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COUNTRY RISK & COUNTRY RISK & POLITICAL RISKPOLITICAL RISK

UNIT 2

CHAPTER 2

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Country RiskCountry Risk• A collection of risks associated with investing in a foreign

country.

• These risks include political risk, exchange rate risk, economic risk, sovereign risk and transfer risk, which is the risk of capital being locked up or frozen by government action.

• Country risk varies from one country to the next. Some countries have high enough risk to discourage much foreign investment.

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• Country risk can reduce the expected return on an investment and must be taken into consideration whenever investing abroad. – Some country risk does not have an effective hedge. Other

risk, such as exchange rate risk, can be protected against with a marginal loss of profit potential.

• The United States is generally considered the benchmark for low country risk and most nations can have their risk measured as compared to the U.S.

• Country risk is higher with longer term investments and direct investments, which are investments not made through a regulated market or exchange

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Sources of Country RiskSources of Country Risk• Macro Risks

– Affect all firms in the host country.

• Micro Risks– Specific to an industry, firm or project in a country.

Whether a particular country risk is micro or macro, it affects the diversifiablility of the risk.

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Assessments of the country riskAssessments of the country risk

• Bank of America

• Business Environment Risk Intelligence

• Control Risks information Services

• Dun and Bradstreet

• Moody’s Investor Services

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Country RiskCountry Risk

A1 – Australia, UK, Canada.

A2 – Japan, Germany, Korea, USA.

A3 – China, Thailand, Mauritius, Chile.

A4 – India, Poland, S. Arabia, Mexico.

B – Sri Lanka, Brazil.

C – Turkey, Kenya.

D – Iraq, Pakistan, Afghanistan.

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Strategies for Managing Country RiskStrategies for Managing Country Risk1. Negotiate the environment with the host

country prior to the investment.• The investment environment• The financial environment

2. Structure foreign operations to minimize country risk while maximizing returns.

3. Obtain political risk insurance.

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1. Negotiate the environment 1. Negotiate the environment with the host country.with the host country.

• The investment environment:– Taxes– Labour issues– Concessions– Obligations and restrictions – Provisions for planned investment divesture– Performance assurance and remedies– International arbitration of disputes.

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• The investment environment.

• The financial environment:– Cash flow remittance.– Access to capital markets.– Subsidized financing.– Corporate governance environment.

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2. Structure foreign operations to 2. Structure foreign operations to minimize country risk while minimize country risk while

maximizing returns.maximizing returns.• Limit the scope of technology transfer to foreign

affiliates to include only non-essential parts of the production process.

• Limit dependence on the single partner.

• Enlist local partners.

• Use more stringent investment criteria.

• Plan for disaster recovery.

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3. Obtain political risk insurance.3. Obtain political risk insurance. • Insurable Risks are….

– Loss is identifiable in time, place, cause, and amount.

– A large number of individuals or business are exposed to the risk.

– The expected loss over the life of the contract is estimable, so that reasonable premiums can be set by the insurer.

– Loss is outside the influence of the insured.

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Political RiskPolitical Risk• Results from political changes or instability in a

country.

• Adverse impact on the working of foreign enterprises located in that country as well as on the financial and commercial operations carried out with that country.

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It includes…It includes…

• War

• Revolution

• Insurrection

• Civil disturbance

• Terrorism

• Negative Media Reports

• Uncertainty over property rights.

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Evaluation of Political RiskEvaluation of Political Risk• In the enterprise itself

• By external consultants

• By specialized agencies.

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• MNCs are self-insured if their risk exposures are diversified across a large number of countries.

• Enterprise itself facilitates evaluating the risk. It is done either by the Director, or he can hire the services of the consultants.

• Only the big companies who are venturing abroad often engage the services of the external agencies (already discussed in slide-14)

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Political Risk ManagementPolitical Risk Management1. By a Multinational:

Required at three stages—

a) Before investment is made in the foreign country:• Dichotomic Decisions – go-no-go approach.

• Assigning a risk premium – as risk is difficult to quantify, it is necessary to be taken into account. So, MNCs assign risk premium to foreign investments.

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b) During the investment is being made in the foreign country.

• Not to localize the whole of production process in one country.

• Plough back the funds generated by the subsidiary rather than bringing new capital from the parent company.

• To increase number of local employees.• To have other local alternatives for the supply.• To establish a joint venture with a local company.• Insurance-

– Public Insurance : countries have established special organizations for insuring the risk inherent in the foreign operations. Example- In England– ECGD (Export Credit Guarantee Department)

– International Organizations : offers private investors insurance to protect their investments against political risk. Example- MIGA

– Private Insurances : who insures new investments as well as the existing ones not covered, partly covered, by the state agencies. Example- Lloyd of London.

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c) While negotiating for compensation:• Settlement disputes: Judicial Tribunal in the host country

or the International Center for Settlement of Investment Disputes (ICID).

2. By Exporting Organizations- against payment defaults:

• Internal Means: • Reduce its exports to such country.• May increase margin on the product.• Possibility to add a risk premium to the price of the

product.

• External Means: • Transfer the risk to some other organization say, a bank.• To sell the credit to the specialized organizations/

invoicing companies. (Allinvoicing.com)

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3. By Banks.• By Buying Back Debt: the bank repurchases the debt,

particularly when there is grave uncertainty about its recovery.

• Example – 1989-91, Poland,had repurchased a part of its external debt for less than a third of its original value.

• This permits the debtor not to pay interest and to pay only a part of the capital borrowed.

• Repurchase should be done only in the currency of debt or convertible currency.

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• By Debt-Equity Swap: Bank credit is sold to the private investor, interested in investing in that country.

• Involves three parties: the creditor-bank, the debtor-country, and the private investor.

• Private investor buys the bank credit on discount. On maturity, it has his credit refunded by the debtor-country in local currency.

• Example – In 1986, Nissan used this system, to set up factory of trucks in Mexico.

• Benefits-• To Investor: opportunity to earn in transactions

• To debtor-country: it obviates the requirement to pay in foreign exchange.

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Role of OPICRole of OPIC

Overseas Private Investment Corporation

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The Overseas Private Investment Corporation (OPIC) is an agency of the United States Government established in 1971 that helps U.S. businesses invest overseas and promotes economic development in new and emerging markets.

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• History– Programs now housed at OPIC started in 1948 – OPIC began independent operations in 1971

• Purpose– To support U.S. private sector investment– To assist in economic growth of developing

countries– To improve American competitiveness– To operate on a self-sustaining basis

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Role of OPIC

• Project Finance

• Political Risk Insurance

• Investment Funds

Since 1971, OPIC has supported investments valued at more than $73 billion, generating more than $40 billion in U.S. exports

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Investor’s EligibilityInvestor’s Eligibility

• U.S. citizen

• U.S. corporations, partnerships or other business – organizations that are over 50% U.S.-

owned

• Foreign corporations, partnerships or other– business organizations that are over 95%

U.S. owned

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Project EligibilityProject Eligibility• Project types

– New projects – Expansions– Acquisitions– Privatizations

• Project Requirements– Positive development effects on the host country.– No negative US economic effects– Any amount of US ownership– Limited foreign government participation– Environmentally sound

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Investment EligibilityInvestment Eligibility• Generally 3-year term or longer

• Will assist exporting that is related to long term – investment commitment

• Contributions of value, including:– Equity– Debt (inter-company debt or bank financing)– Leasing (capital, financial, leasing companies)– Services– Technical assistance

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Country EligibilityCountry Eligibility

• OPIC bilateral agreement required

• Foreign Government Approval (“FGA”) may be necessary

• Must follow country exposure limits

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Project FinanceProject Finance• Limited recourse financing up to $200 million per

– project• Two Financing Facilities:

– Direct Loans for small projects– Loan Guaranties for larger projects

• Sectors supported:– Infrastructure– Natural Resources– Manufacturing– Financial– Other (agribusiness, services, etc.)

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Political Risk InsurancePolitical Risk Insurance

• Coverage Types:– Inconvertibility– Expropriation– Political Violence

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Investment FundsInvestment Funds• Funds:

– Privately owned and privately managed investment companies

– Funds seek long-term capital appreciation– Source of additional equity for investment projects

• OPIC’s Role:– OPIC partially underwrites capitalization of funds– Investments subject to OPIC approval, assuring that

projects meet policy eligibility criteria

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OPIC FundsOPIC Funds• Russia:

– Russia Partners Fund– Major Projects Fund

• Central Europe: – Bancroft-Trefoil Central– Europe Fund

• Poland:– Poland Partners Fund

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OPIC Funds In IndiaOPIC Funds In India

• Preferred Brand International– Deals with Purchase Equipments, implement

marketing and distribution. (lead by:- Ashok & Meera Vasudevan.)

• Sanghvi Movers – Deals with Hydraulic & Crawler Cranes. (Its a

financial Intermediary).

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Role of MIGARole of MIGA

Multilateral Investment Guarantee Agency

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• member of the World Bank group.

• established to promote foreign direct investment into developing countries.

• founded in 1988 with a capital base of $1 billion and is headquartered in Washington, D.C.

About MGIAAbout MGIA

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• Purpose of MIGA:– To promote FDI into developing countries. – To provide guarantees against non-commercial risks to

protect cross-border investment in developing member countries.

– To protect investors against the risks of Transfer Restriction, Expropriation, War and Civil Disturbance, and Breach of Contract (for contracts between the investor/project enterprise and the authorities of the host country).

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• Role of MGIA:– In Promoting FDI Investments…

• by insuring investors against political risk,

• advising governments on attracting investment,

• sharing information through on-line investment information services, and

• mediating disputes between investors and governments.

– In Providing Technical Assistance…• Investment promotion skills training,

• Workshops on basic principles of investment promotion designed for officials.

• Developed FDI promotion center.

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– By Insuring the investors against the risk…• Deterring harmful actions: MIGA’s relationship with

shareholder governments provides additional leverage in protecting investments.

• Resolving disputes

• Accessing funding: Our guarantees help investors obtain project finance from banks.

• Lowering borrowing costs: MIGA-guaranteed loans may help reduce risk-capital ratings of projects.

• Providing extensive country knowledge: MIGA applies decades of experience, global reach, and knowledge of developing countries to each transaction.

• Providing environmental and social expertise: MIGA helps investors and lenders ensure that projects comply with what are considered to be the world’s best social and environmental safeguards.