Political Risk

Define Political Risks. Explain the classification of Political Risks.

The risk that an investment’s returns could suffer as a result of political changes or instability of a country can be defined as political risks.

The key in political risks lies in the stability of a country. It can be broken down as follows:

1. Changes in Policies – In countries where government intervention is common, e.g. China, Vietnam, Myanmar, companies risk adversities when policies changes affect the company’s profitability. Costs of labour may rise when governments intervene through enactment of minimum wages. Government intervention such as adjustments in interest rates, exchange control or changes in tax regulations and rates can adversely affect DFI. China and Vietnam had recently embarked on healthcare reforms. Companies that had invested and applied for new licenses are faced with excessive delays in the application processes. Governments can also increase various taxes that will affect consumption and/ or costs of production. In China, it is usual that policies precede the law; hence the interpretation of the law is uncertain when changes in overall policies change.

2. Blocked Funds – Restrictions on free flow of capital can also affect decisions on DFI. Some jurisdictions impose withholding tax on outward movements of funds. In India, a company may withdraw profits but not capital. During the 1998 financial crisis, Malaysia restricted the flow of capital outwards. Companies that need to do so must go through an approval process with Bank Negara.

3. Protectionism – Governments may choose to protect certain key sectors or industries and hence create policies that benefit local companies and disadvantage foreign companies. The PRC exercise strict controls on the cosmetic industry. Extensive and expensive licensing and approvals are needed to introduce new cosmetic brands in the country. SKII in China displays the products in China but only sells it for pick up...