Political Risk In International Business

International businesses often do encounter political and country risks in markets in which they
operate. Investigate some examples of these risks and show how these risks can be managed.
Political and country risks:
Financial institutions and business organizations operate its business activities abroad in order to
diversify and expand their sources of revenue and profitability. Organizations that make
investment in a foreign market either in the form of equity or assets are exposed to risks that may
arise either from an act of the host government or from other external political events taking
place in that country, these risks include social, political and economic conditions and events that
imposes negative impact on the financial performance and profitability of foreign organizations.
Types of political and country risks:
The following are the main types of political and country risks that may affect the business
performance of an international organization operating in foreign countries.

Nationalization or deprivation:
Nationalization is a process whereby a government takeover privately owned industries,
corporations and resources with or without compensation.
Nationalization is a political risk which makes it very difficult or impossible for international
organizations to invest in a country where businesses are exposed to such risk.
In past governments have nationalized highly profitable industries on the ground that it does not
want foreign ownership of its valuable resources for instance in 2006 the Bolivian government
nationalized the country's oil and natural gas industries. Similarly in January 2007 the
Government of Venezuela announced to nationalize firms in two major sectors of the country's
economy i.e. telecommunications and electricity.In November 2009 the president of Venezuela
announced that he will nationalize banks in the country.

Forced divestiture:
forced divestiture another type of country risk in which an international firm is forced to divest
its business operation, an example of forced divestiture is the Indonesian subsidiary of French
retail giant Carrefour which has been ordered to sell the 75% stake it acquired in smaller rival
Alfa Retailindo in January 2008.

Gradual expropriation:
Expropriation means a quick action of government to seize the assets of foreign entity, but in
gradual expropriation a single international company is targeted by the host government. Gradual
or creeping expropriation involves slow and gradual removal of property rights by way of tax
increase on profits to make a foreign business less profitable, increase in property tax, instituting
increasing barriers, changing the proportion of ownership which must be held locally.In gradual
expropriation the ownership title of business remains in the name of foreign investor but the right
to use the business is diminished as a result of the government interference.
An example of gradual expropriation is when China announced a policy restricting the property
rights of domestic and foreign automakers to transfer their ownership or enter into strategic
alliance in China, by banning the sale or transfer of manufacturing licenses by bankrupt or failing
automakers.
Similarly in Tecinicas Medioambientales Tecmed S.A. V. The United Mexican States it was
declared that the Mexican government has committed expropriation because of non-renewal of a
license necessary to operate the landfill.

Currency inconvertibility and exchange:

Currency inconvertibility means a situation where one currency can not be converted or
exchanged into foreign currency. This is another political risk for an organization operating its
business activities abroad. In such case a foreign government may restrict the right of foreign
firms to repatriate profits to their home country and all profits remain in the foreign country.
Inconvertibility of currency may arise due to passing new legislation or administrative delays. In
administrative delays the bureaucracy in a foreign country takes more time in currency
conversion and creates a financial burden upon foreign companies.
Some countries issues inconvertible currency for instance Cuban peso in order to protect its
citizens from perceived capitalist infiltration, similarly domestic regulators may consider foreign
currency inconvertible in order to protect local investors from bad investment decision i.e.
hyperinflation of currency.

Termination of fuel supply agreements:

Termination of fuel supply agreement is another political risk for an international organization
functioning in a foreign country. A foreign company whose business activities are solely
dependent upon fuel supply under an agreement with the host government, or with the host
company and when such agreement is terminated than in such circumstances the company will
face major problem in continuing its business in such foreign country.

Confiscation:
Confiscation of international business is a severe form of political risks where host government
seizes the assets of a foreign company without compensation. The U.S. 1996 Helms-Burton Law
entitles the U.S. companies to sue companies from other countries that use property confiscated
from U.S. companies following Cuba's communist revolution in 1959. But the U.S. government
waived this law repeatedly in order to maintain good relations with other countries.

Terrorism and kidnapping:

Kidnapping and other terrorist activities are means of making political statements. Small groups
unhappy about the current political or social situation can resort to terrorist tactics to fulfill their
demands. 9/11 tragedy is a prominent example. These groups may target the executives of large
international companies for kidnapping and taking of hostages in order to fund their terrorist
activities.
The current political instability, terrorist activities and internal conflicts in Pakistan is a good
example, where an international firm is exposed to a verity of threats arising from such activities
and makes it impossible for such firm to operate business effectively and increase its
profitability.

Policy changes:
Furthermore good relationship between the host government and international companies is of
vital importance for operating a successful and profitable business and any political change that
modify the anticipated effect and worth of a given economic action by changing the likelihood of
achieving business objectives than it affects international businesses to a greater extent and the
government's hard and fast new policies can create huge problems for international companies.

Contractual frustration:
Frustration of contract means legal termination of contract between the parties because of
unforeseen circumstances which makes the performance of such contract practically impossible.
These circumstances include, accident, change in law, sickness of one of the parties and
interference from third party etc.
In international business perspective companies that enter into trade agreements for export or
import of goods or services either with government or private entities in foreign countries are
often exposed to underlying political risks. Such contract may be frustrated at any time for a
number of political reasons that are beyond the control of the parties.

Transfer:
Transfer risks take place when host government policies imposes limitation on the transfer of
capital, payments, production, people and technology in and out of country i.e. imposing tariffs
or restrictions on import and export, repatriation of capital or remittance of dividend etc.

Trade disruptions:
Devaluation:
Screening for political risks:
In order to operate successful business activities overseas it is very important for international
companies to identify, analyze, measure and manage those political and country risks that are
encountered by such company.

Analysis of political risks:

In order to analyze political risks, these are categorizes in two levels according to their nature,
severity and intensity i.e. Macro political risk analysis and micro political risk analysis.

Macro political risk analysis:

This is an analysis that observes major political decisions likely to affect all businesses in a
country. Macro risk factors include freezing the movement of assets out of the host country,
limiting the remittance of profits or capital, currency devaluation, refusing to perform contractual
obligations previously signed with the MNC's, industrial piracy (counterfeiters), political
disorder and government corruption.

Micro political risk analysis:

This is an analysis that is directed towards government policies and decisions that influence
selected sectors of the economy or specific foreign businesses in the country. The examples are
selective discrimination, industry regulation, imposition of taxes on specific types of activity,
restrictive local laws and host government policies that promote exports and discourage import.

Management of political risks:

Political risks can be managed through applying different strategies i.e. avoidance, reduction or
shifting of risk and post commitment practices.

Avoidance:
If any enterprise realizes that making investment in a country will expose such enterprise to
political risks the most simple strategy to keep away from such political risks is not to invest in
such country and to go somewhere else, this is pre-commitment strategy that can be used before
the commencement and making any final commitment.

Reduction or shifting of risk:

Another way of managing political risk is that a foreign company can implement a financial
structure that shifts risks to local creditors and shareholders.
Similarly contracts can be designed whereby a force majeure clause is included to revise and free
contractual parties from their contractual obligations in case of any violence, coup, insurrection
and long-term trade disruption etc.

Post-commitment practices:
Post-commitment practices mean adoption of strategies after making investment and
commencement of business activities in overseas market. This kind of strategy takes various
forms i.e. modification of employment or the ownership of the business, minority interest,
designing operational structure, diversification and taking insurance policy.

Modification of employment or the ownership of the business:

If a foreign firm's top management is controlled by local nationals or their ownership is
significant or establishing of a joint venture of 50-50 ownership with a local firm than the host
government would have less incentive to nationalize such business.

Minority interest:
Another useful strategy of managing political risks is to adopt minority interest in the business.

Designing operational structure:

Designing the operational structure of business in a way that attracts the inflow of foreign
exchange in the host country and establishing good relations and close cooperation of
management with the host government will also safeguard such firm from any threat from the
host government.

Diversification:
If any political risk is encountered by a foreign firm while operating business activities overseas
the best way is to diversify and expand its business operation into other countries that are not
exposed to such type of risks.

Taking insurance policy:

Moreover to avoid any kind of loss that can be inflicted due to any political or country risk the
company can go for insurance policy but it is very expensive and can minimize the profitability
of such firm.