7 – Political Environment of International Marketing

Introduction

The many political conditions that exist around the world have an impact on international marketing activities. When entering overseas markets, a good manager must be well aware of the situations in which he or she is putting himself and their organisation.

Managers should carefully monitor the political environment from a distance before attempting to enter a new market. Political settings can be highly volatile and change dramatically quickly, so you must devote much effort to understand what to expect from the market.

Ideally, you will want to enter a politically secure and stable market. However, in many cases, rising economies with tremendous business prospects have governments that are far from stable. Before executing any marketing strategy, you must carefully assess the potential for difficulties that could harm your firm against the opportunity presented by the market.

Political risk is the risk of loss that results directly from a government’s activities or changes in a country’s political system. The level of political danger varies according to a country’s history and consistency. In most circumstances, organisations should strive to avoid doing business in countries with a high level of political risk.

If a crisis erupts in a country where you do business, you must be prepared to deal with violence directed at your property and employees. Conflict will almost certainly negatively influence your customer base and sales potential.

7.1 Scope

Most MNCs must deal with complicated political and environmental issues because they must deal with the politics of more than one country. Because of this complexity, multinational corporations must address three political environments: foreign, domestic, and international.

Foreign enterprises and foreign capital investment are sometimes viewed with suspicion and even resentment in developing and least developed countries (LDCs), mainly owing to concerns about possible foreign exploitation of indigenous natural resources. Dependency theory explains why Latin American countries hesitate to accommodate foreign-based multinational corporations (MNCs). According to this idea, Latin America’s continual economic, political, and social developments have forced it to rely on the capitalistic system. In the same way, groups that believe in leftist ideas and swadeshi (indigenous usage thinking) do not want to encourage MNCs to play a big role in the growth of Indian industries. They fear these companies will be able to take too much value from a less developed environment, leaving it underdeveloped and keeping class conflicts and oppressive governments going. Conversely, MNCs should be allowed to operate in highly technological industries where countries lack know-how and in R&D.

Many Americans worry that increased foreign ownership of American assets poses a political and economic threat to national security. Foreign capital inflows increase the stock of domestic capital. This activity raises the country’s standard of living and improves its ability to service its international debt. As a result, the advantages of foreign investment exceed the disadvantages.

In certain circumstances, opposition to imported goods and foreign investments is founded on moral values. For example, several countries’ citizens pressure their corporations not to invest in South Africa because of that country’s apartheid policies. Because of their anti-Muslim policies, Arabian countries have not participated in cooperative ventures in Israel until now.

Whether the politics are foreign, domestic, or international, businesses must remember that the political atmosphere does not remain constant.

For example, in the 1980s, there was a hostile climate in America against China, which has since reversed.

After decades of intense rivalry, both countries became keen on strengthening their political and economic relations to weaken the former Soviet Union’s dominance. Since India and Pakistan’s separation, both countries have fought three wars, and relations are so strained that nuclear power may be used in dire cases. The passage of a bus from Delhi to Lahore and back in which both prime leaders will travel appears to have lowered tensions, and there is a good chance that both nations will have a joint nuclear programme and sign a no-war treaty soon.

Businesses can benefit economically when the connection between the two countries improves or the host government implements a new investment strategy. In the case of India, the country’s economy was heavily regulated and closed, discouraging foreign direct investment. Only in 1991 did a new administration launch the reform programme that has the potential to transform India into one of the world’s most dynamic economies.

Serious problems, on the other hand, can arise when the political situation deteriorates. A favourable investment atmosphere can vanish in an instant.

For example, the United States revoked Chile’s duty-free trade status because the country failed to take “measures to ensure globally recognised worker rights.” Chile has now joined Romania, Nicaragua, and Paraguay in having their membership in the Generalized System of Preferences (GSP) revoked.

The economic sanctions placed by the United States, Japan, and other European countries on India and Pakistan after the nuclear weapons were detonated are once again unreasonable. Before the explosions, both countries, particularly Pakistan, enjoyed excellent economic and military relations with the United States. Under the current sanctions, Pakistan’s economy is at its lowest ebb.

7.2 Governmental Structures

There are two kinds of government systems:

7.2.1 Political Structures

Knowledge of a country’s type of government is required to assess its political environment. Government can be divided into two types: parliamentary (open) and absolutist (closed). In the parliamentary form of government, citizens are meant to be consulted regularly to learn about their ideas and preferences. Policies in this style of administration are thus meant to reflect the desires of the majority of society. Parliamentary governments are found in the majority of industrialised and democratic countries.

Monarchies and dictatorships are examples of absolutist governments. In an absolutist system, the ruling regime dictates government policy without regard for citizens’ needs or opinions. Absolutist countries are generally recently created or in the process of undergoing political upheaval. Absolute monarchies are becoming increasingly rare. The United Kingdom is an excellent model of a constitutional hereditary monarchy. Despite the monarchy, the government is still parliamentary.

Many countries’ political systems do not neatly fit into either group. Parliamentary elections are held in some monarchies and dictatorships, such as Saudi Arabia and North Korea. The former Soviet Union held elections and required voting, but they were not regarded as parliamentary since the ruling party refused to put any alternative on the ballot. Elections were held in countries such as the Philippines under Marcos and Nicaragua under Somoza, but the results were questioned due to the government’s involvement in fraud.

Governments can be classified in various ways at the international political level. However, the best approach to categorise the administration is through political parties. The classification could be based on four sorts of governments:

(i) two-party,

(ii) multiple-party,

(iii) single-party, and

(iv) one-party rule.

In a two-party system, the government is primarily controlled by two parties. The party with the most votes controls the government turn by turn, and the other parties are free to support any of the two parties.

Example: The United States and the United Kingdom are classic examples. Both parties have opposing ideologies that influence government policy when one is elected to establish the government. In the United States, the Republican Party represents the corporate community, whereas the Democratic Party represents the interests of labour and the economically disadvantaged. In the United Kingdom, the Republican Party represents the trade community. At the same time, the Labour Party is frequently regarded as representing both the labour cause and the interests of economically disadvantaged societies.

Many parties are in a multi-party system, but none are strong enough to dominate the government. There have been instances where the larger parties, despite having a slim majority, have been unable to control the government because they require cooperation from other parties. In this circumstance, the government can only be created through a coalition of like-minded parties, each wanting to safeguard its interests. The coalition government is heavily reliant on the cooperation of its coalition partners. There have been times when governments have fallen because one of the coalition government’s parties withdrew its support. A shift in a few votes could be enough to bring down the coalition administration. In such instances, new elections must be held. A typical example of such a government is India, where the ruling Bharatiya Janata Party has more than 23 coalition partners from different states. Countries that use this system include Germany, France, and Israel.

In a one-party system, a country may have some parties operating. Still, one party has such a large majority that there is minimal potential for others to elect representatives to govern the country. India is once again a textbook example of single-party rule following independence and adopting the constitution in 1952. The Indian National Congress dominated the country as the single-largest party until 1982. As a result, a slew of coalition governments could not complete their five-year terms. A single party has ruled Egypt for more than three decades. This sort of government is more stable than coalition governments and is typically found in countries in the early stages of developing a parliamentary system. The drawback is that a single party makes decisions, subjugating some facets of society and annoying the populace. The Institutional Revolutionary Party (IRP) has dominated Mexico since its revolution. Still, economic problems prompted public unhappiness, and as a result, the opposition gathered support for following the changeover of the one-party system.

In a one-party system, the ruling party does not allow for any opposition, leaving the people with no choice. A single-party system, on the other hand, provides for some opposition parties. The former Soviet Union, Cuba, and Libya are all examples of one-party dictatorships. Such a system is prone to devolving towards despotism. A single controlled party may use force or any other necessary measures to prevent the introduction and growth of different parties and maintain its power. China is just another example of a single-party dictatorship.

A country’s economy is dependent on its political stability. South Africa, a developed nation, has struggled with internal and external problems, slowing economic growth. Italy is yet another developed country with a volatile political situation. A failing economy, periodic labour unrest, and internal strife taint its political climate. In comparison, Vietnam is more politically stable than Italy. The stability can be attributed to Vietnam’s highly closed society.

India, the world’s largest democracy, has a solid political infrastructure and institutions withstood numerous crises. The democratic system is so deeply ingrained in India that it is nearly unthinkable that Indians would pick any other system. However, regional, ethnic, linguistic, religious, and economic issues impede India’s political stability. Such problems have been overcome in other democratic countries, such as Australia, but India’s dilemma persists. These regional, ideological, and ethnic issues limit the government’s ability to respond to the demands of any one sector.

Dictatorial systems, monarchies, and oligarchies can give a society enormous stability, but when a ruler dies abruptly, the chance of significant disturbance and revolution is very high.

7.2.2 Economic Structures

Another criterion for classifying governments is their economic systems. Economic systems explain whether a business is privately owned, government-owned, or combines private and government ownership. Three economic systems are the foundation for political classification: communism, socialism, and capitalism.

A socialist government controls and operates large industries, but minor businesses are left to private ownership. According to Communist doctrine, everyone should own and share all resources for the good of society rather than just profit-seeking corporations. In practice, the government controls all productive resources and industries, so the government dictates jobs, production, price, education, and much more. The focus is on human well-being. Profit is not the primary goal of the government, so there is no motivation for workers and managers to enhance productivity.

The former Soviet Union, East European countries, China, Vietnam, and North Korea are all examples of centrally planned economies. These economies have a communist mindset, an active government role in economic planning, a non-market economy, a poor economy, high foreign debt, and rigid and bureaucratic political/financial institutions. The example of North Korea and South Korea, which contrasts these two countries, is fascinating in this context. While North Korea’s economy is contracting, South Korea’s is expanding. South Korea’s GDP of $289 billion surpasses that of North Korea by under $20 billion. North Korea’s exports of $935 million are insignificant compared to South Korea’s exports of $81 billion. It should be mentioned that North Korea has significantly more natural resources than its southern counterpart.

Despite communist countries’ obsession with industrial control, communist administrations are not all alike. Although the former Soviet Union and China share the same underlying ideology, there are significant differences between these two communist behemoths. China has been experimenting with a new sort of communism by letting its citizens work for them while keeping any profit made by unleashing the world’s most significant labour force. In 1985, Time magazine named Chinese leader Xiao Ping its “Man of the Year.” It is important to remember that in China, open markets may exist only with the state’s approval, and government authorities control their operations. Business Week describes China’s economic system as “frontier capitalism.”

Socialism has a lower degree of government control than communism. A socialist government controls and operates large industries, but minor businesses are left to private ownership. Socialism varies in intensity, and not all socialist countries are the same. A socialist nation like Poland had previously tended toward communism due to its strict control over prices and the distribution system. France’s socialist system is much closer to capitalism than communism. Sweden was once a paradigm of what socialism may be, but a medium path between communism and socialism could result in delayed economic growth. Sweden’s economic deterioration is partly attributable to rapid regulatory expansion and the increasing amount of national revenue spent by central and local governments, which increased from 45 percent in the early 1960s to 67 percent in 1986.

Capitalism is a free-market system that allows businesses, competition, and choices for consumers and companies. In a market-oriented system, individuals motivated by private gain can produce goods or services for public consumption under competitive conditions. Supply and demand influence the price of a product. This approach meets societal demands by enabling decentralised decision-making, risk-taking, and innovation. As a result, there is more product variety, quality, efficiency, and cheaper prices.

There are degrees of capitalism compared to the other two economic systems. Compared to the United States, Japan is less capitalistic. Although virtually all Japanese businesses are privately owned, industries are strictly overseen by the government. The MITI and other government agencies in Japan fiercely counsel businesses on what to make, buy, and sell. Japan’s goal is to deploy scarce resources so that the items with the most significant potential for the country are produced as efficiently as possible.

Schindler studied the 200 largest corporations in the United States, the United Kingdom, and Germany from the 1880s to the 1940s and discovered that capitalism took different forms in each nation. In the United States, it was “managerial capitalism,” where managers with little ownership operated businesses and competed hard for markets and products. In the United Kingdom, “personal capitalism” was practised as owners ran their businesses. It was “cooperative capitalism” in Germany, where skilled firms and managers were encouraged to share markets and profit.

There is no such thing as pure communism or pure capitalism, and most governments must find a middle ground between the two extremes. Even countries in the former Soviet Union offer incentives to improve their image. Farmers in China are permitted to sell directly to consumers at local marketplaces. Western European governments promote accessible business while intervening to provide support and subsidies for steel and agricultural exports. The United States is hardly a flawless model of capitalism, either. It has a support price for various dairy and farm products and has occasionally enforced price limits. On July 29, 1991, the International Monetary Fund surveyed selected East European countries, providing an overview of their implemented changes (Table).

	Bulgaria	Czechoslovakia	Hungary	Poland	Romania	Yugoslavia
Price reform	All prices except those freed in Feb. 1991	Prices freed in the sector are believed to be competitive	Domestic pricing has been freed since 1988. More than 92% now free	Most price restrictions ended in 1990. 10% of Prices are now controlled	Most prices are still controlled	75% of the price freed by Dec. 1989
Privatisation	Planning to privatise state firms. No timetable set	Started privatising small businesses. Foreigners can bid only if citizens don’t buy	National Property Agency set up. 130 of 3,000 salable firms were privatized in 1990	8,000 firms to be privatised. Eight sold so far. Foreign shares are limited to 10% without permission	Privatization bill sent to Parliament. Plans to privatise 50% of capital stock of economy over 3 years	Ownership issues are difficult because of the decentralised nature of the worker self-management system
Foreign trade	As of Jan.	As of Feb. 1991,	90% of	No restrictions	All citizens	All public and
	1989, all	exporters of	imports free	on imports.	and	private firms
	firms free to	goods in short	from control	Export	foreigners can	can conduct
	conduct	supply must		restrictions on	now conduct	foreign trade.
	foreign trade.	Have licenses as		15 items	hard currency	87% of imports
	Decree of	must importers		accounting for	trade	free from
	Feb. 1990	of petroleum		1% of total		restriction as of
	liberalised	products and		exports		Feb. 1990.
	importation	munitions				Tariffs low,
	of all goods.					uniform; quota
	300% duty					restrictions on
	imposed on					some imports
	all exports
	except for art
Convertibility	Importation	Liberalised in	Net export	Resident	Started	Convertibility
	and	1991, but local	earnings	convertibility	phased	for commercial
	exportation	currency not	held until	for current	transition to	transactions
	of leva	necessarily	year-end in	transactions.	convertibility	since Dec.
	prohibited	convertible	front	Profit		1989.
	(non		accounts	repatriation		Government
	convertible)		with	limited; use of		suspended
			National	net hard		convertibility
			Bank	currency		into US$ for
				earnings		repatriation at
				controlled		end of 1990
Exchange rate	Since Feb.	Crown fixed	Front is	In Jan. 1990,	In Feb. 1991,	Dinar pegged
policy	3,1991, leva	against US$	fixed against	zloty	dual	to Deutsche
	Has floated.	subject to	a basket of	devalued from	exchange rate	mark subject to
	Rates agreed	periodic	currencies,	Zl 6,000/US$1	system	periodic
	Daily by	adjustment. In	subject to	Zl	introduced. In	adjustments.
	commercial	Dec. 1990,	periodic	9,500/US$1,	Nov. 1990, leu	Rate of Din
	banks and	devalued 17% to	adjustments	bringing	devalued to	7/DM 1 set
	clients	28		official rate in	leu 35/US$1,	Jan. 1990,
	posted by	crowns/US$1.		line with	Devalued on	revised to Din
	National	One rate for all		street rate,	Apr.1, 1991 to	9/DM 1 in
	Bank on	types of		legalised at	leu 60/US$1	1991 for all
	following	Transactions		Same time.		transactions
	day. One rate			Exchange rate
	for all types			set against
	of			US$ for all
	transactions			kinds of
				transactions

 

7.3 Political Risk Assessment

International marketers will have to deal with several political dangers. The hazards posed by the host government to marketers include confiscation, expropriation, nationalisation, domestication, and creeping expropriation. Such actions are more likely to be taken against foreign investments, albeit domestic enterprises are not immune.

For example, in 1945, Charles de Gaulle nationalised France’s three central banks, and more nationalisations happened under the French socialists in 1982.

Confiscation is when the government takes possession of a property without compensation.

For example, once the Chinese communists assumed control in 1949, the Chinese government seized American property. After the country stole the company’s assets without compensation, Occidental Petroleum Company requested that the US examine Venezuela’s GSP eligibility.

Nationalization entails government ownership, and the government runs the enterprise that has been taken over. For example, Myanmar’s foreign trade is nationalised. In general, this action has a broader impact on the industry than on one company. Mexico attempted to manage its debt crisis. President Jose Lopez Portillo nationalised the country’s banking system. Libya’s Col. Gaddafi’s idea of Islamic socialism led him to nationalise all private businesses in 1981. In the 1970s, India nationalised its banking, transportation, and insurance businesses.

Foreign corporations give control and ownership to nationals, either entirely or partially. As a result, private entities are permitted to operate confiscated or expropriated properties. After determining that the state was insufficiently skilled to handle the banking business, the French government devised a plan to sell 36 French banks.

Domestication may occasionally be a voluntary act that occurs without confiscation or nationalisation. The most common reasons for this move are bad economic performance or social pressures. When the situation in South Africa deteriorated and political demands mounted at home, Pepsi sold its South African bottling operations to locals. Coca-Cola indicated that it would hand over ownership to a local company.

The risk of general instability is linked to uncertainty about the future viability of a host country’s political system. The Iranian revolution, which deposed Iran’s Shah, is an example of this risk. Ownership/controlled risk, on the other hand, refers to the chance that the host government will take action (expropriation) to limit an investor’s ownership and control of a subsidiary in that host country.

The risk of operation stems from the possibility that a host government may impose restrictions on the investor’s business operations in all areas, including manufacturing, marketing, and finance. Finally, transfer risk refers to any future actions by a host government that may limit a subsidiary’s capacity to move payments, capital, or earnings out of the host country and back to the parent firm.

The 1970s were a high point for expropriation activity. In 1975, the number of expropriation acts peaked at 83, involving 28 countries, accounting for 14.4 percent of all such acts (574) between 1960 and 1992. According to data from 1980 and 1992, expropriation is improbable.

Political Instability Indicators

When assessing a potential marketing environment, a corporation should identify and evaluate the important indicators of political difficulty. Social dissatisfaction, national attitudes, and host government policies are all factors of political instability.

Social unrest is a social disturbance induced by underlying causes such as economic hardship, internal discord and insurrection, and ideological, religious, racial, and cultural divisions. The conflict has erupted in Lebanon between Christians, Muslims, and other religious groups. Another example of social discontent is the Hindu-Muslim conflict in India. Even if a corporation is not directly involved in local disputes, such conflicts can significantly impact its operations.

Human nature includes both monastery (they want to stand alone) and systems (the desire to stand together), and the two concepts give alternate ways of utilising resources to suit the demands of society. Monopoly promotes rivalry, whereas systems encourage collaboration. “A cooperative society tends to be a closed society,” Alderson explains. Closure is required if the group is to function as a unit.” Despite wanting to modernise its economy, China does not entirely embrace an open economy, which is likely to foster discord among various factions. A cooperative society may have to hinder the spread of new ideas and neutralise an external entity threatening survival. China appears to have learned from the Soviet Union’s mistakes.

A liberated political climate can easily lead to a push for cultural and territorial independence by a long-suppressed national minority group. The group’s tensions, which were unsettled but contained throughout the communist era, are likely to resurface. Three types of conflicts can occur. First, a domestic conflict may evolve into violence limited to the country’s borders. The civil war in Yugoslavia that began in 1991 between Serbs and Croats is a famous illustration of this. Another example is the centuries-old ethnic hostility between Christian Armenia and its neighbouring Muslim Azharbizan, which resulted in 600 Armenian nationalists clashing with Soviet forces during earthquake relief operations in Armenia. Second, an internal conflict may involve interested parties from outside the country.

For example, problems in Yugoslavian Macedonia may necessitate intervention by Bulgaria and Greece.

Finally, the third type of conflict, which can arise from either the first two types of disputes or an international issue, can result in a confrontation between the two countries. Romania and Hungary, which have long-standing grievances against each other, could become involved in this conflict. Though the leading cause is the Kashmir issue, India and Pakistan are also deeply engaged in this type of conflict.

National Attitudes

An assessment of the political climate would be incomplete without examining the attitudes of the host country’s inhabitants and government. The attitude of nationals toward foreign firms and citizens might be hostile. Nationals are frequently concerned about foreigners’ intentions in terms of exploitation and colonialism, and these worries are sometimes linked to concerns about foreign governments’ acts that may be deemed inappropriate. Such sentiments may stem from local socialist or nationalist philosophies, which may be in opposition to government policy in the company’s native country. Governments come and go, but citizens’ enmity endures.

In the 1980s, 12 US corporations decided to depart El Salvador.

Policies of the Government of the Host Country

In contrast to residents’ inherent hate, the government’s stance toward outsiders is frequently transient. The mood can vary with time or with a change in leadership, and it can alter for the better or the worse. The effect of a mood shift can be pretty dramatic, especially in the short run.

Government policy can impact corporate operations both inside and outside. When a policy governs a company’s operations in its native country, the effect is internal. When the policy governs the firm’s actions in another country, the effect is external.

Example: Quebec’s Bill 101 is an internal policy. The bill mandates that all businesses be performed entirely in French and specifies where insurance and trust organisations’ investments will be placed. When this Bill was passed, it resulted in a significant capital flight of approximately $57 billion. One prominent investment firm relocated its $90.2 billion portfolio from Montreal to Ottawa.

Although an external government policy is unimportant to enterprises in a single country, it might generate significant challenges for firms in conflicting countries. For example, a company in one country may be barred from business with unfriendly countries. Due to a border dispute between Chile and Argentina, Argentina has restricted conventional exports to Chile, including petrochemicals, pharmaceuticals, autos, and vehicle parts. The ban hampered the marketing strategies of General Motors, Peugeot, and Renault, all of which supplied Chile with vehicle parts manufactured in Argentina. Similarly, India and Pakistan have curtailed their export-import trade due to the two nations’ long-standing Kashmir boundary dispute.

The employment of hostile rhetoric before an election may be nothing more than a smokescreen, and the ‘bark’ will not always be followed by a ‘bite.’ Companies do not need to take dramatic measures if they can weather the election. Ronald Reagan, a proponent of free trade, shifted to a protectionist stance right before his victory in 1984. Following the election, a free trade policy was reinstated.

Enron Corporation’s experience with India’s $2.8 billion Dhabol project exemplifies this type. Enron and Prime Minister Narasimha Rao’s reformist government rapidly signed memorandums of agreement in 1992 to construct the enormous power complex in Maharashtra. The lack of a domestic partner, the deal’s opacity combined with the company’s efforts to keep the information hidden, the lack of competitive bidding, the assurance of government financing, and a high rate of return (23 percent) all contributed to an unfavourable public opinion. The corporation neglected to consider the feelings of an opposition coalition led by the Bhartiya Janata Party. The party’s state election campaign in 1995 asked for a re-evaluation of the 2015 MWDhabol Project. Enron responded by accelerating development, believing it would be more difficult for a new government to reverse the process. Enron’s plea for the US Energy Department to intervene drew even more significant criticism. In the end, the project was halted before it could be negotiated.

7.4 Political Risk Management and Assessment

An MNC can handle political risk by pursuing either an avoidance or an insurance approach. Avoidance entails avoiding politically unstable countries, and political risk monitoring and analysis can be beneficial in this context. On the other hand, insurance is a mechanism for shifting risk to third parties.

Other ways that MNCs can employ to protect their overseas investments exist. They may wish to reach an agreement with a foreign government regarding their rights and responsibilities. They can increase and sustain bargaining power when their technological, operational, and managerial complexity requirements are beyond the capabilities of the host country.

Furthermore, there are several relevant management strategies. A company may attempt to obtain “cooperation” through long-term contractual arrangements, alliances, interlocking directorates, inter-firm staff flows, and other means. Furthermore, to develop “flexibility,” it may explore product and geographic diversification. Furthermore, operational flexibility can be obtained through flexible input sourcing and global manufacturing.

Previously, a trade minister in the capital could speak for the entire country, but with decentralised decision-making, an MNC must contact numerous republics for information and consent. The table contains some pointers for doing business in Eastern Europe.

Variables	Motivation	Expected sign
Gross National Product (GNP) per capita	Poorer countries may have less flexibility to reduce consumption than more affluent countries. Countries with low GNP per capita may thus be able to solve debt service difficulties by implementing austerity programmes.	+
Propensity to invest	This variable captures a country’s prospects for future growth. The incentive in default is a decreasing function of the propensity to invest since the cost of default (an embargo on future borrowing or a higher cost of future credit) increases with future outputs.	+
Reserves-to-imports ratio	The more enormous reserves are relative to imports, the more reserves are available to service external debt and the lower the probability of default.	+
The current account balance on GNP	This variable is negatively related to the probability of default since the current account deficit broadly equals the new financing required.	+
Export growth rate	Since exports are the main source of foreign exchange earnings for most countries, countries with high export growth rates are likely to service debt.	+
Export variability	Traditionally, the literature has argued that countries with volatile exports are more vulnerable to foreign exchange crises and less creditworthy. In contrast, Eaton and Gersovitz show that the smaller the default risk, the more significant the export fluctuations will be. The underlying rationale is that countries with more volatile exports are more frequently in need of borrowing to smooth consumption across periods of varying income and are, therefore, incited to maintain a good credit record.	?
Net foreign debt to exports	A country with a higher foreign net to exports ratio is more vulnerable to foreign exchange crises and more likely to default.	–
Debt service Difficulties – Dummy variables	When a country is known to have asked some of its creditors for debt relief, other creditors are apprehensive of default, and the credit rating is likely to fall.	–
Political instability indicator	Aliber shows that political instability can reduce a country’s willingness to service debt.	–

 

7.4.1 Insurance, Privatisation: Political, Private, and Government

Privatisation

Privatization is crucial for international and local businesses since it has several competitive ramifications. Overstaffing, poor financial performance, reliance on subsidies, centralised and politicised organisations, and a lack of competition are common characteristics of government-owned or public-sector enterprises worldwide. Privatisation aims to promote competitiveness and efficiency, reduce debt and subsidies, return flight capital, and broaden local equity ownership.

Countries inclined to seek privatisation tend to have the following characteristics: a large budget deficit, a large foreign debt, and a heavy reliance on international institutions such as the World Bank and the International Monetary Fund. Countries pursuing privatisation in Latin America and Asia are those with overburdened state firms and those where the private sector is growing faster than average, making them more prepared to take on activities previously entrusted to state enterprises. However, in Africa, privatisation may have been imposed by external forces even though these governments are not necessarily prepared for the task.

Privatisation has taught governments worldwide several lessons. Chile’s colossal privatisation has a favourable impact on well-being, efficiency, and capital market development, and its divestitures of state-owned firms do not always have a negative distributive and employment effect. Change of ownership was found to be a required but insufficient criterion for effective performance in the case of Poland’s Swarzedz Furniture Co.

Politicians must recognise that privatisation is a political process. Economic improvements are required for a successful programme, and selling certain shares to managers and workers is beneficial. The experiences of Nigeria, Senegal, and Togo have demonstrated that.

(i) A country’s privatisation plan should be tailored to specific conditions.

(ii) highest government level support is required;

(iii) fears of a lack of potential investors in Africa are overblown, and

(iv) transparency in the privatisation process is required.

In the case of India, a centrally planned economy, the bing-bang approach or gradualism has been used to reform its economy. Since 1991, it has been recognised that the bing-bang method did not work. However, progressive liberalisation, opening up its economy to the world market, and foreign direct investments have yielded positive outcomes. As a result, the strategy chosen is determined by the economy’s political situation and economic structure. A stable government has not been since the Congress government took advantage of liberalisation. However, no functional model exists for a functioning market economy with a massive state enterprise sector.

Insurance on three levels: political, private, and government.

Political insurance can be obtained by avoiding and mitigating risks. MNCs can use the risk-shifting method to attain these goals. Chubb and Lloyd’s of London are a limited handful of insurers that have historically offered coverage to pay kidnappers’ ransom demands. Legal and psychiatric fees and compensation for trade secrets and product tampering have been added to the coverage. Some policies may cover the costs of evacuating from a politically unstable country. Executives may be taught how to avoid being kidnapped. Political insurance can be gained from a variety of sources. The public’s trust in their government is the finest source.

Private Insurance: Due to ignorance, many businesses wind up as self-insurers. A better strategy would be to follow Club Med’s lead and transfer political risk to a third party by purchasing political insurance. When President Carter barred US athletes from competing in the 1980 Moscow Olympics in protest of the Soviet Union’s invasion of Afghanistan, NBC’s insurers generously reimbursed the network.

Although property takeover appears to be the most typical cause for acquiring political insurance, the policy should also cover kidnapping, terrorism, and creeping expropriation. Most companies’ coverage of this nature is limited, as revealing such coverage would promote such behaviour.

Government Insurance: Multinational corporations are not required to rely entirely on private insurers. Non-profit, public agencies can provide similar coverage. Overseas Private Investment Corporation (OPIC) and FCIA are the main ones for US corporations. We have United Insurance Company, General Insurance Company, and so on in India. These organisations are business-oriented and aim to assist the government’s private investment.

These organisations offer various services, with political risk insurance being their core focus. It provides three forms of insurance coverage to defend against the risks of

(i) currency inconvertibility,

(ii) expropriation (including creeping expropriation), and

(iii) loss of damage caused by war, revolution, or insurgency.

A typical insurance contract has a term of up to 20 years and a combined yearly premium of 1.5 percent for all three coverages. Private insurers offer three-year policies, so OPIC’s coverage is a plus.

Motorola Inc. is a fantastic example of how OPIC operates. In 1993, Motorola won a proposal to develop, manage, and maintain cellular phone service in Nicaragua. Nicaragua has a deteriorating infrastructure, a deplorable landline telephone system, and a faltering economy. Motorola’s telephone service was one of Nicaragua’s most significant private foreign investments. OPIC contributed $7 million in funding and $8 million in insurance against expropriation and political violence. The help significantly influenced the company’s choice to enter the Nicaraguan market.

7.5 International Organizations and Super-national Organizations

A supranational union is a multi-national organisation in which governments of member states cede negotiated power to an authority. An international organisation has a global membership, scope, or presence. The institutions are as follows:

7.5.1 IMF (International Monetary Fund)

The role of the IMF as a supranational organisation is explored here from the standpoint of political risk analysis. It is worth recalling that the IMF’s position as a supranational organisation has grown in recent years due to its attempts to coordinate the financial world’s reaction to the debt crisis and make its efforts in this regard. The IMF also plays an essential role in making loans for structural reforms in economies experiencing reverse macroeconomic instability and imbalances. There is a growing emphasis on coordinating loan activities between the IMF and other multilateral lending institutions and monitoring the social impact of IMF structural adjustment programmes in developing countries.

7.5.2 The World Bank

The World Bank (together with the IMF) was established during the Bretton Woods Conference in New Hampshire in July 1944, and it became operational on December 27, 1945. The World Bank’s initial goal was to offer financial resources to European countries to reconstruct their war-ravaged economies and later to provide vital external funding to emerging countries at low interest rates. The World Bank and the IMF were established to reinforce the structure and promote the development and efficiency of international financial markets. The World Bank is made up of four significant agencies:

• International Bank for Reconstruction and Development (IBRD – World Bank)
• International Development Association (IDA)
• International Financial Corporation (IFC) (MIGA)

The International Bank for Reconstruction and Development (IBRD) is a non-profit organisation that (IBRD)

The primary goal of the IBRD is to promote social and economic development in developing nations by encouraging higher productivity and resource use so that their population can live a better than fuller life. The World Bank strives to fulfil its goals by providing financial support to developing countries, particularly for specific economically sound infrastructure projects, such as those in power and transportation. The main reason for the emphasis on such projects is that solid infrastructure is required for developing countries to carry out social and economic development programmes. In the 1970s, World Bank loans were also made available to develop borrowing countries’ social services sectors, such as education, water supply and sanitation, housing, etc. Loans were also available to develop indigenous resources like oil and natural gas.

Much of World Bank lending in the early 1980s was policy-based. It attempted to support economic adjustment measures by borrowing countries, particularly those with high external debt. The World Bank also considers using guarantees to assist member country debtors in issuing securities in the governmental financial markets.

World Bank loans are classified into five types.

1. Specific investment loans are 5- to 10-year loans for specific agricultural and rural development projects, urban development, and energy resources.
2. Sector operation loans account for around one-third of World Bank funding. They are intended to fund the growth of specific sectors of a country’s economy, such as oil, energy, or agriculture.
3. Structural adjustments and programme loans are intended to provide the financial assistance required by member nations undergoing extensive institutional and policy reforms to address external sector imbalances.
4. Technical assistance loans are made available to member nations who need to improve their technical competence to plan their development strategies and design and implement specific projects.
5. Emergency rebuilding loans are available to member nations whose economies, particularly infrastructure, have suffered severe damage from natural disasters such as earthquakes or floods.

Association for International Development (IDA)

The IDA was formed in 1960 to provide long-term funds to the Bank’s poorest member countries at low interest rates. The affiliate has no separate organizational structure, and World Bank workers carry out its operations. The World Bank’s President is also the President of IDA. The Association’s primary goal is to offer long-term funding to member countries that cannot afford to borrow under conventional World Bank conditions. IDA funds are intended to support long-term development projects with a protracted gestation period.

As a member country’s economy grows and its per capita income exceeds a certain threshold, it graduates from IDA assistance and becomes eligible for World Bank loans. As of June 30, 1990, IDA had approved $35.82 million in financial aid to member nations. India, Pakistan, Bangladesh, Indonesia, and Egypt are the five recipients of IDA loans. Because India’s economy has improved, it has been removed from IDA and is now eligible for World Bank financing.

International Financial Corporation (IFC)

The International Finance Corporation (IFC) was founded in 1956 to foster the development of private firms in member countries. Although the IFC is mainly run by its personnel, it is overseen by the Bank’s board of executive directors. The President of the World Bank is also the President of the International Finance Corporation.

The IFC invests in equity and lends to commercial firms in developing countries. The IFC cannot accept government loan guarantees because of its mandate. However, the IFC’s principal function is not to provide financial assistance. It acts as a catalyst to encourage private capital flows to developing countries’ private sectors. The IFC is never the sole financier in any transaction, and its participation is usually a small percentage of the overall cash mobilised. In addition, the corporation does not accept management positions or seats on the boards of directors of the organisations to which it lends money. In addition, the IFC advises investee enterprises on financial, technical, and legal matters.

Agency for Multilateral Investment Guarantees (MIGA)

MIGA was founded in 1988 to assist its more than a hundred member countries in creating an appealing investment climate. It aims to promote private investment in developing nations by protecting them from non-commercial (political) risks. MIGA acts as a coinsurer for all other insurers’ reinsurers. It provides four forms of coverage:

(i) money transfer,

(ii) expropriation,

(iii) war and civil disturbances, and

(iv) contract breach.

Premiums are determined by the type of project, the type of coverage, and the project’s specific conditions. The annual premium for each coverage ranges from 0.50 percent to 1.52 percent of the amount insured.

McMoran Copper, a subsidiary of Freeport, wanted to invest $500 million in expanding his copper, gold, and silver mining project in Indonesia. The firm’s US-German-Indonesian owners planned to borrow 75 percent of the capital from commercial banks as “non-recourse finance.” Because the financing necessitates a complicated problem of risks and rewards among the leaders, suppliers, purchasers, and owners, this financing is based on the project’s cash flow. Non-project assets are not committed. MIGA was instrumental in delivering the initial $15 million coverage.