The Political Risk in the Foreign Investment Strategic Decisions

Abstract

Political risk has become a major risk of business firms involved in international operations. Hence risk evaluation is a more and more crucial issue to be dealt with by different organisations: private firms, banks and even government agencies.

Political risk is composed of diverse, non-independent sources of risk, so that, after an identification of the components, one has to solve a multicriterion problem in order to yield a global evaluation.

First, a survey of major evaluation methods is presented.

Second, a systematic comparison of those methods is carried out.

Third, so as to come to a conclusion, a tentative list of major-underlying theoretical difficulties together with main practical implementation problems are evoked.

Our economies are going international. Companies invest increazingly abroad. They do so in order to survive. Bankers worry. They have granted sizeable international credit to help their client firms to export. The most important markets for firms of the developed countries are public works and industrial facilities. The main customers for this type of contracts are Eastern countries and developing countries, particularly in Asia. Obviously, their borrowers present a higher degree of risk than industrialised countries.

A few elements have now come to change the picture and the very notion of risk.

• The emergence of new countries, generally rich in raw materials whose potential for development in huge such as Mexico and Brazil, China and Korea.

• Many companies have to invest abroad if they do not want to be penalized; governments encourage them to do so and competition is keener and keener.

• Colapse of the Russian Empire.

• The coming to power of new heads of state whose reactions may sometimes be irrational.

Managers now must take into account not only revolutions and coups d’etat but also monetary disorders, the sudden imposition of exchange and price controls...

Thus, it is becoming harder and harder to forecast the political future of any country including those which seem to be stable. Consequently, managers wishing to invest abroad must collect as much information as possible on the political, economic and social situation of the host-country (the State they have selected), Embassy reports, notes from various services of the French Ministry of the Economy, of the Ministry of Foreign Affairs and even from intelligence services are useful documents. However, there is a lack of coordination between these various sources; obviously, this is detrimental to companies and the country.

Indeed, most Western countries have set up a system of guarantee against political risks. In 1971, France set up two systems: the first one is managed by the B.F.C.E. (Banque Française pour le Commerce Extérieur), the second by the C.O.F.A.C.E. (Compagnie Française d’Assurance à l’Exportation). The cost of risk coverage varies between 0,4 % and 1 % of the quota guaranteed, according to three criteria: (1) the country selected. (2) the risk involved in the investment itself and (3) the benefit the nation may derive from it.

However, this insurance system is not enough. Field studies. Newspaper articles. World Bank statistics are an irreplaceable source of data.

Moreover, this information is complemented and/or processed by experts and consultants, such as Professors Haner’s Beni. For example the latter forecasts that around 2000 two key groups will become powerful in Morocco: the military and the Soussi (middle class of Berber origin); they now recommend their clients to hire Soussis.

Before making a prognosis on a country, or even to place it on a classification grid. Some companies, banks, public organizations and consulting firms have defined implicity at least, the political risk and identified its elements. They have also set up various assesment procedures and sometimes have turned to integrate them into their financial or global planning.

Therefore, we will try first to define the nature and the different elements constituting a political risk; second, we will present a few approaches to risk assessment and third. We will deal with the questions raised, both at the theoretical and the practical levels. By integrating this risk in the planning process of a company.