Foundations of Country risks
The competitive global economy requires that governments roll out the red carpet. At risk of becoming embroiled in conflicts or changes in operating environ-
ments that it did not anticipate and cannot control.
Economic Nationalism In Pakistan
In January 2010, the government of Pakistan threatened to cancel the $3 billion Reko Diq copper and gold proj- ect led by Canadian investor Barrick Gold and Chilean mining company Antofagasta in the country’s resource-rich Baluchistan province.
Baluchistan was required to provide 25% of the project funding in order to get a 25% return—a tall order for a province with limited financial resources. Baluchistan decided it wanted 80% of the proceeds.
Having accomplished that, Pakistan jeopardized the 15 years it had spent to get to that stage by playing the nationalism card, at a time when FDI had fallen 57% in Pakistan since July 2009.
Extractive enterprises Are Particularly Vulnerable
Extractive industries (involving prospecting for and extracting natural resources) are generally more vulnerable to adverse action on the part of host governments
• They tend to be large and high profile.
• They employ thousands of people and have significant economic
impact on local communities.
• They are strategically important to host countries.
• They are subject to a wide range of legal regimes and laws, which
frequently change.
• They involve the production of waste products, which makes them
more highly scrutinized for environmental compliance than other forms of investment.
Many recent investors in the sector have taken care to establish strong relationships with tribal leaders and negotiate agreements that give all participants a sense of fair play.
All three of the preceding cases demonstrate how the exercise of political power can be the root cause of country risk in international business. In the case of Pakistan, its desperate political and economic situation prompted the government to take a bold action that it would not otherwise have been prepared to take in order to generate future revenue. In the case of Bolivia, the desire to impress his electoral base and be perceived as a champion of the people led President Morales to seize foreign-owned oil and gas assets. And in the case of PNG, the failure of the government to deliver economic benefits to its people created an environment that made it more difficult for foreign investors to operate successfully.
However, before being able to make the right decisions, risk managers and decision makers must first be able to identify and measure what country risk is. The first distinction that must be made is between firm-specific political risks and country-specific political risks.
Firm-specific political risks are directed at a particular company and are, by nature, discriminatory for instance, the risk that a government will nullify its contract with a given firm or that a terrorist group will target the firm’s physical operations.
By contrast, country-specific political risks are not directed at a firm, but rather are countrywide and may affect firm performance. Examples include a government’s decision to forbid currency transfers or the outbreak of a civil war within the host country.
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Country risk broadly refers to the likelihood that a sovereign state may be unable or unwilling to fulfill its obligations toward one or more lenders.6 It involves an assessment of economic performance in the context of a country’s demand for external financing and judgments about the prospect for changes in financial returns.
• Sovereign risk is the risk that a foreign central bank will alter its foreign-exchange regula completely nullifying the value of foreign-exchange contracts.7 It also refers to the risk of government default on a loan made to it or guaranteed by it.
• Political risk concerns those political and social developments that can have an impact upon the value or repatriation of foreign investment or on the repayment of cross-border lending, which may originate within a host country, the home country, or the international arena.8 This includes arbitrary or discriminatory actions taken by governments, political groups, or individuals that have an adverse impact on trade or investment transactions.tions, thereby significantly reducing or