Risk in Business Environment

Bedi Suresh, Business Environment Chapter 4 Risk in Business Environment Pages 52 to 65

What is Risk
Risk is a state in which the number of possible future events/outcomes are larger than the number of events outcomes which will actually take place Different with uncertainty

Types of Risk
Legal risk Political risk Social risk Direct environment risk Natural risk Regulatory risk Economic risk

Scores are aggregated and updated regularly as the environment changes. Countries are rated as follows:

Score
0-19 20-34 35-44 > 45

Risk Assessment
Minimal risk Acceptable High risk Prohibitive

Methods of Assessing Risk

1. Checklist It is a qualitative technique Make a list of those variables which affect the business environment and assign some risk element in it This method gives a rough approximation about the business environment risk and the future outlook

Continued--Checklist can be used for comparing the same country at different time periods or different countries

2. Expert based scoring system

Questionnaires designed to assess environment risk are sent to acknowledged experts and their opinions, observations and comments are obtained Scores are assigned to each question and then it is averaged or aggregated Can be used for cross national comparisons Can be sent to business executives, prominent citizens or social leaders

Continued--Delphi technique can be used

3. Economic Methods
Are used to quantify risk These methods are used for forecasting Factors are identified which affect business environment Cause effect relationship is established Well known methods are Regression Analysis Method and Time Series Analysis Method

4. Rating and Ranking System

Similar to expert based scoring system Countries are ranked Tools for investors and business seeking information about the financial risk Country rating is done on the basis of a number of parameters Economic, Social, Financial, Political etc. Standard and Poor, Bank of America

5. Assessment of Countrys Creditworthiness

Credit worthiness is based on a judgment of the borrower by the potential creditor, of its capacity to repay the new debt Risk of default on a debt obligation is low Credit worthiness of a country is the leading indicator of its business environment risk

6. Risk Benchmarking
Benchmarking is a process in which organizations evaluate various aspects of their processes in relation to ideal practice The acceptable range of different environment factors in a normally functioning healthy economy is ascertained and set as a benchmark Then the environment risk of some other countries is calculated by using the same criteria and compared with the benchmarked risk level

Continued--Relative riskiness of country 1 Actual level of business environment risk of country 1 Actual business environment risk of the reference country 0 taken as benchmark

Risks to be studied
Country Risk Political Risk

Country Risk Analysis

Country risk refers to the likelihood that changes in the business environment adversely affects operating profits or the value of assets in a specific country Therefore, a collection of risks associated with investing in a foreign country is called as country risk Includes political risk, exchange rate risk, economic crisis, transfer risk

Continued--Country risk analysis examines the performance of economy, behavior of the government, and the factors which determine the business environment

Sources of Country Risk

Major types or sources of country risk are political sources, socio-cultural sources and the external sources

Economic sources
GDP per head Changes in industrial licensing policy Variations in price control Taxation and subsidy change Changes in competitive environment Inflationary pressure Changes in income and wealth distribution Growth of unemployment and poverty

Social and Cultural sources

Changes in family patterns Changes in quality and level of education Changing religious and ethical values Changes in life style and living conditions Economic nationalism

External sources
Changes in balance of payments Conditions on repatriation of profits Growth rate and variability of exports and imports Changing volume, pattern and direction of foreign investment Trade disputes b/w countries

Impact of country risk factors

Monetary policy swings Monetary policy is the process by which the central bank controls the supply of money, availability of money and rate of interest.

Expansionary Monetary Policy

Increases the total supply of money in the economy Used to combat unemployment in a recession by lowering interest rates Low rate of interest encourages consumer and investment takes place

Contractionary Policy
Decreases the total money supply Involves raising interest rates in order to deal with inflation Demand for consumer durables may decrease as these goods are heavily based on consumer credit

Industries of high national priority

To reduce the adverse impact of monetary policy changes on selected industries, central bank keeps a margin

Fiscal Policy Variations

Is a measure which deals directly with those matters which immediately influence the consumption and investment expenditure and hence, the income, output and employment in the economy In order to meet the deficit of budget government imposes new taxes, take loans, reduce expenditure or issue the fresh currency

Continued--Every business is impacted by the different means of fiscal policy Government itself is a big buyer and investor, reduced expenditure means slowdown in government demand and slower growth of public infrastructure Rise in commodity taxes has a multiplier effect If government starts borrowing it affects growth of private investment

Exchange control
These controls greatly affect Domestic firms with international business transactions Foreign operations of multinational companies This step is initiated if Dwindling foreign exchange reserves Persistent balance of payments deficits Mounting burden of external debt Difficulties of external debt servicing

Exchange control measures

Multiple exchanges rates Ex. Import of luxury goods may be applied high exchange rate Critically industry input or a consumer good of basic necessity may be applied a low exchange rate High exchange rate may be used to attract foreign investment

Import controls
These controls are applied when the trade and balance of payments positions are adverse and foreign exchange reserves decline Takes place through higher import duties and non tariff measures Firms, both with and without international business operations, are affected by import controls

Trade related investment measures TRIMS

Affect multinational companies and their affiliates Two measures 1. LCRs Local content requirements 2. DBRs Dividend balancing requirements

Price Controls
Price controls are generally applied by the governments on products of mass consumption and substantial public interest like sugar, cement, petroleum etc. Price controls are often complimented by subsidies and distribution of controls

Political Risk Analysis

The risk that an investments could suffer as a result of political changes or instability in a country The philosophy of the ruling government plays a dominant role in determining the current political environment MNCs have to deal with domestic political and foreign political risks

Types of political risk

A firm could be exposed to more than one type of risk at a time Franklin Root (1982) has given the following classification of political risk

General instability risk

This risk originates from the uncertainty about the future viability of the host countrys system The political system may change with a change in government Problem of political instability is more in poor countries This problem is further worsen in countries which are heavily dependent on economic, military and political support from outside

Ownership Risk
It results from the probability that the government might take action which may lead to erosion in ownership There could be the risk of confiscation, expropriation, domestication, nationalization

Operation risk
The government may restrict the operations of the firm in production, finance, human resource management and international business

Transfer Risk
This risk applies to MNCs having affiliates in foreign countries or to the domestic firms having international business operations or subsidiaries in the foreign countries The risk arises from the possible actions of a government which affect remittances or transfer of profits, funds or assets.