Political Risks

Political risk means risk of a change in the government policy. Political risk adversely affects a company’s ability to operate effectively and profitably.

Political risk can deter company from doing international business. When the perceived level of political risk is lower, a country is more likely to attract investment.

All other things being equal, the less developed a country. The greater would be the political risk. 

Following are the major types of political risks:

(i) Confiscation

(ii) Expropriation

(iii) Nationalization

(iv) Domestication

(v) Blocking of funds

i) Confiscation-Confiscation refers to a situation on under which a government forfeits a foreign investment. It means that the government does not pay any compensation for taking over the foreign investment.

(ii) Expropriation-Expropriation refers to a situation under which a government takes over a foreign investment by paying some compensation.

This compensation may not be equal to market value of foreign investment. It implies that a compensation is paid for taking over the foreign investment.

(iii) Nationalization- Nationalization refers to a situation under which a government takes over the ownership of the entire industry.

It means that nationalization affects the entire industry rather than a single company. Nationalization involves transfer of ownership of business to a government agency.

The process of nationalization may or may not have any compensation to be paid to previous owners of the business. It means that a compensation may be paid or may not be paid to the previous owners. 

(iv) Domestication-Domestication refers to a situation under which a government restricts gradually the freedom of operations of a foreign business firm.

The purpose of domestication is to bring the activities of a foreign business firm in line with national interest.

It implies that domestication is a mild form of intervention of a government. Domestication is a gradual encroachment of the freedom of a business firm.

Domestication can be either firm initiated, government-initiated or predetermined. The government initiated domestication is quite risky and is treated at par with expropriation.

(v) Blocking of Funds-Blocking of funds refers to a situation under which a government does not allow a foreign firm remit the funds or earnings back to home country.

Blocking of funds may be temporary or permanent. In this case, there is no danger to ownership and property rights of the funds but a foreign firm is not allowed to repatriate its earnings and investment.

Blocking of funds was a common problem faced by Indians during Idi Amin’s rule in Uganda when it was almost impossible for the Indian firms to repatriate their earnings in any form.

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