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CHAPTER 22CHAPTER 22

THE MEASUREMENTTHE MEASUREMENT

AND MANAGEMENTAND MANAGEMENTOF POLITICAL RISKOF POLITICAL RISK

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CHAPTER OVERVIEW:CHAPTER OVERVIEW:

I.I. MEASURING POLITICAL RISKMEASURING POLITICAL RISK

II.II. COUNTRY RISK ANALYSISCOUNTRY RISK ANALYSIS

III.III. MANAGING POLITICAL RISKMANAGING POLITICAL RISK

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I.I. MEASURING POLITICAL RISKMEASURING POLITICAL RISK

A.A. Two ApproachesTwo Approaches

1.1. CountryCountry--specific perspectivespecific perspective

--usecountry riskanalysisusecountry riskanalysis

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2.2. FirmFirm--specific perspectivespecific perspective

--usesamoremicro approachusesamoremicro approach

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B.B. Political Stability: First ApproachPolitical Stability: First Approach

1. Measured by:1. Measured by:

a.a. Frequency ofgovernmentchangesFrequency ofgovernmentchanges

b.b. Level ofviolenceLevel ofviolence

c.c. Number ofarmed insurrectionsNumber ofarmed insurrections

d.d. Conflict with otherstatesConflict with otherstates

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C.C. Economic FactorsEconomic Factors

1.1. Indicators ofpolitical unrestIndicators ofpolitical unrest

a.a. RampantinflationRampantinflation

b.b. Balance ofpayment deficitsBalance ofpayment deficits

c.c. Slowed growth ofpercapita GDPSlowed growth ofpercapita GDP

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D.D. Subjective FactorsSubjective Factors

1.1. General perceptiontoward privateGeneral perceptiontoward private

enterpriseenterprise2.2. Business Environment Risk IndexBusiness Environment Risk Indexa.a. Usefulness:Usefulness:

anindicator ofgeneral levelanindicator ofgeneral level

ofpolitical riskofpolitical riskb.b. Economicstandpoint:Economicstandpoint:political risk=uncertaintypolitical risk=uncertaintyover property rightsover property rights

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3.3. Capital FlightCapital Flight

a.a. Definition:Definition:

theexport ofsavingsbyatheexport ofsavingsbyanationscitizensbecause ofnationscitizensbecause of

safetysafety--ofof--capital fears.capital fears.

b.b. Measurement: usetheMeasurement: usethebalancebalance--ofof-- paymentaccountpaymentaccount

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c.c. Causes ofcapital flightCauses ofcapital flight

1.)1.) InappropriateeconomicInappropriateeconomic

policiespolicies2.)2.) Expectations ofdevaluationExpectations ofdevaluation

3.)3.) High political riskHigh political risk

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E.E. THE MICRO APPROACHTHE MICRO APPROACH

firmfirm--specific perspectiveused in lightspecific perspectiveused in light

oftheshortcomings ofpreviousmodelsoftheshortcomings ofpreviousmodels1.1. Weakness ofPolitical Risk ModelsWeakness ofPolitical Risk Models

assumeall firmsfacethesame riskassumeall firmsfacethesame risk

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2.2.ExpropriationExpropriation

a.a. IshighlyselectiveIshighlyselective

b.b. Higher probabilityforextractive,Higher probabilityforextractive,

utility,and financial industries.utility,and financial industries.

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II.II. COUNTRY RISK ANALYSISCOUNTRY RISK ANALYSIS

II.II.COUNTRY RISK ANALYSISCOUNTRY RISK ANALYSIS

Primaryfocus: How well isthecountryPrimaryfocus: How well isthecountry

doingeconomically?doingeconomically?

A.A. Fiscal IrresponsibilityFiscal Irresponsibility

--highgovernment deficitshighgovernment deficits

B.B. Controlled Exchange Rate SystemControlled Exchange Rate System

--currencyusually overvaluedcurrencyusually overvalued

C.C. Wasteful Government SpendingWasteful Government Spending

--inabilityto serviceforeign debtinabilityto serviceforeign debt

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D.D. ResourceBaseResourceBase

--lack ofstrong workethiclack ofstrong workethic

E.E. Country Riskand AdjustmenttoCountry Riskand AdjustmenttoExternal ShocksExternal Shocks

1.1. Whataretheimpacts ofexternalWhataretheimpacts ofexternal

shocks:shocks:--how well anation respondsvarieshow well anation respondsvaries

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2.2. Five Common Characteristics ofFive Common Characteristics of

Economic HealthEconomic Health

a.a. Structural incentivesStructural incentives--rewards productiveventuresrewards productiveventures

b.b. Legal structureLegal structure

--stimulatesgrowth offreemarketsstimulatesgrowth offreemarketsc.c. Minimal government regulationsMinimal government regulations

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d.d. Clearincentivesto saveand investClearincentivesto saveand invest

e.e. OpeneconomyOpeneconomy

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III.III. MANAGING POLITICAL RISKMANAGING POLITICAL RISK

III.III. MANAGING POLITICAL RISKMANAGING POLITICAL RISK

A.A. Pr einvestment PlanningPreinvestment Planning

1.1. Four Policy OptionsFour Policy Optionsa.a. Avoidance (no risk)Avoidance (no risk)

b.b. Insurance(shift risk)Insurance(shift risk)

c.c. NegotiateenvironmentNegotiateenvironmentd.d. StructuretheStructurethe

investmentinvestment

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B.B. Operating PoliciesOperating Policies

Five PostFive Post--Investment Policy Options:Investment Policy Options:

a.a. Planned DivestmentPlanned Divestment

b.b. ShortShort--Term Profit MaximizationTerm Profit Maximization

c.c. ChangingtheBenefit/Cost RatioChangingtheBenefit/Cost Ratio

d.d. Developing Local StakeholdersDeveloping Local Stakeholders

e.e. AdaptationAdaptation

--createa postcreatea post--confiscationconfiscationmanagementcontractmanagementcontract