This assignment is all about undertaking risk analysis of a South East Asian country to find out the attractiveness for Foreign Direct Investment (FDI), and finally suggesting changes to be made to the country's economy so as to attract more Foreign Direct Investment. In this case India is the chosen country.
When choosing the right destination for FDI between countries it is important to undertake Risk analysis before considering which country to choose. "Any decision by companies involves weighing opportunity against risk" (Daniels, Radebaugh, Sullivan et al, 2009:12).Therefore it is imperative for a firm, before making any decision to invest in a foreign country, to make a country risk analysis.
On this assignment various country risks for India are highlighted together with their measuring methods(analytical tools) and interpretation so as to come up with vivid suggestions on what to be changed, for India, to become a better FDI destination.
2.0 COUNTRY RISK ANALYSIS:
Country risk analysis in attracting Foreign Direct Investment attempts to identify the imbalances that increase the risk of shortfall in the expected returns of a cross border investment.
Decision in choosing the right destination for FDI exposes the MNE to different types of risks namely political, economic, industry and position. These may make up the country risks. The following is the analysis of country risks in relation to FDI attractiveness for the country of India. .
2.1. Political risk
Political risk is the possibility that political decisions, event or conditions will affect country's business environment in the way that will cost investors some or all of the value of the investments or force them to accept lower than projected rates of returns. The risk arises from the fact that there may be specific risks associated with policy changes due to changes in the governance. For example a military coup- de -tat may result into nationalization of certain industries and even in a democratic setup changes in political parties following different ideologies may result in increased risk..
Political risk analysis is important for FDI decision because MNE are concerned with stable and predictable business environment over the lifespan of the investment.
In analyzing political risk of India the following indicators can be used,
Geographical proximity to trouble maker
India has trouble with control of Kashmir with Islamic government of Pakistan and hence pose a risk to invest in northern part of India for the fear destruction of property and disruption of sales and supplies.
Longevity of regime and presence of multipartism policy
Political risk may occur because of changes in political leaders' opinions and policies, which may cause the need to adjust to changes in the rules governing business. Frequent changes in political leaders and presence of multipartism pose this risk.
But recently inspite of these changes India has not changed fundamentally the FDI related policies. For instance taxation policies regarding FDI have not dramatically changed.
Terrorism and Muslim fundamentalists
India is one of the victims of terrorists' attacks, and recently some hotels were attacked. Therefore terrorism affect negatively the FDI in flows
Generally the analysis of political risk in India give out that India is less risky for FDI with exception that investing in North western part of India which geographically is more proximity to violent neighboring country e.g. Pakistan which posed social unrest and insecurity to northern states of India. Also terrorism threats can pose a big risk.
Economic Risk
This is the Risk which affects the purchasing power of potential customers and the cost of capital of a certain capital.
Factors which may indicate Economic Risks:
Size and Economic growth
GDP per capital
Inflation rate
Interest and exchange rates
Income distribution
Poverty
Balance of Payment (BOP)
Government debts
In analyzing the Economic risk in India various models can be used however the in this case is the IMF's Memo items which provides simple and effective way at analyzing economic risk:
CAD/GDP Ratio
This ratio measure the extent of foreign servings as percentage of GDP. According to IMF memo the acceptable upper limit has been set as -1.96% to 2%. Outside the given limit is considered risky. According to the data shown in the India at glance profile India shows a CAD/GDP ratio of -2.6 in year 2008,
The ratio shows the Instability of Balance of Payment (BOP) hence risky for FDI
That there is more imports and less exports this ratio as seen on India at a glance data shows that the country in deficit on this account for the past 3 periods
Debt Ratio
It measure the amount of foreign exchange outflow as percentage of total foreign exchange inflow the upper limit set by IMF at given year should not exceed 20% in 2008 India had 9% of this ratio which indicates stability of Balance of Payment (BOP) which is not risky for FDI inflows.
Import Reserve ratio
This ratio measures the reserve position as ratio of anticipated imports during that year accepted level by IMF memo the reserve should not be below 3months
It is calculated by the following formula
MRR = Reserve including gold x 12
Required reserve
Whereby;
Required Reserve = Total anticipated imports per annum x 3
12
Given the following data:
Import per year (in USD $ millions) = 345,993
Reserve including gold = 351,259
Required reserve = 345,993 x 3
12
= 86,498.25
MRR = 351,259 x 12
86,498.25
= 48.73
Since the import reserve ratio is 48.73 months this shows India is able to meet imports requirements, that is to say this ratio shows no risky in this area.
Ration
Normative figure (should be)
Good
Bad
Interpretation
CAD/GDP
<(-) 2%
- 1.96%
-2.23%
CAD (foreign savings) should not be more than 2% of the GDP
Debt service ration
<20%
18%
25%
Not more than one fifth of the total inflow of forex into the country should flow out again for payment of principle (amortization) and interest
Import Reserve ratio
>3 months
3.7 months
1.6 months
If it is less than three months then the country may not be able to meet is import requirements
The analysis and interpretation of the three ratio can be shown on the following matrix:
2.3 Industry and Positioning risk
Industry risk represents the chances that may happen for Multinational Enterprise to choose wrong industry to invest in deciding for FDI in a particular country.
After making industry risk analysis and come up with the right industry to invest then positioning risk within that industry arise.
Positioning risk represents the risk that may arise due to the positioning of the product on the Product Life Cycle (PLC) within that industry.
This happens because different phases of product in product life cycle
will represent differing returns on the investments. For example, positioning
product on introduction and growth phases they are likely to more cash outflow due to development costs and increased advertising expenses, hence returns are likely to be low. Positioning in Maturity phase will bring more returns but depends on the
attractiveness of substitute product.
In undertaking industry risk analysis for choosing the right industry to invest in india the following factors should be considered:
The profit potential of the industry
The number of the firms within the industry(to determine the level of competition)
Infrastructure to support the industry
Government regulation on that particular industry
Availability of necessary resources. e.g. labor resources, raw materials etc
In assessing the above factors India is found to be the right destination for FDI in the following industries: electrical equipments, service sector, telecommunications, transportation, gypsum products, cement, construction, food processing and drugs.
In analyzing positioning risk so as to maximize return on a chosen industry in India the strategy clock model can be used. This model is used to determine the level of competition within the
industry. In determining the level of competition we look on the ability of the firm to make profit over and above the industry average, the ability of the firm to determine the future evolution of the industry and the ability of the firm to establish control.
RECOMMENDATION:
As a chief executive Officer of a British after assessing the India's Business Environment and analyzing some risks in some areas of the environment I would recommend some changes to Business environment before making any decision for Foreign Direct Investment (FDI) in that country.
Based on the country risk analysis of India there is no much to be changed but rather on these areas.
3.1 Politically
Political risk is a foremost risk that a Multinational Enterprise has to manage before deciding to invest in a foreign country in order to make India conducive for Foreign Direct Investment the following should be done.
Compensation:
The Government of India should determine and put in plan Compensation to MNE who might be damaged by violence in some parts of India, because many Foreign Direct Investors may fear for the loss of their properties. When Indian government promise to compensate this will attract FDI as the damages once occurred will not appear as a full loss to Investors.
Security
In order for India to be more competitive the Government should put concern on security measures to Personnel and Properties of Foreign companies. Some companies may fear to send their expatriates and other staff as it might be unsafe.
Incentives
As India frequently go through changes in political leaders there is a need to adjust the rules and regulations concerning policy of investing in that country.
These includes offering incentives such as Lower tax, Loan guarantees, low interests, exemption of import duties and subsidized costs like energy and transport, These will enable Multinational Enterprise to lower the costs of operation in a Foreign Country .
Fund Restrictions
The Government should put less restriction on Funds i.e Mobility of Funds. MNEs would like to be liquid in order to meet maturing obligations like, paying dividends, to cover unexpected contingences this will allow easier movement of MNE's financial resources.
Peace negotiation with neighboring countries to reduce Political risk from frequently violence from Pakistan which can pose fear for Foreign Direct Investment in those violent areas.
3.2 Economically
Stabilizing the Balance of Payment (BOP)
- In reducing economic risk the foreign exchange reserve should be improved, since the analysis shows that it stands below the acceptable level according to the analysis performed above.
The Deficit in Current account means that the country is more importing than exporting, the government should discourage importation for non essential goods. This can be done using tariff measures for non essential commodities.
Principally the current account and capital account should balance. The current account deficit happens when country imports more than exports.
- I would also suggest that this situation can be reduced by devaluing the country's currency in this case Rupee which will make imports expensive which will enhance cheaper exports this is to say there is a great relationship of stock marked and currency.
- The impact of this situation in economy it will ease the imports and costs of exports good like Textiles, software and others will come down.
Further more the economic growth of India is at lower rate than its trade partners which as a result imports more than exporting to those trade partners, this is partly account for deficit in the current account. Measures to improve economy by increasing production in various sectors should be adapted like putting incentives in various sectors of economy.
On of the big challenge of this situation to be watched is the changes in exchange rate which may result to inflation.
- Government should control prices
- Ensure the growth in money supply
Reducing government spending
In improving debt ratio the government should take measures in reducing government spending, this in turn will improve budget deficit and hence the economy as a whole. And when the economy improve will attract more foreign direct investments.
Improving Infrastructure
In order to pushup economic activities the infrastructure should be improved tell communications, ports, roads and other infrastructure are very important to country's development in line with progress in economic growth in this case the government should look upon delays done by government department dealing with delusion making, caused by hierarchical organization structure which delays implementing infrastructure projects good infrastructure this will also attract FDIs.
CONCLUSION:
Generally the main factors that influence Foreign Investment in are not specific FDI policies but widely are economic policies which includes trade openness, corporate tax, and other business issues like regulatory quality and burden.
BIBLIOGRAPHY
Books:
Daniels, J.D., Radebaugh, L.H, Sullivan, D.P 2009, International Business: Environment and Operations: 12th edition, USA: Pearson Prentice Hall.
Journal Article:
Prasad, A. 2006. Market entry Decisisons, Journal of management Research 6(3) 138 - 141
Website:
India at a glance (2008) available from
http://devdata.worldbank.org/AAG/ind_aag.pdf.( Accessed on 31st July, 2010)
India Country Profile (2010) available from
http://www.state.gov/r/pa/ei/bgn/3454.htm (Accessed on 31st July, 2010)
