global business environment faculty: dr. bibek ray chaudhuri session 4 : assessment of business...

Global Business Environment

Faculty:Dr. Bibek Ray Chaudhuri

Session 4 : Assessment of Business Environment & CRA and PRA

Session Date:22.1.2012

EPGDIBVSAT 2011-12

Global Business Environment/ Session: 4

Pre-Work

• Read the article on Macroeconomics and Well-timed Business Strategy by Peter Navarro given as readings for this session

• Read Business Strategy and Political Risk

EPGDIBVSAT 2011-12


Session Plan

• Macroeconomics and Business (…Contd.)

• Economic Environment of Countries

• Country Risk Analysis

• Political Risk Analysis

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Key Considerations while assessing Business Environment

• Countries Classified by Income Groups (2007) Low Income (GNI per capita $935 or lower) Lower Middle Income (GNI per capita $936 to $3,705) Higher Middle Income (GNI per capita $3,706 to $11,455) Higher Income ($11,456 or more)

• Countries Classified by Economic Systems Command Economies Market Economies Mixed Economies

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Key Considerations while assessing Business Environment

• Economic Growth Past trends in GDP Growth Stability of the economy

• Inflation Interest rate Exchange Rate Cost of living General Confidence in a Country’s Economic System

• Surpluses & Deficits BOP External Debt Internal Debt & Privatization

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Making sense of the Information: Country Risk Analysis

• Performance• Strategy Goals: Autonomy, Productivity & Equity Policies: Fiscal, Monetary, Industrial etc.

• Context: are given for a country (constraints & resources)

Political Institutional Ideological Physical International

• Evaluation Diagnosing the causes Evaluating the Future

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Firm Strategy

• Given the CRA the firm should understand how its interests are affected by alternative scenarios

• Self Reading:Case of Japan (for diagnosing the causes)Case of China (for scenario generation)

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Firms performing CRA

• Standard & Poor’s

• Moody’s

• Economist Intelligence Unit

• Political Risk Services

• Business Environmental Risk Intelligence

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Components of CRA

• Country History in order to identify aspects that could interfere in the

country´s future behavior reducing the ability or willingness to payback any external commitment

The structure of the government and its features like political and administrative organization

Social aspects and their key-indicators like HDI, population growth rate, infant mortality rate

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COUNTRY RISK AS A CORPORATE RISK

• Dependency Level: Whether dependent on a narrow range of goods

• State of Finances: How much dependent on external sources of funding

• Whether trading with few countries

• Whether too dependent on imports

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Indicators which are important for Assessment

• Domestic GDP GDP Growth rate GDP per capita Gini Index Unemployment rate Internal Savings/GDP ratio Investment to GDP ratio Gross Domestic Savings/Gross Domestic Fixed

Investment

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Domestic (Continued)

• Fiscal Policy Budget Deficit/GDP ratio Internal Debt/GDP ratio

• Monetary Policy Inflation rate Money Supply Growth Real Rate of Interest rate

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External

• Growth rate of Exports• Variance of Exports• Growth rate of imports• Necessary imports• Export/Import ratio• Trade Balance• Current account/GDP ratio• International Reserves• (International Reserves-Gold)/Imports• External Debt/GDP ratio• Short term debt/Reserves(minus gold)

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External (continued)

External Debt Services/Exports Capital Inflows Exchange currency rate

• Risk Management Practices

• Conjectural Aspects What’s in store for the future? Vision of leaders Projected cash flow on the basis of BOP

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CRA (continued)

• How the nation is seen by the World: mainly in terms of capital inflows

• Ability and Willingness to pay back

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Strengths

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Weaknesses

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CRA (continued)

• Risk levels and Exposure Limit

• Pricing System

• Follow up

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Post Work

• Group activity

choose a country and perform a CRA

the assignment should be submitted as PPTs by March 31st , 2012

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POLITICAL RISK ANALYSIS

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Introduction

• Definition of Political Risk

Possibility of an unexpected politically- motivated event affecting the outcome of an investment

Instability vs. risk

Classified based on• - actor responsible• - nature of effect• - breadth (micro vs. macro)

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Types of Political Risks

CauseCause

ResultResult GovernmentGovernment OthersOthers

Property LossProperty Loss ConfiscationConfiscation DestructionDestruction

Income LossIncome Loss DiscriminationDiscrimination DisruptionDisruption

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Main Types of Political Risks

a) Expropriation “Forced divestment of equity ownership of a foreign direct investor”

(Minor 1994) Peaked in the mid-70s; almost nil now Mostly Africa till 1980, then Latin America Declined since:

-Key sectors already nationalized-Economic need = > privatization-Regulate rather than expropriate

Many hosts have joined MIGA (Multilateral Investment Guarantee Agency)

Some controversy over future:- is free enterprise here to stay, or will there be a backlash when

privatization, etc. fails to provide widespread benefits?

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Main Types of Political Risks (Continued)

b) Terrorism Terrorist acts infrequent, but spectacular– - L. America #1 esp. kidnappings– - U.S. – owned corps. Esp. targets, U.S. public institutions– - China, India, Turley, Israel etc.– -sept 11, Iraq Little research-seems to be primarily groups denied a voice in

legitimate channels Symbolism particularly important (MacDonalds, etc.)c) Selective Intervention Most risks are less dramatic changes in the rules of the game. Some areas of government policy affect foreign-owned companies

more than most domestic ones

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– Restrictions on Cross-Border Transfer of Resources Tariffs, NTBs inhibit sourcing, exporting FX controls limit repatriation Capital controls Labour regs

– Taxation Concerns Restrictions on transfer pricing Unitary taxation policies Withholding taxes Availability of tax holidays and other incentives

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– Investment Restrictions Sectoral restrictions Requirements for JVs, local ownership Transparency of licensing procedures Requirements for disclosure of technology Requirements for forced divestiture

– Operating Restrictions limits on expansion, ownership of land, etc. Discriminatory access to labour, inputs Restrictions on local market access Performance requirements (e.g. employment & export levels, etc.) Unequal access to government procurement

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– Non-Neutrality of the Legal Environment Judges or other arbiters insulated from political pressure International and regional conventions International conventions re compensation Guarantees of national treatment

– Regulations with Differential Effects on Foreigners Some may be much harder for foreign companies to

comply with

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d) “Crossfire” Problems Activities may lead to international or home country sanctions or

consumer boycotts against the country or firms that deal there– - human rights abuses (e.g. imprisonment, torture or murder

of political opponents; use of prison labor; persecution of minority groups; not abiding by election results)

– - conflicts with neighboring countries– - lack of concern for the environment, endangered species,

etc.– - disregard for international agreements (e.g. re nuclear non-

proliferation)– - the misuse of social issues as means of protectionism– What kind of cross-fire problems associated with Iraq wine-makers in

the Bordeaux region faced?

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Techniques of PRA

• Observational Data Techniques : Based on historical data of destabilizing events and level of economic deprivation forecasts are generated

• Expert-Based Techniques: Unstructured/Unsystematic: based on discretion of the analyst with

no explicit procedure Unstructured/Systematic: parameters are specified but degree of

usage and how inference is drawn is not explicit Structured/Unsystematic: Rating of experts are considered but the

basis of these ratings are not available (BERI Index) Structured/Systematic: consistent panel of experts rate on a specific

set of issues for different groups (WPRF)

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Inverted U-Curve and Political Stability

Political Instability

High

Low

Low

Low

High

HighEconomic Development

Living Standard

Expectations

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Political Risk

• Empirical Relationship Most studies examine correlates of expropriation

Minor (1993): no link with stability

Positive correlations (more risk)• - extractive, service and key sectors• - JVs with the host government• - host countries with pervasive governments • (“hands-on”)• - medium-technology• - need for scapegoats• - “obsolescing bargains”

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Empirical Relationship (Continued)

Negative correlations (less risk)

- integrated subsidiaries that depend on rest of network

- low/high tech- lobbying

Makhija (1993): information indicating convergence of MNC actions and government economic objectives

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The Economist Method Political Risk Service (PRS) -- 100

points

33 points economic factors:• falling GDP/per capita• high inflation• capital flight• decline in productivity• raw materials as percentage of exports

50 points politics:• bad neighbours• authoritarianism• staleness• illegitimacy• generals in power• war/armed insurrection

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The Economist MethodPolitical Risk Service (PRS) -- 100 points

17 points society:• urbanization• Race• Religious fundamentalism• corruption• ethnic tension

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Managing Political Risk (counter moves)

Insurance from EDC, etc. JVs with local or foreign partners Local stakeholders Structural dependency Lobbying Planned divestiture with s/t profits Integrate with strategy Security for expatriates General rule: make the costs to the government of an undesirable move to the firm very costly. Provide

“incentives” for appropriate government regulations and policies.

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MNE Evaluation by Countries

• Concern of GovernmentsIndependence: Whether the presence of

MNE will affect sovereignty of the host country

Impact on Domestic firmsHidden Value: Undervaluation of assets,

non-transfer of technology etc.Responsibility: Long-term or short run

commitment

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Cost-Benefit of MNEs

ENOTRF

BenefitCost

/}*

ratio

•F= Local factor payments by MNEs•R*= After tax payments to local capital•T= Taxes collected by the government•O = Opportunity cost of local factors•N = Net External Economies•E = Payments to external factors of production•If this ratio is greater than one then the project is beneficial for the society

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Other Methods

• Present Value of Costs and Benefits

• Shadow price adjustments

• Shifting perceptions over time

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Divergence of Perceived Benefit-Cost Ratio

Economic Benefit

Cost Ratio

Perceived by Host Govt.

Perceived by Multinational Enterprise

Zone of disagreement

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Example of Differing Valuations

Item Sub-Item MNE-Value Govt. Value

Sales 20 18

Material (-)14 (-)11.5

Local Labour 6 0

Imported Raw Material 6 10

Local Raw Material 2 1.5

Overhead (-) 2 (-)4

Interest (-2.3) (-)4.6

Remitted Abroad 2 4

Paid Locally 0.3 0.6

Profit 1.7 (-)2.1

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Post-Work-Session 5

• Group Assignment• Perform a Political Risk Analysis of your chosen

country considering any of the following sectors Oil FMCG Automobiles Steel• Assignment must be submitted by 31st March,

2012 in PPT format

global business environment faculty: dr. bibek ray chaudhuri session 4 : assessment of business...

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