Explain factors affecting political risk.

(a) Company-related factors

(i) Form of Ownership.
The Company’s ownership is also an important component of its vulnerability to risk. Local ownership is usually viewed favourably by governments, thus wholly owned subsidiaries are at greater risk while joint ventures with the locals are less risky.

(ii) Nationality of Management.
If the management is entirely foreign, the company is more
vulnerable to political risk than a company having mixed nationals in the management or
locals in the management. The fact that the degree of risk in any situation is a function of the
country and company specific risks, the company while assessing the risk needs to take into
account both types of risks.

(iii) Nature of Industry.
The nature of the industry also determines the political risk. We
observe in the world that some industries are subject to more government regulations as
compared to others. This is because these industries are seen as being important to
development and therefore the government wishes to control it. The pricing of the product of
these industries affect population in general, therefore it is necessary to control these for
political hold on population. Some industries are crucial and strategic to some countries,
therefore these industries attract more regulation.

(iv) Level of Operation.
The companies with complex, globally integrated operations appear
to be relatively safe from government intervention. These operations are difficult to take over and regulate. Suppose the parent company control the source of supply of a technology or
raw material. It is not possible for the government to regulate this operation.

(v) Level of Technology and Research & Development.
High and sophisticated technology companies and those companies having high degree of research and development content
International Financial Management are difficult to be regulated. This is because these
qualities are quite individual and have been developed over a long period of time after
substantial efforts.

(vi) Level of Competition.
The companies having little competition are also not regulated
because the host government is unable to replace them.

(b) Country-related factors
(i) Resource Base: Countries rich in natural resources have less economic instability. The
nations are different in their natural, technological and financial resources, therefore, political
risk assessment also requires analysis of the resource base. This is because shortage or
abundance of resources can cause economic, political or social instability. For example,
excess of population relative to other resources would cause unemployment leading to social
and political tensions.

(ii) Country’s Capacity to Adjust to External Shocks: If a country has vast resource base, the
country will process greater capacity to respond to external shocks. The national spirit of
population is also important factor to adjust to external shocks. Cuba and Iraq are two
countries where the national identity was responsible for bearing external shocks.

(iii) Wasteful Government Expenditure: Wasteful public spending is potential indicator of
financial problems. This spending refers to the unproductive spending in the economy. In this
case, even the borrowings from abroad are used to subsidize consumption in the economy. In
this case, the government has less savings to draw on to pay foreign debt and therefore resorts
to exchange controls and higher taxes. This would inject inflation and capital flight into the
economy.

(iv) Controlled Exchange Rote System.
The controlled exchange rate system compounds the balance of payment problem and thereby makes fiscal discipline difficult. The' control' should not be confused with 'regulations'. By controlled system we mean the government using currency controls to fix exchange rate, i.e. the pegging of the currency. In controlled exchange rate systems, usually the domestic currency is overvalued, which implied
subsiding the imports.

(v) Fiscal Discipline.
One of the important indicators of fiscal discipline is the fiscal deficit
as a percentage of gross national product. The higher is this ratio, the more the government is
promising to its population relative to the resources it is obtaining from them. The fiscal gap
can force governments to resort to the expropriation or create a politically risky situation.

(c) Sociological Factors
Sociological factors are related to religious diversity, lingual diversity, ethnic diversity and
political dogmatism. Greater is religious diversity, the greater will be chances of social
discontent because every religious group tries to assert its supremacy over others. Similarly
the diversity in language and ethnic groups create social tensions. Political dogmatism among
various political groups also create political instability in the country resulting in higher
political risk.

(d) Geographical Factors
The nations are living in a particular geographical configuration and that if the environment
around the nation is hostile, greater level of political risk exists. More number of border
disputes imply greater degree of political risk. Similarly, if a nation is more prone to
calamities, (historical data), greater is the political risk.

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maurice.mutuku answered the question on April 25, 2019 at 06:43