CHAPTER 22CHAPTER 22

THE MEASUREMENT THE MEASUREMENT AND MANAGEMENT AND MANAGEMENT OF POLITICAL RISKOF POLITICAL RISK

CHAPTER OVERVIEW:CHAPTER OVERVIEW:

I.I. MEASURING POLITICAL RISKMEASURING POLITICAL RISK

II.II. COUNTRY RISK ANALYSISCOUNTRY RISK ANALYSIS

III.III. MANAGING POLITICAL RISKMANAGING POLITICAL RISK

I.I. MEASURING POLITICAL RISKMEASURING POLITICAL RISK

Basic Management Approach:Basic Management Approach:

1.1. Identify political risk/consequencesIdentify political risk/consequences

2.2. Develop policies in advance to copeDevelop policies in advance to cope

MEASURING POLITICAL RISKMEASURING POLITICAL RISK

I.I. MEASURING POLITICAL RISKMEASURING POLITICAL RISK

A.A. Two ApproachesTwo Approaches

1.1. Country-specific perspectiveCountry-specific perspective

-use country risk analysis-use country risk analysis

MEASURING POLITICAL RISKMEASURING POLITICAL RISK

2.2. Firm-specific perspectiveFirm-specific perspective

-uses a more micro approach-uses a more micro approach

MEASURING POLITICAL RISKMEASURING POLITICAL RISK

B.B. Political Stability: First ApproachPolitical Stability: First Approach

1. Measured by:1. Measured by:

a.a. Frequency of government Frequency of government

changeschanges

b.b. Level of violenceLevel of violence

c.c. Number of armed insurrectionsNumber of armed insurrections

d.d. Conflict with other statesConflict with other states

MEASURING POLITICAL RISKMEASURING POLITICAL RISK

C.C. Economic FactorsEconomic Factors

1.1. Indicators of political unrestIndicators of political unrest

a.a. Rampant inflationRampant inflation

b.b. Balance of payment deficitsBalance of payment deficits

c.c. Slowed growth of per capita GDPSlowed growth of per capita GDP

MEASURING POLITICAL RISKMEASURING POLITICAL RISK

D.D. Subjective FactorsSubjective Factors

1.1. General perception toward General perception toward private private enterpriseenterprise

2.2. Business Environment Risk IndexBusiness Environment Risk Indexa.a. Usefulness:Usefulness:

an indicator of general levelan indicator of general levelof political riskof political risk

b.b. Economic standpoint:Economic standpoint:political risk=uncertainty political risk=uncertainty over property rightsover property rights

MEASURING POLITICAL RISKMEASURING POLITICAL RISK

3.3. Capital FlightCapital Flight

a.a. Definition:Definition:

the export of savings by a the export of savings by a

nation’s citizens because of nation’s citizens because of

safety-of-capital fears.safety-of-capital fears.

b.b. Measurement: use the Measurement: use the

balance-of- payment accountbalance-of- payment account

MEASURING POLITICAL RISKMEASURING POLITICAL RISK

c.c. Causes of capital flightCauses of capital flight

1.)1.) Inappropriate economic Inappropriate economic policiespolicies

2.)2.) Expectations of devaluationExpectations of devaluation

3.)3.) High political riskHigh political risk

MEASURING POLITICAL RISKMEASURING POLITICAL RISK

E.E. THE MICRO APPROACHTHE MICRO APPROACH

firm-specific perspective used in lightfirm-specific perspective used in light

of the shortcomings of previous of the shortcomings of previous modelsmodels

1.1. Weakness of Political Risk ModelsWeakness of Political Risk Models

assume all firms face the same riskassume all firms face the same risk

MEASURING POLITICAL RISKMEASURING POLITICAL RISK

2.2.ExpropriationExpropriation

a.a. Is highly selectiveIs highly selective

b.b. Higher probability for extractive,Higher probability for extractive,

utility, and financial industries.utility, and financial industries.

II.II. COUNTRY RISK ANALYSISCOUNTRY RISK ANALYSIS

II.II.COUNTRY RISK ANALYSISCOUNTRY RISK ANALYSISPrimary focus: How well is the countryPrimary focus: How well is the countrydoing economically?doing economically?

A.A. Fiscal IrresponsibilityFiscal Irresponsibility-high government deficits-high government deficits

B.B. Controlled Exchange Rate SystemControlled Exchange Rate System-currency usually overvalued-currency usually overvalued

C.C. Wasteful Government SpendingWasteful Government Spending-inability to service foreign debt-inability to service foreign debt

COUNTRY RISK ANALYSISCOUNTRY RISK ANALYSIS

D.D. Resource BaseResource Base

-lack of strong work ethic-lack of strong work ethic

E.E. Country Risk and Adjustment to Country Risk and Adjustment to External ShocksExternal Shocks

1.1. What are the impacts of externalWhat are the impacts of external

shocks:shocks:

-how well a nation responds varies-how well a nation responds varies

COUNTRY RISK ANALYSISCOUNTRY RISK ANALYSIS

2.2. Five Common Characteristics of Five Common Characteristics of Economic HealthEconomic Health

a.a. Structural incentivesStructural incentives

-rewards productive ventures-rewards productive ventures

b.b. Legal structureLegal structure

-stimulates growth of free -stimulates growth of free marketsmarkets

c.c. Minimal government regulationsMinimal government regulations

COUNTRY RISK ANALYSISCOUNTRY RISK ANALYSIS

d.d. Clear incentives to save and Clear incentives to save and investinvest

e.e. Open economyOpen economy

III.III. MANAGING POLITICAL RISKMANAGING POLITICAL RISK

III.III. MANAGING POLITICAL RISKMANAGING POLITICAL RISK

A.A. Preinvestment PlanningPreinvestment Planning

1.1. Four Policy OptionsFour Policy Options

a.a. Avoidance (no risk)Avoidance (no risk)

b.b. Insurance(shift risk)Insurance(shift risk)

c.c. Negotiate environmentNegotiate environment

d.d. Structure the Structure the investmentinvestment

MANAGING POLITICAL RISKMANAGING POLITICAL RISK

B.B. Operating PoliciesOperating PoliciesFive Post-Investment Policy Options:Five Post-Investment Policy Options:a.a. Planned DivestmentPlanned Divestmentb.b. Short-Term Profit MaximizationShort-Term Profit Maximizationc.c. Changing the Benefit/Cost RatioChanging the Benefit/Cost Ratiod.d. Developing Local StakeholdersDeveloping Local Stakeholderse.e. AdaptationAdaptation

-create a post-confiscation -create a post-confiscation management contract management contract