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What is a Political Risk?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 02 December 2016
  • Copyright Protected:
    2003-2016
    Conjecture Corporation
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Sometimes referred to as country risk, political risk is the potential for shifts in a nation’s political climate or changes to trade laws and regulations to have an adverse effect on the ability of international investors or corporations to do business with entities within that nation. Risk of this type may be represented by something as simple as an amendment to an existing regulation that places additional restraints on trading activities, or be as severe as changes in governmental personnel that threaten to undermine the entire process of doing business in that country. As with any type of risk in a business setting, the idea is to identify the current level of risk as well as any factors that could cause that risk level to increase over time. Doing so helps individuals and businesses to assess whether the degree of political risk present is worth the returns that are likely to result from the relationship.

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One example of a relatively minor factor that could increase political risk is changing how imported goods are processed at the time they enter the nation. Should changes in trade laws require that those goods remain in a quarantine situation for a longer period of time than previously thought, this could mean that the owner of the goods would miss opportunities to sell those goods at the most advantageous price. The end result is that since the buyer earns less profit, there is a good chance he or she will want a lower price from the seller. This makes the business deal less rewarding for both parties, and could cause one or both to discontinue the business relationship altogether.

A more extreme example of political risk has to do with shifts in economic policies when there is a significant change in the central government of a nation. For example, should a nation undergo a political coup where the new regime adopts trade policies that are very different from previous policies, multinational businesses may choose to withdraw from doing business in that nation. This is especially true if there is concern about the stability of the new regime and the potential of not receiving goods ordered and paid for, or not being able to collect payment for goods that were ordered and shipped to that country. In situations of this type, it is not unusual for international businesses to step back from the situation and observe conditions until they are convinced that the degree of political risk is within reason, and that the potential profit is worth the current risk level.

Political risk does not remain at a constant level. For this reason, it is important to periodically assess the degree of risk that currently exists with any nation, even those where the economy and the government remain fairly stable. It is also important to consider potential future events that have a good chance of taking place within a given period of time. Doing so can make it possible to develop strategies that help to minimize or possibly even prevent losses due to the effects of those events, while also providing time to develop alternative business relationships that can replace opportunities that are no longer viable, due to some sort of political or governmental changes.

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