Directions:
In this assignment, you will create a project which includes the following:
- Collect information on a developing country
- Evaluate the main risks affecting FDI in the country
- Summarize the information and provide a recommendation
Instructions
This is a group assignment, up to a maximum number of two members per team. The assignment is due by 5:00pm on Wednesday January 31st.
Prepare a risk analysis of a country of your choice, with the following restrictions:
The country or economy has to be considered a “developing economy” by an international organization such as the UN, the World Bank, or the IMF; and/or The country’s capital markets must be considered “emerging market” by MSCI
You cannot select one of the countries analyzed in the textbook, in the 10th edition (Chapter 16, Exhibits 16.10-Vietnam, and 16.11-Turkey) or in earlier editions. (See page 463 in textbook to see list of countries to choose from)
Format: You will summarize your findings and conclusions following the format of exhibits 16.10 and 16.11 (i.e., a one-page exhibit summarizing the relevant information, followed by two short paragraphs that explain the meaning and implications of the information in the exhibit, see the following example
Actions).
Guidelines:
The risk analysis should be done from the perspective of a multinational company considering investing (i.e., FDI) in the country. Refer to Chapter 16 to understand the types of risks associated with FDI and the appropriate evaluation (pp. 458-465). You may also find it helpful to review the exhibit and discussion associated with sovereign ratings on p. 350.
I recommend you start at the link below to gather essential country information, but then consult other sources to complete your analysis:
Export Finance Australia – Country ProfilesLinks to an external site.
Look at recent Wall Street Journal, Financial Times, or The Economist articles for current events that have put the country in the news and discuss what the current climate is for multinational investment.
Take advantage of existing sources available through the library (Databases, Browse, Subject=Business and Economics)
Use resources from international organizations, such as the World Bank, the IMF, OECD, etc. as well as local resources if possible.
In addition to economic, political, and financial variables following chapter 16, make sure to describe the type of currency regime (pegged, floating), and whether there are currency derivatives available to manage currency risk.
Also, discuss the importance of foreign capital flows for the country (i.e., relate to the Balance of Payments chapter).
It is said that there are four major factors that attract foreign direct investment:
- Stable property rights
- Peaceful industry-labor relations
- Political stability
- Cost advantages in wages, taxes, and infrastructure
Make sure to cite sources as appropriate (this can be done in a separate page if necessary, following MLA style guidelines)
You will submit your work to this Canvas assignment page. Refer to the attached rubric for grading details. This assignment will close at the stated due date and time. Late submissions will not be possible.
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Political Risk and FDI In assessing investment opportunities in a foreign country, it is important for a parent firm to take into consideration the risk arising from the fact that investments are located in a foreign country. A sovereign country
can take various actions that may adversely affect the interests of MNCs. In this section, we are going to discuss
how to measure and manage political risk, which refers to the potential losses to the parent firm resulting from adverse political developments in the host country. Political risks range from the outright expropriation of foreign
assets to unexpected changes in the tax laws that hurt the profitability of foreign projects.
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Page 459
Political risk that firms face can differ in terms of the incidence as well as the manner in which political events
affect them. Depending on the incidence, political risk can be classified into two types:
The communist victory in China in 1949 is an example of macro risk, whereas the predicament of Enron in India,
which we will discuss shortly, is an example of micro risk.
Depending on the manner in which firms are affected, political risk can be classified into three types:
Examples of transfer risk include the unexpected imposition of capital controls, inbound or outbound,
and withholding taxes on dividend and interest payments. Examples for operational risk, on the other
hand, include unexpected changes in environmental policies, sourcing/local content requirements, minimum wage law, and restriction on access to local credit facilities. Lastly, examples of control risk include restrictions imposed
on the maximum ownership share by foreigners, mandatory transfer of ownership to local firms over a certain
period of time (fade-out requirements), and the nationalization of local operations of MNCs.
1. Macro risk, where all foreign operations are affected by adverse political developments in the host country.
2. Micro risk, where only selected areas of foreign business operations or particular foreign firms are affected.
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1. Transfer risk, which arises from uncertainty about cross-border flows of capital, payments, know-how, and the like.
2. Operational risk, which is associated with uncertainty about the host country’s policies affecting the local
operations of MNCs.
3. Control risk, which arises from uncertainty about the host country’s policy regarding ownership and control of
local operations.
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Recent history is replete with examples of political risk. As Mao Ze-dong took power in China in 1949, his
communist government nationalized foreign assets with little compensation. The same happened again when Castro took over Cuba in 1960. Even in a country controlled by a noncommunist government, strong nationalist
sentiments can lead to the expropriation of foreign assets. For example, when Gamal Nasser seized power in Egypt
in the early 1950s, he nationalized the Suez Canal, which was controlled by British and French interests. Politically, this move was immensely popular throughout the Arab world.
Expropriations of foreign-owned assets peaked again in the 1970s, with as many as 30 countries involved in
expropriations each year. Since then, however, expropriations had dwindled to practically nothing. This change
reflected the popularity of privatization, which, in turn, is attributable to widespread failures of state-run
enterprises and mounting government debts around the world. As Exhibit 16.9 shows, expropriations picked up
the pace again in the mid-2000s. Hajzler and Rosborough (2016) reported that a total of 162 expropriation acts
occurred across 44 countries during 1990–2014, with 44 percent of these taking place in resource-based industries such as mining. Venezuela alone reportedly accounted for almost 25 percent of the expropriation acts during this
period. Examples include the 2007 nationalization of ConocoPhillips’ oil production ventures in Venezuela.
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EXHIBIT 16.9 Expropriation Acts by Sector, 1990–2014
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Another well-known episode of political risk involved Enron. In 1992, the Enron Development Corporation, a
subsidiary of the Houston-based energy company, signed a contract to build the largest-ever power plant in India,
requiring a total investment of $2.8 billion. Severe power shortages have been one of the bottlenecks hindering India’s economic growth. After Enron had spent nearly $300 million, the project was canceled by Hindu nationalist
politicians in the Maharashtra state where the plant was to be built. Subsequently, Maharashtra invited Enron to
renegotiate its contract. If Enron had agreed to renegotiate, it may have had to accept a lower profitability for the project. As can be seen from the Enron fiasco, the lack of an effective means of enforcing contracts in a foreign
country is clearly a major source of political risk associated with FDI.
Political risk is not easy to measure. When Enron signed the contract to build a power plant in India, it
perhaps could not have anticipated the victory of the Hindu nationalist party. Many businesses
domiciled in Hong Kong were nervous about the intentions of Beijing in the post-1997 era. Difficult as it may be, MNCs still have to measure political risk for foreign projects under consideration. Experts of political risk analysis
evaluate, often subjectively, a set of key factors such as:
Source: Hajzler, Christopher, and Jonathan Rosborough. “Government Corruption and Foreign Direct Investment Under the Threat of Expropriation.” Bank
of Canada Staff Working Paper 2016-13, 2016
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The host country’s political and government system: Whether the host country has a political and administrative
infrastructure that allows for effective and streamlined policy decisions has important implications for political risk. If a country has too many political parties and frequent changes in government (like Italy, for example),
government policies may become inconsistent and discontinuous, creating political risk.
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Track records of political parties and their relative strength: Examination of the ideological orientations and
historical track records of political parties would reveal a great deal about how they would run the economy. If a party has a strong nationalistic ideology and/or socialist beliefs, it may implement policies that are detrimental
to foreign interests. On the other hand, a party that subscribes to a liberal and market-oriented ideology is not
very likely to take actions to damage the interests of foreign concerns. If the former party is more popular than the latter party and thus more likely to win the next general election, MNCs will bear more political risk.
Integration into the world system: If a country is politically and economically isolated and segmented from the rest of the world, it would be less willing to observe the rules of the game. North Korea, Iraq, Libya, and Cuba are
examples. If a country is a member of major international organizations, such as the EU, OECD, and WTO, it is
more likely to abide by the rules of the game, reducing political risk. In the same vein, as China joins the World Trade Organization (WTO), MNCs operating in China may face less political risk.
The host country’s ethnic and religious stability: As can be seen from the civil war in Bosnia, domestic peace can
be shattered by ethnic and religious conflicts, causing political risk for foreign business. Additional examples are provided by Nigeria, Rwanda, Northern Ireland, Turkey, Israel, Sri Lanka, and Quebec.
Regional security: Real and potential aggression from a neighboring country is obviously a major source of political risk. Kuwait is an example. Countries like South Korea and Taiwan may potentially face the same risk
depending on the future course of political developments in East Asia. Israel and its Arab neighbors still face
this risk as well.
Key economic indicators: Often political events are triggered by economic situations. Political risk thus is not
entirely independent of economic risk. For example, persistent trade deficits may induce a host country’s government to delay or stop interest payments to foreign lenders, erect trade barriers, or suspend the
convertibility of the local currency, causing major difficulties for MNCs. Severe inequality in income distribution
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Page 461MNCs may use in-house experts to do the analysis. But often, MNCs use outside experts who provide
professional assessments of political risks in different countries. For example, Morgan Stanley offers an in-depth analysis of country/political risks using a variety of data sources, including government and private sector
publications, statistics provided by international organizations, newspaper articles, and on-site due diligence in
countries with government officials and the private sector. Similarly, government agencies provide political risk
analysis that can be useful to companies and investors. Exhibits 16.10 and 16.11 provide such analyses
conducted by the Australian government for two countries: Vietnam and Turkey. The exhibits provide an example
of how political risk analysis may be conducted. Credendo, a Belgian export credit agency, publishes country risk ratings, including ratings of expropriation and government action risk.
(e.g., in many Latin American countries) and deteriorating living standards (as in Russia after the collapse of
the Soviet Union) can cause major political disturbances. Argentina’s protracted economic recession and the eventual collapse of the peso–dollar parity led to the freezing of bank deposits, street riots, and three changes of
the country’s presidency in as many months in 2002.
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EXHIBIT 16.10 Political Risk Analysis: Vietnam
Sovereign Rating: Moody’s: B1, Outlook: Stable; S&P: BB−, Outlook: Stable
Political Strengths
Political Weaknesses
Political & Governance Indicators
Economic Strengths
Political stability with Communist Party in government since end of the country’s civil war in 1975
Widespread support for the CPV (Vietnam Communist Party) reflects its success in raising living standards and creating and
maintaining security
Inconsistent and evolving regulations
Unreliable legal system and corruption
A lack of financial transparency, insufficient protection for minority owners, and poor corporate governance
World Bank Ranking—Ease of doing business
Freedom House—Political rights and civil liberties
Transparency International Ranking—Corruption Perception Index
OECD country risk rating (Scale: 0–7, 0 is least risk, 7 is highest risk)
68th/190
Not Free
117th/180
5
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Sovereign Rating: Moody’s: B1, Outlook: Stable; S&P: BB−, Outlook: Stable
Economic Weaknesses
Economic Indicators
Transformation to market oriented economy since late 1980s
High GDP growth facilitated by foreign investment
Well educated and cheap labor force
Sizable natural resources and advantageous location
Membership in TPP trade agreement
Large fiscal deficits and weak banking system
Plethora of state-owned enterprises and less diversification
Industry and credit policies favor state-owned enterprises
Lack of infrastructure
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Sovereign Rating: Moody’s: B1, Outlook: Stable; S&P: BB−, Outlook: Stable
Source: www.efic.gov.au, World Bank, and IMF, 2018 figures.
GDP ($US bn)
GDP per capita ($US)
Real GDP growth (15-year average, %)
Fiscal balance (% of GDP)
Public debt (% of GDP)
Foreign direct investment (% of GDP)
Current account (% of GDP)
External debt (% of GDP)
Foreign reserves (% of GDP)
241
2,482
6.8
−4.7
57.8
7.3
2.2
49.7
26.3
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EXHIBIT 16.11 Political Risk Analysis: Turkey
Sovereign Rating: Moody’s: Ba3, Outlook: Negative; S&P: B+, Outlook: Negative
Political Strengths
Political Weaknesses
Political & Governance Indicators
Economic Strengths
Transition to democracy at the end of 1970s
Significant liberalization and stabilization by a drive to join European Union
Rapid decline in poverty incidence
Instability fuelled by conflict between the army and the civilian government
Strained relations between religious conservatives and secular modernists
Proximity to war-torn Syria
World Bank Ranking—Ease of doing business
Freedom House—Political rights and civil liberties
Transparency International Ranking—Corruption Perception Index
OECD country risk rating (Scale: 0–7, 0 is least risk, 7 is highest risk)
43rd/190
Partly Free
78 /180th
5
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Sovereign Rating: Moody’s: Ba3, Outlook: Negative; S&P: B+, Outlook: Negative
Economic Weaknesses
Economic Indicators
Key dimensions of economic performance on par with central and eastern European countries
Was able to weather the recent global economic crisis
Debt is highly sought after by foreign investors
Healthy growth forecast
Mounting macroeconomic imbalances and major reliance on foreign financing
Widening current account deficit, surging credit growth and building inflation pressures
High business cycle and currency risk
Lira is a volatile emerging market currency
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The collapse of the Soviet Union in the late 1980s forced Vietnam to transform from central planning and autarky to market orientation and international re-integration. Overall, this has been very successful. GDP growth has
averaged nearly 8 percent a year, with foreign investment a key driver. Per capita income has risen from US$100 in
1990 to nearly US$2,482 in 2018. Vietnam has a number of attractions for investors and exporters: a large, young, and rapidly growing population; a labor force that is relatively well educated and cheap; sizable natural resources;
an advantageous location; and a high level of political and social stability. Vigorous policy stimulus and spending
helped Vietnam avoid the worst of the global financial crisis. But the authorities are now facing a fiscal deficit topping 6 percent of GDP, accelerating inflation, and a weakening banking system. On the other hand, Vietnam is
Sovereign Rating: Moody’s: Ba3, Outlook: Negative; S&P: B+, Outlook: Negative
Source: www.efic.gov.au, World Bank, and IMF, 2018 figures.
GDP ($US bn)
GDP per capita ($US)
Real GDP growth (15-year average, %)
Fiscal balance (% of GDP)
Public debt (% of GDP)
Foreign direct investment (% of GDP)
Current account (% of GDP)
External debt (% of GDP)
Foreign reserves (% of GDP)
769
9,445
2.6
−1.9
30.4
1.7
−5.7
56.7
12.0
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benefiting from the growing integration in global value chains. Standard & Poor views the country’s external
foreign currency debt as speculative grade with a BB-rating and a stable outlook, and Moody’s rating for the same is B1. Public debt is equivalent to 58 percent of GDP and contingent liabilities—in the banking sector and state-
owned enterprises—are large.
The Vietnamese Communist Party (CPV) has been in government since the end of the country’s civil war in 1975.
The party has a firm grip on power, which ensures a high degree of political stability. Although the party’s communist ideology has become less important over time, it led to a plethora of state-owned enterprises, which
span most sectors and account for nearly 40 percent of GDP. Foreign investors face a number of challenges,
including: inconsistent and evolving regulations, an unreliable legal system, a weak banking system, corruption, and industry and credit policies that favor state-owned enterprises.
transparency.org
Provides data about the Corruption Perceptions Index.
We next introduce the Corruption Perceptions Index (CPI) compiled annually by Transparency
International, a global civil organization. The CPI provides a composite measure of perceived corruption in the public sector based on surveys and assessments from many institutions, such as the World Bank, Economist
Intelligence Unit, and World Economic Forum. The level of perceived corruption in a particular country may serve
as a useful gauge for the uncertainty about the rule of law and political risk, broadly defined, that MNCs and
international investors may face in the country. Exhibit 16.12 presents the CPI for 2020. The index ranges from
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0 (highly corrupt) to 100 (highly transparent). According to the CPI 2020 that surveyed 180 countries, Denmark
and New Zealand are the most transparent countries in the world, followed by Finland, Singapore, Sweden, Switzerland, Norway, the Netherlands, Germany, and Luxembourg. Australia, Canada, Hong Kong, and the United
Kingdom tie and rank 11th. The United States ranks 25th, behind Japan (19th) and France (23rd). Taiwan ranks
28th, Qatar (30th), and Botswana (35th). Most developing countries rank much lower. For example, Malaysia ranks 57th, South Africa 69th, China 78th, India and Turkey both 86th, Brazil 94th, Indonesia 102nd, Mexico
124th, Russia 129th, and Nigeria 149th. Somalia, Syria, and South Sudan were found to be the least transparent
countries in the world.
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EXHIBIT 16.12 Corruption Perceptions Index 2020
Rank Country/Territory Score
1 Denmark 88
1 New Zealand 88
3 Finland 85
3 singapore 85
3 sweden 85
3 switzerland 85
7 Norway 84
8 Netherlands 82
9 Germany 80
9 Luxembourg 80
11 Australia 77
11 Canada 77
11 Hong Kong 77
11 United Kingdom 77
15 Austria 76
15 Belgium 76
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Rank Country/Territory Score
17 Estonia 75
17 Iceland 75
19 Japan 74
20 Ireland 72
21 United Arab Emirates 71
21 Uruguay 71
23 France 69
24 Bhutan 68
25 Chile 67
25 United states of America 67
27 seychelles 66
28 Taiwan 65
29 Barbados 64
30 Bahamas 63
30 qatar 63
32 spain 62
33 Korea, south 61
33 Por tugal 61
35 Botswana 60
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Rank Country/Territory Score
35 Brunei Darussalam 60
35 Israel 60
35 Lithuania 60
35 slovenia 60
40 saint Vincent and the Grenadines 59
41 Cabo Verde 58
42 Costa Rica 57
42 Cyprus 57
42 Latvia 57
45 Georgia 56
45 Poland 56
45 saint Lucia 56
48 Dominica 55
49 Czechia 54
49 Oman 54
49 Rwanda 54
52 Grenada 53
52 Italy 53
52 Malta 53
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Rank Country/Territory Score
52 Mauritius 53
52 saudi Arabia 53
57 Malaysia 51
57 Namibia 51
59 Greece 50
60 Armenia 49
60 Jordan 49
60 slovakia 49
63 Belarus 47
63 Croatia 47
63 Cuba 47
63 sao Tome and Principe 47
67 Montenegro 45
67 senegal 45
69 Bulgaria 44
69 Hungary 44
69 Jamaica 44
69 Romania 44
69 south Africa 44
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Rank Country/Territory Score
69 Tunisia 44
75 Ghana 43
75 Maldives 43
75 Vanuatu 43
78 Argentina 42
78 Bahrain 42
78 China 42
78 Kuwait 42
78 solomon Islands 42
83 Benin 41
83 Guyana 41
83 Lesotho 41
86 Burkina Faso 40
86 India 40
86 Morocco 40
86 Timor-Leste 40
86 Trinidad and Tobago 40
86 Turkey 40
92 Colombia 39