Transcript Political Risk

Fall 2008 Version
Professor Dan C. Jones
FINA 4355
Risk Management and Insurance: Perspectives in a Global Economy
17. Political Risk Management
Professor Dan C. Jones
FINA 4355
Study Points
Modes of foreign market entry
Nature of political risk
Risk analysis
Risk control
Financing the political risk exposure
The importance of monitoring
Political considerations in emerging markets
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Modes of Foreign Market Entry
Exporting
Use of a domestic intermediary
Foreign direct investment (FDI)
Joint venture
Wholly-owned subsidiary
Branch
Differences in the level of political risk
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Political Risk
Any governmental action that diminishes the value of a firm
operating within the political boundaries or influence of that
government
Elements (selected)
Nationalization (taking of property with compensation)
Confiscation (taking of property without compensation for criminal
activity)
Expropriation (taking of property without compensation in eminent
domain)
Contract repudiation
Note on “Expropriation”
Currency inconvertibility
Depending on the country and
jurisdiction, the property owner may
receive some compensation but the
amount is likely below the market value
of the property.
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Political Risk Management
Identification/measurement of loss exposure
Political/legal environment
Socio/ethnical environment
Economic/financial environment
Regional/international environment
Use of external data/analysis
Internal analysis
Frequency and severity of an adverse event
Changes in firm value
Benefit-cost analysis
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Public Information Sources (Table 17.1)
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The World at Risk – August 2008
China
The Olympic Games begins and a massive security operation is
mounted in Beijing. Earlier, 16 policemen in Kashgar were killed in an
attack by separatist Muslim militants.
Venezuela
President, Hugo Chávez, issues 26 decree laws, the provisions of
which could lead to a big increase in the role of state.
Rwanda
A commission accuses French officials – including the late president,
François Mitterrand, and two former prime ministers – of actively
supporting the Hutu génocidaires who massacred 800,000 ethnic
Tutsis and moderate Hutus in 1994.
The Economist.com
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Coface @Rating (Selected Countries, August 2008)
Business Climate Rating
Country @Rating
Afghanistan
D
D
Bahrain
A3
A3
Brazil
A4
A4
China
B
A3
France
A1
A1
Georgia
C
C
India
A4
A3
North Korea
D
D
Pakistan
C
C
Russia
B
B
Rwanda
D
D
United Kingdom
A1
A1
United States
A1
A2
Source: http://www.trading-safely.com
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Risk Ratings by Economic Intelligence Unit
Sudan
Sovereign
Currency CCC
Banking sector
Political
Econ structure
CC
CCC
C
CC
Iran
Sovereign
Currency BB
Banking sector
Political
Econ structure
B
CCC
CC
BB
Economic Intelligence Unit (Feb 2007)
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Political Risk Control Techniques
Integrative strategies
Discourage the host government from interfering with the operation of
the firm
Managerial approaches
Increase in communication and tighter relationships (e.g., use of
local resources including personnel)
Financial approaches
FDI through joint venture
Fair, accurate and open financial reporting
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Political Risk Control Techniques
Defensive strategies
The cost of interference > the cost of letting the firm stay
Managerial approaches
Joint venture partner from outside the host country
Minimum use of host country nationals
Use and enforcement of intellectual property rights
Financial approaches
Source equity/debt financing from within the host country
Minimize retained earnings locally
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Financing the Political Risk Exposure
Financing the Political Risk Exposure
Retention
Insurance
Intergovernmental agencies
Governmental agencies
Private companies
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Multilateral Export Credit Agencies (Table 17.2)
The correct name for
the Arab is “Inter-Arab
Investment Guarantee
Corporation.”
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The Multilateral Investment Guarantee Agency
Created in 1988 as a World Bank Group member
Promote FDI in emerging economies
Offer political risk insurance (guarantees)
Over $2 billion in capital paid by 163 World Bank member
countries
Click Here to Go to
the Webpage
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The Inter-Arab Investment Guarantee Corporation
Established in 1975 to foster inter-Arab investment flows
Provide coverage for inter-Arab investments and export
credits against non-commercial risks
$83 million capital in 2002
Click Here to Go to
the Webpage
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Overseas Private Investment Corporation (U.S.)
Established in 1971 to help US business investments
overseas, foster economic development in emerging
markets, and complement the private sector in managing the
risks associated with FDI
Up to $250 million per project against:
Currency inconvertibility, expropriation or political violence
Protection of up to 20 years of equity life or maturity
Previously “Overseas
Private Insurance
Corporation”
Click Here to Go to
the Webpage
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The Export-Import Bank of the U.S.
Finance the export of U.S. goods and services
Does not compete with private sector lenders
Pre-export financing
Commonly one-year transaction-specific or revolving loan
Small Business Multi-Buyer Export Credit Insurance
Commercial losses due to insolvency, bankruptcy and default (up to
95% coverage)
Political losses due to war, revolution, cancellation of an import or
export license, currency inconvertibility (up to 100% coverage)
Click Here to Go to
the Webpage
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Other Risk Insurance Providers
Export-Import banks around the
world
Private insurance firms
American International Group
African Export-Import Bank
The Chubb Group
Export Import Bank of Japan
Zurich (North America)
the Export Import Bank of
India
…
Lloyd’s
…
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In Your Countries?
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Differences between Public and Private Insurance
Public insurers must consider their governments’ policy
objectives
Private insurers are in the business to make a profit while
avoiding undue risk.
These providers are perceived as being more flexible.
Their coverages can be more expensive.
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Differences between Public and Private Insurance
In general, public-sector insurers rely more on published rate
schedules than do private insurers
Government policy toward a particular country or region heavily
influences pricing and coverage availability.
Traditional actuarial methods based on probabilities are less
applicable. Hence, private insurers use portfolio
management and diversification to assure spread of risks,
both in terms of coverage provided and geographic area.
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The Importance of Monitoring
MNCs should carefully monitor the effectiveness of their
political risk management programs, including the
environment in the country of operation.
Circumstances that create political risk in one country may
create it in another.
Marketing practices that are effective in a developed country
may provoke suspicion and controversy in a developing
country.
Managerial practices that are effective in the home country
may precipitate labor unrest in a host country.
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Political Considerations in Emerging Markets
Eastern Europe
Asia
Latin America
Middle East
Africa
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Case Study: Iran
Not in the Text.
Background
Persia until 1935
Became an Islamic republic in 1979
Religious scholars as political leaders
1980-1988 war with Iraq
Designated as a state sponsor of terrorism
Nuclear development
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People
Population of 65.6 million
Median age
26.4
15~64
72.3%
Life expectancy
Infant mortality of 36.94 per
1,000 lives at birth
Life expectancy
69.39 (male)
72.4 (female)
Ethnicity
Persian (51%), Azeri (24), …
Religion
Muslin (98%)  Shi’a (89%) and
Sunni (9%)
Source: CIA World Factbook (August 2008)
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Economy
Central planning with large
enterprises
47% services and 42% industry
Per capital GDP (purchasing power
parity) of $8,900
GDP real growth of 5%
Exports – gas, carpets
Imports – raw materials, capital
goods, technical services
15.8% inflation (2003*)
15% unemployment (2002*)
40% below poverty line
Single exchange rate system since
2002
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Iran – International Disputes
Fitch Credit Rating (December 2003)
B+ (long-term rating)
B (short-term rating)
Outlook – stable
S&P
Do not rate
Moody’s
Withdrew rating action in June
2002
US government concerns
that the rating was
“inconsistent” with U.S.
sanctions
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Insurance in Iran
The history
Initially serviced by foreign insurers
1935 – First, state-owned insurance firm established
1979 – The industry (with 12 foreign firms) nationalized, leaving only
state insurers: Iran Insurance Company, Asia Insurance Company,
and Alborz Insurance Company
The regulator
Bimeh Markazi (Central Insurance, www.centinsur.ir) of Iran
established in 1971
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Insurance in Iran
The market
The market is closed to the private sector and foreign firms
Third party motor liability insurance is compulsory
Related activities
Social Security Organization (SSO) for workers’ compensation type of
coverage
Medical Service Organization (MSO) for medical insurance to anyone
who selects not to be insured by Iranian commercial insurer or SSO
Export Guaranty Fund of Iran (ECGD)
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Insurance Data – Premium
Source: http://www.centinsur.ir/frmHome_en-IR.aspx
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Insurance Data – Claims
Source: http://www.centinsur.ir/frmHome_en-IR.aspx
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Discussion Questions
Discussion Question 1
With increasing internationalization of national economies,
would you expect political risk exposures to grow or diminish
in importance? Justify your answer.
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Discussion Question 2
Could political risk exposures of MNCs might be hedged in
the capital market? Speculate as to how this might be
accomplished.
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Discussion Question 3
An entire national economy can be exposed to political risks
in the sense that the actions of other governments can
diminish its collective “value.” How should governments
apply sound risk management principles to such exposures?
Do government considerations in this respect differ
fundamentally from those of firms?
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Discussion Question 4
Can governmental political risk exposures justify the
creation, maintenance and protection of a domestically
owned insurance industry? Justify your response.
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Discussion Question 5
We discussed two strategies for political risk management:
an integrative strategy and a defensive strategy. Pick a
country (or a political environment) for which an MNC might
use an integrative strategy. Pick another country (or an
environment) for which an MNC might use an integrative
strategy. Support your choice for each with logical
explanation. Would your choices of countries, tactics or both
change depending on the nature of business?
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