1. Political Risk - risk that originates from government
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Government imposes control over an enterprise's operations within a border or even outside
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Firm specific risk - conflict between a business and the host government
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Also called micro risk
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Different firms have different risks
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Example - restaurant chain versus electronics manufacturing
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Electronics company requires large capital investment
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Restaurant owner could lease space, etc.
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Foreign exchange rate risk is a firm specific risk. However it does not result from government
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Government and firms have conflicts over:
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Foreign control over key industries
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Infringe on national sovereignty
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A Dubai company wanted to buy six U.S. ports in 2006
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Caused an uproar in the United States because Dubai is a city in a Muslim country
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A British company owned the ports and wanted to sell the ports
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Local interests versus foreign company's interests
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Government protects
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Defense industries - all countries impose restrictions on military equipment and supplies
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Agricultural industries - many countries protect agricultural markets
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Infant industries - countries protect new industries
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U.S. used it in 18th century to compete with Europe
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Encourage domestic industry to thrive and grow
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Gov. prevents international investment or foreign companies from entering country
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Tariffs - countries collect taxes on imports
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Causes higher price and reduces imports
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Government collects revenue
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Foreign company may invest within country to circumvent trade barrier
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Some third world countries have tax evasion problems and collect the revenue from tariffs because gov. controls the ports
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Trade Blocs - countries form free trade zones
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Members have no or little trade protection; nonmembers have trade protection
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Foreign company may invest within country to circumvent trade barrier
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European Union and North American Free Trade Association (NAFTA)
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Conditions imposed on foreign companies
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Government may force firm to use local companies, local resources, and local labor
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Transportation control - pipeline, highway, electric wires pass through a country
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Government bargains for control by threatening to shut down
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Example - Sudan split into two countries; petroleum is located in South Sudan while pipelines lead through North Sudan to the ports
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North Sudan threatens to shut down pipelines and bargains with South Sudan
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Market control - firms and government strive for control over markets
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Example - Organization of Petroleum Exporting Countries (OPEC)
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Use quotas to reduce petroleum supplies to boost petroleum prices
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OPEC members nationalized their petroleum industries
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Ownership - government requires foreign company a joint venture with government or local firms
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Form joint ventures in former communistic countries, such as Kazakhstan
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Common in national defense, agriculture, banking, or critical minerals industry
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Western firms bring technology, efficient management practices, and investment
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Was common in Japan, Mexico, China, India, and South Korea
2. A country could exhibit characteristics that endangers investment
- Characteristic 1: A country experiences changes in government leadership often or a country has too many political parties.
- Government policies and laws quickly change.
- South American countries alternate between pro-business and socialist governments.
- Government relaxes taxes and regulations during business phase and changes positions during its socialistic phase as it punishes businesses.
- Strong nationalistic gov. may not view foreign investment favorably
- Characteristic 2: International investors collect information about a foreign country's political leaders or a country's economic environment.
- Leaders believe in free markets and limited government are likely to pass favorable government laws and regulations to foreign investment.
- Heritage Foundation collect statistics on countries and measures economic freedom.
- Characteristic 3: Some countries have contentious ethnic groups or religious fanaticism.
- Poor investment choice
- Bosnia and Herzegovina has three ethnic groups: Bosnians, Croats, and Serbs.
- Bosnians are Muslims; the Croats are Catholics while the Serbs are Orthodox Christians
- They fought the Bosnian War during the early 1990s after Yugoslavia had broken up.
- Characteristic 4: Enterprises relocate to countries with uneven income gaps.
- Businesses use the cheap labor force.
- Foreign investors avoid a country with deteriorating economic conditions.
- A country with high levels of poverty and massive unemployment breed protests, riots, and revolutions.
- Protestors can damage the foreign investors' assets.
- In extreme cases, the rioters and protestors could murder foreigners and tourists.
3. Country risk - risk originates by investing in a particular country. Political risk specifically entails problems with the government, while country risk is the risk for the entire country
3. Global specific risk - risk originates at the global level
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1. A.M. Best assigns country risk using a five-tier scale
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The scale ranges from I to V with I being the lowest risk and V being the highest risk
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A.M. Best uses country risk analysis to determine how the factors outside an insurer's control affect its ability to meet its obligations to its policyholders.
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These analyses include:
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Assessment of local accounting rules
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Government policies and regulation
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Economic growth and social stability
Rating |
Country |
Tier 1 |
Australia, Austria, Canada, Denmark, Finland, France, Germany, Gibraltar, Guernsey, Isle Of Man, Jersey, Luxembourg, Netherlands, Norway, Singapore, Sweden, Switzerland, United Kingdom, and United States |
Tier II |
Barbados, Belgium, Bermuda, British Virgin Islands, Cayman Islands, Chile, Hong Kong, Ireland, Italy, Japan, Liechtenstein, Macau, New Zealand, Slovenia, South Korea, Spain, and Taiwan |
Tier III |
Anguilla, Bahamas, Bahrain, Brazil, China, Cyprus, Israel, Kuwait, Malaysia, Malta, Mexico, Netherlands Antilles, Oman, Poland, Qatar, Saint Kitts and Nevis, Saudi Arabia, South Africa, Thailand, Trinidad and Tobago, and United Arab
Emirates |
Tier IV |
Antigua and Barbuda, Argentina, Brunei, Colombia, Costa Rica, El Salvador, India, Indonesia, Jordan, Kazakhstan, Mauritius, Morocco, Panama, Peru, Philippines, Russia, Tunisia, and Turkey |
Tier V |
Algeria, Belarus, Bolivia, Bosnia and Herzegovina, Dominican Republic, Ecuador, Egypt, Ghana, Guatemala, Honduras, Jamaica, Kenya, Lebanon, Libya, Nicaragua, Nigeria, Pakistan, Syria, Ukraine, Venezuela, and Vietnam |
2. Coface is France's export credit underwriter
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Coface offers insurance to companies that sell to a foreign company and the foreign company defaults
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The default could result from a bankruptcy, violent protests, a revolution, or international war
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Coface ranks a country's business climate that uses the same ranking scale
Country |
Rating |
Definition of Rating |
Australia, Canada, Hong Kong, Japan, Luxembourg, New Zealand, Norway, Singapore, Sweden, Switzerland, and Taiwan |
A1 |
The steady political and economic environment has positive effects on an already good payment record of companies. Very weak default probability |
Austria, Belgium, Chile, Denmark, Finland, France, Germany, Kuwait, Malaysia, Malta, Netherlands, Qatar, South Korea, and United States |
A2 |
Default probability is still weak even in the case when one country's political and economic environment or the payment record
of companies are not as good as A1-rated countries |
Brazil, China, Czech Republic, Estonia, India, Israel, Mauritius, Namibia, Oman, Poland, Slovakia, Slovenia, South Africa, Thailand, Trinidad and Tobago, United Arab Emirates, and United Kingdom |
A3 |
Adverse political or economic circumstances may lead to a worsening payment record that is already lower than the previous categories, although the probability of a payment default is still low |
Algeria, Bahrain, Botswana, Colombia, Costa Rica, Iceland, Ireland, Italy, Lithuania, Mexico, Morocco, Panama, Peru, Saudi Arabia, Spain, Tunisia, Turkey, and Uruguay |
A4 |
An already patchy payment record could be further worsened by a deteriorating political and economic environment. Nevertheless, the probability of a default is still acceptable |
Benin, Bulgaria, Cape Verde, Croatia, Dominican Republic, El Salvador, Gabon, Ghana, Hungary, Indonesia, Jordan, Kazakhstan, Latvia, Papua New Guinea, Philippines, Portugal, Romania, Russian Federation, Senegal, and Tanzania |
B |
An unsteady political and economic environment is likely to affect further an already poor payment record |
Albania, Angola, Argentina, Armenia, Azerbaijan, Bangladesh, Bolivia, Burkina Faso, Cameroon, Congo, Cyprus, Djibouti, Ecuador, Egypt, Ethiopia, Georgia, Greece, Guatemala, Honduras, Jamaica, Kenya, Lebanon, Macedonia, Madagascar,
Mauritania, Mongolia, Montenegro, Mozambique, Nicaragua, Niger, Paraguay, Sao Tome and Principe, Serbia, Sierra Leone, Sri Lanka, Timor-Leste, Togo, Uganda, Venezuela, Vietnam, and Zambia |
C |
A very unsteady political and economic environment could deteriorate an already bad payment record |
Afghanistan, Belarus, Bosnia and Herzegovina, Burundi, Cambodia, Central African Republic, Chad, Congo, Cuba, Equatorial Guinea, Eritrea, Guinea, Haiti, Iran, Iraq, Ivory Coast, Kyrgyzstan, Lao, Liberia, Libya, Malawi, Mali, Moldova,
Myanmar, Nepal, Nigeria, Pakistan, Rwanda, Sudan, Syria, Tajikistan, Turkmenistan, Ukraine, Uzbekistan, Yemen, and Zimbabwe |
D |
The high risk profile of a country's economic and political environment will further worsen further a generally very bad payment record |
References
A.M. Best. 2012. Available from http://www3.ambest.com/ratings/cr/crisk.aspx (accessed on 10/16/2012)
Coface. 2012. Rating Table. Available from http://www.coface.com/CofacePortal/COM_en_EN/pages/home/risks_home/country_risks/rating_table?geoarea-country=&crating=&brating= (accessed on 10/16/2012)
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