1. Strategic Market Management 7th Edition – David Aaker
Political Factors By
Dr. Ravindra Pratap Gupta

2. ISSUED IN PUBLIC INTEREST
Advisable “All material in slides need not be understood. Use your current working environment and experience to relate to situations. Errors and omissions regrettable. Subject to corrections on Being brought to notice.”

3. Quote-1
The Future
Success of an MNC lies in resolving Political Risk Factors with understanding Economic Risk Factors
Ravindra Pratap Gupta

4. Chapter Overview Political Risks & Economic Risks
Political Risks Types
Problems in Accessing Political Risk
Predicting Country-Specific Risk
Why Country Risk Analysis Is Important
Political Risk Factors
Financial Risk Factors
Techniques to Assess Country Risk
Measuring Country Risk
Comparing Risk Ratings among Countries
Actual Country Risk Ratings across Countries
Incorporating Country Risk in Capital Budgeting
Applications of Country Risk Analysis
Reducing Exposure to Host Government Takeovers
Managing Political Risk

5. A. Political Risks & Economic Risks
1. Definition of Political risk
The unanticipated likelihood that a business’s foreign Analysis reviews, the major political decisions likely to affect all enterprises in the country.
Is the potentially adverse impact of a country’s environment on an MNC’s cash flows.
Political Risks: stem from changes in policy positions or environmental conditions.
Economic Risks: are associated with changes concerning market, competitive, and technological factors that can diminish a firm's effectiveness and profit potential.
Actors responsible for political risks becoming an actuality are more easily identifiable than those responsible for economic risks becoming an actuality

6. B. Political Risks Types….
Depending on how firms or investors might be affected by an incidence, political risk can be classified into 3 categories:
Country specific risks (Macro risks)
Political & Economic stability of the country, attitude of government and public in the host country towards government of foreign investors
Host country’s political & government administrative infrastructure. For example, number of political parties, frequency of change in governments, (this can cause frequent policy changes, and inconsistent & discontinuous economic and political environment.)
Track records of political parties and their relative strength, e.g. what type of ideology they support, what is the ideology of the main party?
Firm specific risk (Micro risks)
Conflict between the activities/goals of firm and those of the host country as evidenced by existing regulations.
Global specific risks
These too affect the MNCs at the project or corporate level but originate at the global level.

7. Country specific risks (Macro risks)
Originate at the country level-these affect MNCs at the project and corporate level and
They include:
Transfer risk, Government policies that limit the transfer of capital, payments, production, people, and technology in and out of the country
Tariffs on exports and imports
Restrictions on exports
Dividend remittance
Capital repatriation

8. Country specific risks (Macro risks)
Operational risks: Government policies and procedures that directly constrain management and performance of local operations
Price controls
Financing restrictions
Export commitments
Taxes
Local sourcing requirements
Ownership control risks: Government policies or actions that inhibit ownership or control of local operations
Foreign-ownership limitations
Pressure for local participation
Confiscation
Expropriation
Abrogation of proprietary rights
Confiscation-To confiscate means to take away temporarily for security or legal reasons. Confiscation means the action of taking or seizing someone's property with authority i.e seizure.
Expropriation-Compulsory seizure or surrender of private party for the state's purposes, with little or no compensation to the property's owner.
Abrogation of proprietary rights-To abolish by formal or official means

9. Firm specific risk (Micro risks)
These affect the MNC at the project/corporation level.
Three types:
Interest rate and Foreign exchange risks,
These arise from fluctuation in host country’s interest rate or currency vis-à-vis home currency.
Business risks, arise from factors affecting cash flows and hence profitability of the firm, such as change in taxation for foreign firms, or local disputes with trade unions or suppliers, etc.
Governance & Control risks, arise from uncertainty about the host country’s policy regarding ownership, and control of local operation, restriction on access to local credit facilities, goal conflict between a MNC and the host government.

10. Global specific risks
These too affect the MNCs at the project or corporate level but originate at the global level.
Examples:
Terrorism
Anti-globalization movements
Environmental concerns
Poverty
Cyber attacks

11. C. Problems in assessing political risk
Difficulties in anticipating:
If any change is likely to occur over the life of the project.
How those changes might affect the host country’s goal priorities?
How new regulations might be implemented to reflect new priorities?
What might be the likely impact of such changes on the firm’s operation?

12. D. Predicting Country-Specific Risk
In order to assess country specific risks, one needs to assess political & economic stability of a country in terms of;
1) Evidence of turmoil or dissatisfaction
2) Indicators of economic stability
3) Trends in cultural and religious activities
Data can be assembled by;
a) Monitoring the local media (local newspapers, radio & TV broadcasts.
b) Publications of diplomatic sources
c) Tapping knowledge of outstanding expert consultants
d) Contact other businesses who have had recent experience in the host
country
e) Conduct on site visits
f) Examine reports of the ratings agencies

13. Watch for Significant changes are rarely identified in advance.
Economic indicators may not continue moving in the same direction in the future.
Assessment of only one rating company is not sufficient.
Consider ratings of a number of agencies that assess county risks, such as:
S&P
Moody’s
EIU
Euromoney
Institutional Investor
International Country risk guide
Milken Institute Capital Access Index
Overseas Private Invest Corp.

14. E. Why Country Risk Analysis Is Important
Some Adverse Impacts:
A terrorist attack
A major labor strike in an industry
A political crisis due to a scandal within a country
Concern about a country’s banking system that may cause a major outflow of funds
The imposition of trade restrictions on imports
Country risk analysis can be used:
To monitor countries where the MNC is currently doing business.
As a screening device mechanism to avoid conducting business in countries with excessive risk.
To revise its investment or financing decisions in light of recent events.

15. F. Political Risk Factors
Attitude of consumers in the host country
Some consumers are very loyal to locally manufactured products.
Actions of host government
The host government may impose special requirements or taxes, restrict fund transfers, and subsidize local firms.
MNCs can also be hurt by a lack of restrictions, such as failure to enforce copyright laws.
Blockage of fund transfers
If fund transfers are blocked, subsidiaries will have to undertake projects that may not be optimal for the MNC.
Currency inconvertibility
The MNC may need to exchange earnings for goods if the foreign currency cannot be changed into other currencies.

16. F. Political Risk Factors….
War
Internal and external battles, or even the threat of war, can have devastating effects.
Bureaucracy
Bureaucracy can complicate businesses.
Corruption
Corruption can increase the cost of conducting business or reduce revenue.

17. G. Financial Risk Factors
Indicators of economic growth
The current and potential state of a country’s economy is important since a recession can severely reduce demand.
A country’s economic growth is dependent on several financial factors:
a. Interest Rates
b. Exchange Rates
c. Inflation

18. H. Techniques to Assess Country Risk
1. Checklist approach-
2. Delphi Technique: collecting independent opinions without group discussion.
3. Quantitative Analysis
4. Inspection Visits
5. Combination of Techniques

19. H. Techniques to Assess Country Risk…
The checklist approach involves rating and weighting all the macro and micro political and financial factors to derive an overall assessment of country risk.
The Delphi technique involves collecting various independent opinions and then averaging and measuring the dispersion of those opinions.
Quantitative analysis techniques like regression analysis can be applied to historical data to assess the sensitivity of the business to various risk factors.
Inspection visits involve traveling to a country and meeting with government officials, firm executives, and consumers to clarify uncertainties.
The Combination of Techniques often, firms use a variety of techniques for making country risk assessments.
For example,use the checklist approach to develop an overall country risk rating, and some of the other techniques to assign ratings to the factors.

20. I. Measuring Country Risk
1. Variation in Methods of Measuring Country Risk
The procedures for quantifying country risk will vary with the assessor, the country being assessed, as well as the type of operations being planned.
2. Using the Country Risk Rating for Decision Making
Firms use country risk ratings when screening potential projects, and when monitoring existing projects

21. I. Measuring Country Risk….
The checklist approach involves:
Assigning values and weights to political and financial risk factors,
Multiplying the factor values with their weights, and summing up to give the political and financial risk ratings,
Assigning weights to the risk ratings, and
Multiplying the ratings with their weights, and summing up to give the country risk rating.

22. Determining the Overall Country Risk Rating

23. Derivation of the Overall Country Risk Rating

24. Criteria for Quantifying Political Risk

25. J. Comparing Risk Ratings among Countries
1. Create a Foreign Investment Risk Matrix
a. Which displays the financial (or economic) and political risk by intervals ranging across the matrix from “poor” to “good.”
b. Each country can be positioned in its appropriate location on the matrix based on its political rating and financial rating.

26. Actual Country Risk Ratings Across Countries

27. K. Actual Country Risk Ratings across Countries
1. Vary substantially among countries
2. Higher values represent less risk
a. Especially industrialized countries
b. Risk ratings change over time

28. L. a. Incorporating Country Risk in Capital Budgeting
If the risk rating of a country is acceptable, the projects
related to that country deserve further consideration.
Country risk can be incorporated into the capital budgeting analysis of a proposed project either by
adjusting the discount rate or
by adjusting the estimated cash flows.

29. L. a. Incorporating Country Risk in Capital Budgeting….
Adjustment of the discount rate
The higher the perceived risk, the higher the discount rate that should be applied to the project’s cash flows.
Adjustment of the estimated cash flows
By estimating how the cash flows could be affected by each form of risk, the MNC can determine the probability distribution of the net present value of the project.

30. M. Applications of Country Risk Analysis
As a result of the crisis that culminated in the Gulf War in 1991, many MNCs reassessed their exposure to country risk and revised their operations accordingly.
The 1997–98 Asian crisis caused MNCs to realize that they had underestimated the potential financial problems that could occur in the high-growth Asian countries.
Following the September 11, 2001 attack on the United States, some MNCs reduced their exposure to country risk by downsizing or discontinuing their business in countries where U.S. firms may be subject to more terrorist attacks.

31. N. Reducing Exposure to Host Government Takeovers
Use a Short-Term Horizon
This technique concentrates on recovering cash flow quickly.
Rely on unique supplies or technology
In this way, the host government will not be able to take over and operate the subsidiary successfully.
Hire local labor
The local employees can apply pressure on their government if they are affected by the takeover.
Borrow local funds
The local banks can apply pressure on their government if they are affected by the takeover.
Purchase insurance
Investment guarantee programs offered by the home country, host country, or an international agency insure to some extent various forms of country risk.

32. N. Reducing Exposure to Host Government Takeovers….
Use project finance
Project finance deals are heavily financed with credit, thus limiting the MNC’s exposure.
The loans are secured by the project’s future revenues and are “nonrecourse.”
A bank may guarantee the payments to the MNC.

33. O. Managing Political Risks
Pre-investment Planning:
Avoidance
Insurance
Negotiating the environment
Structuring the investment

34. O. Managing Political Risks….
Operating Policies:
Planned divestment
Short-term profit max
Changing the perceived cost/benefit ratio of taking over by the host government
Developing local stockholders
Adaptation e.g., lobbying/politicking
International production "network" strategy
Controlling the location of intangible assets
Local purchasing strategy
"Sourcing" and "movement" of funds policy

35. O. Managing Political Risks….
Post Expropriation Policies:
Rational negotiation
Applying power
Legal remedies
Management surrender

36. Dr Ravindra Pratap Gupta
Quote-2
“"The most serious mistakes are not being made as a result of wrong answers. The truly dangerous thing is not asking the right questions."
Dr Ravindra Pratap Gupta

37. Question Q 6. Discuss Political Risks & its types? Discuss Political
Risk Factors?
Q 7. Discuss the Problems in Accessing Political Risk. Explain Predicting Country-Specific Risk? Why Country Risk Analysis Is Important?

38. Thanks