Mapping the New Political Risk

By Minor, John | Risk Management, March 2003 | Go to article overview

Mapping the New Political Risk

Minor, John, Risk Management

The map of political risk has taken on a changing form over the past twenty years. Along with new breeds of risk comes intensified concern over how it is handled. In a survey by the World Bank two years ago, approximately half of the investors said that political risk is a higher priority than it was five years before. Only thirty percent of risk managers, however, are confident of their management of this risk, according to a 2001 survey of the Fortune 1000.

Recent headlines justify this concern--the economic meltdown in Argentina, ongoing political crises in Venezuela, rising tensions between nuclear powers in South Asia, escalating violence in the Middle East and terrorist threats in Southeast Asia.

Political Risk of the, Past

Political risk is the threat that social, political or economic factors in a foreign country may affect the feasibility and profitability of an organization's global operations. Sources of political risk can include frequent or unexpected government changes, shifts in government policies, economic instability, nationalization, privatization, civil unrest, endemic corruption or a lack of infrastructure.

This framework definition--the specifics of which are debated--covers political actions that have varied depending on the location and the era.

Prior to 1985, political risks centered largely on post-colonial declarations of independence, civil wars and left-wing takeovers. The newly formed nations would confiscate or nationalize any foreign investors' properties, declaring an end to exploitation and the start of national sovereignty. During that time, around the globe, nearly two thousand expropriations occurred, and 15 percent to 20 percent of all U.S. foreign direct investment was lost.

A few notable examples:

* The abrupt fall of the Shah of Iran led to the nationalization of foreign-owned properties and contract default by the Iranian revolutionary government.

* Toward the end of the Yom Kippur War (in which Israel prevailed against its Arab neighbors), major Arab oil producers imposed an embargo (to punish the United States and other Western nations for supporting Israel); this was followed with the nationalization of foreign-held oil concessions in many Arab countries.

* Salvador Allende's Chile (one of the world's largest copper-producing countries) nationalized foreign-owned copper mines, a move that was applauded throughout the developing world as an act of defiance against the "economic imperialism" of the West.

* In India, the Janata Party, which held power from 1977 to 1980, expelled foreign firms (such as IBM) that refused to share their technology with domestic competitors. Coca-Cola was kicked out for refusing to reveal its secret formula.

The Past Twenty Years

The pace of loss due to political risk has not been tempered by changing times. Over the past twenty years, Aon alone has processed over $3 billion in such claims. And the Overseas Private Investment Corporation (OPIC) of the United States has paid out over $1 billion in claims over roughly the same period. (Established in 1971, OPIC is a U.S. government agency whose mission is to facilitate U.S. private investment in developing countries around the world through the use of financing and political risk insurance.)

The change in the nature of the risk can be seen in an expropriation in the mid-1980s of Belco Petroleum Corporation's Peruvian operations. Belco maintained offshore production until 1985, when its license to operate offshore rigs was revoked after a dispute over taxes with the Garcia government. Essentially, the Peruvian government imposed retroactive punitive taxes on the company, which it refused to pay.

This was one of the largest political risk insurance claims the market had seen at the time ($230 million). It illustrates the changing pretenses used by host governments (even leftist governments) for expropriating foreign-owned assets. …

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