Foreign Direct Investment (FDI) is exposed to multi-interventions by both the governments host and home. A political Dramatic event grabs headlines and business man, industrialist and managers' attention. Although most firm's focus on governmental actions news, or policy that may can reduce the company value, share price. There are occasionally government actions that increase the value of the firm.
Definition of Political Risk
"Political Risk Defined as the variability in the value of the firm (or subsidiary) that is caused by uncertainly about political or policy changes. As with other types of risk, this risk can be represented by a distribution of the firm's value due to political incidents". (Click & Coval 2002, p. 402)
The political System and Its Functions
The political system is designed in such a way that a society is feasible into a functioning unit. A domestically or international business has an enormous effect of the country's political system. The political system is also influenced by a variety of internal factors, such as the nature of the population and influence of corporations and governmental bureaucracies, and the strength of the politicians. (Daniels & Radebaugh 1998, p.104)
Two main categories of political-risk
Jeffrey D. Simon future explained Macro and Micro Political Risk "Macro Political- risk variables include those actions and policies that are directed against all foreign business in a host country, while developments that affect only selected business or specific sector are defined as Micro Political- risk." (Solberg 1992, p.124)
Macro risks
Transfer risk-"which arise from uncertainty about cross-border flows of capital payments and know-how."It also includes that imposition on capital controls it may be inbound or outbound, and withholding taxes on dividend and interest payments is called the transfer risk." (Eun & Resnick 2007, p.411)
Operational risks- "These are similar to firm specific risk and are associated with uncertainty about the host country's policies affecting the local operations of MNCs." An unexpected change in host country environmental or foreign policies, which is sourcing local requirements, minimum wage law and restriction on local credit facilities any such problem which affect the company's operation in the country is mean to be operational risk (Eun & Resnick 2007, p.411)
Control risk- "which arises from uncertainty about the host country's policy regarding ownership, and control of local operation." It includes restriction imposed on the maximum ownership share by foreigners, mandatory transfer of ownership to local firms over a certain period of time. (Eun & Resnick 2007, p.411)
Micro risks
Foreign exchange risk- It Refers to fluctuations in the domestic currency value of assets, liabilities, income or expenditure due to such unanticipated changes in exchange rates, Company's use many techniques which are available to cover or hedge exposure to such kind of risk .(Ephraim Clark 2002, p. 373)
Business risk- which arises from factors affecting cash flows and profit of the firm may be a change in taxation for international companies, or local disputes with trade unions or suppliers, manufactures etc.
If we explain from a broader perspective, political risk can be divided into three stability causes
Political Stability
Political stability is often seen as an important criterion of the real political risk. It indicates, in general terms, the probability of a country's involvement in, or being affected by, acts of terror, war or internal violence from groupings within the country or sanctions or blockades from other nations. The Constant risk of rapid and unexpected change in economic policy is extremely damaging for any MNC company or International Investor in the host country. (Grath 2009, p. 22)
Social Stability
The countries Social Stability also have a great importance, mainly on a long term planning. However, the development in many countries, show all too well how unexpectedly and rapidly social instability can turn into violence or terrorist activity that can paralyse the, growth of country or its 2economy countries like Iraq, Afghanistan , Pakistan. Social stability also refers to the safety of the citizen on the country, there may be diversify cultural and not religious antagonism. (Grath 2009, p. 23)
Economic Stability
To maintain the confidence of a country and its economy. Economic Stability is equally important. A weak infrastructure, dependence on single export or import commodities, a high debt burden and lack of raw materials are critical factors that, together with other developments, can easily change economic stability in a short time. Even currency restriction and other more indirect currency regulations such as 'pegging' against other currencies, often USD, could have serious long -term economic consequences, as seen in many countries. (Grath 2009, p. 23)
Managing Political Risk
If the multination company is willing to invest in a political risk environment then there are a variety of measures are available to help reduce the Company's political risk. An obvious strategy is to purchase insurance through one of the various political risk insurance programs, such as the U.S government's Overseas Private Investment Corporation (OPIC), Multilateral Investment Guarantee Agency by the World Bank (MIGA). Such insurance only protects asset value, however and not to the potential cash flows.
Another possible way is to change the structure of investment in the host country, and also the benefits of host country intervention. For example, firms should be ready to shift activities through multiple sourcing or segmented productions. It can also control inputs through high level of imports.
Third and effectively means of reducing the risk is to borrow extensively in the local currency. So that a debt denomination decision pertains to political risk. So the country nationalizes the subsidiary, it also nationalizes debt. Even back to back loan are sometime useful if capital controls pose some restrictions.
If the company is entering into some joint venture and take local partners represents another strategy for reducing political risk. Which makes that the partner won't be in the position to become our competition and must also be unable to take over the whole operations. Using the host government as the joint venture partner. ( Jeff Madura 2000, p.
Political Risk of Coca-Cola in India
Political risk can originate from the host or the home country, and the foreign operation of the coca-cola company has indeed been affected many times by both the U.S and foreign government. Coke's operation in India provided a high profile example of political risk.
In India, the coco cola company had developed a successful business and coke became the country's leading soft drink during 1970s. As a part of a new investment policy restricting foreign ownership to less than half of any project, the Indian government required all wholly owned foreign sub-sidiaries to dilute their equity. Recognizing that this requirement may have required that it share its secret formula, coca-cola refused to dilute its stake, and instead withdraw from India in 1977. The Indian government's equity dilution requirement clearly reduced the value of coke's Indian subsidiary. Coke's bottlers, family-owned business that brought concentrate and mixed the beverage, were also hurt because they were left without a product.
In 1977. Parle began botling s local cola product called Thumbs Up. By the 1990's parle brands represented a majority of the soft drink market. The Indian government also began liberalizing restriction on foreign ownership in the 1990s, and coca-cola decided to re-enter the Indian market. In 1993, coke returned to India by buying thumbs up and other brands from parle. In this situation, re-entry was somewhat easier because of Coke's earlier presence. However, the Coca-Cola Company is embarrassed by the fact that Thumbs up remains more popular than The Real Thing, Coke. (Wall street journal, 10 July 1998, p. A1)
Above scenario shows us that how the International Company was running a successful product in the market which faced the new investment policy by the Indian government. And still after re-entering to Indian market in 1993 through accusation of Parle's band Thumbs Up. It has been embarrassed by the fact that Thumbs up remains more popular than The Real Thing, Coke.
Political risk in China
As Mao Ze-dong took power in china in 1949, his communist government nationalized foreign assets with little compensation. Even a country controlled by a non-communist government, strong nationalist sentiments can lead to the expropriation of foreign assets. According to Coface analysis by Sylvia Greismen and Pierre Paganelli (2004-05), The Chinese government has categorized FDI in 4 ways i.e. "encouraged, tolerated, restricted and prohibited- by sector". But still there are sectors in which FDI is prohibited like post services control of traffics of airlines and media while sectors like telecom, real estate and sectors like gas, water and central heating supply are open for foreign investors. There are a lot of undertakings for international investors in the Chinese market, like they have access to the retail markets without any restrictions from 2005. For any foreign investment it requires an approval from the government but the level of issuing body depends upon the amount of investment made. The local authorities are given more powers because it is more effective in enforcing legalisation nationally but still the central government kept the rights of carefully examining the locally approved projects. For incentives in taxation generally an international investor invests through a foreign investment company. The principle of "public ownership of land" exists due to which foreign investors can only acquire a lease maximum for 50 years for an industry. And also the foreign investors are required to give job preference to the local Chinese people and foreign people in very rare cases. (The Handbook Of Country Risk 2004-2005, p.218)
Current Scenario
A Hong Kong based Political and Economic Risk Consultancy (PERC) said India, Malaysia and Thailand face the highest political and social risk among Asia-Pacific countries in 2009, mainly because of internal instability. India's highest risk score of 6.87 on a scale of 10 also reflected fears over Pakistan, (PERC) said in a report, warning of social unrest and insecurity if things worsened in the neighbouring nation.
This consultancy assessed 16 countries on factors such as the risk of disruptive political change, the threat posed by social activism and vulnerability to policy changes by other governments. Contributing to India's high score was uncertainty over the outcome of general elections next year, rising communal violence and increased militant attacks, PERC said in the report released on Monday.
"India, Thailand and Malaysia are not so much vulnerable to negative fallout from the global financial crisis as they are to factors that are mainly internal," (Robert Broadfoot, 2009) managing director of PERC, told Reuters.
The coming Global economic storm is going to make the situation worst. The countries underlying attraction of foreign policy should remain same no matter who wins the next election. Even the countries economic is not must affected by the global financial crisis the political risk for international investor in India is much higher compare to Asian economy PERC said.( Reuters, 2009)
The global recession cut exports of Indian goods heavily record in March, It was the longest slide in a 10year Industrial output fell in February by the most in more than 14 years, while job losses have hurt consumer spending. (Tushar Poddar)a Mumbai-based economist at (Goldman Sachs Group Inc.), told Bloomberg that there are no major differences in the economic policies of Congress and BJP, with both vowing to increase spending on roads and power to support India's economic growth.
Congress plans would plan to launch some new foreign investment policy in the coming 5years on ruling. Alternatively, the BJP has precedence of supporting investment flows and free trade when it was last in power between 1998 and 2004.For an emerging market it is not only survive but thrive in a competitive inter-connected and multi-polar economy, India needs to be a stable government in place who will continue to push for foreign investment and foreign policy which would attract and benefited to foreign investor India needs to participate with the developed world economically and in policy and show a decrease of political risk as collateral. (Reuters & BRIC, 2009)
Political Risk Ranking
The Above Statistic shows that the Political risk in India is comparatively more than that of China the statistical ratio was published by ECONOMIST INTELLIGENCE UNIT in March 2009 which indicates that India is on 49 risk ranking were as china is on 35 such factors affect FDI flow in India by the foreign investors. Some were this statistic also shows that the Government policy is not much stable in the countries. If the countries are into the globalisation and liberalization then they should emerge with the world economy and to make country a trade fee zone, like removing some trade barrier for the international investors making foreign policy a better profitable and attractive.
Conclusion
In context of better foreign investment both the countries needs to have good foreign policy which can attract and benefited to the international investor.
Indian needs to be a stable government so that the political risk can be minimised and severe actions should be taken against the terrorism and cross bordering countries. There are much more political issue arise between the political parties, if the ruling party has few foreign investing policy then the opposition parties object the decision as they see their own profit to the heights the corruption. Yet the government is trying to minimise the problems paced by the international investors. Were as in china the foreign investors wants to invest in the prohibited sector post services control of traffics of airlines and media while sectors like telecom. Chinas government has quite few good opportunities than India to attract the foreign investments in the country.
Hence the political risk in India is comparatively more than china and even the foreign investors prefer to invest in china.
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