New Geopolitics Spotlights Political Risk Management: What Can You Do about "Inefficiencies" of Overseas Economies?

By Levinsohn, Alan | Strategic Finance, January 2002 | Go to article overview

New Geopolitics Spotlights Political Risk Management: What Can You Do about "Inefficiencies" of Overseas Economies?


Levinsohn, Alan, Strategic Finance


American flags are raised and flown ubiquitously today in America. But in many countries overseas, American flags are coming down--not necessarily torn down by protesters in the streets, but voluntarily taken down by U.S. corporate officials trying to manage heightened risks.

The science of risk management has advanced remarkably in two decades. Many financial managers now employ a toolkit of techniques to offset international risk exposures of foreign exchange, interest rates, or liquidity. But few are prepared to deal with the leap in political risk that today's new geopolitics presents.

Government instability, social unrest, corruption, lawlessness, terrorism, or militancy of all stripes makes for a volatile brew of political risk that American business managers, with their relatively clean markets and stable government, are generally unaccustomed to.

ALL POLITICS ARE LOCAL

"You can hedge currency and interest rate risk, but you can't hedge the risk of rioters burning down your store, the government seizing your assets, or consumers thinking you want to poison them," says Eric Falkenstein, an economist and former risk manager of KeyCorp as well as Moody's Risk Management Services.

For instance, Moody's Investors Service, the credit rating agency, has been trying to build a viable business in India for about 10 years and hasn't made a "dime off the operation," Falkenstein says. India's attraction is its population of one billion and "quasi-capitalist and somewhat stable government." In 1991, India introduced an industrial policy that was supposed to be vastly simpler, more liberal, and more transparent than its predecessor. The new policy actively promotes foreign investment as indispensable to the country's international competitiveness, according to Political Risk Services, a provider of economic and political data, analysis, and forecasts.

Still, it was "impossible" for Moody's to use its brand name and open an office directly; it had to work through an Indian affiliate, according to Falkenstein. Above all, India's many "informal rules--things that we would call blatant graft"--were costly and added risk.

"You have to pay people off," Falkenstein states. "To operate in various districts you have to get a license. And who do you get your license from? Well, maybe you have to pay off the mayor and also someone from the city attorney's office, and because all the jurisdictions overlap, you have to pay them off sequentially, and they're all kind of competing against each other, and you keep paying them off thinking it'll end, but it never seems to."

Even making political payments doesn't ensure you can concentrate on your business. "The law is so amorphous and vague they can interpret it to shut you down at any time," Falkenstein adds.

That nearly happened to a client company of Tom Copeland, a corporate finance consultant with Monitor Group. Copeland was helping his client open a plant in an Asian country he preferred not to name. He advised his client company to forge an equity relationship with a local company that had some political clout-the same advice he'd give any firm venturing into an unstable country no matter how much financial wherewithal they have. In this case, it was a joint venture with a national conglomerate of the host country.

"The first day the plant was opened, the mayor of the local town and his friends dug a ditch across the access road of the plant, arguing it might take months for the road to be repaired," he says. The repair required a "tax." Copeland's client immediately contacted its joint venture partner, and "it didn't take more than 24 hours before the ditch was repaired and the problem went away."

PERSPECTIVES ON POLITICAL RISK

Economically, corruption is no different from terrorism or lawlessness. They're all political hazards that cause losses. But while the current terrorism war may raise the level of global uncertainty and complexity, cross-border strategy, trade, international investment, partnership, mergers, and acquisitions will presumably carry on. …

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