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How to Assess Political Risk? Different Models and Techniques The Importance of Theory ► ► ► The number and nature of variables, their combinations, and the weights assigned to them by the model builders are the result of a theory held by model builders. Every analysis and assessment that is derived from those variables are therefore dependent on an underlying theory about the causes of politically sourced losses. Theories lead to variation because of different views of “nature of government” variable, important since the 1960s. Also, definition of “stability” less clear over the years, as it has become obvious that the impact of stability is very context dependent. Does instability of an authoritarian government have the same impact as instability of a democratic government? The PRS Group, Inc. <www.prsgroup.com> ►Two analyses: The International Country Risk Guide (ICRG) model for forecasting financial, economic, and political risk, created in 1980. Focuses on three subcategories of risk: political, financial, and economic. Separate index is created for each of the subcategories. The Political Risk Services (PRS) provides a series of risk ratings in Country Reports, each of about 70 pages. Underlying these risk ratings is the Prince Model. report provides the current level and likely change of risk indicators for 18-month and 5-year time spans. ► 18-month (12 indicators): political turmoil; equity restrictions; operations restrictions; taxation discrimination; repatriation restrictions; exchange controls; tariff barriers; other import barriers; payment delays; fiscal and monetary expansion; labor policies; foreign debt. ► 5-year (4 indicators): investment restrictions; trade restrictions; domestic economic problems; international economic problems. ► Each PRS: International Country Risk Guides International Country Risk Guide (ICRG) variables and their weighting in the index: ► ► ► Political: government stability (12); socioeconomic conditions (12); investment profile (12); internal conflict (12); external conflict (12); corruption (6); military in politics (6); religious tensions (6); law and order (6); ethnic tensions (6); democratic accountability (6); bureaucracy quality (4). Financial: foreign debt as a percentage of GDP (10); foreign debt service as a percentage of XGS (Exports of Goods and Services) (10); current account as a percentage of XGS (15); net liquidity as months of import cover (5); exchange rate stability (10); Economic: GDP per head of population (5); real annual GDP growth (10); annual inflation rate (10); budget balance as a percentage of GDP (10); current account balance as a percentage of GDP (15). Examples of Factors Used to Generate Estimates ► Government policies related to: Limitations on equity (i.e. foreign ownership) Restrictions on and interference with corporate operations Discriminatory taxation or tariffs Non-tariff barrier discrimination Restrictions on profit repatriation Currency exchange restrictions or controls Wage fluctuations Fiscal and monetary policies Magnitude of foreign debt (Developed by William Coplin and Michael O’Leary) An Example: Changing Investment Regulations in the Indian Computer Industry The Prince Model Coplin and O’Leary’s model for using expert predictions ► ► ► ► Analyses are generated by a team of three to seven country specialists, hired as consultants, for each country. The team members each provide independent estimates that are combined into the forecasts in the reports. The network includes more than 250 area specialists spread throughout the US and several other countries. Specialists with academic (60%), business (5%), government (15%), and general consulting (20%) background. Most important selection criterion: demonstrated ability to analyze the politics of the country (publications, reputations in the field, professional background, and graduate training). Tested by having them complete an analysis of an existing report. Step one: Clearly State The Risk ► The change that will create a business loss must be explicitly defined ► The immediate process by which the loss will occur should be explicitly defined Example: Foreign investment will be barred from the Indian computer hardware industry ► Resulting Risk Statement: The Government of India will change its investment laws to bar foreign investment in the computer hardware industry. Example: The Government of India will change its investment laws Step two: Identify all actors who affect the outcome (current and potential): All political parties Local firms in the computer industry Foreign firms in the computer industry Computer industry customers Computer industry suppliers Foreign governments that care about the computer industry Workers who will be affected by regulatory change Public interest groups concerned with computerization Public interest groups concerned with nationalism Other foreign investors in India Government bureaucrats who affect computer industry Next Steps: Determining Likelihood 3: Determine power for each actor (rating is 0-3, where zero means no power to affect the outcome; three means can single handedly affect the outcome). ► Step 4: Determine position (rating is from –3 +3; negative three means very strongly opposed; positive three means very strongly in favor). ► Step 5: Determine salience or conscious importance (rating is 0-3, where zero means they don’t really care about the outcome; three means that their life turns on this issue). ► Step Step Six: The Impact of Alliances ► ► ► ► Look across the actors, to see if any of them are willing to make alliances that might shift their power, position or salience ratings. Possible alliances may be based on common positions on this topic or on any historical links between the actors. Possible alliances on this topic may also arise because of common plans for future action (e.g. political parties that hope to create coalition government) If an alliance is likely and will shift ratings, adjust your estimates. (typically estimate risk with and without alliances and compare results) To Generate a Final Estimate ► ► ► ► ► Multiply each actor’s power, position and salience ratings Total those products across all actors Divide by the number of actors. The resulting number will vary between –27 and +27. The higher the number, the more likely the event is to occur. If the number is strongly negative, the opposite event may be likely, but since the analysis isn’t necessarily symmetric you really need to do it again with the risk stated in the opposite way to be confident with that conclusion. Why do a PRINCE Analysis? of the PRINCE analysis is based on educated estimates; so, the result is not perfect, but the exercise… ► Forces you to be explicit about your political risk assumptions. ► Provides insight into where you need to intervene in the political process if you want to change the environment. ► Much The Economist Intelligence Unit (EIU) Model ► ► ► ► country risk model containing political, social, and economic/financial variables with a total rating value of 100 points. The variables represented “political risk” defined in terms of outcome losses covered by political risk insurance. A score of zero meant no risk, the max score meant max (prohibitive) risk. Variables (weight): bad neighbors (3), authoritarianism (7), staleness (5), illegitimacy (9), generals in power (6), war/armed insurrection (20), urbanization pace (3), Islamic fundamentalism (4), corruption (6), ethnic tension (4). Factors of the Composite EIU Risk Rating ► Political risk (22% of the composite) ► Economic policy risk (28%) (a) Political stability (war, social unrest, orderly political transfer, politically motivated violence; and international disputes) (b) Political effectiveness (change in government orientation; institutional effectiveness; bureaucracy; transparency/fairness; corruption; and crime). Determined with 27 variables in five categories: monetary policy; fiscal policy; exchange rate policy; trade policy; and regulatory environment. Incorporates global environment, growth, current account, debt, and financial structure groupings with 28 variables. Covers 10 variables of currency conditions ► Economic structure risk (27%) ► Liquidity risk (23%) The BERI Model ► ► Business Environment Risk Intelligence (BERI) is a country risk model based on a set of quantitative indices. Profit Opportunity Recommendation (POR) is a macro risk measure; an average of 3 ratings, each on a 100-point scale. Represents all aspects of country risk: Political Risk Index (PRI) is composed of ratings on 10 political and social variables. Operations Risk Index (ORI) comprises 15 political, economic, financial, and structural variables. R Factor (Remittance and Repatriation), a weighted index covering the country’s legal framework, foreign exchange, hard currency reserves, and foreign debt. ► Risk is calculated for the present, as well as oneyear and five-year frames.
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