16. mnc risk management 5

MNCs &

Risk Management.. …

              Country Risk ..…

Country Risk

When business transactions occur across international borders, they carry additional risks not present in domestic transactions

These additional risks, called country risks, typically include risks arising from a variety of national differences in economic structures, policies, socio-political institutions, geography, and currencies.

Country Risk

Risk is made of uncertainty and uncertainty stems from lack of reliable information

Country risk is composed of all the uncertainty that makes specific the risk of country exposure

Δ Country Risk > Domestic Risk

Country risk

Country risk results from a set of complex and interdependent socio-economic, financial and political factors, that are specific for a particular country, but that can quickly evolve given the country’s global integration

Country Risk

So, What Does Country Risk Mean?

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

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

What country risk is NOT

Country risk is NOT a monopoly of foreign creditors, exporters, importers, or investors

Domestic residents (households, investors, corporate sector) also face country risk from their own country’s socio-economic situation:

The country’s goverment can take arbitrary decisions that will affect the residents’ situation

The country can be contaminated by negative regional or global forces

How does country risk materialize?

1. CREDITOR = Payment arrears, default, rescheduling, write down and/or write off

2. INVESTOR = Capital control Limits on dividends and capital repatriation; Contractual

obligations and legal commitment : contract repudiation, corruption; Public guarantees: unilateral

suspension3. TRADE

PARTNER = Supplies and purchases (imports of goods & services) delays, defective

merchandise Sales (exports of goods & services) payment arrears

Tsunami & Natural Risk Disasters

Hurricane Katrina 08/2005= $59 billion Thailand 12/2004= $5 billion Hurricane Ivan 2004= $7,4 billion Hurricane Wilma 2005= $10,3 billion Hurricane Andrew (1992)= $21,6 billion Hurricane Charley : $7,7 billion Japan’s Earthquake= $1 billion

Main components of country risk

Quantifiable but ultimatelyjudgmentalInsurable and diversifiable

Qualitative assessment

o Economic risko Financial risko Foreign exchange risk

o Political risk o Cultural environment risko Legal and contractual risk (repudiation, confiscation, bribes...)o Regional contamination risk (spill-over effect)o Systemic risk (global crisis)

Sovereign Risk

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Sovereign Risk concerns whether a government will be unwilling or unable to meet its loan obligations, or is likely to renege on loans it guarantees

Sovereign Risk

Sovereign risk can relate to transfer risk in that a government may run out of foreign exchange due to unfavorable developments in its balance of payments

It also relates to political risk in that a government may decide not to honor its commitments for political reasons

Transfer Risk

Transfer Risk is the risk arising from a decision by a foreign government to restrict capital movements

Restrictions could make it difficult to repatriate profits, dividends, or capital

For example : a growing current account deficit as a percent of GDP implies an ever-greater need for foreign exchange to cover that deficit

Thailand in 2007: Tightening Of Foreign Ownership Rules!

Draft law requiring that Thai citizens hold >51% of the voting rights for a company to be deemed Thai, discouraging inward FDI

MNCs have one year to sell down any equity holdings >49%

Exceptions: service industries (accounting, legal services, hotels, advertising and construction)

Sovereign and Transfer Risks

Sovereign risk = risk stemming from the country government's policy

Transfer risk = risk that a foreign country’s private sector might be unable to meet its

payment obligations due to restrictions on remittances of capital, dividends, interest, fees, debt payments… Why? exchange restrictions, discretionary balance of payments policy, moratorium or breach of

contract

Political Risk - Definition

The risk of loss when investing in a given country caused by changes in a country's political structure or policies, such as tax laws, tarrifs, expropriation of assets, or restriction in repatriation of profits

For example, a company may suffer from such loss in the case of expropriation or tightened foreign exchange repatriation rules, or from increased credit risk if the government changes policies to make it difficult for the company to pay creditors

Political Risk

For investors, political risk can simply be defined as the risk of losing money due to changes that occur in a country’s government or regulatory environment. Acts of war, terrorism, and military coups are all extreme examples of political risk. Expropriation of assets by the government – or merely the threat – can also have a devastating effect on share prices

In early 2007, Venezuelan President Hugo Chavez abruptly

announced plans to nationalize CANTV, the local phone company. CANTV’s shares plunged almost 50% before the details of Chavez’s plans emerged. Investors sold first and asked questions later.

Political Risk

But political risk comes in many other forms. Other examples include: a new president or prime minister, a change in the country’s ruling party, or an important piece of new legislation

All of these changes can have a big impact on a country’s economic environment and investor perceptions about a country’s prospects

Political Risk

For multinational companies, political risk refers to the risk that a host country will make political decisions that will prove to have adverse effects on the multinational's profits and/or goals

Adverse political actions can range from very detrimental, such as widespread destruction due to revolution, to those of a more financial nature, such as the creation of laws that prevent the movement of capital

Political Risk

In general, there are two types of political risk, macro risk and micro risk

Macro risk refers to adverse actions that will affect all foreign firms, such as expropriation or insurrection

Micro risk refers to adverse actions that will only affect a certain industrial sector or business, such as corruption and prejudicial actions against companies from foreign countries.

Political Risk

For example, after Fidel Castro's government took control of Cuba in 1959, hundreds of millions of dollars worth of American-owned assets and companies were expropriated

Unfortunately, most, if not all, of these American companies had no recourse for getting any of that money back

Political Risk Mitigation

So how can multinational companies minimize political risk?

There are a couple of measures that can be taken even before an investment is made

The simplest solution is to conduct a little research on the riskiness of a country, either by paying for reports from consultants that specialize in making these assessments or doing a little bit of research yourself, using the many free sources available on the internet (such as the U.S. Department of State's background notes)

Main Public Sources of Country Risk Intelligence

IMF/World Bank BIS OECD Regional Development Banks (AfDB, IDB, EBRD, AsDB) UNDP, UNCTAD Export Credit Agencies (Coface, Hermes, ECGD, SACE,

CESCE, Eximbank…) CIA US State dept.

Specialized Country Risk Analysis Institutions

EIU International Financial Risk Institute BERI (Business Environment Risk Index) Rating agencies: Dun and Bradstreet, Moody ’s, S & P,

FITCH IBCA Institutional Investor & Euromoney Frost & Sullivan Credit Risk International The Institute for International Finance AT Kearney COFACE

Political Risk Mitigation

While that strategy can be effective for some companies, sometimes the prospect of entering a riskier country is so lucrative that it is worth taking a calculated risk

In those cases, companies can sometimes negotiate terms of compensation with the host country, so that there would be a legal basis for recourse in the event that something happens to disrupt the company's operations

Political Risk Mitigation

However, the problem with this solution is that the legal system in the host country may not be as developed and foreigners rarely win cases against a host country

Even worse, a revolution could spawn a new government that does not honor the actions of the previous government

If you do go ahead and enter a country that is considered at

risk, one of the better solutions is to purchase political risk insurance

Country risk analysis

Country risk analysis involves the assessment of a private or public foreign entity’s ability and willingnessability and willingness to service its external obligations in full and in time (contractual, debt servicing, import payments, legal commitment…).

It incorporates a forward-looking estimate of default probability

Country Risk Assessment

Economic risk: low growth, inflation, low and declining investment and savings ratios, interest rate rise, banking system structural weaknesses, budget deficit, economic overheating…

Financial risk: credit crunch, banking crisis, current account deficit,

Foreign Exchange risk: drop in official international reserves, Fx Rate overvaluation, devaluation, liquidity and solvency risk, capital controls

Political Risk Mitigation

Risk mitigating options

Insurance cover and guarantee

ECAs IFIs

Private & Official Cofinancing

Private

Market-based instruments

Securitization Debt swapsAsset trading

Risk mitigation strategies

Engage in open, competitive bidding, avoiding ‘fast track’ arrangements. Participation in the latter may invite the accusation that you have bribed local officials

Examine the political connections of your local partners carefully. Close association with the current regime may be advantageous now, but once key figures are removed from the political stage you could be in for some nasty surprises

Be a good corporate citizen, contributing to the host country's economy and culture with worthwhile public projects

Risk mitigation strategies

Cultivate connections with public officials outside the industry in which the company operates. They may become very useful in a crisis.

Do not limit your discussions to representatives of the national or local government. They may not necessarily be a good indicator of public opinion. Make a point of establishing an informal dialogue with local journalists, as well as human rights and environmentalist groups. The alternative - keeping a low profile - can make you appear secretive.

Avoid enlisting home government support if the local authorities threaten to break agreements. Such a tactic is often counter-productive, particularly if it is done publicly

Thank YouBest of Luck….