Political and country risk in IB

&
Ethics, CSR and Corporate sustainability

Political and country risks:

Financial institutions and business organizations operate its business activities abroad in order to
diversify and expand their sources of revenue and profitability. Organizations that make
investment in a foreign market either in the form of equity or assets are exposed to risks that may
arise either from an act of the host government or from other external political events taking
place in that country, these risks include social, political and economic conditions and events that
imposes negative impact on the financial performance and profitability of foreign organizations.

Types of political and country risks:

The following are the main types of political and country risks that may affect the business
performance of an international organization operating in foreign countries.

Nationalization or deprivation:

Nationalization is a process whereby a government takeover privately owned industries,

corporations and resources with or without compensation.

Nationalization is a political risk which makes it very difficult or impossible for international
organizations to invest in a country where businesses are exposed to such risk.

In past governments have nationalized highly profitable industries on the ground that it does not
want foreign ownership of its valuable resources for instance in 2006 the Bolivian government
nationalized the country’s oil and natural gas industries. Similarly in January 2007 the
Government of Venezuela announced to nationalize firms in two major sectors of the country’s
economy i.e. telecommunications and electricity.In November 2009 the president of Venezuela
announced that he will nationalize banks in the country.
Forced divestiture:

forced divestiture another type of country risk in which an international firm is forced to divest
its business operation, an example of forced divestiture is the Indonesian subsidiary of French
retail giant Carrefour which has been ordered to sell the 75% stake it acquired in smaller rival
Alfa Retailindo in January 2008.

Gradual expropriation:

Expropriation means a quick action of government to seize the assets of foreign entity, but in
gradual expropriation a single international company is targeted by the host government. Gradual
or creeping expropriation involves slow and gradual removal of property rights by way of tax
increase on profits to make a foreign business less profitable, increase in property tax, instituting
increasing barriers, changing the proportion of ownership which must be held locally.In gradual
expropriation the ownership title of business remains in the name of foreign investor but the right
to use the business is diminished as a result of the government interference.

An example of gradual expropriation is when China announced a policy restricting the property
rights of domestic and foreign automakers to transfer their ownership or enter into strategic
alliance in China, by banning the sale or transfer of manufacturing licenses by bankrupt or failing
automakers.

Similarly in Tecinicas Medioambientales Tecmed S.A. V. The United Mexican States it was
declared that the Mexican government has committed expropriation because of non-renewal of a
license necessary to operate the landfill.

Currency inconvertibility and exchange:

Currency inconvertibility means a situation where one currency can not be converted or
exchanged into foreign currency. This is another political risk for an organization operating its
business activities abroad. In such case a foreign government may restrict the right of foreign
firms to repatriate profits to their home country and all profits remain in the foreign country.
Inconvertibility of currency may arise due to passing new legislation or administrative delays. In
administrative delays the bureaucracy in a foreign country takes more time in currency
conversion and creates a financial burden upon foreign companies.

Some countries issues inconvertible currency for instance Cuban peso in order to protect its
citizens from perceived capitalist infiltration, similarly domestic regulators may consider foreign
currency inconvertible in order to protect local investors from bad investment decision i.e.
hyperinflation of currency.

Termination of fuel supply agreements:

Termination of fuel supply agreement is another political risk for an international organization
functioning in a foreign country. A foreign company whose business activities are solely
dependent upon fuel supply under an agreement with the host government, or with the host
company and when such agreement is terminated than in such circumstances the company will
face major problem in continuing its business in such foreign country.

Confiscation:

Confiscation of international business is a severe form of political risks where host government
seizes the assets of a foreign company without compensation. The U.S. 1996 Helms-Burton Law
entitles the U.S. companies to sue companies from other countries that use property confiscated
from U.S. companies following Cuba’s communist revolution in 1959. But the U.S. government
waived this law repeatedly in order to maintain good relations with other countries.

Terrorism and kidnapping:

Kidnapping and other terrorist activities are means of making political statements. Small groups
unhappy about the current political or social situation can resort to terrorist tactics to fulfill their
demands. 9/11 tragedy is a prominent example. These groups may target the executives of large
international companies for kidnapping and taking of hostages in order to fund their terrorist
activities.

The current political instability, terrorist activities and internal conflicts in Pakistan is a good
example, where an international firm is exposed to a verity of threats arising from such activities
and makes it impossible for such firm to operate business effectively and increase its
profitability.

Policy changes:

Furthermore good relationship between the host government and international companies is of
vital importance for operating a successful and profitable business and any political change that
modify the anticipated effect and worth of a given economic action by changing the likelihood of
achieving business objectives than it affects international businesses to a greater extent and the
government’s hard and fast new policies can create huge problems for international companies.

Contractual frustration:

Frustration of contract means legal termination of contract between the parties because of
unforeseen circumstances which makes the performance of such contract practically impossible.
These circumstances include, accident, change in law, sickness of one of the parties and
interference from third party etc.

In international business perspective companies that enter into trade agreements for export or
import of goods or services either with government or private entities in foreign countries are
often exposed to underlying political risks. Such contract may be frustrated at any time for a
number of political reasons that are beyond the control of the parties.

Transfer:
Transfer risks take place when host government policies imposes limitation on the transfer of
capital, payments, production, people and technology in and out of country i.e. imposing tariffs
or restrictions on import and export, repatriation of capital or remittance of dividend etc.

What are political risks in international business?

Political risk happens when countries change policies that might negatively affect a business,
such as trade barriers. Employing hedging strategies and purchasing political risk insurance are
two ways companies can reduce the impact of international business risks.
Political risk is an exercise of political power that can affect a company’s value. For example, a
government embargo may prohibit trade with a foreign country, which will prevent the sale of a
company's products in that country’s markets. A government may also prohibit the departure or
arrival of merchant ships to and from its ports, which may prevent the shipment of a company's
goods to its customers or the receipt of materials a company needs to manufacture products.

Strategies for Managing Global Political Risk :

Falling oil prices, plummeting equity markets, social instability, and terrorism: These are some
of the political risks facing global businesses today, according to Marsh’s recent Political Risk
Map 2016.

Such events put pressure on already-stagnant emerging economies and lead to potential conflicts
between global and regional powers. These risks have only intensified as businesses rely more
on international operations to drive profitability.

No matter the location of your headquarters or which countries generate the bulk of your sales,
your business must now be prepared for political risk to develop in any part of the world —
including countries that have long been thought to be safe or stable.

Four strategies can help you minimize your political risk:

1. Manage your credit risk. A government’s inability to honor its financial obligations can
quickly spread to the private sector. Take the opportunity now — before a crisis develops — to
assess your potential credit risks in the countries where you or your suppliers do business, and
review your credit-control procedures.

2. Ensure your supply chain can withstand unplanned disruptions. The complexity and
interconnectivity of today’s supply chains means that trouble in just one country can disrupt your
entire global network. Work with your risk advisors to develop detailed response plans that
consider the need for alternative suppliers or ports.

3. Prepare and protect your people. Political violence or other instability can develop quickly
and with little warning. That makes advance planning and testing of communications and crisis
plans critical.

4. Use your risk management dollars wisely. A credit and political risk insurance policy can
provide coverage for political violence, expropriation, currency inconvertibility, non-payment,
and contract frustration.

Despite the many geopolitical risks that your business can face, political risk insurance remains
readily available. Insurers continue to view political risk as an attractive line of business, and are
competing aggressively for new and existing business.

Consider structuring political risk policies to provide coverage for multiple countries — either
for a specific region or for a longer list of countries that you can specify. That can allow you to
obtain protection even for countries where coverage is often difficult to secure on a single-
country basis — for example, Russia. With some rare exceptions, most organizations can
purchase multi-country insurance policies at attractive prices and with favorable terms, including
broader definitions and multi-year coverage.

Such an approach can help you to avoid taking chances purchasing coverage for individual high-
risk countries, allowing you to more effectively protect your assets virtually everywhere that you
do business. And in a buyer’s market, now is the time to lock in low rates for the next several
years in order to protect shareholder value drive continued growth in your business.

Political Risk Effects

Political risk in international business results from various factors that can negatively affect a
company’s income or complicate its business strategy. These factors include macroeconomic
issues such as high interest rates and social issues such as civil unrest. Government actions, like
confiscating a company's assets, make it difficult to acquire financing, which can affect the
ability of a company’s supply chain to support production.

Other political events may mean a company will be unable to convert foreign currency, export or
import goods and supplies, or protect in-country assets. According to Aon, a provider of risk
management, insurance and reinsurance services, these and other effects of political risk can lead
to higher operating costs, factory shutdowns and operating losses.

Factors That Contribute to Political Risk

Companies that launch international operations must be alert to factors that contribute to political
risk. For example, a change in a country’s leadership, or the rapid deterioration or improvement
in a country’s economic environment, can affect the business environment.

Impending regulatory changes by government agencies, or even the frequent discussion of

regulatory changes, are also causes of political risk. The same is true of changes in trade
agreements made by multilateral agencies. Finally, current or imminent social unrest poses a
major risk to a country's business environment.

How to Manage Political Risk

Business leaders can manage political risk using a three-step process. First, risk managers must
identify political risks — whether they come in the form of higher taxes, terrorist activity or
something else — and determine how those issues might affect the company's ability to meet its
business objectives. Next, managers must quantify the impact of particular risks on company
performance using a financial model, such as discounted cash flow. Managers then connect that
impact to a company’s risk tolerance.

For example, assume an international business strategy can increase returns by $1 million but
expose a company to a $3 million loss. In this case, a company must decide whether to
implement the strategy or forego it. If leaders choose to implement the strategy, they will
implement a risk response to manage the risk, such as purchasing property insurance.

Screening for political risks:

In order to operate successful business activities overseas it is very important for international
companies to identify, analyze, measure and manage those political and country risks that are
encountered by such company.

Analysis of political risks:

In order to analyze political risks, these are categorizes in two levels according to their nature,
severity and intensity i.e. Macro political risk analysis and micro political risk analysis.

Macro political risk analysis:

This is an analysis that observes major political decisions likely to affect all businesses in a
country. Macro risk factors include freezing the movement of assets out of the host country,
limiting the remittance of profits or capital, currency devaluation, refusing to perform contractual
obligations previously signed with the MNC’s, industrial piracy (counterfeiters), political
disorder and government corruption.

Micro political risk analysis:

This is an analysis that is directed towards government policies and decisions that influence
selected sectors of the economy or specific foreign businesses in the country. The examples are
selective discrimination, industry regulation, imposition of taxes on specific types of activity,
restrictive local laws and host government policies that promote exports and discourage import.

Management of political risks:

Political risks can be managed through applying different strategies i.e. avoidance, reduction or
shifting of risk and post commitment practices.

Avoidance:

If any enterprise realizes that making investment in a country will expose such enterprise to
political risks the most simple strategy to keep away from such political risks is not to invest in
such country and to go somewhere else, this is pre-commitment strategy that can be used before
the commencement and making any final commitment.

Reduction or shifting of risk:

Another way of managing political risk is that a foreign company can implement a financial
structure that shifts risks to local creditors and shareholders.

Similarly contracts can be designed whereby a force majeure clause is included to revise and free
contractual parties from their contractual obligations in case of any violence, coup, insurrection
and long-term trade disruption etc.

Post-commitment practices:

Post-commitment practices mean adoption of strategies after making investment and

commencement of business activities in overseas market. This kind of strategy takes various
forms i.e. modification of employment or the ownership of the business, minority interest,
designing operational structure, diversification and taking insurance policy.
Modification of employment or the ownership of the business:

If a foreign firm’s top management is controlled by local nationals or their ownership is

significant or establishing of a joint venture of 50-50 ownership with a local firm than the host
government would have less incentive to nationalize such business.

Minority interest:

Another useful strategy of managing political risks is to adopt minority interest in the business.

Designing operational structure:

Designing the operational structure of business in a way that attracts the inflow of foreign
exchange in the host country and establishing good relations and close cooperation of
management with the host government will also safeguard such firm from any threat from the
host government.

Diversification:

If any political risk is encountered by a foreign firm while operating business activities overseas
the best way is to diversify and expand its business operation into other countries that are not
exposed to such type of risks.

Taking insurance policy:

Moreover to avoid any kind of loss that can be inflicted due to any political or country risk the
company can go for insurance policy but it is very expensive and can minimize the profitability
of such firm.
Ethics - accepted principles of right or wrong that govern the
conduct of a person, the members of a profession, or the
actions of an organization

i) Business ethics -‐ accepted principles of right or wrong governing

the conduct of business people
ii) Ethical strategy -‐ a strategy, or course of action, that does
not violate these accepted principles

Ethics and International Business

The most common ethical issues in business involve:
i)Employment practices
ii)Human rights
iii)Environmental pollution
iv)Corruption
Employment Practices
What practices should be used when work conditions are inferior
in a host nation?
Human Rights
What is the responsibility of a foreign multinational when
operating in a country where basic human rights are not
respected?
Environmental Pollution
Should a multinational feel free to pollute in a developing nation
if doing so does not violate laws?
Corruption
Is it ethical to make payments to government officials to secure
business?
Ethical dilemma:
An ethical dilemma is a situation of making a choice between two or more
alternatives. An agent is in unpleasant and difficult situation because he/she often
needs to make a choice between ethical and unethical alternatives, and when it
comes to the ethical alternatives, he/she should choose the best one.
Sustainability
Sustainable strategies – strategies that not only help the MNC
make good profits, but that also do so without harming the
environment while simultaneously ensuring that the company
operates in a socially responsible manner with regard to its
Stakeholders Sustainable strategies can be good for shareholders,
the environment, local communities, employees, and customers

What is sustainability-‐based approach to business:

1) do not harm people or the planet and at best create
value for stakeholders, and

2) focus on improving environmental, social, and governance (ESG)

performance in the areas in which the company has a material
environmental or social impact (such as in their operations, value
chain, or customers).
Some advantages of sustainability practices:
i) Help drive competitive advantage through stakeholder
engagement
ii) Improve risk management
 iii) Foster innovation
iv) Improve financial performance
v) Build customer loyalty
vi) Attract and engage employees
Definitions of CSR
The broadest definition of corporate social responsibility is concerned with what is
– or should be – the relationship between global corporations, governments of
countries and individual citizens. More locally the definition is concerned with the
relationship between a corporation and the local society in which it resides or
operates. Another definition is concerned with the relationship between a
corporation and its stakeholders.
The principles of CSR
Because of the uncertainty surrounding the nature of CSR activity it is difficult to
define CSR and to be certain about any such activity. It is therefore imperative to
be able to identify such activity and we take the view that there are three basic
principles which together comprise all CSR activity.
These are:
Sustainability;
Accountability;
Transparency.
Sustainability will be considered in detail in chapter 4 while accountability and
transparency will be considered in chapter 5. So here we will just outline the
concepts.
Sustainability
This is concerned with the effect which action taken in the present has upon the
options available in the future. If resources are utilised in the present then they are
no longer available for use in the future.
 Accountability
This is concerned with an organisation recognising that its actions affect the
external environment, and therefore assuming responsibility for the effects of its
actions. This concept therefore implies a quantification of the effects of actions
taken, both internal to the organisation and externally. More specifically the
concept implies a reporting of those quantifications to all parties affected by those
actions. This implies a reporting to external stakeholders of the effects of actions
taken by the organisation and how they are affecting those stakeholders.
Transparency
Transparency, as a principle, means that the external impact of the actions of the
organisation can be ascertained from that organisation’s reporting and pertinent
facts are not disguised within that reporting. Thus all the effects of the actions of
the organisation, including external impacts, should be apparent to all from using
the information provided by the organisation’s reporting mechanisms.
Transparency is of particular importance to external users of such information as
these users lack the background details and knowledge available to internal users
of such information. Transparency therefore can be seen to follow from the other
two principles and equally can be seen to be a part of the process of recognition of
responsibility on the part of the organisation for the external effects of its actions
and equally part of the process of transferring power to external stakeholders.

Advantages of international business

1. Obtaining Valuable Forex: A country can earn valuable Forex by exporting its
goods to other countries.

2. Division of labor: International business leads to the specialization of product

production. Therefore, high-quality products that you have the greatest advantage.
3. Optimal use of available resources: International businesses reduce the waste of
domestic resources. It helps countries make the best use of their natural resources.
Each country produces those products that have the greatest advantage.

4. Improving the standard of living of people: The sale of surplus products from
one country to another leads to increased income and savings for people in the first
country. This will improve the standard of living of the population of the exporting
country.

5. Consumer Benefits: Consumers also benefit from international business. They

are free to use a variety of better quality products at a reasonable price. Therefore,
consumers in the importing country have a variety of products, which is an
advantage.

6. Promotion of industrialization: The exchange of technical knowledge allows

developing and developing countries to establish new industries with the help of
foreign aid. Therefore, the international business helps the industry develop.

7. International Peace and Harmony: International business eliminates competition

between different countries and promotes international peace and harmony. Build
interdependence and increase mutual trust and integrity.

8. Cultural Development: International business encourages the exchange of

cultures and ideas between more diverse countries. You can adopt a better way of
life, clothing, food, and more from another country.
9. Economics of large-scale production: International business leads to large-scale
production due to high demand. Every country in the world can benefit from large-
scale production.

10. Product price stability: International business reduces large fluctuations in

product prices. It leads to stable product prices around the world.

11. Expanding the product market: International business expands the product
market around the world. As the scale of the business expands, the profits of the
business will increase.

12. Benefits in an emergency: International business allows you to face

emergencies. In the event of a natural disaster, we can import goods according to
your needs.

13. Creating Employment Opportunities: International companies promote

employment opportunities in export-oriented markets. It raises the standard of
living of countries dealing with international business.

14. Increasing public income: The government imposes import and export taxes on
this transaction. Therefore, the government can make a lot of money from
international business.

The disadvantages of international business are as follows.

1. Negative economic impact: One country affects the economy of another through
international business. In addition, large-scale exports hinder the industrial
development of importing countries. As a result, the economies of importing
countries are suffering.

2. Competition with developed countries: Developing countries cannot compete

with developed countries. Unless an international business is managed, it impedes
the growth and development of developing countries.

3. Competition between nations: Fierce competition and the desire to export more
products can create competition between nations. As a result, international peace
can be hampered.

4. Colonization: Due to economic and political dependence and industrial

recession, importing countries may be colonized.

5. Exploitation: International business leads to exploitation from developing

countries to developed countries. Prosperous and dominant nations regulate the
economies of poor nations.

6. Legal Issues: The different laws, regulations, and customs procedures that
different countries follow to have a direct impact on import and export trade.

7. Unwanted fashion promotion: Cultural values and heritage are not the same in
all countries. There are many aspects that may not be suitable for our environment,
culture, traditions, etc. This obscenity is often created in the name of cultural
exchange.
8. Language Issues: Different languages in different countries create barriers to
establishing business relationships between different countries.

9. Dumping policy: Developed countries tend to sell their products to developing

countries at prices below production costs. As a result, industries in developing
countries have been closed.

10. Complex technical steps: International business is very technical and has
complicated procedures. It contains various uses for important documents. Expert
service is required to handle complex procedures at various stages.

11. Shortage of commodities in exporting countries: Traders may prefer to sell

commodities to other countries instead of their own in order to make more profits.
As a result, there is a shortage of products in the country of origin.

12. Negative impact on the domestic industry: International business represents a

threat to the survival of early and early industries. Foreign competition and
unlimited imports can disrupt our country’s future industry.