The immediate pre- and post-election periods’ buoyancy or depression in the stock market is a reflection of how business conditions are impacted by political shifts. The business climate is influenced by the government’s viewpoint on corporate operations and effective business communication. The way that the government operates will affect what every company does. The government may decide to set the economic direction of the nation, as it does in the United States of America, or it may decide to enable and, in reality, provide free and fair competition, allowing private companies to influence the nation’s economic orientation.
A business is attracted to and impacted by political events even if it views itself as an economic entity. Thus, it becomes essential for the company, particularly an international business, to monitor both the domestic and international political environments. Because the multinational corporate firm operates in a host country as a guest, it is especially necessary for it to monitor developments in the host country’s domestic political environment.
Analyzing the Political Environment in International Business
The government’s orientation can often disclose whether or not international business can thrive in that country. The ideological leanings of a country may be capitalism, socialism, a blend, or another kind. Many countries’ beliefs have undergone significant modifications in recent years. The most spectacular example has been the demise of the communist USSR and Eastern Europe, followed by the adoption of market-led policies and ideas.
Another significant change has been the opening up of the Chinese economy alongside India. Similarly, several African countries, such as Zimbabwe and Tanzania, are discarding their centrist leanings in favor of market-led economies. This variable is also influenced by nationalism because the business entity must exist and operate within that country.
Expropriation of foreign-held assets may result from a nationalist ancestry. These concerns, through their influence, create political risks.
Political Risk
Political risk refers to the sensitivity of a project’s returns to the political actions of a sovereign government. This concept raises various difficulties, the most significant of which is that political risk is related with fund blocking and expropriation (or domestication of investment) by a foreign government, for a corporation operating across its national borders. Political developments also affect import restrictions, tax controls, price controls, exchange laws, counter trade, and other areas that can have a significant impact on the value of the exporting enterprise and its survival.
Blockage of finances: A temporary or permanent blockage of finances is an issue that is directly related to the subject of political risk. The term “blockage of funds” refers to the fact that, while a corporate company may own the cash and retain property rights, it is unable to export its earnings.
Expropriation is the most extreme form of political vulnerability. Expropriation is the confiscation of property by the government, with or without compensation. Even when payment is forthcoming, it does not equate with the firm’s value, which is the sum of a firm’s future revenues. Reimbursement is frequently fixed with the book value of assets in mind.
Expropriation occurs frequently in modern economic history. It can happen for a variety of reasons, including the desire to keep national assets as “hostage” in international disputes.One example is the confiscation of Union Carbide’s assets following the Bhopal disaster in India.
While enterprises operating within the borders of the host countries incur these risks, firms operating outside the political limits are also influenced by political risks.These dangers are frequently manifested in the form of exchange controls, import restrictions, tax controls, price controls, counter-trade measures, and other similar measures.
Domestication
Domestication is the process of transferring control of a foreign investment to national ownership in order to align the firm’s actions with national interests. It differs from expropriation in that it is a gradual infringement on a foreign operator’s freedom of operation. Domestications are classified into three categories. There are three types of domestication: 1.firm initiated domestication, 2.government initiated domestication, and 3.predetermined domestication.
Whereas corporate initiated and predetermined domestication are low risk, government initiated domestication is on par with expropriation. The risk profile difference is a result of the discount factor employed in the capital budgeting decision. While in the case of preset and self-started domestication, the firm has the ability to utilize discount rates knowing the project duration, both variables are unknown or unplanned for in the situation of government initiated domestication. Furthermore, in a government-sponsored domestication scheme, the economics of the operation may go crazy since corporations are required to sell a specific amount of their ownership by a certain date.
Political Risk Management
Political risk management can be carried out either before or after an investment is made. The former is pre-investment planning, whereas the latter is post-investment planning. The international marketer has four alternatives for pre-investment planning for political risk management. They are as follows:
Avoidance
This strategy entails avoiding political risk by making no foreign investments. However, this is an option that may only be exercised prior to making the decision to go worldwide.
Insurance
Several corporate and non-business groups have emerged in recent years to insure political risk insurance. Political risk can be insured for any businessman.Despite variable premiums being charged for various commercial activities, the multinational businessman now has the option of insuring his political risk of expropriation available to him. However, insurance does not provide complete coverage because insurance companies insure the book value of assets, whereas the firm’s worth is determined by the stream of future earnings. Any expropriation would result in a decrease in the firm’s worth. What insurance does is limit losses by underwriting the value of assets. Currently, 90 to 95% of the insured value is recoverable. In India, the Export Credit Guarantee Corporation is in charge of insuring political risks.
Negotiating the Environment
Agreements reached between the industry and the ruling government are referred to as negotiating the environment. Concession agreements are another name for it. The sole disadvantage of this strategy is that it may result in the rejection of the previous contract by the incoming government in nations with a low level of political stability.
Investment Structure
It entails diversifying investments so that they are not concentrated in any one country. The company can also help with financial structuring. This entails raising money alongside government participation, i.e., some share is supplied by MNC, while the remainder is raised from domestic sources, namely the foreign government and its population.
Planning for After-Investment
Political risk develops even after the investment choice has been made, implying that the corporation is already committed in terms of the country. As a result, even after the investment choice has been made, the corporation must develop plans to prevent losses and maximize compensation in the event of expropriation. Among these strategies are the following:
Planned Divestment
This refers to the sale of assets in a foreign country over a specified length of time in order to reduce the risk associated. This technique entails recovering the investment cash as well as the required return over a specified length of time, following which the productive asset is sold to local inhabitants.
Short-term Profit Maximization
In this method, long-term goals are sacrificed in favor of short-term aims. In light of the changing conditions, the corporation reduces expenses and raises profit margins in order to recoup the initial investment.
Change in Benefit/Cost Ratio
Altering the benefit/cost ratio is another option for preventing or delaying expropriation. Before taking over foreign investments, a government normally conducts a cost benefit analysis of the benefits and drawbacks of expropriation. If the analysis may be skewed in favor of the firm by increasing the cost vs. benefit, the expropriation decision may be delayed.
Develop Local Stockholders
This method of generating local stockholders has worked wonders for reducing political risk and has frequently resulted in favorable treatment being meted out to them.
Adaptation
Today’s businessmen have learned that it is not necessary to possess assets in order to earn profits. Management contracts can also provide profits. The existence of this fact has been shown by Indian experience with management contracts in Middle Eastern countries.
Conclusion
Political stability, government orientation, and nationalism are the three key issues for any multinational commercial firm. While political stability is vital for any commercial entity, it is especially crucial for an international company enterprise since it reflects the success or failure of any corporate concern, because political stability is typically related with economic policy stability. Changes in regime, violence, and cultural differences based on language or other factors can create a highly insecure economic climate. Other issues confronting international business are government orientation and nationalism.