23 COUNTRY RISK AND POLITICAL RISK ANALYSIS ee After reading this chapter, you will + Understand the meaning and importance of country and political risk analysis ‘Appreciate how such an analysis could be beneficial for the multinational enterprises The recent civil unrest in Syria has weakened the economy from a growth rate of more than 5% in 2007 to the negative growth rate of -25% in 2012. Amid conflicts, considering the prospects of peace, the World Bank has forecasted that the country is likely to attain positive economic increase in the civil casualty. In fact, 40% people of its Population are homeless and a bulk of them are refugees in other countries and at least 1,50,000 people died during the confli continuous crisis and its devastating results are leading Syria towards an economic cri crisis coupled with deindustrialisation and rising debt is affecting the Syrian economic outlook. In this scenario, crude oil production in the country has decreased drastically. The production of crude oil prior to the conflict was 3,80,000 barrels per day, which decreased to 20,000 barrels per day—a decrease of about 95% in the Production of crude oil. The oil and gas exports of the country accounted for a major part of export earnings, which has now reduced significantly. In addition to the oil sector, the industrial and agricultural sectors have also been affected by the recent ongoing conflict in the country. Around 75% of the industries are not Operating now in Aleppo, a major Syrian city. This is a serious matter, as it is leading to deindustrialisation. The Damascus Securities Exchange (DSE) has lost its global value since the start of the civil 429430 © Business Environment: Indian and Global Perspective unrest. It is estimated that the stock exchange has lost 86% of its value. The result of economic slowdown is the increasing inflation in the country. Inflation has been increasing at a higher rate, creating a situation of stagflation. 20.0 3000.0 = 2 Sen 2500.0 8 g 2000.0 = 100) 1500.0 § é | 8 & so! 1000.0 | 500.0 & 0.0+ FOOL Ee. 2003 2004 2005 2006 2007 2008 2009 2010 —+— Real GDP growth --t= Inflation —e-~ GDP per capita Exhibit 1 Pre-crisis economic scenario. Source: World Bank. Although some optimism is apparent from the point of view of the World Bank in Exhibit 1, yet the country's economic scenario poses a major risk for business communities in the country. The country risk is associated with both economic performance of the country and also the political scenario of the country. The current situation highlights that Syrian economy is moving towards a serious economic crisis due to the political scenario. The assessment of political risks and country risks entails a major loss in the industrial sector as well as in the oil sector. In addition, the investment in infrastructure sector will also have a high risk while assessing return on investment. Exhibit 2 Syria's GDP growth forecast in 2010 US$ (%). Source: Central Bank of Syria. Also, the Doing Business Report 2013 ranked the country 147th among 185 economies. Its overall score decreased by 7 compared to the previous year, reflecting lower scores in 8 out of 10 indicators. In 2014, this rank again slipped to 165th, which is a matter of concern both for Syria as well as its trade and investment partners. Source: This case is written by the authors based on inputs from the following sources: 1. World Bank Country and region specific forecasts and data. 2. CNBC, http://www.enbe.com/id/100994327 3. The Economist, http://www.economist.com/blogs/newsbook/2011/04/unrest.syria 4. http://carnegieendowment.org/sada/2013/11/19/losing-syria-s-economic-future/gu5})Country Risk and Political Risk Analysis * 431 Pe 23.1 RISK ANALYSIS Country risk analysis and political risk analysis are the important tools to understand the current economic scenario and forecast the future economic situation. Country risk analysis examines the overall macroeconomic performance of a country and also the planning and policy framework of its government. The concepts are widely used by business houses, public sector, etc. to formulate strategies. For example, if a firm intends to do business in Africa, then it needs to formulate strategies for the same. To do the same, the firm would need a holistic view of African countries, which would include assessment of both the economic and political situations in these countries. In order to make such assessments, the concepts of country risk analysis and political risk analysis are employed. 23.2 COUNTRY RISK ANALYSIS Conceptually, the country risk analysis is a process of environmental scanning of macroeconomic indicators of a country, coupled with the examination of policies and frameworks of the same” country for both long and short-term periods. We know that every country has its own economic system and the policy framework (see Chapter 4 on Economic Systems). For example, India has a Planning Commission as a major institution for formulating long-term as well as short-term policy planning. It also formulates the five-year plans for the country (see Chapter 5 to know more about five year plans). In case, a foreign firm intends to do business in India, it will have to scan the emerging economic opportunities through examination of macroeconomic indicators and their performance (see Chapter 6 to know more about macroeconomic indicators). In addition, to understand the future scenario, the firm would also undertake a holistic view of planning and targets that are being set up under these plans. Considering the above contextual aspects of country risk analysis, it may be construed that it consists of some theoretical formulations. These theoretical formulations are related to country’s economic performance at domestic level, its international or global economic expansion and its long-term policies set out to achieve the economic goals, With domestic performance, the \analysts may choose indicators from the national income acCounting and its trends. This is again based on the objective of the analyst while carrying out the country risk analysis. The analysts may choose the indicators that fulfil the requirements as per the set objectives. Coming to the aspects of international performance, some important risks are analysed. The external economic performance relates to the performance of the economy at the current and capital account. It is also closely related to the rate of interest and exchange rate scenario. In order to avoid the exchange rate risk, analysts look at the related indicators. Exchange rate has significant impacts on both the current account and the capital account balance (see Chapter 22 to know more about foreign exchange risks). It also affects investment. On account of the government planning, it is important for an analyst to do a detailed analysis of the policies. In order to do this exercise, the framework includes examination of sectoral strategies. This exercise again requires objectivity in analysis. The objectivity means identification of sectors that are strategically important for a firm. For instance, if a firm wants to make investment in infrastructure sector, then the firm will do an analysis of the programmes and plans in infrastructure while doing the country analysis. | Deb432 © Business Environment: Indian and Global Perspective 23.2.1 Evaluation and Diagnosis of Risk With the above framework, the process of country risk analysis, thus, includes four major aspects, viz. economic performance, current and future policies and strategies, legal frameworks, and institutional frameworks. These aspects of country risk analysis are discussed as follows: 1. Economic performance: Economic performance is based on the macroeconomic indicators of a country. Generally, the data on macroeconomic performance is published by the countries through their respective agencies. In addition, data on macroeconomic indicators are also published by the multilateral institutions such as the IMF, the World Bank and the UN. The data published by the multilateral institutions are very important in the context of comparative analysis of more than one country. Government agencies as well as firms extensively use the data published by multilateral institutions. In addition, there are also some social indicators, which may be useful to examine the risk of doing business in a country. Social indicators, such as demographic structure, Poverty, employment, education, health, etc. are vital for an economy. The countries doing well on these indicators are also expected to have good economic performance and also better business prospects. 2. Planning and strategies: The government, as an entity, also works in a systematic manner. It has its own structure and framework. The government of a country formulates policies to attain the long-term as well as short-term objectives. These Strategies are being formulated as per the present performance and future need. For instance, we would like to cite an example of recent policies on transport development in India. The Government of India has formulated National Transport Development Policy Committee (NTDPC) under the Chairmanship of a noted economist, Dr. Rakesh Mohan. The committee has submitted the report to the Government of India. The report has formulated Policies and strategies for the development of transport sector in the country for 2032. Now, suppose if a firm wants to make an investment in India in the infrastructure sector in the logistics industry, it will need to examine the current policies and strategies of the transport sector in the country as well as the future strategies, which are documented in the reports of the committee. 3. Legal framework: Mere formulation of strategies and policies will not be the solution for attaining both long-term and short-term economic and social goals of a country. In order to achieve a set goal for a particular sector, the government not only formulates Policies but also gives a legal status to these policies. The legal status of policies is called an act. For each sector, the government has a legal framework with the provision of acts. In case of India, the government has planned to pursue a liberalised economic Policy as well as has also found space to pursue a socially significant policy such as those related to food security. Also, the Government of India has formulated policies to attract FDI in multibrand retail sector, which is deemed good for the industry, and has also enacted act to pursue the policy further. Similarly, through food security ordinance, the Government of India has also enacted a new subsidy policy. With the purpose of country risk analysis, these policies are very important. Investors have to examine the nature of the economy through these legal frameworks (read Chapter 12 toCountry Risk and Political Risk Analysis. * 433 know about India’s legal framework governing businesses). In addition, the case of New Land Acquisition Act also has an imperative role for the infrastructure development. Thus, for country risk analysis, these elements are taken care off. 4. Institutional framework: To do a country risk analysis, an examination of the role of institutions is also important. Institutions, which are also the regulators, play an imperative role in bringing out the economic policies in practice. For example, when we carry out country analysis, we need to examine the set of institutional frameworks for various sectors such as industries, corporate sectors, infrastructure, financial markets and money markets, etc. With a focus on infrastructure, particularly shipping industry, the foreign firms need to examine the institutional mechanism before coming for business in India. In this regard, institutions like Tariff Authority of Major Ports (TAMP) is an institution, which is playing a pivotal role in developing a competitive port sector. 23.3 POLITICAL RISK ANALYSIS Political risk analysis is another important tool for understanding the risks associated with a country while doing the business. Political risk is defined as a risk, which is political, strategic or geopolitical in nature that arises due to civil war, civil unrest, geopolitical disorder, regional contentions, disputes, etc. These unrests cause political instability in a country. Therefore, a foreign firm or government agency looks forward to a stable government or political system in the country, where it intends to do business. With this background, it becomes very important for an analyst to value the political risk. ‘The development of the concept of political risk has evolved over the period of time. The phases of theoretical development of political risk analysis have also been affected by the development of global policies and the global political scenario. The multinational firms also try to mitigate the political risks associated with their respective businesses in different countries. Mitigating political risk has now become easier with the strengthening of the multilateral trading system. With the development of multilateral institutions, particularly Bretton Wood Institutions and GATT/WTO, the global businesses can now easily get pre-requisite information needed for making political risk analyses (see Chapter 14 to know more about international organisations). In fact, political risk is related to the political instability in a country or the region. In addition, this risk is also associated with the kind of political regime. We have seen in the recent past that Myanmar was ruled under dictatorship of Military Junta and in Afghanistan, the regime was not recognised by the international community. Thus, if there is 2 continuous and frequent change, or an internationally unacceptable regime in any country, then it makes the business environment unpredictable for the foreign companies. Then, there exist political risks for the corporations as well as for the governments when they plan to do business with such countries. It affects the investment flows to a large extent. 23.3.1 Importance of Political Risk Analysis Companies doing business at global level always face issues related to a country’s political434 * Business Environment: Indian and Global Perspective scenario. For example, as per The American Chamber of Commerce in Egypt, the revolution in the country in 2011 and the coup in 2013 led to the disruption of internal political security. This resulted in an increase in the political risks for the firms doing business in Egypt. There are 950 members of the American Chamber of Commerce in Egypt engaged in business in Egypt as well as in America. Some Egyptian companies are doing business in America, which is also one of the members of the chamber. The current political unrest caused major problems for the industries in their operation. The issues like energy shortages are yet to be solved. Energy is an important ingredient of industries.’ There is an increasing uncertainty in Egypt for the business communities desiring for investment. This highlights the importance of political risk analysis. A business firm requires to analyse the risk of investment in a country before making an investment. The associated risk also includes political risk and its valuation. The analysis of such risks is very tactical, as the existence of complex relation between economics and politics makes it an exhaustive and a carefully crafted task. The analysis also tries to formulate strategies to mitigate or manage the political risks. 23.3.2 Valuing Political Risk Before designing adequate strategies to tackle the political risk, it is important for the corporations to do work on the following two aspects: 1. Assess the type of risks 2. Valuing the risk The assessment of political risk broadly embraces the identification of possible dangers to the political situation of a country. The methodologies that are accepted in corporate strategies to assess the pal litical risk analysis include event tree analysis, subjective analysis and statistical modelling, etc. Event tree analysis is based on the negative events that occur in a country. Generally, the analysts, based on periodical events, can assess the political risks and also carry out the valuation of risks. In addition, a macro-level analysis as well as a micro-level analysis can also be used while doing the country and political risk analyses. Macro-level analysis can be carried out through the identification of major political risks, for example, identification of political stability. Generally, the political instability in a country is caused by several parameters such as frequency of change in the government, events like civil unrest, insurgencies, inter-state or inter-country conflicts, etc. Some of the economic factors such as inflation, slow growth and industrial downturn may also be included into these analyses. It is also related to the internal governance. For example, corruption in a country also leads to inflation as well as economic slowdown. These can be a political risk arising out of the criticism of the policies of the government and the resultant political crisis and unrest. In the process of subjective analysis of political risks in a country, several subjective factors are considered such as people’s perception of private sector, role of households, 1.htp://www.economist.com/blogs/schumpeter/2014/04/investment-egypt 2. Lemens, P.L. and Rodney J. Simmons (1998), ‘System Safety and Risk Management’, NIOSH Instructional Module, A Guide for Engineering Educators (Cincinnati, OH: National Institute for Occupational Safety and Health): IX-3: IX-7.Country Risk and Political Risk Analysis * 435 economic policies and perception about the government, etc. These subjective factors have a potential impact on a country’s political scenario. After assessing the potential political risks, the valuation process anlyses that how these risks potentially impact the economic stability, including growth process, monetary policies, financial institutions, etc. These are also assessed in terms of government’s fiscal measures. Some of the research organisations carrying out country and political risk analysis include: 1. Business Monitor International (BMI) 2. Country Risk Solutions 3. Economist Intelligence Unit (EIU) 4. Eurasia Group 5. Maplecroft 6. Oxford Analytica Business in Afghanistan After the breakdown of Taliban's regime and the US intervention in Afghanistan, the country has been continuously in a period characterised by reconstruction and economic transition. During the period of reconstruction of Afghanistan since 2001, India has been playing a vital role. In the context of India's historical ties with Afghanistan, business prospects for Indian firms have increased after 2001. Table 1 India’s Trade with Afghanistan (US$ million) [ 2005-06 | 2006-07 | 2007-08 | 2008-09 | 2009-10 | 2010-11 | 2011-12 | 2012-13 Export 142.67 | 182.11 | 249.21 | 394.23 | 463.55 | 411.78 | 510.90 | 47256 Import 58.42 | 3437 | 109.97 | 126.24 | 125.19 | 146.03 | 128.06 | 115.80 Total trade | 201.09 | 216.48 | 359.18 | 520.47 | 588.74 | 557.81 | 638.96 | 588.36 Source: Export Import Data Bank, Department of Commerce, Government of India As per the recent statistics, India’s trade with Afghanistan has increased more than three- fold since 2001 due to the increasing presence of Indian companies in the country. More than hundred companies have invested in the countries’ businesses. The investment pattern indicates that the share of services sector is high. According to a report published by the South and South-West Asia division of UNESCAP, Afghanistan is emerging from its long period of conflicts with strong economic performance. The report Doing Business with Afghanistan suggests that there exist various opportunities in the sectors such as mineral resources, agriculture, food processing industry, carpets, construction sector and communication sector, etc. As per the report, the country's economic scenario is positive. The report highlights that between 2002 and 2009, Afghanistan's average per capita GDP increased by more than 75% in real terms. In addition, the real GDP growth in 2012 has been 12% owing to good agricultural harvest. However, in 2014, the withdrawal proposal of foreign troops caused apprehensions among the investors. Amid this scenario, it was expected that the major companies from India may slash436 © Business Environment: Indian and Global ‘Perspective their investments in the country. It was expected that the Afghan Iron and Steel Consortium, led by Steel Authority of India Limited (SAIL) may bring down the initial outlay to US$1.5 billion. Source: This case is written by the authors based on inputs from the following sources: - Doing Business with Afghanistan, UNESCAP, 2013, http://sswa.unescap.org/pdf/Doing-Business-with- Afghanistan-Report Hires.pdf - DNA News, 20, November 2013, Indian companies may slash the biggest investment plan in Afghanistan, http://www.dnaindia.com /money /report-indian-companies-may-slash-the-biggest-investment-plan- in-afghanistan-1922171 CASE QUESTIONS 1. Examine the role of SAIL in Afghanistan. 2, What are the prospects for Indian businesses in Afghanistan? REVIEW QUESTIONS What do you mean by country risk analysis? What are the areas that country risk analysis covers? Discuss the aspects used to evaluate and diagnose a countiy risk. Define political risk analysis. What are the two important aspects for doing political risk analysis? Discuss the importance of political risk analysis. ae rere SUGGESTED READINGS Cullen, John B. and Parboteeah, K.P., 2010, International Business: Strategy and the Multinational Company, Routledge, New York. Doing Business Report 2014, World Bank and IFC. Hill, C.W.L. and Jain, A.K., 2009, International Business: Competing in the Global Marketplace, Tata McGraw-Hill Education, New Delhi. Rugman, A.M. and Hodgetts, R.M., 2004, International Business, Pearson Education, Delhi Sundaram, A.K. and Black, J.S., 1995, The International Business Environment: Text and Cases, PHI Learning, Delhi.