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Global Business Environment Session 4 : Assessment of Business Environment & CRA and PRA Faculty: Dr. Bibek Ray Chaudhuri Session Date:22.1.2012 EPGDIBVSAT 2011-12 Pre-Work Global Business Environment/ Session: 4 • 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 Global Business Environment/ Session: 4 • • • • Macroeconomics and Business (…Contd.) Economic Environment of Countries Country Risk Analysis Political Risk Analysis EPGDIBVSAT 2011-12 Key Considerations while assessing Business Environment Global Business Environment/ Session: 4 • 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 EPGDIBVSAT 2011-12 Key Considerations while assessing Business Environment Global Business Environment/ Session: 4 • 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 EPGDIBVSAT 2011-12 Making sense of the Information: Country Risk Analysis Global Business Environment/ Session: 4 • 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 EPGDIBVSAT 2011-12 Firm Strategy Global Business Environment/ Session: 4 • 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) EPGDIBVSAT 2011-12 Firms performing CRA Global Business Environment/ Session: 4 • • • • • Standard & Poor’s Moody’s Economist Intelligence Unit Political Risk Services Business Environmental Risk Intelligence EPGDIBVSAT 2011-12 Components of CRA Global Business Environment/ Session: 4 • 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 EPGDIBVSAT 2011-12 COUNTRY RISK AS A CORPORATE RISK Global Business Environment/ Session: 4 • 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 EPGDIBVSAT 2011-12 Indicators which are important for Assessment Global Business Environment/ Session: 4 • 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 EPGDIBVSAT 2011-12 Domestic (Continued) Global Business Environment/ Session: 4 • Fiscal Policy Budget Deficit/GDP ratio Internal Debt/GDP ratio • Monetary Policy Inflation rate Money Supply Growth Real Rate of Interest rate EPGDIBVSAT 2011-12 External Global Business Environment/ Session: 4 • • • • • • • • • • • 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) EPGDIBVSAT 2011-12 External (continued) Global Business Environment/ Session: 4 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 EPGDIBVSAT 2011-12 CRA (continued) Global Business Environment/ Session: 4 • How the nation is seen by the World: mainly in terms of capital inflows • Ability and Willingness to pay back EPGDIBVSAT 2011-12 Strengths Global Business Environment/ Session: 4 EPGDIBVSAT 2011-12 Weaknesses Global Business Environment/ Session: 4 EPGDIBVSAT 2011-12 CRA (continued) Global Business Environment/ Session: 4 • Risk levels and Exposure Limit • Pricing System • Follow up EPGDIBVSAT 2011-12 Post Work Global Business Environment/ Session: 4 • Group activity choose a country and perform a CRA the assignment should be submitted as PPTs by March 31st , 2012 EPGDIBVSAT 2011-12 Global Business Environment/ Session: 4 POLITICAL RISK ANALYSIS EPGDIBVSAT 2011-12 Introduction Global Business Environment/ Session: 4 • Definition of Political Risk Possibility of an unexpected politicallymotivated event affecting the outcome of an investment Instability vs. risk • • • Classified based on - actor responsible - nature of effect - breadth (micro vs. macro) EPGDIBVSAT 2011-12 Types of Political Risks Global Business Environment/ Session: 4 Cause Result Government Others Property Loss Confiscation Destruction Income Loss Discrimination Disruption EPGDIBVSAT 2011-12 Main Types of Political Risks Global Business Environment/ Session: 4 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? EPGDIBVSAT 2011-12 Main Types of Political Risks (Continued) Global Business Environment/ Session: 4 b) Terrorism – – – – c) 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 EPGDIBVSAT 2011-12 Main Types of Political Risks (Continued) Global Business Environment/ Session: 4 – 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 EPGDIBVSAT 2011-12 Main Types of Political Risks (Continued) Global Business Environment/ Session: 4 – 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 EPGDIBVSAT 2011-12 Main Types of Political Risks (Continued) Global Business Environment/ Session: 4 – 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 EPGDIBVSAT 2011-12 Main Types of Political Risks (Continued) Global Business Environment/ Session: 4 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 nonproliferation) - 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? EPGDIBVSAT 2011-12 Techniques of PRA Global Business Environment/ Session: 4 • 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) EPGDIBVSAT 2011-12 Inverted U-Curve and Political Stability Global Business Environment/ Session: 4 High Expectations High Living Standard Political Instability Low Low Low Economic Development High EPGDIBVSAT 2011-12 Political Risk Global Business Environment/ Session: 4 • 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” EPGDIBVSAT 2011-12 Empirical Relationship (Continued) Global Business Environment/ Session: 4 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 EPGDIBVSAT 2011-12 The Economist Method Political Risk Service (PRS) -- 100 points Global Business Environment/ Session: 4 • • • • • • • • • • • 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 EPGDIBVSAT 2011-12 The Economist Method Political Risk Service (PRS) -- 100 points Global Business Environment/ Session: 4 • • • • • 17 points society: urbanization Race Religious fundamentalism corruption ethnic tension EPGDIBVSAT 2011-12 Managing Political Risk (counter moves) Global Business Environment/ Session: 4 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. EPGDIBVSAT 2011-12 MNE Evaluation by Countries Global Business Environment/ Session: 4 • 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 EPGDIBVSAT 2011-12 Cost-Benefit of MNEs Global Business Environment/ Session: 4 Cost Benefit ratio F R * T } O N / E •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 EPGDIBVSAT 2011-12 Other Methods Global Business Environment/ Session: 4 • Present Value of Costs and Benefits • Shadow price adjustments • Shifting perceptions over time EPGDIBVSAT 2011-12 Divergence of Perceived Benefit-Cost Ratio Global Business Environment/ Session: 4 Perceived by Multinational Enterprise Economic Benefit Cost Ratio Zone of disagreement Perceived by Host Govt. EPGDIBVSAT 2011-12 Example of Differing Valuations Global Business Environment/ Session: 4 Item Sub-Item MNE-Value Sales Govt. Value 20 Material (-)14 18 (-)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 EPGDIBVSAT 2011-12 Post-Work-Session 5 Global Business Environment/ Session: 4 • 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