Global Business Environment

1. Global Business Environment Session 4 : Assessment of Business Environment & CRA and PRA Faculty: Dr. Bibek Ray Chaudhuri Session Date:22.1.2012

2. 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

3. Session Plan • Macroeconomics and Business (…Contd.) • Economic Environment of Countries • Country Risk Analysis • Political Risk Analysis

4. 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

5. 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

6. 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

7. 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)

8. Firms performing CRA • Standard & Poor’s • Moody’s • Economist Intelligence Unit • Political Risk Services • Business Environmental Risk Intelligence

9. 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

10. 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

11. 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

12. Domestic (Continued) • Fiscal Policy • Budget Deficit/GDP ratio • Internal Debt/GDP ratio • Monetary Policy • Inflation rate • Money Supply Growth • Real Rate of Interest rate

13. 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)

14. 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

15. CRA (continued) • How the nation is seen by the World: mainly in terms of capital inflows • Ability and Willingness to pay back

16. Strengths

17. Weaknesses

18. CRA (continued) • Risk levels and Exposure Limit • Pricing System • Follow up

19. Post Work • Group activity choose a country and perform a CRA the assignment should be submitted as PPTs by March 31st , 2012

20. Political Risk Analysis

21. 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)

22. Types of Political Risks

23. Main Types of Political Risks • 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?

24. Main Types of Political Risks (Continued) • 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.) • 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

25. Main Types of Political Risks (Continued) • 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

26. Main Types of Political Risks (Continued) • 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

27. Main Types of Political Risks (Continued) • 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

28. Main Types of Political Risks (Continued) • “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?

29. 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)

30. Inverted U-Curve and Political Stability High High Expectations Living Standard Political Instability Low Low Economic Development High Low

31. 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”

32. 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

33. 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

34. The Economist MethodPolitical Risk Service (PRS) -- 100 points 17 points society: • urbanization • Race • Religious fundamentalism • corruption • ethnic tension

35. 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.

36. MNE Evaluation by Countries • Concern of Governments • Independence: Whether the presence of MNE will affect sovereignty of the host country • Impact on Domestic firms • Hidden Value: Undervaluation of assets, non-transfer of technology etc. • Responsibility: Long-term or short run commitment

37. Cost-Benefit of MNEs • 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

38. Other Methods • Present Value of Costs and Benefits • Shadow price adjustments • Shifting perceptions over time

39. Divergence of Perceived Benefit-Cost Ratio Perceived by Multinational Enterprise Zone of disagreement Economic Benefit Cost Ratio Perceived by Host Govt.

40. Example of Differing Valuations

41. 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