RISK MANAGEMENT Ann Pickard – When risk is not a game

How do most companies go about quantifying country risk?
While an aversion to risk is prevalent in many boardrooms, rising global competition, diminishing supplies of natural resources and changing labour costs are forcing companies to consider countries that were once viewed as too risky. Using simplified portfolio concept, most multinational corporations divide their existing and planned operations into the categories of safe, moderate, high and prohibitive risk.
Safe places are advanced industrial countries. Any tendency toward nationalism or socialism is offset in varying degrees by the country’s efficiency, technical competence, economic needs and market opportunities.
Complications exist in day-to-day operations in moderate risk countries but the structure of the political environment and economic policy is sufficiently stable to permit changes in government without seriously altering the business environment. Special situations such as needed resources are necessary before foreign-owned business should consider investment in high-risk country and prohibitive risk countries merit no investment.
Management should adopt portfolio that is acceptable to its corporate strategic plan, taking into consideration company size, experience and management philosophy. Quite often the fear of instability deters far more investments than it should and even the most conservative companies should consider and undertake some high-risk investments.
Profits should be commensurate with the level of risk, and relatively inferior business environment must result in significantly higher earnings than might be expected in safe places.

What’s the best way for companies to identify and analyse risks?
I’d recommend using three categories of risk for companies doing business abroad: operating, socio-political and financial risks.
Some examples of operating risks would be that company selling goods and services in foreign environment immediately encounters problems due to different laws, customs, languages and values. Manufacturers must use the local labour force and rely on the domestic infrastructure. All companies must plan for potentially discriminatory practices and regulations. All these factors plus many others generate risks for the company attempting to do business and earn profit in an unfamiliar environment.
Examples of socio-political risks would be changes in government, be that through normal process or through traumatic incident such as assassination or coup d’état. new government may improve or bring decline in social stability, while population growth, wealth distribution and migration can undermine stability without change in government.
When it comes to financial risks, it’s essential for any company’s operations that it has the freedom to convert local currency and repatriate earnings and capital to the home country. So the capacity and willingness of the host country to provide foreign exchange are crucial factors. The legal framework is pivotal to repatriation, because the approval procedure is frequently used to delay access to convertible currency.

Looking at operating risks, what are the key considerations which companies need to assess?
I’d separate operating risks into four sub-categories. First would be potential problems due to the host government’s policies, programmes and practices. Then economic concerns, including real growth of GDP, inflation, fiscal performance, unemployment levels and similar criteria. These are followed by currency issues such as credit availability and exchange rates and, lastly, production factors such as labour militancy, corruption and bureaucratic problems.

Taking the first point you mentioned, the host government, what in particular would you be looking at?
Host government risk can range from highly critical for corporations with capital intensive operations, to minimal for those firms with rented offices who are simply selling their services or using leased equipment.
Changes in government, whether legitimate or otherwise, give rise to new policies and personal relationships with officials. These changes can be termed as “foreign company negative”, “neutral” or “positive”. But all policy and personnel shifts have the potential to be disruptive to business operations if the foreign company has not planned for the change.
Planned democratic changes can also be either devastating or helpful to multinationals. Looking back to when the French Socialists first took power in France under Francois Mitterrand, the government’s goal was to increase its control over business with form of centralised economic control. Nationalisation of large French firms was one result and multinationals were consequently reluctant to consider France as possible site. At the other extreme during this same period, Margaret Thatcher’s laissez-faire business philosophy made the United Kingdom relatively friendly business location compared with how it had been under Labour government.

Which economic factors need close scrutiny?
The reasons behind increases or decreases in gross domestic product, inflation, and money supply trends are indicators which must be considered. And the quality of the interpretation of economic data is really crucial, as it is for all qualitative and quantitative criteria used in country risk assessment. Macroeconomic numbers can frequently be misleading.
As for inflation, rising consumer and wholesale price indices can cause disastrous problems for companies. Two countries may have the same double digit inflation, but if one has the financial means for hedging against parallel currency devaluation; regulations permitting adjustments of asset values; and legal means of retaining profit margins, the business environments can be very different. So special practices must be adopted and technically competent personnel must be assigned to optimise cash management, secure asset evaluation, and reduce the cost of supplies and services.
Unemployment, labour costs and income inequalities also need to be studied. The level of job formation and the quality of jobs being created are basic indicators of social stability, workforce attitudes and political continuity. An elitist power structure, corruption and wide income discrepancies can aggravate the situation, while both low and high unemployment rates can affect business operations.

And currency considerations?
It’s important to assess three key factors: credit availability, financing and exchange rates. Foreign companies are often excluded from local currency markets. Countries that are short of foreign exchange, and prefer to relieve pressure on local liquidity, are often forced to import convertible currency for working capital. In other cases, foreigners must borrow at higher rate than domestic firms. Even if both domestic and foreign firms are treated the same, the government’s domestic borrowing to finance the budget deficit frequently leaves very little credit for day-to-day operations.
Medium and long-term loans for construction of new facilities, and expansion of existing operations, is an important risk assessment factor. Projects usually require more foreign exchange than local currency, so it is tactical to maximise local currency loans if the cost of money is not prohibitive. This will allow debt service from earnings in the country, and also an option for use of cash that cannot be repatriated. Risk increases when convertible currency loans are used for local currency applications, because corporate headquarters could be forced to meet interest and principal payments during foreign exchange shortages.

What about administrative and production factors as they might impact operations?
Daily operations will always include things such as obtaining approvals and licences, working with tax authorities, using domestic transportation and communication networks, and sometimes beco

Visited 6 times, 1 visit(s) today
Close Search Window