Roldan & Rahman: The Importance of Political Risk for European Business

From the chapter:

Countries in turmoil fill the front pages of newspapers one day after another: Russia, Yemen, Venezuela, Syria, Nigeria, and Greece. Companies, meanwhile, fear unpredictable change, even as they seek to profit from the opportunities that change  creates – a freshly privatized industry in Tunisia, a new government in Nigeria, or new licenses for solar infrastructure in Brazil. The examples are plentiful. To help weigh these risks and make investment decisions, corporations routinely consult economic risk analysts. However, making global investment decisions based only on economic data can be, to say the least, misleading.

Political risk is concerned with the impact of politics on markets. It focuses on understanding the drivers of policy decisions – such as the passage of laws, the behavior of political leaders, and the rise of popular movements – in order to anticipate how these can affect the business environment – in short, all the factors that might politically stabilize, or indeed destabilize, a country. Political risk focuses on the incentives and constraints behind political action rather than on the action itself. While economics will tell you whether an indebted government can pay its debts, political risk will focus the attention on whether it will be willing to do so.

Political risk analysis is nothing new for large global investors. However, the significance of any given risk varies depending on the investor. The concerns  of a hedge fund manager are very different from those of a long-term corporate investor. While the former is focused on immediate political developments that will impact tomorrow’s markets – for instance, whether Greece will decide to default on one of its debt repayments – the latter wants to understand deeper political trends such as regulatory dynamics, consumer attitudes, corruption risks, or the integrity of a country’s constitution.

Available here.