COURSE: GLOBAL BUSINESS MANAGEMENT MGT610

DR. DIMITRIS STAVROULAKISPROFESSOR OF HUMAN RESOURCE MANAGEMENTDEPT OF ACCOUNTINGTEI OF PIRAEUS

Country Risk Besides advantages, foreign countries bear inherent

risks for investors.

Country risk results from a set of complex and interdependent socio-economic, financial and political factors. These factors are specific for a particular country, but they can spread fast due to global integration.

On the other hand, a country can be easily contaminated by negative regional or global forces.

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Risk Assessment How much acceptable is high risk?

Risk LevelRisk Level

AcceptabilityAcceptability

Unacceptable riskUnacceptable risk

Tolerable risk level if anticipatedTolerable risk level if anticipated

Managed risk with properManaged risk with properhedging or insurancehedging or insurance

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Main components of country risk

Economic risk Financial risk Foreign exchange risk

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

Quantifiable but ultimatelyQuantifiable but ultimatelyJudgmental,Judgmental,Insurable and Insurable and DiversifiableDiversifiable

QualitativeQualitativeAssessmentAssessment

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Country Risk Assessment

Economic risk: Low growth, inflation, low or declining investment and savings ratios, interest rate rise, structural weakness of the banking system, budget deficit, liquidity and solvency risk (when a nation’s capital assets are composed more of debt than of equity) etc.

Financial risk: Credit crunch, banking crisis, current account deficit.

Foreign Exchange risk: Drop in official international reserves, devaluation, capital controls.

NATIONALIZATION

In the spring of 2006 the Venezuelan government ordered all oil MNC to form Joint Ventures with state-controlled firms, the latter holding the majority stock.

When Total and ENI refused to conform, their oil fields were seized by the army.

By the same time President of Bolivia Evo Morales seized all oil fields from MNC.

By the same time President Rafael Correa of Ecuador confiscated all oil fields of Occidental Petroleum – the dispute continuing up to the present

Country Risk Assessment (cont) Political Risk:

(1)The risk incurred by lenders, exporters, or investors, when a payment or the repatriation of an investment is restricted afterwards by the arbitrary decision of the host country government. This decision may be carried out through confiscation, repudiation (refusal to endorse an agreement), nationalization, default (breaking the promise of paying back) etc.

(2)The risk owed to political turmoil, government change, or deteriorating governance: lack of transparency, political speculation, corruption, nepotism, bureaucracy.

Corruption is important, because it has been pointed by MNC as a cardinal reason for exiting, or minimizing investment in a country (e.g. IKEA in Russia).

Corruption Perception Index (CPI) 2010

Corruption Perception Index (CPI) 2012

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• Pre-investment strategy to anticipate blocked funds• Fronting loans

• Creating unrelated exports

• Obtaining special dispensation

• Forced reinvestment

Blocked FundsOwnership Structure

Intellectual Property

• Joint venture

• Legal action in host country courts

Human Resource Norms

• Understand and respect host country religious heritage

• Local management & staffing

Religious Heritage

• Disclose bribery policy to both employees and clients

• Retain a local legal advisor

• Support worldwide treaty to protect intellectual property rights

Protectionism• Support government actions to create regional markets

Transfer RiskCultural and

Institutional Risk

Strategies for Countering Country-Specific Risks

Nepotism and Corruption

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Country-Specific Risks

Transfer risks concern the limitations on the MNC’s ability to transfer funds into and out of a host country without restrictions.

MNCs can react to potential transfer risk in 3 stages:

Prior to making the investment, a firm can analyze the effect of blocked funds

During operations a firm can attempt to move funds through a variety of repositioning techniques

Funds that cannot be removed have to be reinvested in the local country to avoid deterioration in real value

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Transfer Risk

MNCs use mostly the following strategies for transferring funds under restrictions:

Alternative conduits for repatriating funds Transfer pricing goods & services between

subs Leading and lagging payments Using fronting loans Creating unrelated exports Obtaining special dispensation

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Transfer Risk (cont)

Fronting loans: Transferring funds from parent to host country. Certain countries (China) impose restrictions to the entrance of foreign capital. A fronting loan is a parent-to-sub loan channeled

through a financial intermediary. The lending parent deposits the funds in an

international bank, let’s say in London. That bank in turn “loans” this amount to the

borrowing subsidiary. In essence, the bank “fronts” for the parent.

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Transfer Risk (cont) Creating unrelated exports

The main reason for strict exchange controls is the host country’s inability to attract hard currency. Anything a MNC can do to generate export sales helps the host country.

For its contribution to the host country economy, the MNC may ask for more currency repatriation.

All costs of establishing and operating the sub are paid in local currency.

The MNC may organize regular expensive events, conferences, and galas in the particular host country, all paid in local currency.

Special dispensation If the firm is in an important industry to the development of

the host country, it may bargain for a special exemption in order to repatriate some funds.

Transfer Pricing. Sale contracts are signed between the sub and the parent, but

trade terms invariably seem to favor the parent (high prices when the parent sells to sub, low prices when sub sells to parent).

E.g. the sub purchases goods for $100.000 from the parent. These goods had been previously purchased from another sub for $10.000, and the parent simply had them repackaged.

Agreements between hoteliers and tour operators: deposits in foreign banks.

Other uses of Transfer Pricing: Helps to justify high prices of MNC products in the host country

whenever invoices are examined by local inspectors. Enables MNC subs to evade high business taxation in certain

countries. E.g. a Greek firm establishes a sub in Bulgaria as an intermediate. The Bulgarian sub orders materials from UK, and then sells them to Greece at a high price.

The home country has enacted low business taxation, therefore subs are “squeezed-out” of cash, that has to be piped and taxed at the HQ.

Transfer Risk (cont) Leading & Lagging Payments

They are based on calculated expectations of currency exchange swings. In order to get enough funds out of the host country, if the sub’s currency is likely to depreciate, the sub pays the parent in advance. If the sub’s currency is likely to rise, then payments are delayed.

E.g. if the Malaysian Ringgit (MYR) is expected to drop regarding the USD, then the local sub is eager to pay the HQ now.

MH Bouchet/CERAM (c)

Business Environment Risk Intelligence BERI provides a Political Risk Index assessing the social and political environment of a country. It is built on the opinion and scores provided by a hundred experts with a diplomatic or political science background. Governance quality is included into political risk analysis along with government effectiveness and social indicators. http://beri.com

Political Risk Services[1]: The PRS analyses cover a hundred countries and are updated on a quarterly basis. International Country Risk Guide measures and tracks corruption perception in government, law and order, expropriation risk, as well as the quality of bureaucracy. These measures stem from the subjective assessment of experts around the world.http://prsgroup.com

Thanks to its unique policy dialogue with more than 180 countries, the World Bank has developed a comprehensive database of composite governance indicators, measuring perceptions of voice and accountability, political stability, government effectiveness, regulatory quality, rule of law, and corruption. www.worldbank.org/wbi/governance/

The London-based Economist Intelligence Unit (EIU) provides a comprehensive é-year forecasting country risk analysis on some 100 EMCs., on a quarterly basis. The EIU method flows from expert’s answers to a series of 77 predetermined qualitative and quantitative questions. http://eiu.com

To look upon governance and corruption, Moody’s takes into consideration the structures of social interaction, social and political dynamics, as well as the economic fundamentals. Moody’s relies on the judgment of a group of credit risk professionals to weigh the various risk factors as well as the impact of each of these factors upon business prospects. http://moodys.com

Standard and Poor’s rating approach is both quantitative and qualitative. It is based on a checklist of 10 categories, including governance and political risk. The political risk factors gauge the impact of politics on economic conditions, as well as the quality of governance and the degree of government support in the population. S&P assigns short term and long-term ratings. http://standardandpoors.com

Euromoney publishes ratings of some 180 countries since 1982 on a semi-annual basis. The methodology is built from a blend of quantitative criteria and qualitative factors coming from surveys with about 40 political analysts and economists. Political risk receives a 25% weighting, as much as economic performance. Countries are graded on scale from 0 (worst) to 100 ( best). www.euromoney.com

Institutional Investor’s ratings are published twice a year since 1979 to assess the creditworthiness of about 150 countries, based on a survey of some 100 international bankers’ perception of creditworthiness, including economic, financial and socio-political stability criteria. The resulting score scales from zero (very high chance of default) to 100 (least chance of default). www.institutionalinvestor.com

Transparency International, a non-profit non-governmental organization in Berlin, provides an annual survey of corruption practices in nearly 90 countries since 1995. The Corruption Perception Index is based on a wide network of information sources with local NGOs, domestic and foreign corporations, investors, and business contacts. www.transparency.org

MH Bouchet/CERAM (c)

Heritage Foundation established since 1985, in partnership with the WSJ, an economic freedom index for some 160 countries, both industrialized and developing. The ranking is based on various socio-political and economic criteria, including political stability, state interference, regulatory framework, institutional strength, and corruption scope. www.heritage.org

PricewaterhouseCoopers’s Opacity Index measures the lack of clear, accurate, formal and widely accepted practices in a country’s business environment. As such, it focuses on the relative state of corrupt business practices, the transparence of the legal system and the regulatory framework. It represents a quantitative approach to measuring opacity and its resulting extra risk premium that stems from the additional business and economic costs.www.opacityindex.com/

The Institute for Management Development’s World Competitiveness Report analyses 49 industrialized and emerging economies around the world based on a far-reaching survey since 1989. Its analysis of the institutional framework addresses issues such as state efficiency, transparency of government policy, public service’s independence from political interference, bureaucracy as well as bribery and corruption.www.imd.ch

Freedom House focuses since 1972 on corruption levels in a number of developing and transition economies around the world. FH publishes an annual assessment of state of freedom in various countries on the base of political rights and civil liberties. Political stability and civil liberties are ranked on a scale of 1 (best) to 7 (worst). www.freedomhouse.org/ratings.index.html

The Political and Economic Stability Index of Lehman Brothers and Eurasia measures relative stability in around 20 EMCs by integrating political science theories with financial markets developments. The monthly evaluation uses both quantitative and qualitative criteria, including institutional efficiency, political legitimacy, economic performance, and government effectiveness. www.legsi.com

Political and Economic Risk Consultancy (PERC) specializes in strategic business information and analysis in East and Southeast Asia, with emphasis on corruption and business costs. Annual risk reports survey over 1,000 senior expatriates living in to obtain their perceptions of corruption, labor quality, intellectual property rights risks and other systemic shortcomings. www.asiarisk.com