Political Risk

Definition

Political Risk is the possibility that the Political and Legal Environment in which a firm operates, expressed as the set of governmental or other civic body policies, rules and preferences may develop in directions that are adverse to the firm's business operations. In extreme manifestations political risk may include revolution, war or other significant change in the policy stance of the sovereign entity

Political Risk Manifestations

A classification of political risk phenomena (from the perspective of an internationally operating business) has been given in

• Political Uncertainties:
  • War
  • Revolution
  • Coup d'tat
  • Democratic changes in government
  • Other political turmoil
• Government Policy Uncertainties
  • Fiscal and monetary reforms
  • Price controls
  • Trade restrictions
  • Nationalization
  • Government regulation
  • Barriers to earnings repatriation
  • Inadequate provision of public services
• Macroeconomic uncertainties
  • Inflation
  • Changes in relative prices
  • Foreign exchange rates
  • Interest rates
  • Terms of trade
• Social uncertainties
  • Changing social concerns
  • Social unrest
  • Riots
  • Demonstrations
  • Small-scale terrorist movements
• Natural Uncertainties
  • Variations in rainfall
  • Hurricanes
  • Earthquakes
  • Other natural disasters

Nature of Political Risk

Political risk can be linked to changing societal and/or governmental attitudes toward business practices, for example their environmental, ethical or social profile and impact (see Sustainable Finance), which in turn may lead to legislation or other measures that may invalidate existing business plans and operations.

Political Risk is experienced differently by entities within a sovereign region and those outside the region but with interests / activities there (in the context of)

Political Risk can also be segmented into Micro Political Risk (affecting specific entities) and Macro Political Risk (affecting all entities in a specific jurisdiction)

Political risk factors can be according to whether they are internal or external, the former being reflections of the country's political structure, the latter being linked to its relations with other countries (also denoted Geopolitical Risk). In the modern global economy there is significant dependency between the internal and external domain and geography is by far no the sole determinant of political and economic relations between countries.

Political risk includes Regulatory Risk, that is, the risk that applicable regulatory frameworks may be amended in directions that negatively affect business plans and franchises.

While overlapping with, political risk has elements that are quite distinct from Sovereign Risk and Country Risk. These risk types are conventionally linked with scenarios in which a Sovereign State is in financial and economic difficulties. Hence while an unwillingness to repay sovereign obligations is by definition a political decision at the sovereign level it is but a specific policy decision among a broader possible set.

Identification, Measurement and Mitigation

Political risk is identified and measured through Political Risk Analysis

Political risk can be controlled / managed with risk management tools such as:

• limits for country exposure
• Political Risk Insurance
• Outright sales of exposures

See Also

• Sovereign Risk
• Country Risk
• Transfer Risk
• Wikipedia on Political Risk

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