Defining Political Risk In Emerging Market Economies
Political Risks are characterized as the non-market challenges and complications businesses face when investing in emerging and frontier market economies. Although the risks exist continuously in those economies, they are essentially dormant. They become active upon the occurrence of a triggering event, like a political decision that advances new policies which are inconsistent with existing policies or events that are in any way connected to political instability including terrorism, riot, coup, civil war, insurrection or sedition. When political risks shift from dormant to active they immediately become both more severe and more likely to occur have the potential of negatively impacting the outcome, profitability or even the viability of investments and business ventures.
Quantifying Political Risk No Easy Task
Although it is widely believed that geopolitical risk can be quantified and managed, companies that invest in emerging markets do so because they generally believe they have adequately quantified the risk they will face to an extent which is sufficient for them to abdicate much of their ability to manage that risk.
For example, a company that is going to build a new facility must decide between two parcels of land for the location of the facility. One of the parcels is significantly less expensive than the other but it is located within the 100-year flood plain, which means it is susceptible to flooding every 100 years. The other parcel is not susceptible to flooding but is considerably more expensive. Because it is sufficiently less expensive, the company may decide to proceed with building on the flood-prone parcel because they believe they have adequately quantified the risk of flooding, even though in so doing they are abdicating their ability to manage future flooding.
Mitigating Geopolitical Risk In Emerging Markets
Similarly, the risk that political decisions, political conditions or political instability could materially affect the profitability, continuation or even the viability of their business is routinely faced by companies that invest in emerging markets. Until recently, companies interested in investing in emerging and frontier markets were limited to a binary choice. They could do the deal and accept the risk or pass on the deal and completely avoid the risk.
Neither, in this case, is a good option. Deciding on the first option may force the company to accept more risk than they are comfortable accepting, and the second option, while risk-free, absolutely guarantees they will make zero profits.
Fortunately, the marketplace developed a solution for Political Risk that creates a third option that is decidedly superior to those which were previously available. The introduction of Political Risk Insurance allows companies to more aggressively pursue the profits and growth potential offered by emerging market opportunities while substantially reducing the risks their investment will face.
Political Risk Insurance Expanded Content Series
This article, which defines and assess the political risks many companies face when expanding into emerging markets is part of our expanded content series on Political Risk Insurance, as are the pages presented just below. We published this content series to ensure our clients have the information they need to more fully understand Political Risk Insurance as well as the long-term costs and benefits. Start at the beginning with the Political Risk Insurance service page and then read the expanded support content in the series.
- Political Risk Insurance: Learn how political risk insurance empowers companies to pursue emerging market opportunities by limiting political risk.
- PRI Approved Countries: While not available worldwide, there are 160 emerging and frontier market countries approved for political risk insurance.
- Political Risk: Expanded content to provide political risk information to support our clients with Quantifying And Managing Political Risk In Emerging Markets.
- Emerging Markets: Detailed information in support clients and the potential opportunities provided by Emerging Market Economies.