By definition, political risk is a risk to businesses that are the direct result of political change and instability. Every country has a certain amount of political risk associated with it, but some countries’ risks are greater in magnitude. In most cases, political risk comes from changes that stem from new administrations in the government. For example, legislation on the process, exchange rates, and restrictions can cause companies to struggle. This post will walk you through several types of risks and help you better deal with them.
The Different Categories of Political Risk
Politics can have a profound impact on business but before looking at some ways to lower the risks, let’s learn about some of the different categories.
Trade Barriers: Certain trade barriers can create huge headaches. Tariffs are one such barrier, decreasing margins and creating bottlenecks in foreign markets. Most of the time, trade barriers are created by changes in political leaders or trade wars between two nations.
Taxes: Our next barrier should come as no surprise. Changes in tax rates can affect the profitability of businesses because they limit the profitability of assets.
Legislation: Governments might put legislation into place that makes it more expensive for businesses to comply. So they’ll have to make changes to operations and other business processes.
Changes to Administration: Politics comes with turmoil sometimes, which usually results in delays. One example of a delay that can impact a business is when a government temporarily stops approving permits due to the new administration.
Instability: Some countries experience a lot of political instability in the form of terrorist attacks, civil war, and insurrection. These disruptions can be devastating to businesses over a prolonged period.
Economy: Politics greatly influence the economy of a country. Interest rates play the greatest factor, impacting asset prices and the costs of operating a business.
Prepare For Political Risks
If you’re operating a multi-national business, then you can’t outright avoid political risks, but you can prepare for it. Here is a three-step process that can be used to manage these types of risks.
Identifying the risks associated with a location is always going to be the first step. How can the politics of this area directly impact our overall vision? You should write down any possible risks ranging from an increase in taxes to the likelihood of war. You can only prepare for risk once you have identified it.
Once you have a list in front of you, your team can develop a set of risk scenarios based on the evidence at hand.
Now it’s time to measure the possibility of each risk scenario actually becoming a reality. Then quantify the potential impact of each scenario. For instance, you can estimate the financial impact of a specific event by using a discounted cash flow analysis. The idea here is to understand exactly what your tolerance levels are.
Other types of scenarios might include operational impacts, which can be measured using other tools. Whatever the case, you need to have an understanding of “what if” this certain risk becomes a reality.
Once you have identified and measured specific risks, you can develop a system for managing those risks. The first step of managing risk is to create a roadmap for risks that you determine would be the most detrimental to your business. These are known as priority risks.
Most companies will create several options to deal with each scenario. Then they can choose the option that is best for the given situation.
Of course, you can always hire risk management consultants like Back Office Pro to help you find political risks that might impact your business.