNTRY?

Pay attention to the attitude of the leaders.

• And what they have to say about specific countries.

• Anger of the labor toward foreign policies…

• toward foreign firms of specific countries

• or firms.

OPERATIONS RISK

QUESTION:

WHAT IS THE LIKELIHOOD THAT A GOVERNMENT WILL CHANGE

POLICIES THAT IMPACT ON FOREIGN FIRMS’ PROFITABILITY.

THINGS TO LOOK FOR.

DEBT SERVICE RATIO

EXTERNAL DEPENDENCE

LIQUIDITY

DEBT SERVICE RATIO

A COUNTRY’S ANNUAL DEBT INTEREST AND PRINCIPAL LIABILITY

AS A PERCENT OF EXPORTS OF GOODS AND SERVICES

How do countries score?ACCEPTABLE <20%

Poland, Malaysia, Thailand

PRECAUTIONARY >20% BUT <30%

Chile, India, Mexico, Turkey

DANGEROUS >30%

Argentina, Brazil, Hungary, Indonesia

(Data is from 1995)

It may be all right if a country:

• Has highly diversified export base.– Both products and markets.

• Can reduce imports in a crisis.– Fraction of total imports that comprise of oil

and food (over 35% is alarming).

• Has long-term capacity to repay debt.– Total debt/GDP (over 40% is alarming)

How do these measure up?

Oil& Food Total Debt

Ratio-94 to GNP-97

• Argentina 07% 38%

• Brazil 26% 23%

• Hungary 19% 52%

• Indonesia Low 62%

EXTERNAL DEPENDENCEA COUNTRY’S TOTAL EXPORT &

IMPORT BILL AS A PERCENTAGE OF ITS GNP (1998)

• Argentina 18%

• Brazil 15%

• Hungary 107%

• Indonesia 55%

LIQUIDITY

LENGTH OF TIME A COUNTRY CAN CONTINUE TO IMPORT AT THE PRESENT LEVEL BY DRAWING

DOWN ITS FOREIGN EXCHANGE RESERVES.

2-3 MONTHS IS PRECAUTIONARYLESS THAN 2 MONTHS IS ALARMING

(Data for 1998)

• Argentina 8.5 Months

• Brazil 6.5 Months

• Hungary 4.5 Months

• Indonesia 4.5 Months

ECONOMIC POLICY

• IS THE COUNTRY INVESTING IN EDUCATION & INFRASTRUCTURE?

• IS IT OPEN TO TRADE?

• IS IT LETTING THE MARKET HAVE ITS WAY?

INTERVENTION BY GOVERNMENT

BREEDS BUREAUCRACY THAT PULLS THE COUNTRY BACKWARDS.

IT BREEDS CORRUPTION AND INEFFICIENCY.

POLITICAL RISK SCORES

LOW

Switzerland

Norway

Austria

Germany

Netherlands

Brunei

Japan

HIGH

Liberia

Somalia

Sudan

Iraq

Myanmar

Uganda

Ethiopia

HOW TO COPE WITH POLITICAL RISK

Avoidance Approach

Insurance Approach

Negotiation Approach

Insurance Approach

Political Risk Insurance

– Overseas Private Investment Corporation (OPIC)

– American International Group

– Lloyds of London

Bargaining Approach

WHEN THE BARGAINING POWER POSITION OF A FIRM RELATIVE TO

THAT OF THE HOST GOVERNMENT IS STRONG, THE FIRM WILL

EXPERIENCE LOW LEVEL OF INTERVENTION IN ITS OPERATIONS.

BARGAINING POWER OF MNCs

• Access to Technology

• Integration in Global Production

• Access to Global Markets

• Access to Foreign Exchange

• Provider of Jobs & Capital

BARGAINING POWER OF COUNTRIES

• Market Size and Growth Potential

• Attractive Resource Base

• Attractive & Efficient Infrastructure

• History of Consistent , Flexible, and Fair Relations with Foreign Investors

BARGAINING POWER FRAMEWORK

RELATIVE BARGAINING POSITION OF THE FIRM

AND

OUTCOME STAKE FOR THE FIRM

Low Outcome Stake

Walk Away

If Charged, Avoid the Charge

High Outcome Stake/Low Bargaining Position

Accede to Demands

High Outcome Stake/High Bargaining Position

Negotiate