Bon Voyage

Political risk analysis Rear Admiral Grace Murray Hopper (Dec. 9, 1906 Jan. 1, 1992), was an American computer scientist and naval officer who coined the phrase, "A ship in port is safe, but that's not what ships are built for." Successful businesses and their owners are not adverse to risk, but before setting course to establish a business or partnership in another country, the wise owner first assesses the risks they must navigate. Below are two scenarios of such potential risks. First Scenario A business has been importing glassware from an East European country for several years and, after conducting thorough financial and commercial due diligence, decides to purchase a local producer, a famous nineteenth century factory. However, the sale triggers protest from the employees that foreigners are buying a historic national company and this expands into general protest of the government's privatization policy. The government responds by declaring the initial privatization improper and reverses it, without compensating the business for its investment. The business files a lawsuit, but their claims are repeatedly rejected and when their local bank accounts are frozen, they abandon the market completely. Second Scenario A business has been granted a license by a regional governor in Central Asia to market the off-take of a local mine. They are aware of competing business interests in the mining sector and have secured the strong support of the local governor by committing to hiring local employees, including the governor's son-in-law. After considerable investment, they begin operations and their business is very lucrative. One year later, the governor is investigated by the national authorities for abuse of office and removed from his position. His replacement is the nephew of the country's president and he revokes the business's license, awarding it to his daughter's company, and prosecutes the business. Investors beware These are both true stories, with some of the identifying details changed. As more markets have opened up over the last twenty years, investors have found themselves confronting difficult situations not anticipated in most business plans. These include a host of problems associated with political and social factors that are combined under the heading of political risk, which one analyst defines as "the possibility that political decisions or events in a country will affect the business climate in such a way that investors will lose money."1 Defining political risk Political risks include a variety of problems and challenges that derive from the political structures or environment of a country rather than from its economics or the commercial issues of the business venture. The most dramatic political risks are those of war or expropriation of property resulting from a revolution or other rupture in political order. Less obvious examples include changes in legislation, special treatment for privileged local competitors, or state-sponsored attacks on a production site. Some factors can increase the vulnerability of a venture to political risk. These include involvement in a sensitive or strategic industry, such as mining, and participating in corrupt relationships, which can provide a convenient target for politically motivated attacks, even in a country in which corruption is endemic. Mitigating your risk There are several steps investors can take to mitigate the risk of harm to their business. The first is to conduct political risk analysis, examining a set of factors, including the structure of government and the nature of political leaders, a history of successful transitions in government, the existence of a durable legal system, and the level of civil conflict. The goal of the analysis is to provide a framework for deciding whether a country is a viable investment target, to identify risk factors to be addressed in structuring the investment, and to construct a contingency plan in advance for extreme situations. Risk analysis isn't a guarantee Political risk analysis is thus a useful tool for identifying problems that lie outside standard commercial pre-investment analysis. However, it is less useful in actually protecting an investment. It is often based on conclusions drawn about past actions and is not necessarily successful in predicting future outcomes. As an analyst with the United Kingdom's Overseas Development Office states, "political information, unlike economic information, is more difficult to quantify and its interpretation is more subjective." 2 The first scenario above occurred in a country in which the risk of expropriation of property was deemed by most analysts to be very low. In addition, investors often engage in activities that increase their vulnerability in unpredictable ways, as in the second example. A not-uncommon response to weak institutions and the lack of rule of law is for investors to attempt to reach unofficial solutions to challenges, often by bribing civil servants. This approach, in addition to being unethical and illegal, increases the dependence on particular political figures, whose positions may be unstable, and ensures that neither the host nor home judicial systems are available for recourse. The insurance option The easiest mechanism for protecting against political risks is to obtain political risk insurance from either a private or public insurer. The World Bank's Multilateral Investment Guarantee Agency, for example, covers "expropriation, breach of contract, currency transfer restriction, and war and civil disturbance."3 However, the key element of a successful investment in a risky environment is a sound exit strategy. Political risks are seldom subject to influence and the ability to withdraw from a project or a market is ultimately the only reliable protection. Footnotes: 1. Llewellyn D. Howell, The Handbook of Country and Political Risk Analysis (East Syracuse, NY: Political Risk Services, 1994), p. 4. 2. Lauren Phillips, Opinion 74 (August 2006): p. 1 3. World Bank website, January 2007. Rani Kronick is a political scientist and business-risks consultant, specializing in Eastern Europe and Central Asia. She has worked in Europe with Arthur Andersen and in London with Control Risks Group. She is based in southern Washington County, New York. Her email address is: ranikronick@yahoo.com.