POLITICAL RISK MANAGEMENT

Political risk indicates the commencement of risk arising due to change in the
governing body of a country and therefore poses a risk to the investors who have
investments in financial instruments like debt funds, mutual funds, equity, etc.
Specific terms like corruption, terrorism, etc., related to the politics of a country may
arise due to change in a political scenario, which further might result in a change in
the regulations of the nation.

Political risk can also be termed as geopolitical risks that arise due to conflict between
two countries. There can be hindrance across the businesses and finally slash the
confidence level of the investors.

Political risk can adversely affect all aspects of international business from the right to
export or import goods to the right to own or operate a business.

HOW TO MANAGE POLITICAL RISK?

1. Avoiding Investment:

The simplest way to manage political risks is to avoid investing in a country ranked
high on such risks. Where investment has already been made, plants may be wound up
or transferred to some other country which is considered to be relatively safe. This
may be a poor choice as the opportunity to do business in a country will be lost.

2. Adaptation:

Another way of managing political risk is adaptation. Adaptation means incorporating

risk into business strategies. MNCs incorporate risk by means of the following three
strategies: local equity and debt, development assistance, and insurance.

3. Threat:

Political risk can also be managed by trying to prove to the host country that it cannot
do without the activities of the firm. This may be done by trying to control raw
materials, technology, and distribution channels in the host country. The firm may
threaten the host country that the supply of materials, products, or technology would
be stopped if its functioning is disrupted.
 4. Lobbying:

Influencing local politics through lobbying is another way of managing political risks.
Lobbying is the policy of hiring people to represent a firm’s business interests as also
its views on local political matters. Lobbyists meet with local public officials and try
to influence their position on issues relevant to the firm. Their ultimate goal is getting
favourable legislation passed and unfavourable ones rejected.

5. Minimizing Fixed Investments:

Political risk, of course, is always related to the amount of capital at risk. Given equal
political risk, an alternative with comparably lower exposed capital amounts is
preferable. A company can decide to lease facilities instead of buying them, or it can
rely more on outside suppliers, provided they exist. In any case, companies should
keep exposed assets to a minimum to limit the damage posed by political risk.

6. Political Risk Insurance:

As a final recourse, global companies can purchase insurance to cover their political
risk. Political risk insurance can offset large potential losses.

7. Local Borrowing:

Financing local operations from indigenous banks and maintaining a high level of
local accounts payable maximize the negative effect on the local economy if adverse
political actions were taken. Many companies prefer local partners because they can
then borrow locally instead of adding an additional level of risk with the investment
funds being in a currency which is different from the currency of all the sales and
costs of the venture.

COMMON TYPES OF POLITICAL RISKS

To better understand the impact that certain political risks can have on your business,
let’s look at three of the most common types.

1. Expropriation/government interference

For no apparent reason or with no justification, foreign governments can seize,

confiscate or otherwise expropriate a company’s investment. They can even adopt a
series of measures that have the effect of expropriation. In either case, the result is that
a firm could lose overseas investments or assets.

2. Transfer and Conversion

During an economic crisis, foreign governments or central banks may decide to

impose restrictions or prohibitions on the conversion of the local currency to hard
currency or may prevent hard currency from leaving the country.

3. Political violence

Political terrorism, war, civil strife or other forms of political violence can damage or
destroy a company’s assets and prevent it from conducting operations essential to
doing business.