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Managing Political Risk in Emerging Markets

Does your company do business on the ground in emerging markets, or is it selling to government customers in developing economies? If it’s doing either, are you aware of how the political risks of these markets can threaten your bottom line? If you’re not clear about the hazards, or if you recognize them but don’t manage them systematically, you’re not alone. According to recent research, many businesses—both in America and abroad—don’t do nearly enough to reduce their exposure to political risk in emerging markets. These risks include:

  • Import/export restrictions

  • Foreign exchange restrictions

  • Breach of contract by a foreign government

  • Changes in laws and regulations

  • Expropriation

  • Civil disturbance and other forms of political violence

As American firms look for new business abroad, especially in emerging markets, the urgency of managing these risks will steadily increase. Many businesses, in fact, are now confronting these hazards and are deeply concerned about them.

As just one example, a 2018 survey of more than 450 multinationals that operate in emerging markets revealed that political risks are already affecting their bottom lines. One in five of these companies had suffered a loss from civil disturbance during the previous three years, one in four from foreign exchange restrictions and one in three from breach of contract by a foreign government. And the situation is likely to get worse, not better.

Given these developments, it’s a puzzle that so many businesses pay so little attention to political risks. This is even more surprising when you consider that effective political risk management can provide important benefits such as:

  1. A better understanding of how political events could affect your investments.

  2. The ability to seize opportunities in markets that could be very profitable, but involve political risks.

  3. The ability to make better decisions about how to reduce your political risks.

To sum up: By not managing your political risks effectively, you may expose your company to severe losses while losing out on some important advantages. This, obviously, doesn’t make a lot of sense.

Four steps to managing political risk

The key to protecting yourself is to have a clearly defined strategy for managing your political risk, with a formally designated risk manager who’ll watch for these hazards and find ways to deal with them. One of the most common strategies is a four-step process based on identification, measurement, mitigation, and monitoring.

1. Identify your risks

Through your risk manager, you gather pertinent information about the types of political risk your company faces, or is likely to face, in the target country.

Next, you identify the political risks that most threaten these goals. Seizure of assets might be a low-ranked hazard if you’re only exporting to the country from Canada, for example, but potentially a serious one if you bring valuable assets into an emerging market to perform contract work on the ground.

2. Measure your exposure

You rank the risks you’ve identified and measure your exposure to each one. This involves attaching numbers to the risks to reflect their potential financial effects on your company. These measurements will help determine whether the risk level of a market is within your tolerance, thus helping you decide whether to enter it.

3. Mitigate your risks

You take measures to lower the probability of a risk and to reduce its effects if it becomes a reality. How you do this will be determined by the nature of your company.  If you’re making an investment, for example, you could work with local partners whose familiarity with their market can help you avoid problems. To help protect you if trouble hits, you could purchase insurance that covers political risks.

4. Monitor your risks

Once you’ve established how your risk management process will work, you set up routines for reporting, evaluation, and review. There should be formal channels for regularly reporting political risk issues, both upward to senior management and downward to the personnel who manage your on-the-ground operations. These routines should become part of your normal business activity, and your risk manager must make sure that they don’t fall into disuse as time passes.

In this case, you can turn to outside experts. There are numerous private-sector agencies that specialize in providing their clients with detailed information on political risks in world markets, and in helping companies establishing their political risk management systems. Even companies with effective political risk management, however, may find that some markets leave them more exposed than is comfortable. In these cases, insurance can fill the gap.


© De Angelis & Associates 2020. All Rights Reserved.


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