What are some of the risks that foreign companies face in emerging markets due to the political and legal framework?

Question

What will be an ideal response?

Answer 1

Political risk stems from the probability of adverse effects on a multinational’s business due to the political events in the host country. Many factors such as breach of contract, expropriation, political violence, revolution, sabotage, terrorism and restrictions on currency transfer are included when considering political risks. Political risks may relate to seizing a multinational’s assets, or more commonly, explicit or implicit actions of the government against the set contractual obligations.

Even when governments are friendly, adverse changes may occur due to elections or government response to an emerging pressure. Thus, a company needs to assess the political climate before entering a market and monitor the changes closely after the entry as well.

Many political risks stem from nationalism, which is based on the preservation of a country’s economic independence. Nationalism can lead to restrictions on imports, and tariffs and barriers to trade, in order to promote the consumption of domestic products. Alternatively, countries may restrict foreign investors’ entry and demand that they can only invest in the country as minority interest partners of joint ventures with locals. Many countries also demand that a percentage of the content of a product should be local (Ghauri and Cateora, 2010). Examples of other risks stemming from the political environment can be: exchange controls when the government restricts the flow of funds; tax controls when the taxes are raised without warning; pricing controls when the government sets the prices; or labour problems when the countries control the labour practices of a firm.

In more severe forms, nationalism may lead to governments’ control of the foreign investment or even confiscation of a company’s assets. National legal systems can create challenges to new entrants especially if the laws are focused on limiting or controlling foreign investment. Laws which restrict the foreign investment increase country risk and influence foreign entry into the economy. Governments can also impose restrictions on the firms’ activities within their borders thereby reducing the host firms’ efficiency. In order to discourage foreign entry, governments can complicate the bureaucracy necessary to undertake activities such as exporting, importing or logistics. Other restrictions can be placed on the ownership structure of the foreign firm as many governments seek joint ventures with local firms. Similarly, many governments have local content laws in an effort to boost the domestic economy.

A country may use economic sanctions to make a political statement or political action may be used to enhance the country’s prospects. The power of the political parties is important because the role that businesses are allowed to play in a given country’s market is influenced by the philosophies of those parties. However, other agents such as unions, special interest groups and lobbyists need to be considered as they can have the power to influence the business landscape in a country.