UNIVERSITY OF ZIMBABWE

FACULTY OF COMMERCE

DEPARTMENT OF ACCOUNTANCY

NAME: MASARA OWEN

REG NUMBER: R1810891

COURSE: INTERNATIONAL FINANCIAL MANAGEMENT

COURSE CODE: MACC 504

PROGRAMME: MASTER OF ACCOUNTANCY (MACCP)

LECTURER: MR JECHECHE

Assignment II
Question
‘With reference to new Zimbabwe discuss political risk in relation to its sources and how
it can be measured and managed in order to attract FDI and also make MNCs maximise
their value. Support your answers with empirical evidence and theories relating to
political risk’

Lecturer Comment (s):

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University of Zimbabwe | MACC 504: International Financial Management

Introduction

Multinational Corporations (MNCs) commonly exploit on foreign business opportunities by

venturing into foreign direct investment (FDI), which is investment in real assets (such as land,
buildings, or even existing plants and other equipment) in foreign countries. They engage in
joint ventures with foreign firms, acquire foreign firms, and form new foreign subsidiaries. In
all these arrangements or types of FDI an MNC can generate high returns when managed
properly. However, FDI requires a substantial investment and can therefore put much capital
at risk. The existence of countries risks impacts on global investment strategies (Filipe eta al,
2012). Moreover, if the investment does not perform as well as expected the MNC may have
difficulty selling the foreign project it created. Given these return and risk characteristics of
FDI, MNCs tend to carefully analyse the potential benefits and cost & conducting the country
risk analysis before implementing any type of FDI. FDI involves a complex system of analysis
for the conditions of countries’ attraction. Political conditions are a very central point of
analysis when a company studies a country. The different frameworks that allow to analyse the
attraction of investments show that the international political environment always works as an
important factor for companies to go to international business. The stability of politics of a
country’s government is often determinant to get investments, particularly investments from
an international company (Filipe et al, 2012). Financial managers must understand the potential
return and risk associated with FDI, the application of capital budgeting to international
projects & the measurement of country risk so that they can make investment decisions that
maximise the MNC’s value.

Definition of terms

Risk is future contingency of deviation of ex-post returns from ex-ante returns of an investment
and this deviation may either be profitable or unprofitable to a commercial venture (Kansal,
2015).

Political risk is substantially equated to political instability and radical political change in the
host country derived from government action which will result in discontinuities/ disruptions
in the business environment has the potential to affect the profits or the objectives of a firm.
(Robock 1971; Thunell 1977; Micallef 1982); Green 1974; Thunell 1977).

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Political risk analysis, in risk management is the study of economic and social discontinuities
and changes which result in speculative constraints and opportunities for transnational business
(Andrews, 1995). It is the analysis of the probability that political decisions, events, or
conditions will significantly affect the profitability of a business or the expected value of a
given business decision. A wide spectrum of political risks may affect business, and political
risk analysts use both qualitative and quantitative methodologies to analyse and assess such
risks (Matthee, 2019).

Foreign direct investment (FDI) is a direct investment into production or business in a

country by an individual or company of another country, either by buying a company in the
target country or by expanding operations of an existing business in that country to gain some
measure of ownership control. Foreign direct investment is in contrast to portfolio
investment which is a passive investment in the securities of another country such
as stocks and bonds. Foreign direct investment (FDI) occurs when a firm invests directly in
new facilities to produce and/or market in a foreign country. Once a firm undertakes FDI it
becomes a multinational company.

A Multinational Corporation (MNC) is a company engaged in producing and selling goods

or services in more than one country, ordinarily consists of a parent company located in the
home country and at least five or six foreign subsidiaries, typically with a high degree of
strategic interaction among the units (Shapiro, 2013).

New Zimbabwe is a second republic as a result of coup which happen in November 2017 when
President Emerson Dambudzo Mnangagwa took over power from Former president Robert
Gabriel Mugabe.

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Sources of political risk in Zimbabwe

i. Political Instability or upheaval

Political risk sources can be categorised into internal (endogenous) and external (exogenous)
sources. Political risk factors originate within the country itself, they are known as internal
sources of political risk factor (Essel and Mostert 2013). The factors are political upheaval
includes political revolution, social movements, protests, strikes, civil commotions, internal
armed conflicts like, insurrections, riots, mutiny, rebellion, military coup or civil war which
may arise due to social mobilisation or change of public opinions aimed at thwarting
corruption, creating political imbalance or instability, removing existing power structure.
Therefore, the higher the improprieties present in political or administrative system (nepotism,
corruption, bribery, red-tapism and administrative laxity), higher is the risk of such upheaval
and lesser is the viability of investments (Kansal, 2015). The internal sources of political risk
factors may originate from government and other pressure groups in dire social environment.
In Zimbabwe there is a current crisis regarding the legitimacy of the current administration.
The 2018 general elections were adjudged not to have been free and fair by several international
observer missions and disputed by the main opposition party, the Movement for Democratic
Change (MDC). Whilst the Constitutional Court affirmed the ruling party’s victory, the general
population, business community and civic organisations still believe the votes were
manipulated. The government deployed security forces to suppress protests against the election
results, leading to bloodshed in August 2018 and January 2019 which is a breach of democracy.
The government’s failure to deal with the deteriorating social and economic situation in the
country also resulted in massive uprisings against the government in January 2019. Once again,
the government shut down all internet connections and social media platforms, thereby
damaging investor and business confidence whilst they deployed security forces on unarmed
civilians in the dark period.

The Zimbabwean government has a serious legitimacy crisis, and has relied on the security
forces to suppress dissent by the hopeless masses but in the same vein creating a bad human
rights record. This current crisis has adversely affected the country’s economic transformation
as investors have adopted a wait and see attitude. Whilst the government has been globetrotting
selling the ‘Zimbabwe is open for business mantra, no sane investors can pool his resources
and capital in a country with no legitimate government and deteriorating macro-economic

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conditions. The opposition party, social movements, civic organisations and the masses are
always mooting protests, strikes and civil commotions which all have a negative impact on the
operations of a MNCs. Most of these rights have always been associated with work stoppages,
destruction of property and public infrastructure, massive looting of shops and businesses, civil
unrest and of late, bloodshed.

Furthermore, empirical evidence shows that investors shun countries with a high political risk
when selecting investment destinations, as a way of managing risk. The best method of
managing political risk is avoidance as little can be done by the investor to transform the
political risk of the desired destination. Consistent with the behavioural theory hypothesis, all
else equal, firms with risk averse executives are more likely to avoid investing in politically
risky countries. Traditional economic theory typically views managers as homogeneous and
always making decisions in the best interest of shareholders. In contrast, according to
behavioral theory, the characteristics of the individual manager can affect how an executive
manages her firm (Johnson and Tversky, 1983; Slovic, 1987; Gervais, Heaton, and Odean,
2011; Palomino and Sadrieh, 2011). Hence behavioral theory predicts that firms with risk
averse executives might adopt more conservative corporate policies because such policies fit
the personal risk profiles of the executives. Agency-Theory Hypothesis: Firms with risk averse
executives are more likely to avoid investing in politically risky countries if the executives are
less inclined to manage the firm in the interest of shareholders and if the executives are young.
Agency theory explores, among other things, conflicts that exist between managers and
shareholders when their interests are not aligned. Agency theory suggests that the degree of
misalignment between managers’ and shareholders’ incentives can exacerbate the degree to
which managers make decisions more reflective of their own interests than those of
shareholders.2 For example, the degree to which risk averse executives implement corporate
risk management according to their personal risk preferences is stronger when agency conflicts
are particularly acute (Stulz, 1984; Smith and Stulz, 1985; Holmstro¨m and Ricart, Costa, 1986;
Ross, 2004).

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ii. Change of the administration

Change of government is always associated with policy changes and a period of uncertainty to
the business community and investors. Typical of the definitions of political risk as change and
its (negative) effects on business are those of Bunn & Mustafaoglu, 1978; Choi (1979;and
Schollhammer 1978. The authors note a trend towards increasing nationalism on the part of
host governments, and proposes the use of an ecological explanatory model of political
behaviour in a study of 39 countries by the University of Cape Town on Causes of Political
Risk. No explicit model of the business is proposed, although he does discuss briefly, methods
of integrating assessments of political risk into the investment decisions of firms involved in
foreign direct investment.

Changes in governments can bring changes in policy, regulations, and interest rates that can
prove damaging to foreign businesses and investments. Policy inconsistent prevails in
Zimbabwe. The change of the government in November 2017 has brought some changes
politically and economically. The country has gone through policy inconsistence which
exposed companies to incur some losses. In addition, the RBZ Exchange Control Directive to
Authorised Dealers RU28/2019 of 22 February 2019 retention on foreign Export Retention
Threshold of Manufacturing companies is 20% to RBZ. This means for every exports to foreign
countries RBZ will get 20% from the sale proceeds from manufacturing companies. This is not
favourable to a company like Delta Corporation Limited as it struggles to acquire foreign
currency. The company is selling all its products in RTGS dollars. The company will then need
to source foreign currency from the domestic market where foreign currency is very scare. This
will increase the cost since the rate will be always higher due to demand of the foreign currency
especially the United States dollar. Based on these facts Zimbabwe’s situation is not conducive
for FDI through the flow MNCs in the country

iii. Lack of confidence in the administration

Economic Nationalism and Acts of Government Some typical definitional approaches based
on historical trends toward economic nationalism, of the mid to late 'sixties and early 'seventies,
are those which view political risk as being caused exclusively by the actions of governments.
Exemplary of this approach are Gillespie 1989, Buuckley, 1987, Gebelen et al, 1978. Buckley-

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s paper deals with the consequences of government intervention in national economies. He
defines the causes of political risk as the exposure to change in value of an investment or cash
position because of government actions. Following the trend noted above, he delineates two
main routes to analysing the causes of political risk. The macro, applying to all companies, and
the micro. As an example of a macro-measure, he reviews Haner's BERI, 2in detail. Buckley
conceives government action as expropriation - and in his paper, makes recommendations for
post-expropriation policies. In Zimbabwe there is lack of clear and consistence policies
especially on the issue to do with and reform and indigenisation. The MNC will find it difficult
to invest fully in Zimbabwe because the application of policies will be not consistent and
thereby resulting policy failing to act as a standing answer for the recurring problem. White
Farmer who invested a lot on the farms were evicted from land they occupied and they are not
even compensated. This will eventually send a bad signal to the prospects investor in line with
the signalling theory as this is a sign of political risk. Based on this the country status has a
repelling instead of attracting political risk.

In addition, the current administration composition consist a huge composition from the old
dispensation. Zimbabwe there is lack of confidence in the market driven by high exchange rates
consumers resorting to hording and business viability has remained low. Zimbabwe’s hope for
real economic turnaround hangs on the country’s ability to solve the on-going political
challenges facing the country. This instability has led to the lack of foreign direct investments
into the country. The new administration is engaging the international community on economic
forums creating conducive environment for open business, however the political risk is still
high due to contested elections and protest by citizens makes Zimbabwe unattractive for
business. The country is experiencing acute foreign currency. The Shareholder might not
require to invest in Zimbabwe as they will not receiving their dividends and share of profit in
time. For instance Delta Corporation Limited in Zimbabwe is facing some difficulties in paying
dividends to its foreign shareholders. According to the information released, the company as
at 15 November 2018 owe about US$30 000 000.00 to both our shareholders and some of our
creditors, Chief Executive Officer, Pearson Gowero told analysts in the capital, Harare. The
company was continuously engaging the government through the central bank to clear some of
the impediments in accessing foreign currency. In addition, as of 23 December 2018, the
company reported that it owes foreign suppliers US$41 000 000.00 and that it was also unable
to remit dividends to its foreign shareholders.

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The sources of political risk factors may also be classified as government-related versus society
related. Riots and terrorism may be classified as society-related sources of political risk factors
as they are caused by the society instead of the government (Essel and Mostert (2013). The
government may, on the other hand, be the source of political risk factors when it changes taxes
and economic policies. Transfer risks originate when government regulations impact on the
capability of an enterprise to transfer funds. An increase or decrease in rate of taxes is a good
example of political component and this directly affects business. The new administration has
put in place austerity measure needed to resuscitate the economy which was put on its knees
with the previous administration. However following the introduction of monetary policy and
fiscal policy in 2018 October government introduced a new tax of 2% per every dollar on all
electronic transactions from 5 cents per transaction. This may apply to the transfer of funds
between various locations or between local and foreign currencies. Although amount raised
from this tax have managed to cover the domestic debt which was very high according to
Minister of finance and economic development professor Mthuli Ncube, it have an impact on
aggregate demand which raises the political risk of multinational companies.

iv. Renewal of sanctions by America on Zimbabwe

Sanctions imposed by United States of America on Zimbabwe crippled the Zimbabwe’s efforts
of attracting FDI. Although the sanctions are said to be targeted they affect Zimbabwe’s new
administration to revive or kick start the economy. Trade sanctions are likely to be a source of
political risk. Zimbabwe was placed under sanctions list by United States of America which is
a heavy blow to Zimbabwe as far as trade is concerned. The old dispensation policies had their
predictable results, by voiding property rights, he killed investment. The previous government
was spending four times the budgeted expenditure in the 2000s. Shapiro (2014) In a vain
attempt to curb this inflation, The price controls were there order of the days, the government
imposed price controls on fuel and food, leading to shortages economic sanctions was imposed
on Zimbabwe.

Furthermore, the government can respond as what happens on 01 August 2018 and January
2019. The response by the government may not be favourable as this can lead to the death and
dispersion of several citizens. The death and movement of people from the country reduces the
MNC customer base. Some other international organisation may raise concerns about the

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human rights and freedom of the Zimbabwean country and this will lead to them extending
sanctions to the nation. This is will again create an environment which is not concussive for
the operation of the MNC in Zimbabwe. These organisations can impose more sanctions on
Zimbabwe citing that international sanctions are political and economic decisions that are part
of diplomatic efforts by countries, multilateral or regional organizations against states or
organizations either to protect national security interests, or to protect international law, and
defend against threats to international peace and security. These decisions principally include
the temporary imposition on a target of economic, trade, diplomatic, cultural or other
restrictions (sanctions measures) that are lifted when the motivating security concerns no
longer apply, or when no new threats have arisen. The empirical work by reflect that executives
of the MNC avoid investing in risky countries as way to manage risk.

Sanctions include limitation of activities of one or several countries from specific types of
transactions the sanctioning countries and international bodied typically pursue this issue to
oblige the target country to accept some conditions of the imposing country or body. Farani
(2012) in Zimbabwe it is about land issue. Sanctions can be divided into military, economic,
international and political although some sanctions may fall into many categories (Charnovitz
2001). FDI is unlikely to come through due the in conducive environment for investment as a
result of the economic sanctions despite all the efforts by the new dispensation of engagement
and reengagement with the Western countries. The old regime or the first republic of Zimbabwe
used to call a look east policy where they were befriending countries like China and Russia.

Measuring or assessing political risk

There is no universal measure of political risk and there is a lot of disagreements among
scholars. Political risk can be measured by political stability in a country. Political stability is
measured by the frequency of changes in government changes, constantly having political
coups, civil wars, conflicts with other stakeholders and the period the current regime will be in
power and whether they will be willing and able to enforce its foreign inmate guarantee. A
nation with high political stability will be one where politics was extremely predictable.
Dictatorial or totalitarian governments are probably the most stable followed by democracies
then mild term to long term dictatorship. Some failed states have wrecked by years of internal
political violence or severe economic disaster. Around the world, fundamentalist religious

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movements have entered the political arena in a direct challenge to one of the basic principles
of the modern age (Shapiro, 2014). In the new Zimbabwe there is high level of political stability
despite the stay led by some political parties and religious sects. The August shooting
Zimbabwe is one of the safest destinations of investing in as far as peace is concerned. The
current president is moving towards a democracy where he is operating an open door policy.
Political risk can also be measured by economic factors such as country debt, Gross Domestic
Product and Balance of Payment (BOP) deficit. There are some obvious economic factors that
affect economic stability (instability) in a country. The long term growth rate of GDP per capita
would be one of them. The contention is that the higher GDP growth rate will lead to more
stable governments, and vice versa Miljkovic (2008). Although the economic conditions are
partially responsible for present instability of the Philippine government, they pose less of an
immediate threat than political factors intelligence memorandum (1950). In the new Zimbabwe
the rate of inflation is increasing it is now around 60% and the BOP deficit have reduced
significantly due to policies implemented by the minister of finance such as payment of duty
on car imports by US dollar. This reduced the import bill significantly since the US dollar is
scarce. The government also reduced the BOP deficit by increasing the price of fuel which was
the lowest in the region neighbouring countries were consuming fuel inn Zimbabwe taking
advantage of the arbitrage profits. The better a country’s economic output the lesser likely to
face political instability and political turmoil that will inevitably hash foreign direct investment.
Capital flight is a good indicator of the degree of the political risk. It is defined by Shapiro
(2014) as the export of a nation’s savings by citizens because of safety of capital fears. It is
measures using the balance of payment. Capital flights are caused by inappropriate economic
policies, expectation of devaluation or the imposition of capital controls and high political risk.
It can be triggered by a country’s specific events or by a macro economic development that
causes a large scale shift in investor preferences. In Zimbabwe towards the end of Mugabe era
there were a lot of issues concerning capital flight as billion went missing for instance the 15
billion diamond money went missing in 2017. This shows the high level of political risk due
to corruption. However with the current government all the loopholes for illegal capital flight
were dealt with Capital flight is difficult to measure because it is not directly observed in most
cases never the less one can usually use the capital outflow using a balance of payment figure.

More subjective measures of political risk are based on general perception of the country’s
attitude towards private international businesses. The government consider private enterprises

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as an evil to be eliminated as soon as possible. While investors in the whole world are willing
to spend considerable time and money employing lawyers and accountants to carry out due
diligence on planned investments particularly in foreign jurisdictions very few resources if any
are allocated to examining the political factors that may influence success of a venture.
Although political risk has been receiving more attention these years there are some notable
exceptions, most political risk assessments remain both superficial and subjective. Zimbabwe
is being viewed as a destination which is unsafe for investments that’s the reason why we have
failed to lure meaningful foreign direct investments despite all the efforts by the president about
the openness for business of Zimbabwe.

Managing political risk

While MNCs vary in the level of risk appetite, most studies show that they are risk averse or
they have a very low appetite for risk. They also vary in the extent to which they are able to
deploy cosmopolitan country managers reasonably familiar with the social and cultural
environment in which company operates. There are several strategies that can reduce foreign
company political risk. Engage in open competitive bidding, avoiding fast track arrangements.
Participation in latter may invite accusations that you have bribed local officials. There is need
to examine the political connections of your local partners carefully. Close association with the
political party which is administering the economy may help a multinational company to
mitigate against political risk. If the company is operating in Zimbabwe there is need to respect
the national history and support national government programs such as Independence Day,
national unity day, national cleaning day as well as heroes day celebrations. How there is
danger if there is going to be a change of government shortly.

Political risk insurance is part of risk transfer and is considered to be the most effective strategy
for handling political risk factors (Esseland and Mostert, 2013). Multinationals need to pay
special attention to analysing whether the organisation should purchase political risk, trade
credit, or other types of insurance policy that may cover in the event of loss escalating from
political tension in the country of operation. Insurance or guarantees against various political
risks can be purchased from a number of private insurance companies, such as Lloyd’s of
London, and various governmental agencies, such as the Agency for International
Development (AID) (James, et al, 2008). The political risks covered may include expropriation,

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currency inconvertibility, war, and revolution. According to Marsh and Guy (2019) if the MNC
is relying upon a supplier which was placed under sanctions list in a country which has been
banned from accessing the materials then multinationals may need to access alternative
suppliers of critical materials in order to ensure continuity of the business since the risk
associated with sanctions may go beyond an organisation’s own operations the government
need to help. Organisations should maintain an open line of communication with insurance
underwriters to obtain any necessary approval before taking any action to minimise loss. In
addition, MNCs can encourage their governments to enter into bilateral agreements with the
governments of the desired investment country to protect their investments. For instance, the
government of Zimbabwe entered into Bilateral Agreements with the government of South
Africa which aim to protect South African businesses operating in Zimbabwe. This came after
the aftermath of the land invasions.

To resolve the risk of expropriation of foreign assets like in the case of Zimbabwe, there is
need for dialogue with the affected parties and map up the payment plan to compensate the
nationalised company owners and white farmers for the developments made on the farms.
Zimbabwean white farmers were robed their assets as well as their investments on the farms.
If Zimbabwe is to improve its relations and subjectivity of political environment and property
rights should be done. This is similar to the case of nationalised American companies in
Venezuela, the Venezuelan government compensated in a manner quite similar to the
participation of agreements worked out in a most of the Middle Eastern oil producers Maurer
(2011). The companies also received market contracts to sell Venezuelan oil in international
markets. The problem was on the standard of compensation, in light of the uncertainties and
disagreements which surround the law regarding the standard of compensation the best solution
that could be hoped for in the present stage of international law is for states to settle for
compensation through treaties.

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Therefore, political risk assessment is a key determinant of the foreign direct investment and
competitiveness of MNCs. Political risk assessment is today a task of paramount importance
for the international investor. While in the past political risk was often conceptualised in terms
of hostile action by host countries' governments, with the quick pace of globalization its nature
and sources have considerably changed, raising the interest of scholars belonging to different
fields, from international economics to international relations, from empirical political science
to psychology and decision theory. In an era in which global equilibria have changed and once
clear-cut distinctions such as “developing” vs. “developed” countries have become blurred,
intelligence and risk management have become a major source of concern. The issue of the
relationship between politics and the activity of international investors has become even more
burning in light of the ongoing economic and financial crisis, a crisis whose causes are – at
least partially – ascribable to questionable policy choices.

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University of Zimbabwe | MACC 504: International Financial Management