Question

Describe the various sources of political risk. Provide an example of each form. Answer: We can classify political risk according to the actions or events that cause it to arise, including:

Answer 1

Sources of Political Risk

Political Risk is the risk that occurs when a government action interferes with a company’s functioning. When companies try to do business in other countries, there is host of risk factors in these countries. Political risks occur due to direct government action. E.g. macroeconomic and social policies, political instability etc. government interferes through

• Tax increases
• Breach of contract
• nationalizations of foreign companies
• Forced contract renegotiations
• Currency controls

Other actors that generate political risk

• Corruption
• legal inefficiency
• political unrest, terrorism

Actions by the foreign and host country's government, and other events occurring due to the prevalent political scenario, may result in loss of earning potential, managerial control and/or assets, and other similar losses and disadvantages. The underlying risks in the scenario are classified as political risks of operating a business in a foreign country, because of their political nature and sources of origin.

The three major types of political risks are

1. Ownership risk- risk in maintaining corporate assets and property, and the lives while operating in an international country.

2. Operational risks- may occur due to interference in the operation of the day-to-day tasks of a business.

3. Transfer risk- risks associated with the transfer of money and profits from the foreign market to the home country.

Political risks can take many different forms and may have different sources.

a. Gradual Expropriation- the concept of expropriation means that the government of the host country seizes assets of the foreign company quickly. In gradual expropriation, particular companies are identified. The government of the host country may levy more taxes, remove the property rights, cause more barriers and take other measures so that the foreign business entity turns to be less profitable. China restricted the rights of foreign and domestic automakers. These companies were required to either enter into a strategic alliance with the Chinese government or would have to transfer ownership rights. This a form of gradual expropriation.

b. Currency inconvertibility/Transfer- a host government may not allow a foreign business to take away profits from the host country, and cause barriers like currency inconvertibility. Some new legislation, as well as legislative delays, can cause this problem. Restrictions can also be placed on the transfer of other assets like intellectual property rights and technology.

c. Termination of existing agreements- the host government may terminate existing agreements such as fuel agreements, and thus the foreign business may not be able to operate any further.

d. Confiscation- the asset of the company may also be seized or confiscated by the foreign host government, and no compensation might be provided for it. Following the communist revolution in Cuba, the US enacted the Helms-Burton law according to which companies of the USA can sue the foreign governments for confiscation. However, the law was waived off later.

e. Terrorism- political instability may result in acts of espionage, kidnapping, and terrorism, all of which can spoil the prospects of foreign business.

f. Policy changes- when the relations between the home country and host country suffer, business prospects also reduce. Policy changes may make it hard for a business to operate in a foreign land.