PAPERS INTERNATIONAL

FINANCIAL MANAGEMENT
“Funding Foreign Investment and Political Risk”

Oleh :

KASNA NINGSI KUSUMA A012192039

PRODI MAGISTER MANAJEMEN

PASCASARJANA UNIVERSITAS HASANUDDIN
MAKASSAR

2020
 KATA PENGANTAR

Puji dan syukur kepada Tuhan Yang Maha Esa, karena atas berkat dan
rahmat-Nya sehingga penulis dapat menyelesaikan makalah yang berjudul
“Funding Foreign Investment and Political Risk”.

Penulis menyadari bahwa makalah masih jauh dari kata sempurna oleh
karena itu, semua bentuk perbaikan, saran, kritik dan masukan sangat penulis
harapkan untuk peningkatan kualitas tulisan penulis di kemudian hari. Besar
harapan penulis agar makalah ini dapat memberi nilai tambah yang positif bagi
pembaca semua.

Makassar, December 2020

Penulis
A. Political Risk Effect on Foreign Investment Decisions
There are many factors, most of which are interrelated with one another
with a very complex pattern that has caused the slow recovery of investment in
Indonesia to date. These factors range from what is often mentioned in the mass
media, namely security problems, lack of legal certainty, and poor infrastructure
conditions, to worsening labor conditions . In simple terms, it can be said that the
investment climate reflects a number of factors related to a particular location that
form opportunities and incentives for investors to conduct business or
investment productively and develop. More concretely, a conducive business
or investment climate is a climate that encourages someone to invest with the
lowest possible costs and risks on the one hand, and can produce the highest
possible long-term returns, on the other (Stern, 2002). For example, several
studies show that in China and India, as a result of the improvements in the
investment climate in the 80s and 90s that drastically reduced investment costs
and risks, private investment as a share of gross domestic product (GDP) an
increase of nearly 200 percent.
There are a number of factors that greatly influence whether or not
the investment climate in Indonesia is good. These factors concern not
only political and social stability, but also economic stability, basic infrastructure
conditions (electricity, telecommunications and road and port infrastructure), the
functioning of the finance sector and labor market (including labor issues),
regulation and taxation, bureaucracy (in terms of time and costs created), issues
of good governance  including corruption, consistency and certainty
in government policies that directly or indirectly affect the net benefits of long-
term risk costs of investment activities, and property rights from land to
contracts. (Tulus Tambunan, 2006).
In a World Bank report on the investment climate (World Bank, 2005),
among these factors, macroeconomic stability, level of corruption,
bureaucracy, and certainty of economic policy are the four most
important factors . Although it differs slightly in the ranking of investment
constraints between countries, the results of the World Bank survey are supported
by the results of the annual survey on country competitiveness conducted by The
World Economic Forum (WEF), the results of which are shown in its annual
report, The Global  Competitiveness Report . As can be seen in Figure 2, based on
the percentage of respondents, it turns out that the three factors inhibiting business
that get the top rank are inefficient bureaucracy , bad infrastructure, and tax
regulations. Therefore, political risk is a major concern for foreign investor
companies - from industrialized countries and developing countries - when it
will penetrate emerging markets. At the same time, investors maintain a positive
outlook on the economy and business prospects in developing countries, which
are expected to attract direct investment growth globally as the economy
recovers. Based on previous studies and the results of surveys conducted by
international institutions, there are several factors that influence the entry of FDI
into a country, namely as follows:
a. Economic growth
Increasing economic growth in a country can increase investor interest
in investing in FDI. An increase in Gross Domestic Product indicates an
increase in market size so that countries that have increased in GDP
can become regions that become the basis for making sales. Several countries
in East and Southeast Asia show a positive trend between FDI and GDP, these
countries include: China and Singapore.
b. Political Risk
Political risk is related to the potential inflow of FDI in some
countries, this political risk is related to potential uncertainty. So that this
potential for uncertainty can reduce the fall in FDI in a country.
c. Other macroeconomic variables
 Apart from GDP and political risk, there are several other
macroeconomic variables that determine the entry of FDI into
a country. Among them are the institutions or stages that must be passed in
investing in a country. Macroeconomic stability , health and education are
also factors determining the inflow of FDI.
The increase in FDI capital inflows was relatively limited. As a form
of capital flows which are long-term and relatively vulnerable to shocks, the
economy, FDI inflows are expected to help drive investment
growth sustainable in Indonesia. Therefore, it is important to know the factors
that play an important role in encouraging foreign investors to invest in the form
of FDI in Indonesia, especially East Java. However, the fluctuation of the level of
investment that has entered to date is not only seen from the factor of economic
development, but also in terms of the risks that exist in the destination
country. Because the higher the risk the higher the return value. And the lower the
risk value, the lower the return value faced by investors.
Especially for investors who will invest in developing countries, there are
many factors that must be considered and considered before finally deciding to
invest. There are several risks that must be faced when investing in the destination
country. One of the considerations that must be considered in depth is political
risk . There is a pattern of a positive relationship between political risk in
Indonesia and the level of investment inflow. The change in conditions of
political stability in 1998 indicated a decline in investment in
Indonesia. However, as conditions in Indonesia improve, investment in the
country is increasing. The increase in investment in Indonesia as a result
of economic improvement and stability in Indonesia is also shown by the increase
in the Global Competitiveness Index over the last 3 years. This index is one of the
references for investors to invest in a country. (FDI determinants, 2007).
Indonesia is one of the countries that has increased its competitiveness
index ranking compared to several other Asian countries. According to the
calculation of the Global Competitiveness Index, the increase in ranking that
occurred in Indonesia was caused by improvements in several factors, as can be
seen from the table showing the competitiveness index , which
includes: macroeconomic stability and efficiency in the market. However, the
increase in investment has not been maximized, especially when compared
to other countries , especially in Asia, Indonesia is still a country with a low
level of foreign investment incentives, even below several Southeast Asian
countries, especially in the infrastructure sector, such as: Singapore, Korea,
Malaysia, Thailand, India. Therefore, it is necessary to make efforts to encourage
increased investment in Indonesia. Investments made in Indonesia have not
reached optimal levels, indicated by the following factors :
1. The rate of return on investment is reflected in the downward trend in
the Incremental Capital Output Ratio (ICOR). The decrease in ICOR
shows an indication that capital productivity has decreased.
2. The average percentage of FDI realization on applications submitted
has only been around 50% since the 1990s. This figure shows that most of
the plans for foreign projects that have received permission from
the government have not been implemented.
3. In terms of infrastructure availability, Indonesia is arguably
still underdeveloped compared to several neighboring countries.
4. Labor productivity in the post-crisis period has decreased, and is still
lower than that of some neighboring countries .
5. Human resource development has not
shown significant progress compared to neighboring countries as indicated
by education expenditure against total government expenditure.
6. The high risk at both the macro and micro levels.
7. According to a survey conducted by the World Bank, it shows that in
terms of the number of procedures, time and costs to start a business, the
 process of starting a business in Indonesia is one of those that have major
obstacles compared to other countries.
 
Meanwhile, from a governance perspective, the level of corruption in
Indonesia has not shown significant improvement. This is the cause of the
high micro risk in carrying out economic activities in Indonesia .
Political risk and political instability according to green,
are inversely correlated with the degree of modernization and adaptation of the
political system, the more developed and more sophisticated the political system
is, the lower the risk and the lower the prospects for political instability in the
event of sudden structural changes . Political risk increases when the political
system is more primitive, the state is less adaptive, or the state is more vulnerable
to being influenced by surrounding interests. More importantly, the level of
political risk is assumed to be positively correlated with the stress caused by the
acceleration of economic modernization , whereby the political system can
penetrate to its highest point of crisis when faced with complex demands caused
by rapid development , social dislocation, and the emergence of undesirable
issues. has the institutional capacity to cope with: levels of expectation, fairness
of distribution and the emergence of strong new constituencies.
For Green, the presentation suggests investment strategies to avoid various
political risks. First, identify which system type countries fall, then the strategies
used or designed that reflect the country's political risk profile. Thus, in the case
of a military dictatorship where the legitimacy is low, the use of force
everywhere, and suddenly the regime change or popularity increases,
avoiding long-term investment , using short-term investment vehicles,
minimizing usually forfeiting, efforts to withhold investment in liquid
and easy assets. to be drawn. Conversely, emerging societies that fall into what
Green calls instrumental and quasi-instrumental systems promise minimal
political risk, invite long-term investment, and are able to support higher
irreplaceable costs by exposing infrastructure (mining, production) to political
risks. low. Unexpectedly, adaptive systems play the role of displaying the lowest
level of political risk and the highest level political stability, able to absorb long-
term investment, high sunk costs , and multiple investment exposure with
relatively low political risk.
In making foreign investment, investors have
their own considerations . Consideration was directed to a variety of factors in the
country the country where the investment objectives. The industry factor that will
be entered is a consideration for investors. Investors must decide to invest in
an industrial sector. However, before entering the industrial level, investors must
first decide which countries to invest their capital in. This is related to
globalization, where investors must be able to compete in the industry they
choose. Furthermore, this competition can be won if investors have correctly
decided to invest in a country that supports their industrial business. Broadly
speaking, the cost and benefit factors are two things that are the main
consideration. Foreign investors certainly want efficiency in their investments
with optimal returns in foreign countries. Investors are interested in investing
their capital in a country that has political stability, because this will have
a significant influence on the business development of these investors. The
worsening of the investment climate generally occurs due to increased country
risk and unstable socio-political conditions that have a significant effect on capital
flows.
One of the motives of foreign investors related to this research is to seek
political security. Foreign investors tend to invest in countries with stable political
conditions. If investors feel that the state of government can affect their business,
foreign investors will move to other countries with better quality
government, which is reflected in their political situation. In general, the
indicators for each variable relate to cost and profit factors , in relation to foreign
investors' consideration of choosing a country. The relationship between the
indicators for each variable and the level of FDI in is as follows:
a. Voice and Accountability
1) The affordability of information on a country's public offices by para
foreign investors.
2) Transparency of government in notifying policy changes domestic
investment with respect to incoming foreign investment.
3) Dialogue between the government and foreign investors.
b. Political Stability and Absence of Violence
1) State security conditions that may disrupt operations foreign business.
2) The level of terrorism in a country that can threaten performance
foreign investment.
c. Government Effectiveness
1) Delays in the local government bureaucracy of the process investment,
where foreign investors would have to wait longer if complicated
procedures - complicated.
2) The amount of time and costs involved in making an intermediate
agreement local government and foreign investors.
d. Regulatory Quality
1) Policies regarding general costs that must be incurred by foreign
investors.
2) Policies regarding fees to be incurred by foreign investors with respect
to the local workforce.
e. Rule of Law
1) The level of quality of legal institutions in dealing with problems
relating to business and the economy
f. Control of Corruption
 1) Government quantities at various levels (for example in sections
taxation) involved in the corrupt process when foreign investment
come in.
2) The quantity and frequency of foreign investors who have to pay an
amount certain money for the smoothness of the investment process.
Apart from factors related to costs and benefits, investors also consider
other motives for investing in foreign countries , including:
a. looking for a market, to get additional income by supplying goods to new
markets
b. looking for raw materials, where this consideration is related to natural
resources that will be processed further
c. looking for production efficiency or cost reduction , in which investors
invest in countries that have cheaper production factor prices so that their
processed products can be sold at competitive prices, both domestically
and for export
d. The search for excellence of knowledge or knowledge seeking , by making
investment in the country - the country forward in a field of similar
efforts in order to gain knowledge and experience in the relevant business
e. economies of scale , where investors try to develop competitive
advantages in various parts of management (production, marketing,
finance, research and development, distribution, and purchasing) to
produce products for sale in new markets.
f. Maintaining existing customers (keeping domestic customers)  , that
is , when one party decides to invest in a country where its consumers are
located.
g. Multiple sourcing , where foreign investors must be prepared to comply
with regulatory regulations in more than one country. Things to be
considered by the investor is the amount of costs to be incurred in
 connection with the treatment policy in the country - the country in which
to invest
h. seek political security
(Sartono, 2001; Shapiro, 2003).
One of the motives of foreign investors related to this research is
to seek political security. Foreign investors tend to invest in countries with
stable political conditions. If investors feel that the state of government
can affect their business, foreign investors will move to other countries
that have better quality government, where this is reflected in their
political situation.
So, economic stability is very important to pay attention to not only to
maintain the stability of the country, but also to attract foreign investors to invest
in Indonesia. However, we cannot just look at it from that point of view, because
the conditions in each country or region are not the same, we cannot equate
investors' considerations with developing countries, because it is clearly very
different, in terms of systems and implementation or operation, it is different from
developing countries. Foreign investors will be interested in investing in a country
that has a conducive situation, because with this situation, the business carried out
by foreign investors in a country can be well controlled and predictable . So as we
understand that political risk is seen as a tool to understand the existing situation
where political and social factors can affect the ability of the state and willingness
to respect its financial obligations.
B. Maintain Stability of Macroeconomic Factors
The factor in which the government, including keeping political risk from
escalating or minimizing political risk, is a macroeconomic factor, in which the
government also has a role in creating conducive macroeconomic conditions to
attract the attention of foreign investors (Parjiono, 2007). Macroeconomics in a
country is related to the level of foreign direct investment. Many variables are
included in macroeconomic problems. These factors have an influence on the
 level of incoming FDI. Factors in the macroeconomics of a country are one of the
analyzes for foreign investors , which are included in the country analysis. The
investment climate in a country is a matter of consideration for foreign investors,
which includes all policies concerning the country's macroeconomic conditions ,
such as the level of economic growth, labor issues, and even the country's social
and political conditions (Solnik and McLeavey, 2009). As said by one of the
investors from Japan, Daiwa Technical Press Co., in one of the online media:
"We do not see political stability, but more on the ease of management licensing,
both as pure PMA and as a Joint Venture and must exist transparency. And also
emphasizes the importance of improving road infrastructure as well ports and
guarantees of energy supply, both gas and electricity ”.
Because until now, investors still see environmental conditions in East
Java which still need a lot of improvement, especially in terms of infrastructure
that is still inadequate. And they also need a guaranteed energy supply that is still
not guaranteed. 
C. Factor - Factor in Macroeconomics
a. Unemployment
Providing employment opportunities in accordance with the number of
available workers is an important responsibility of an economy. In its
development, the increasing number of private companies encourages the
development of job opportunities. However, the government remains
responsible for meeting the work needs of its citizens (Sukirno, 2000). In
relation to the level of foreign investment , things that must be considered are
the ability of local workers in the managerial field and the use of technology
that will be brought along by foreign investors (Parjiono, 2007). If
the workforce can adjust to the needs of foreign investors , the level of FDI
entering the country concerned will improve. Another thing that is of concern
to the government in this case is labor costs, where foreign investors
will consider the amount of labor costs they have to spend compared to their
investment returns (Agiomirgianakis et al, 2006).
b. Inflation
Inflation is a condition in which the price - the price increased in
general in a country. The cause of inflation does not only come from
excessive money supply but is driven by other factors, such as salary
increases, political instability, the effect of foreign inflation, and the decline in
currency values (Sukirno, 2000). High inflation
indicates macroeconomic instability in a country. This is a factor inhibiting
the entry of FDI, because foreign investors are reluctant to invest in countries
with high production costs (Rezafimahefa and Hamori, 2005).
c. Economic growth
Economic growth is a long - term economic problem . In each period,
a society will increase its capacity and other production factors to
produce goods and services. However, not all countries can achieve economic
growth in accordance with the development of the increasing
production capacities of production factors (Sukirno, 2000). With the right
government policies, it is expected that the total productivity factor
will increase so that the macroeconomic condition becomes stable. Economic
growth itself can be highlighted through the business cycle and long-term
sustainable growth in the country concerned. This long-term growth is
reflected in the country's GDP (Gross Domestic Producy) level, where a
high level of GDP encourages more foreign investment (Rezafimahefa and
Hamori, 2005; Solnik and McLeavey, 2009).
d. Foreign Exchange Rate (Forex)
Problems will arise when a country cannot become a stable foreign
exchange rate. This occurs when there are excessive imports . Due to the
excessive imports, the domestic currency has fallen so that the prices of these
imported goods become expensive and accelerate
inflation. The declining value of the currency and this uncertain condition
reduce the enthusiasm of foreign investors to invest so that this will slow
down economic expansion in the future (Sukirno, 2002; Rezafimahefa and
Hamori, 2005).
The results illustrate that political risk depends on
the strategic behavior of the multinational as partners and host companies
have strategic interactions with local governments.

DAFTAR PUSTAKA
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