Tuesday, November 23, 2010

4 common types of political risks for International Markets operations


For multinational corporations, the meaning of political risk covers the potential threat that a host country will make political decisions, planned or sporadic, that will prove to have unfavorable effects on the corporation profits and goals, causing investors to lose some or all of the value of their invested assets. Undesirable political actions or events might be in wide range from completely disastrous, such as widespread destruction due to revolution or riots, to those of a more financial nature, such as creation of laws that prevent free movement of the capital (Investopedia, 2006).

The common types of political risks are as follows: systemic, procedural, distributive, and catastrophic political risks (Daniels, Radebaugh, & Sullivan, 2001). Let's review each type in more details.

Systemic Political Risks

Company investing in the international business sector, might be a subject of the inherited political risks initiated from substantial changes in the business policies of the host government. The regulations shifts might be directed to the general market structure, or it might be focused on the particular business sector, or even on a small operational niche. The possible reasons for the policies changes might be related to the new government establishment, shifts in the strategic views on the economic sector, or even personnel changes among top government officials, responsible for the country economic course.

Some of the systemic political risks sources might be even beyond the national government abilities to control and regulate economy, if they come from the global international business events and processes. Regional economic and financial crisis will eventually influence the economic outputs of the corporate division, located in the zone, affected by such an economic downturn.

Example: Enactment of capital and currency controls in Malaysia in 1998 was perceived absolutely negatively by international investors, causing capital to be withdrawn from the country. However, further currency stabilization, falling interest rates, and rising stock prices proved the point of the investors, who believed in the strengthening of country economy (Devadason).

Procedural Political Risk

Procedural risk reflects the potential cost and its deviation to perform the whole range of operational activities in the host country, including smooth movements of the final products, raw materials, finances, human resources, and any other components essential for successful business operations. Government and authorities' corruption, unsettled labor disputes, high level of bureaucracy, ineffective business decision-making, preferential treatment for certain businesses might lead to the low business efficiency and transaction costs increase.

Example: A former executive of Houston-based Global Engineering, Construction and Services Company, Albert Stanley, has pleaded guilty to bribing Nigerian officials in order to secure contracts to build liquefied natural gas facilities in the country. He claimed that the government officials insisted on the certain amount of kickback in exchange for the artificially delayed case approval (Ikokwu, 2008).

Distributive Political Risk

Any country, striving for the economic prosperity, is interested deeply in foreign investments in its economy. However, as foreign corporations are starting to get significant profits from its business ventures in the host country, local government might decide to reevaluate its guidelines on the fair wealth distribution between the foreign corporation and the local government needs. At this stage, national government might perform certain revision of their tax codes, regulatory structures, and monetary policy to capture greater benefits from foreign companies, decreasing the return on invested capital to the shareholders (Daniels, Radebaugh, & Sullivan, 2001).

Example: Following the reelection of President Hugo Chavez, and after announcing certain nationalization plans (mainly in telecommunications and electricity), the Venezuelan government has intensified its rhetoric against foreign oil and gas companies (Grenome & Socanos, 2007). The whole atmosphere of the foreign investment to the country, especially in the affected industries, strengthened the distributive political risk for all foreign corporations. Moody's Investors Service immediately changed the risk rating outlook to on the oil sector in the country to negative from stable (Hess & O'Shaughnessy, 2007).

Catastrophic Political Risk

Catastrophic political risk includes unanticipated political changes that largely affect all business operations in the country, but can be especially dangerous for local operations of the foreign companies. That includes military conflicts, racial and ethnic clashes, civil war, terrorism, etc. (Daniels, Radebaugh, & Sullivan, 2001).

Example: From 2002, Kenyan economy was considered as one of the most promising developments in Africa with annual growth of 2.8% in 2003, 4.3% in 2004, 5.8% in 2005, 6.1% in 2006, and 7.0% in 2007. However, the violence that broke out after the December 27, 2007 general election paralyzed the economy completely in January and early February 2008. And even now, while country shows some signs of recovery, events in the political arena still pose the greatest risk to the Kenyan economy (Makau, 2008).

References

Daniels, J.D., Radebaugh, L.H., & Sullivan, D.P. (2001). Globalization and Business. New York: Prentice Hall. Ch. 10, pp. 239-243.

Devadason, R. (n.d.). Investment Risk - Political Risk. Retrieved September 4, 2008, from http://www.freecoolarticles.com/FP15.14.htm

Grenome, L., & Tsokanos, B. (2007, February 14). S&P: Ongoing political risk in Venezuela still poses challenges for foreign oil and gas companies. Retrieved September 8, 2008, from http://www.bnamericas.com/research_detalle.jsp?documento=79414&idioma=I

Hess, W.L., & O'Shaughnessy, J. (2007, February 13). Moody's changes outlook on Venezuelan heavy crude oil projects to negative. Retrieved September 8, 2008, from http://bnamericas.com/research_detalle.jsp?documento=79034&idioma=I

Ikokwu, C. (2008, September 5). Nigeria: LNG � American admits bribing Nigerian officials. Retrieved September 5, 2008, from http://allafrica.com/stories/200809050001.html

Investopedia (2006). What is political risk and what can a multinational company do to minimize exposure? Retrieved September 4, 2008, from http://www.investopedia.com/ask/answers/06/politicalrisk.asp

Makau, J. (2008, July 3). Kenya: Political risks and threat to economy. Retrieved September 8, 2008, from http://allafrica.com/stories/200807031022.html


13 comments:

Col Rob Maness said...

Recommendable post. Thanks for sharing this podt on different political threats. Such an informative post.

Unknown said...

References.👌

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