Political Risk Definition Examples Top 2 Types Of Political Risk

Political Risk Definition

Political risks can also be termed geopolitical risks that arise due to conflict between two countries. There can be hindrances across the businesses and finally slash the confidence level of the investors.

Types of Political Risks

Political uncertainty arises from the marketplace of the country. Several businesses surround the economy’s marketplace.

Change in government leads to a change in regulations and changes in business scenarios. For example, any change in the corporate taxCorporate TaxCorporate tax is a tax levied by the government on the profits earned by a company at a fixed rate each year and is calculated in accordance with specific tax regulations.read more rate by the ruling government can change corporate profitsCorporate ProfitsCorporate profit, or ‘profit after tax, is the net income received from the business after deducting direct expenses, indirect expenses and all the applicable taxes from the total revenue generated by the company during the year.read more. Certain legal aspects also may challenge the way of doing business, lower profitability, and enhance risks for the investors.

This risk may arise at any level, such as the national, federal, state, etc. Thus, based on the scenarios, political risks can be divided into two types such as macro risks and micro risks.

The macro risk is related to the multinational companies which have businesses in the country and the adverse effects faced by those companies.Micro risks arise from internal conflicts such as corruption, poverty, cynical manipulations, etc.

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Political Risk (wallstreetmojo.com)

How to Identify?

There are no concrete measures where one could identify such risks.

To be specific, one has to be very keen on the existing political scenario of the country and look for a change in the qualitative aspects of the economy.The changes need to be followed, and the simultaneous impact on the businesses.The change in economic scenario depends upon the country’s regulations, while the stance the existing government takes is hard to predict. Specific regulations, like enhancing individual or corporate tax, might lead to inflation or stagflation. Thus, to understand the political risk, one has to apply qualitative techniques.Certain risks related to the macro-level may arise during the civil war between two countries, resulting in those countries closing down borders. Thus, a war situation can affect business scenarios and investments.As per the micro scenarios are concerned, strict regulations, along with changes in the legal systems, might change the profitability of the companies. At the same time, incentives offered to the weak sectors may result in boosting the particular industry. The above action might create competition among investors.

Examples of Political Risks

Example #1

Since Donald Trump came into power in the U.S. in 2015, there have been several changes in trading policies. There has been the imposition of import duties primarily on Chinese goods, which caused a trade warTrade WarA trade war occurs when one country raises its tariff on imports, and the other country responds by raising its own tariff to restrict imports.read more kind of situation, causing a business slowdown for the Chinese companies, further adding pressure to the Chinese investors. The Trump government also imposed strict regulations on the USFDA, the governing body of the pharmaceutical sector. Thus, this kind of change in the scenario results in macro risks for the investors.

Example #2

The entry of immigrants from Asian countries to several parts of Europe is causing an imbalance in the socio-economic structure of the continent. Thus, there may be a rise in the unemployment of local labor due to the availability of cheap labor from other countries. Therefore, the above situation might be positive from the business point of view while it might cause trouble for the local citizens of the country.

How to Manage Political Risk?

One of the primary solutions to deal with political risk is to take political-risk insurance, which could help compensate for the business loss if it happens during any political dilemma.

Another school of thought suggests that one should ensure the key personnel of businesses, too, along with the business itself.The business should have a clause that should be flexible enough to combat the upcoming political risks.There should be plan B ready for the business, which could compensate the investor’s pocket if the primary plan fails.The company has to manage the cash cycle or rather the working capital cycle very carefully because, in case of any trouble to the business, the Management has to drag the business out of the turmoil situation.Thus, a business is suggested to hold cash for better business prospects.

Measurement of Political Risk

The changes witnessed by the business due to change in the political scenario depicts the actual terms of growth in real terms. Every business management has budget figures and estimates of its cash flow scenario.

Thus, the amount of deviation the business experienced should be recorded as the change in profitability due to aforesaid political risks. One can measure such risk by comparing the actual with the forecasted amount.

Political Risk Insurance

Several multinational companies offer political risk insuranceRisk InsuranceRisk insurance refers to the risk or likelihood of something harmful or unexpected happening, such as the loss or damage of a person’s valuable assets, or the injury or death of a person, which the insurers assess and uses to calculate the premium that the policyholder must pay.read more, depending upon the current political situation of the country. The risks include poverty, terrorism, drastic economic change, etc. The premium of the insurance depends upon the present scenario of the nation, followed by the socio-economic method of the country.

However, in many cases, the company does not guarantee the compensation described above in the loss. In these cases, the terms and conditions needed to match.

Conclusion

In many cases, multinational companiesMultinational CompaniesA multinational company (MNC) is defined as a business entity that operates in its country of origin and also has a branch abroad. The headquarter usually remains in one country, controlling and coordinating all the international branches. read more tend to avoid any political nuisance. In several instances, the business houses get unique benefits from the government of the country. The reason is that the existing government wants to motivate corporations to improve the country’s situation by creating jobs for the youth and eradicating poverty and joblessness.