Political Risk: Conceptualization, Definition, Categorization, and Methodologies

India Kashmir Elections

Indian paramilitary soldiers stand guard near Sheri Kashmir cricket stadium where Prime Minister Narendra Modi, portrait seen in the backdrop, is expected to address a campaign rally ahead of local elections in Srinagar, India, Monday, Dec. 8, 2014. Separatists called for a strike as authorities imposed a daytime curfew Monday across the disputed Himalayan region of Kashmir, barring residents from leaving their homes. Main roads leading into Srinagar were lined with razor wire to contain traffic, and police and paramilitary soldiers were patrolling on foot and in armored vehicles. These and other considerations contribute to high levels of political risk in Kashmir. (AP Photo/Dar Yasin)

Journal of Political Risk, Vol. 3, No. 4, April 2015.

By Vishrut Kansal

Abstract

The paper is aimed at presenting a conceptual analysis of the political risk that impacts investors, project sponsors, creditors, and host government alike. First, an attempt to conceptualize and define political risk is made along with its subsequent categorization into its different types. Then, the methodologies of mitigating and managing political risk are elucidated upon. Lastly, political risk insurance as a mitigating factor of political risk is briefly dwelt upon. While presenting this overview, concerted attempt has been made to identify the practical techniques that investors and host governments may adopt while undertaking decisions involving political risk.

Definition of Political Risk

Risk is future contingency of deviation of ex-post returns from ex-ante returns of an investment.[1] This deviation may either be profitable or unprofitable to a commercial venture. Most of these risks relating to a project are either commercial or non-commercial. Commercial risks arise when profitability of the project, and consequent fulfillment of debt obligations, is uncertain owing to market conditions.[2] Non-commercial risks, on other hand, are unrelated to market conditions.[3] Political risk is one such non-commercial risk.[4]

There is no universally acceptable definition of what is or what constitutes political risk.[5] This obscurity is beneficial as it presents a scope to tailor the concept of political risk to include, and attempt to mitigate, risks which may be specific to only a particular economy, sector or a firm. The fact that political risk may either be systematic or unsystematic therefore presents a unique paradox in attempt to define political risk. This, however, does not obviate the need to balance pedantry with semantics. Encapsulating a workable idea of political risk assumes significance in order to appreciate its divergence from much wider concept of country risk. In brief, country risk includes financial [viz. loan default or unfavorable loan restructuring, delayed payment of supplier’s credits, etc.] and economic risks [viz. Inflation, International liquidity ratios, current account balance, etc.] beside political risks of investing in a particular country.[6] In contrast, an attempt to equate political risks with the risk of radical political change or political instability will turn out to be fallacious for its narrowness in its inability to account for the possibility of a positive impact of political phenomena on investment.[7]

In this backdrop, the Multilateral Investment Guarantee Agency (MIGA) has attempted to define political risks as those “associated with government actions which deny or restrict the right of an investor/owner (i) to use or benefit from his/her assets; or (ii) which reduce the value of the firm.”[8] This definition is worth noting for two fundamental reasons: first, MIGA is an international financial institution which was established in 1988 as a member of World Bank Group under Article 1 of The Convention Establishing the Multilateral Investment Guarantee Agency to which 181 countries (including India) are signatories;[9] and second, by defining political risk through its impact on investors, this definition presents a laudable scope for extrapolation and flexibility w.r.t. other aspects of political risk, like:

1. Nature of association of political risk with government’s actions: This accommodates possibility of government’s actions bearing direct or inverse relationship with political risk; political risk being either positive or negative; and, subjective analysis of government’s actions in risk assessment.

2. Nature of government: It includes any form of government viz. socialist, welfare-state, communist, etc. and any form of political system viz. democracy, republican, parliamentarian, presidential, etc.

3. Causes behind, and nature of, government’s actions: First, actions must include omissions; second, such actions or omissions must be unexpected or unforeseen;[10] third, causes for such actions may either be exogenous to the country [i.e. international political concerns including terrorism], or endogenous [i.e. domestic politics like, change in ruling political party, regulatory changes, etc.], or an interaction of the two;[11] and lastly, it is inclusive of such actions of government which are shaped by socio-economic conditions or political pressure exerted by opposition political parties, NGOs, trade unions and other lobby groups, minority groups, separatist movements, social movements etc.[12]

In objectively assessing political risk through actions of government, the definition limits inherent subjectivity in political risk analysis. For instance, high subjectivity in assessing risk of terrorism will be substantially contained if measured through objective lens of existing legal framework and political fervor against terrorism. Furthermore, said government actions may belong to past, present or predictable future, thereby allowing better assessment of political risk, relative to aforementioned scenario wherein political risk is equated to risk of political change. Inherent in concept of change is the future impact of present actions, which ignores the bearing past had on present, thereby constraining the scope of political risk.[13]

4. Investor/Owner: Notwithstanding that the existing literature on political risk is extensively premised on foreign investment, MIGA’s definition doesn’t use the term ‘foreign’ before investor/owner. Political risk must assume equal significance in relation to domestic investment in a company or a project. In leaving scope for accommodating this possibility of defining political risk even in relation to domestic investments, MIGA’s definition paves way for a progressive approach towards conceptualization of political risk.

One may argue that in ignoring the impact of such risk on stakeholders other than investors/owners, this definition narrowly conceptualizes political risk. For instance, even governments may bear impact of negative political risk by incurring opportunity costs of lost foreign investments, or, fiscal deficit if such political risk had been passed on to the government by the project sponsor.[14] Be that as it may, one may argue that even the adverse effects on country’s economy are arising as an indirect outcome of political risk being faced by investors/owners qua their investments.

Therefore, almost pan-global recognition of MIGA’s definition of political risk (by its signatory member-states), coupled with its carefully balanced out flexibility, conclusively ascertain the desirability of adopting this definition. Having thus broadly determined what political risk is; it becomes important to roughly identify what constitutes such risk.

Types of Political Risks

The expansiveness of political risk highly counteracts any systematized approach towards categorizing its different manifestations. Nevertheless, at the risk of excessive generalization, one approach to contain dimensionality of this concept may be to analyze it through three different categories: first, actors responsible for political risk [Government, or non-Government like terrorists, geopolitics, etc.]; second, nature of effect of actors [property loss or income loss]; and third, breadth of political risk [macro or micro].[15] In brief, macro political risks affect all foreign investments and operations in the host country, regardless of industry [for instance, expropriation, currency and trade controls, changes in tax and labour laws, regulatory restrictions, etc.], while micro political risks are specific to a particular economy, sector, or a project company/firm [like, stringent regulatory controls qua mining operations by private firms].[16]  

However, it must be noted that each actor is capable of producing the effect of political risk through its unique actions. For instance, Government may cause property loss to sponsors/investors by confiscation through nationalization of a specific project; while other entities (like terrorists) may cause such property loss through destruction of the project assets.[17] Similarly, while Government may, by adopting discriminatory regulatory policies, cause income loss to all foreign investors in coal block mining; other entities (like displaced inhabitants) may cause such income loss through disruption of mining activities of a specific project.[18] The breadth of such actions is only one among many relevant considerations in political risk analysis and assessment (infra). Therefore, actions of government or non-government entities which ultimately pose political risk must be analyzed as yet another category. However, it is evident that this category of actions causing political risk is not independent in its manifestation from other three categories previously noted. Therefore, any attempt to rationalize types of political risk on basis of actions causing such risk must not be wholly alienated from other three categories. Desirability of this approach is in its multi-dimensionality in reflecting the material aspects from (aforementioned) all facets of political risk. Also, this approach is in consonance with MIGA’s definition of political risk as being “associated with government actions”. In this context, MIGA holds that types of negative political risk “include war, revolutions, government seizure of property and actions to restrict the movement of profits or other revenues from within a country.”[19] However, we must refrain from adopting MIGA’s categorization of types of political risk (even when inclusive) as conclusive for, it will amount to attributing excessive significance to one among many players concerned with political risk [including host governments, other agencies and insurers, investors/owners, etc.]. Therefore, taking into account the desirability of scope for excursion from MIGA’s categorization, negative political risk has been generally divided into following types:

1. Risk of expropriation: Nathan holds that expropriation risk is either direct or indirect.[20] Direct expropriation risk is the “risk that the host government will [wholly or partially] nationalize the assets or equity of the project company in an arbitrary or discriminatory manner or without payment of just compensation.”[21] It also includes other forms of forceful alienations of project assets at the instance of host government; viz. forceful sale of assets or production to an instrumentality of host government at below market prices.[22] Direct expropriation deprives a project sponsor/investor the right to use or benefit from the project assets in any manner and, is therefore, an extreme and most dramatic form of political risk.[23] Although developing countries, including India, are increasingly adopting model of economic development which is based on public private partnerships (PPP) and privatization, even a minor risk of direct expropriation significantly affects investment decision of project sponsors.[24] Indirect expropriation risk, on other hand, is the risk of “major contract disputes that affect the assets and ownership structure” of a project company or a firm.[25] This includes host government’s (politically-driven) debt default, failure to deliver on a contract, etc.[26]

Example: Direct expropriation of captive coal block mines by Government of India from private companies after first-cum-first-serve allocation of such mines was held as constitutionally ultra vires by Supreme Court of India in Manohar Lal Sharma v. The Principal Secretary & Ors. [Coalgate Judgement] W.P. (Crl.) 120/2012

2. Risk of changes in regulatory regime: It means the risk of politically motivated changes in regulatory policies or legal framework of the host government which render the project unprofitable. Examples may include: import and export restrictions, price controls, excessive taxation (like taxes on windfall gains, duplicate tax claims by both central and state government), stringent environmental laws or labour standards, preferential policy towards protection of domestic companies or financial institutions, etc.[27] Even ‘cash flow expropriation’ or ‘resource nationalism’, by host government, aimed at expropriating cash, i.e. money raised through project, instead of its physical assets, through government regulatory policies is also included.[28] Such policies include: “increased taxation over transfer pricing within companies, [requiring] companies to partner with local firms for specific activities such as processing (providing a hidden subsidy), or retroactive [application of taxes] or environmental or health and safety fines.”[29] Hood explains that regulatory changes may occur, inter alia, when there is a change in ruling government, or even the preexisting host government changes its priorities, or when the political system itself changes.[30] For instance, if the power to effect such regulatory changes is delegated to administrative authorities in a parliamentary democracy (like India), the risk will be much higher for lack of need of extensive parliamentary deliberations. If, sufficiently prior to enacting such adverse regulatory changes, the host government notifies the concerned investor/owner, this risk may be minimized.

Example: Enactment of Section 7 of Electricity Act 2003 (w.e.f. 10 June 2003), which de-licensed power generation by any generating company subject to compliance with technical standards, reduced the risk of regulatory regime in relation to captive power generation in India. Another example may be the imposition of corporate tax on foreign investments by clarification in nature of retrospective amendment of Income Tax Act 1961 undertaken by Finance Act 2012 to effectively overturn ratio of Vodafone International Holdings v. Union of India C.A. 733/2012 (Sup.Ct.).

3. Risk of war and terrorism: Since wars and terrorist organizations [like Al-Qaeda, ISIS etc.] are no longer associated with a specific nation-state or a geographical area [viz. cyber terrorism], politically motivated wars and terrorism are not country risks rather political risks.[31] Nevertheless, there may arise circumstances wherein such war or terrorism is focused against specific industry, sector, economy, government or its policy framework, viz. Eco-Terrorism. Even ancillary impacts owing to such acts of terrorism or war, viz. halt of transport owing to border/road closure due to inter-state fighting are included within this risk.

Example: Risk of terrorist activities (especially, in transport sector like, aviation and metro-rail) around Obama’s visit to Delhi, India for Republic Day celebration in 2015; risk of disruption of projects by naxalites in MoU Belt, especially in Dantewada, Chhattisgarh, etc.

4. Risk of imposition of capital controls: There is a risk of host government adopting stringent currency or trade controls. Administrative delays in approving capital transfers, excessive/severe limits on repatriation of profits [like, by imposition of onerous tax on conversion of currency, etc.] are examples of currency controls.[32] Imposition of trade barriers, licensing requirements, etc.; restrictions on cross-border transfer of resources are examples of trade controls.[33] Hood explains by empirical evidence that uncertainty of severity and duration of these controls are aggravating factors for political risk.[34] 

Example: India allows free repatriation of profits once all the local and central tax liabilities are met. Imposition of Goods and Services Tax (GST) would decrease existing onerous tax liabilities and thus, is expected to further liberalize the repatriation of profits.

5. Currency risk: Weiss explains that there is a risk of inconvertibility of local currency revenues into foreign currency required to pay off the debts owing to foreign exchange shortage in host country.[35] Currency risk also includes risk of devaluation which is the shortfall in ex ante returns from foreign investment owing to depreciation of local currency in which revenue was earned in host country.[36] This currency risk becomes political risk when the currency market is fixed or regulated by the host government or its instrumentality.

Example: There is a greater risk of China allowing its currency to depreciate in 2015, because of domestic economic slowdown and other international factors.[37]

6. Risk of political upheaval (other than war or terrorism): It includes political revolution, social movements, protests, strikes, civil commotions, internal armed conflicts [like, insurrections, riots, mutiny, rebellion, military coup d’état, civil war etc.] which may arise due to social mobilization or change of public opinions aimed at thwarting corruption, creating political imbalance or instability, removing existing power structures, etc.[38] Therefore, higher the improprieties present in political or administrative system [viz. nepotism, corruption, bribery, red-tapism, administrative laxity, etc.], higher is the risk of such upheaval and lesser is the viability of investments.

Example: Risk of separation of Telengana and Andhra Pradesh which materialized from 2010 onwards upon formation of Srikrishna Committee on Telangana or the Committee for Consultations on the Situation in Andhra Pradesh (CCSAP).

7. Risk of ‘crossfire’ sanctions: This is the risk of incurring sanctions or consumer boycotts by host government or consumer base in host country because of infliction by of “human rights abuses (e.g. imprisonment, torture or murder of political opponents; use of prison labor; persecution of minority groups; not abiding by election results); conflicts with neighboring countries; lack of concern for the environment, endangered species, etc.; disregard for international agreements [e.g. Nuclear Non-Proliferation Treaty); misuse of social issues as means of protectionism, etc.” by your project company or your home country.[39] It includes the risk of “loss of social license to operate”, i.e. opposition by indigenous, social, environmental or political groups to economic projects or, boycott of products of specific brand whereby, extensive delays, increase in social costs, market imbalances, safety costs, etc. result in impracticability or unprofitability of the venture.[40]

Example: risk of opposition by environmentalists to Adani Group’s Great Barrier Reef Project in Australia owing to its past disregard for environmental concerns.

8. Risk of non-neutrality of legal framework: Risk of judicial biasness against foreign investors assumes greater significance if the judiciary (including quasi-judicial bodies) is not insulated from political pressure.[41] This risk somewhat reduces if the host country is signatory to international/regional conventions which safeguard international investments, promote natural justice, principle of rule of law and doctrine of separation of powers.[42]

It must, however, be in no way construed as an exhaustive list of types of political risk. In fact, each type or category in itself is also not exhaustive, and may at times overlap with other similar categories. This is because, the concept of political risk is dynamic and its contours ever expanding. Insofar as this list is an amalgam from different sources, it is also worthwhile to note that different stakeholders have recognized and defined types of political risks differently. As mentioned before, there is no universal recognition of different types or limits of such types of political risks.

Political Risk Management

From now on, we will proceed with the presumption that political risk is negative, i.e. unprofitable for the impugned business venture/investment. The process of political risk management by any investor/sponsor/owner before taking an investment decision involves three stages: (i) identification of political risk; (ii) assessment of political risk; and, (iii) action plans for management or mitigation of political risk.[43] If, however, such investment has already been made in a business, which is now affected with negative political risk, the sponsors/investors/owners must directly initiate ‘post-entry’ action plans for mitigation of such risk.

Identification of Political Risk

Identification of of the type of political risk relevant to a specific investment is crucial for its later assessment and mitigation. Risk Managers are usually appointed by MNCs to identify the main political risks of investment qua particular industry, sector, economy, and geography. The foremost task of risk manager is to separate real political risk from ‘headline hype’ or perceived risk, i.e. those highly publicized socio-political upheavals which are often perceived as political risk but may instead offer an equally or more significant investment opportunity.[44] Political risks should neither be farfetched nor inconceivable even with reasonable/due diligence. Therefore, the factors contributing to perception of such risk have to be carefully analyzed on basis of highly verifiable, well-defined and specifically relevant data; and then, the factors which may partially or fully offset this risk have to be considered. After such careful analysis, if the risk still remains substantial enough not to be ignored, the risk has to be identified as a potential political risk. All such potential political risks have to be then prioritized qua their material significance to the company. The criteria for such prioritization usually includes: combination of probability and impact (both, material and good-will) of such risk, board level concerns, vulnerability to extremities, finance plan, corporate structure etc.[45]

Now the question emerges as to what data should be conceivable as highly relevant to identification of any political risk, and from where such data should be accessed or obtained. It is important to keep in mind that the perception of what data is relevant and the perception of political risk on same or similar data may subjectively vary.[46] Therefore, identification of relevant data with sufficient objectivity is to be done at both, holistic political level and, at specific level of inquiry, by taking into account past experiences and sufficient empirical evidence (historical probabilities). For instance, Nathan has proved by empirical study of historical analysis of political regimes that democracy leads to lower levels of political risks owing to constraints [viz. reputational, judicial, political, social, etc.] imposed on executives in such regimes.[47] Beside the factum of nature of political system, other important aspects at identification of political risk may include:[48]

government budget deficits, transparency, openness of the economy, political stability or degree of acceptable instability, savings, development and social stability, economic planning failures, political leadership, external conflict, corruption in government, military in politics, organized religion in politics, law and order tradition, racial and national tensions, political terrorism, civil war risks, quality of bureaucracy, repudiation of contracts by government, expropriation of private investments, losses from exchange controls, enforcement of laws in past (including practices for accessing legal recourse and enforcing awards), strength of institutions (including the efficiency of the agency involved, strength and quality of institutions in arbitration proceedings, assistance provided by the judiciary, and existence of and support for alternative dispute resolution mechanisms), effectiveness of policies and procedures (including their timeliness, such as the length of arbitration procedures) relative to global best practice.

Relevant data may be obtained from any of following sources: (i) comprehensive databases of political risks maintained by agencies and consultants like Business Environment Risk Intelligence (BERI) Political Risk Index, the Economist Intelligence Unit (EIU) Political Instability Index, EURASIA’s Global Political Risk Index, Euromoney, Transparency International, World Audit Organization, Delcredere Ducroire, Verisk Maplecroft, International Country Risk Guide (ICRG), World Bank Group’s Investing Across Borders database, etc.; (ii) specialized political risk consultants like Corr Analytics, Business International, F&S Political Risk, Political Risk Services (PRS), etc.; (iii) “local subsidiaries and partners, public domain, other companies, industry associations, local organizations”, and other reliable sources in host country.[49] However, reliance on judgement of host-country level experts may be fallacious on two accounts: first, there may be concealment of data because of conflict of interest [in revealing the requisite information regarding potentiality of political risk and the consequent impact of withdrawal of parent company’s investments from local operations in host country];[50] and second, much of the data relating to political turmoil including possibility of war is classified and not accessible to general public. Therefore, corporations usually rely on empirical data studies on identification of political risks provided by consultants mentioned before.

Measurement or Assessment of Political Risks

Coping with uncertainty in forecasting political risk incurs time and research costs which get sunk if the process turns out to be futile for insufficiency of predictability. Paucity of reliable statistical data, especially in relation to small market for impugned project in developing countries, may present formidable unit costs to any such attempt at political risk assessment.[51] Therefore, first, a superficial assessment must be undertaken through careful analysis of database of different political risk indices [per country or specific geographical locations] provided through open or trial access by agencies aforementioned viz. ICRG, Delcredere Ducroire, Verisk Maplecroft. In-depth political risk assessment must be undertaken only if the probability of losing investment from political risks is superficially high and; sunk costs by loss of such investment are relatively much higher than the costs of such assessment.

Action Plans for Management or Mitigation of Political Risks

The perceived political risk must be gauged against ex-ante profits and returns from investment, while bearing in mind that investments are intrinsically risky in nature.[52] Upon this thorough cost-benefit analysis, decision to ignore, completely avoid, manage or mitigate the political risk must be undertaken. Political Risk Mitigation includes ‘pre-entry’ prevention and ‘post-entry’ protection against perceivable risks. Other action plans include, external or internal financing of such political risk through political risk insurance (PRI).[53] All these action plans are aimed at mitigation or management of political risk, either generally or risk specific level.

General Mitigation of Political Risks

The investment decision must be pragmatically made taking into consideration the effect which several dimensions of political risk play out in practice. For instance, usually stable democracies are preferred over monarchies (supra) because of popular constraints over whimsical action by political regime.[54] Despite taking into account these broad considerations, strategic flexibility to ensure adaptability to political risks (in practice) must be adopted by investors through:

1. Diversification: undertaking a wide variety of investments (i.e. investment portfolio diversification using political risk as key factor),[55] non-committal of resources into fixed and specific assets overseas, undertaking sub-contracting, leasing and sub-leasing, diversification of production catering to different markets, reducing structural dependence on a single country [viz. in relation to market for raw material or sale of product, increased flexibility to switch supplies through global operations or international product markets including the ability to recruit globally], etc.[56]

2. Decentralization of decision making: Decentralization leads to freedom of sub-units in quickly making decisions to allow for smooth liquidation of assets, withdrawal of investments, exit from business, etc. if the political risk seems to be materializing.[57]

3. Avoiding long-term commitments: of resources including labour, capital, physical assets etc. through insertion of relevant contractual clauses.[58]

4. Implementation of intelligence system: to monitor recent social, political and environmental trends that may reasonably impact business. Such monitoring allows enough opportunity to respond to brewing political risks.[59]

5. Lobbying: Influencing host government through informal negotiations, industry associations, business goodwill, personal contacts, advice from ambassadors of domestic country, etc. is strategically important.[60] Presence of influential management is significant in this regard. Further, investor/owner must not antagonize host government with threat of recourse to commercial dispute mechanism unless no other option left for this leads to loss of reputation of host government and consequent friendly business atmosphere for the investment concern.[61]

6. Local Stakeholders: It is empirically proven that if there are local stakeholders [like, sponsors/investors, market shareholders, creditors, debtors, etc. of host country] including Government in PPP model, political risk (especially, of nationalization) reduces.[62] A joint business venture is preferable with a domestic company which understands the political risk environment in host country, or which is in favor or position to lobby the host government.[63]

7. Negotiations with host government: to secure preferential arrangements from host government for instance, concession in taxation, licensing, etc.[64] Abrogation of guarantee obtained from host government will vest a right in project sponsors/investors to claim compensation, thereby allocating the risk to the host government itself.[65]

8. Indispensability to host government: Such indispensability allows bargaining leverage to the corporation for, any adverse impact on its operations would result in increased economic, social or political loss.[66] This indispensability may be created by offering net social benefits, through CSR, creation of public trusts, adoption of public relations campaigns and development model consistent with national aspirations like, sustainable development, self-sustenance etc.; making scarce and significant resources available to the economy through technical expertise, managerial skills, product or capital access to export market, etc.; partnerships with NGOs; and, social investments in community initiatives, education, health, public infrastructure development, etc.[67]

9. Financial Hedging: Hedging through financial instruments like, forward supply contracts, currency trading, commodity hedging instruments, etc. may offset or limit the financial exposure to political risks, especially currency risks.[68] Furthermore, an escrow account could be maintained with sufficient liquid assets to pay off the debt obligations if political risks actually materialize.[69]

10. Managing Reputational and integrity risks: Bribing officials in relation to project, money laundering, terrorist financing, indifference to mitigating social and environmental costs of projects, ignoring standards set by applicable environmental and labour laws, non-performance of contractual obligations qua host government (viz. in PPP), exploitation of consumers, adopting anti-competitive policies, etc. increase the risk of compromise of reputation and integrity of business.[70] Such face high political risks of expropriation, regulatory changes, losing social license to operate, etc. Therefore, businesses must aim at working with clean reputation in public relations.

As emphasized before, the host government is also a crucial actor in political risk and a significant stakeholder in profits from increased project investments if such risk is minimized. Therefore, host governments through regulation of their economic, financial and political regimes must attempt to attract investments through minimization of political risks primarily by economy-wide interventions aimed at strengthening investors’ confidence.[71] Host government must adopt an unbiased legal framework that provides legal remedies to investors against arbitrary and unlawful interference by any actor, be it governmental or non-governmental.[72] Predictability and stability of the legal and political framework through fairness and rule of law, accessibility of judicial mechanisms including arbitration, right to prompt, sufficient and just compensation against unlawful actions, etc. enhance investors’ confidence. If the laws w.r.t. acquisition of property and expropriation of assets are biased in favor of industrial development, risk of expropriation almost reduces to nullity. Similarly, host government must allow investors to freely and promptly repatriate project funds in a convertible currency of their choice. Licensing requirements must be reduced. Corruption, non-transparency, bribery, administrative laxity, communalization of politics, etc. must be eradicated to uphold the integrity of host country. This may be done through publication of list of unethical or illegal activities or other patterns of behavior adverse to public policy, which if found to be perpetrated by investors/sponsors/owners in past, would be used to deselect them.[73]

Risk – Specific Mitigation

In addition to aforementioned ways, political risks may be mitigated by ways corresponding to specific risks which such project in given industry/sector is likely to encounter. Having identified the type of political risk which substantially haunts the concerned project, action plan aimed at mitigation of only that particular risk must be adopted to reduce costs. For instance, tourism industry is concerned with political risk of currency risks which can be hedged through financial instruments and forward trading in currency; mining, oil & gas industries are concerned with political risk of expropriation and breach of contract by host government which can be curtailed by entering into business relationships with local stakeholders having government lobbies; and, power and infrastructure companies are concerned with risk of sporadic political violence which can be dealt with by maintaining sufficient liquid assets in escrow account to deal with debt obligations till such violence lasts.[74] Other than these methods, mitigation of specific political risks is through transfer of such risks to political risk insurers. Since, PRI is an important facet of any political risk mitigation, let us deal with it separately.

Political Risk Insurance (PRI)

Following types of agencies may provide insurance to investors, sponsors, creditors, and government instrumentalities against one or more types of political risks:[75]

1. International Insurance Organizations/Agencies, which are usually multilateral agencies that provide project finance and PRI to the private sector projects. Examples include: International Finance Corporation (IFC), MIGA [for foreign investments in recognized developing countries], Overseas Private Investment Corporation (OPIC) [for foreign investors from US in recognized developing countries], Commonwealth Development Corporation of England, and American International Group, Inc. (AIG), BERNE Union etc.

2. Export Credit Agencies, which support the sale of exports by providing financing and PRI. Examples include: Export Import Bank of India (Exim Bank), Nippon Export and Investment Insurance (NEXI) of Japan, Export Credits Guarantee Department (ECGD) of England, COFACE of France, etc.

3. International Development Banks, viz. World Bank, Asian Development Bank (ADB), and International Bank for Reconstruction and Development (IBRD), that usually support private infrastructure projects through project financing and political risk insurance.

4. Other Insurance Agencies including Private Credit Agencies and Banks, viz. General Insurance Corporation of India (against terrorism risk), Sinosure of China, Lloyd’s Group, Chartis Insurance (USA), Sovereign Risk Insurance Ltd. (Bermuda).

5. Reinsurance Companies, which provide reinsurance coverage for political risks in both trade and investments. Examples include: Munich Re and Hannover Re of Germany, Swiss Re of Switzerland, and Berkshire Hathaway/General Re of the USA, etc.

As a viable alternative to individually insure specific political risks of high magnitude, these institutions may develop an insurance pool (like, GAREAT of France, Pool Re of UK, Terrorism Risk Insurance Pool of India, etc.) for insurance or re-insurance of such political risks. In alternative, they may form a syndicate to co-finance and insure upto separate limits the risk faced by individual project. Export credit agencies usually adopt this mechanism to insure upto large amounts.[76]

All the institutions mentioned above provide insurance for different types of political risks [not all types of political risks, discussed before, are covered by a single PRI] at different rates of premium and deductibles. They provide insurance cover to a limited extent of investment [such limit of insurance liability varies with each agency]. Therefore, PRI doesn’t completely insulate investors from losses owing to political risks.[77] They have different eligibility criteria and their insurance coverage may be applicable only w.r.t. specific industry and specific geographical location. Definition of political risk and the types of such risk are defined restrictively to cover specific types of contingencies. There are a number of exclusions, performance warranties, waiting periods, and coinsurance features built in almost all PRI policies.[78] Other prohibitive conditions viz. compliance with ILO worker rights standards may be imposed.[79] With such plurality at play, determinative factors in selection of appropriate insurer usually include extent of coverage, quality of services offered by the insurer, policy terms and conditions, flexibility and negotiability of such terms, price of insurance premiums, etc.[80] For instance, terrorism risks should ideally be insured against by host government agencies either severally or in insurance pool with other agencies. This is because, “in the case of potential terrorist attacks, the government has powerful intelligence gathering capabilities that no private insurer can muster – and this is the sort of information that the government will not readily share with insurance companies.”[81]

Update: An earlier version of this article was titled “Political Risk: An Analysis”. We apologize for the confusion.

Vishrut Kansal is a third-year BA LLB (H) student  at the The W.B. National University of Juridical Sciences in Kolkata, India. Matthew Michaelides provided editorial oversight for this article. JPR Status: Working Paper, archived 4/5/2015. 


[1] The Economic Times, ‘Definition of ‘Risk” <http://economictimes.indiatimes.com/definition/risk> accessed 15 January 2015; Investopedia, ‘Risk and Diversification: What Is Risk?’ <http://www.investopedia.com/university/risk/risk1.asp> accessed 15 January 2015

[2] Nachiketa, ‘Insuring Investments Abroad’ [1972] EPW 1138

[3]Vladan S. Perišić , Nenad Avramović, Miloš Marković, ‘Foreign Direct Investment and Non-Commercial Risk’ [2014] Annals of the University of Oradea (2) 93 < http://imtuoradea.ro/auo.fmte/files-2014-v2/Vladan%20Perisic%20-%20Nenad%20Avramovic%20-%20Milos%20Markovic%20FOREIGN%20DIRECT%20INVESTMENT%20AND%20NON-COMMERCIAL%20RISKS.pdf> accessed 15 January 2015

[4] Nachiketa, ‘Insuring Investments Abroad’ [1972] EPW 1138

[5] John Hood and M. Shahid Nawaz, ‘Political Risk Exposure and Management in Multi-National Companies: Is There a Role for the Corporate Risk Manager?’ [2004] Risk Management 6 (1) 7-18 <http://www.jstor.org/stable/3867931> accessed 15 January 2015

[6] Enrico C. Perotti and Pieter van Oijen, ‘Privatization, Political Risk and Stock Market Development in Emerging Economies’ [1999] OECD <http://www.oecd.org/daf/ca/corporategovernanceofstate-ownedenterprises/1923974.pdf> accessed 15 January 2015

[7] Cecilia Emma Sottilotta, Political Risk: Concepts, Definitions and Challenges (Working Paper Series, LUISS School of Government, Rome, Italy 2013) < http://eprints.luiss.it/1206/1/SOG-WP6-2013_Sottilotta.pdf> accessed 15 January 2015

[8] Multilateral Investment Guarantee Agency (MIGA), ‘Glossary of Terms Used in the Political Risk Insurance Industry’ <http://www.miga.org/documents/Glossary_of_Terms_Used_in_the_Political_Risk_Insurance_Industry.pdf> accessed 15 January 2015

[9] The World Bank, ‘Member Countries of Multilateral Investment Guarantee Agency (MIGA) (2014) <http://www.worldbank.org/en/about/leadership/members#4> accessed 15 January 2015

[10] Shapiro, ‘The Measurement and Management of Political Risk’ (Wiley.org) <http://www.wiley.com/college/fin/shapiro366102/ppt/ch22.ppt> accessed 15 January 2015

[11] Arvind Mahajan, ‘Pricing Expropriation Risk’ [1990] Financial Management 19 (4) 77-86, <http://www.jstor.org/stable/3665612> accessed 15 January 2015; Cecilia Emma Sottilotta, Political Risk: Concepts, Definitions and Challenges (Working Paper Series, LUISS School of Government, Rome, Italy 2013)

[12] Accenture, ‘Managing Political Risk Controlling Loss, Finding Opportunity’ (2012) <http://www.accenture.com/us-en/Pages/insight-managing-political-risk-controlling-loss-finding-opportunity.aspx> accessed 15 January 2015

[13] Cecilia Emma Sottilotta, Political Risk: Concepts, Definitions and Challenges (Working Paper Series, LUISS School of Government, Rome, Italy 2013)

[14] Stephan Dreyhaupt, Ivan Nimac, Kusi Hornberger, Political Risk: The Missing Link in Understanding Investment Climate Reform? (1st, World Bank, Washington D.C. 2012) < https://openknowledge.worldbank.org/handle/10986/10416> accessed 15 January 2015

[15] Shapiro, ‘The Measurement and Management of Political Risk’ (Wiley.org)

[16] John Hood and M. Shahid Nawaz, ‘Political Risk Exposure and Management in Multi-National Companies: Is There a Role for the Corporate Risk Manager?’ [2004] Risk Management 6 (1) 7-18; Cecilia Emma Sottilotta, Political Risk: Concepts, Definitions and Challenges (Working Paper Series, LUISS School of Government, Rome, Italy 2013); Albert Phung, ‘What is political risk and what can a multinational company do to minimize exposure?’ (Investopedia.com) <http://www.investopedia.com/ask/answers/06/politicalrisk.asp> accessed 15 January 2015; Invesopedia, ‘Micro Risk’ <http://www.investopedia.com/terms/m/microrisk.asp> accessed 15 January 2015; Invesopedia, ‘Macro Risk’ <http://www.investopedia.com/terms/m/macrorisk.asp> accessed 15 January 2015

[17] Shapiro, ‘The Measurement and Management of Political Risk’ (Wiley.org)

[18] Ibid

[19] Multilateral Investment Guarantee Agency (MIGA), ‘Glossary of Terms Used in the Political Risk Insurance Industry’

[20] Nathan Jensen, ‘Political Risk, Democratic Institutions, and Foreign Direct Investment’ [2008] The Journal of Politics 70 (4) 1040-1052

[21] Edith Brown Weiss, Leo H. Phillips, Jr., Hugh G. McCrory, Jr., Gregory E.McGowan, Jose W. Fernandez and David Bamberger, ‘Infrastructure Projects in Developing Countries’ [1995] Proceedings of the Annual Meeting (American Society of International Law) 89 (5-8) 19 – 36 <http://www.jstor.org/stable/25658882> accessed 15 January 2015.

[22] Accenture, ‘Managing Political Risk Controlling Loss, Finding Opportunity’ (2012)

[23] John Hood and M. Shahid Nawaz, ‘Political Risk Exposure and Management in Multi-National Companies: Is There a Role for the Corporate Risk Manager?’ [2004] Risk Management 6 (1) 7-18; Arvind Mahajan, ‘Pricing Expropriation Risk’ [1990] Financial Management 19 (4) 77-86

[24] Edith Brown Weiss, Leo H. Phillips, Jr., Hugh G. McCrory, Jr., Gregory E.McGowan, Jose W. Fernandez and David Bamberger, ‘Infrastructure Projects in Developing Countries’ [1995] Proceedings of the Annual Meeting (American Society of International Law) 89 (5-8) 19 – 36

[25] Nathan Jensen, ‘Political Risk, Democratic Institutions, and Foreign Direct Investment’ [2008] The Journal of Politics 70 (4) 1040-1052

[26] Accenture, ‘Managing Political Risk Controlling Loss, Finding Opportunity’ (2012)

[27] Edith Brown Weiss, Leo H. Phillips, Jr., Hugh G. McCrory, Jr., Gregory E.McGowan, Jose W. Fernandez and David Bamberger, ‘Infrastructure Projects in Developing Countries’ [1995] Proceedings of the Annual Meeting (American Society of International Law) 89 (5-8) 19 – 36

[28] Accenture, ‘Managing Political Risk Controlling Loss, Finding Opportunity’ (2012)

[29] Ibid

[30] John Hood and M. Shahid Nawaz, ‘Political Risk Exposure and Management in Multi-National Companies: Is There a Role for the Corporate Risk Manager?’ [2004] Risk Management 6 (1) 7-18

[31] Ibid

[32] Accenture, ‘Managing Political Risk Controlling Loss, Finding Opportunity’ (2012)

[33] Shapiro, ‘The Measurement and Management of Political Risk’ (Wiley.org)

[34] John Hood and M. Shahid Nawaz, ‘Political Risk Exposure and Management in Multi-National Companies: Is There a Role for the Corporate Risk Manager?’ [2004] Risk Management 6 (1) 7-18

[35] Edith Brown Weiss, Leo H. Phillips, Jr., Hugh G. McCrory, Jr., Gregory E.McGowan, Jose W. Fernandez and David Bamberger, ‘Infrastructure Projects in Developing Countries’ [1995] Proceedings of the Annual Meeting (American Society of International Law) 89 (5-8) 19 – 36

[36] Ibid

[37] V. Anantha Nageswaran, ‘On track for a weaker Yuan in 2015’ (Livemint.com 2015) <http://www.livemint.com/Opinion/tPNwpapcDfoOa0wOsSoeDN/On-track-for-a-weaker-yuan-in-2015.html> accessed 15 January 2015

[38] Repsol, Terrorism Risk and Insurance Markets in 2012 (1st, OECD, Paris, France 2012); Edith Brown Weiss, Leo H. Phillips, Jr., Hugh G. McCrory, Jr., Gregory E.McGowan, Jose W. Fernandez and David Bamberger, ‘Infrastructure Projects in Developing Countries’ [1995] Proceedings of the Annual Meeting (American Society of International Law) 89 (5-8) 19 – 36

[39] Shapiro, ‘The Measurement and Management of Political Risk’ (Wiley.org)

[40] Accenture, ‘Managing Political Risk Controlling Loss, Finding Opportunity’ (2012)

[41] Shapiro, ‘The Measurement and Management of Political Risk’ (Wiley.org)

[42] Ibid

[43] Repsol, Terrorism Risk and Insurance Markets in 2012 (1st, OECD, Paris, France 2012)

[44] Accenture, ‘Managing Political Risk Controlling Loss, Finding Opportunity’ (2012)

[45] Ibid

[46] Cecilia Emma Sottilotta, Political Risk: Concepts, Definitions and Challenges (Working Paper Series, LUISS School of Government, Rome, Italy 2013)

[47] Nathan Jensen, ‘Political Risk, Democratic Institutions, and Foreign Direct Investment’ [2008] The Journal of Politics 70 (4) 1040-1052 <http://www.jstor.org/stable/30219483> accessed 15 January 2015

[48] John Hood and M. Shahid Nawaz, ‘Political Risk Exposure and Management in Multi-National Companies: Is There a Role for the Corporate Risk Manager?’ [2004] Risk Management 6 (1) 7-18; Enrico C. Perotti and Pieter van Oijen, ‘Privatization, Political Risk and Stock Market Development in Emerging Economies’ [1999] OECD

[49] John Hood and M. Shahid Nawaz, ‘Political Risk Exposure and Management in Multi-National Companies: Is There a Role for the Corporate Risk Manager?’ [2004] Risk Management 6 (1) 7-18; Accenture, ‘Managing Political Risk Controlling Loss, Finding Opportunity’ (2012); Stephan Dreyhaupt, Ivan Nimac, Kusi Hornberger, Political Risk: The Missing Link in Understanding Investment Climate Reform? (1st, World Bank, Washington D.C. 2012)

[50] Arjun Makhijani, ‘Managing Political Risks’ [1981] EPW 1269

[51] Briance Mascarenhas, ‘Coping with Uncertainty in International Business’ [1982] Journal of International Business Studies 13 (2) 87-98 <http://www.jstor.org/stable/154298> accessed 15 January 2015

[52] John Hood and M. Shahid Nawaz, ‘Political Risk Exposure and Management in Multi-National Companies: Is There a Role for the Corporate Risk Manager?’ [2004] Risk Management 6 (1) 7-18

[53] Repsol, Terrorism Risk and Insurance Markets in 2012 (1st, OECD, Paris, France 2012)

[54] Nathan Jensen, ‘Political Risk, Democratic Institutions, and Foreign Direct Investment’ [2008] The Journal of Politics 70 (4) 1040-1052

[55] Accenture, ‘Managing Political Risk Controlling Loss, Finding Opportunity’ (2012)

[56] Hoffmann, V.H. and Engau, C. (2011) Strategizing in an Unpredictable Climate: Exploring Corporate Strategies

to Cope with Regulatory Uncertainty. Long Range Planning 44: 42-63.

[57] Ibid

[58] Ibid

[59] Ibid

[60] John Hood and M. Shahid Nawaz, ‘Political Risk Exposure and Management in Multi-National Companies: Is There a Role for the Corporate Risk Manager?’ [2004] Risk Management 6 (1) 7-18; Accenture, ‘Managing Political Risk Controlling Loss, Finding Opportunity’ (2012)

[61] John Hood and M. Shahid Nawaz, ‘Political Risk Exposure and Management in Multi-National Companies: Is There a Role for the Corporate Risk Manager?’ [2004] Risk Management 6 (1) 7-18

[62] Ibid; Shapiro, ‘The Measurement and Management of Political Risk’ (Wiley.org)

[63] Accenture, ‘Managing Political Risk Controlling Loss, Finding Opportunity’ (2012)

[64] John Hood and M. Shahid Nawaz, ‘Political Risk Exposure and Management in Multi-National Companies: Is There a Role for the Corporate Risk Manager?’ [2004] Risk Management 6 (1) 7-18

[65] Edith Brown Weiss, Leo H. Phillips, Jr., Hugh G. McCrory, Jr., Gregory E.McGowan, Jose W. Fernandez and David Bamberger, ‘Infrastructure Projects in Developing Countries’ [1995] Proceedings of the Annual Meeting (American Society of International Law) 89 (5-8) 19 – 36

[66] Arjun Makhijani, ‘Managing Political Risks’ [1981] EPW 1269

[67] Accenture, ‘Managing Political Risk Controlling Loss, Finding Opportunity’ (2012)

[68] Ibid

[69] Edith Brown Weiss, Leo H. Phillips, Jr., Hugh G. McCrory, Jr., Gregory E.McGowan, Jose W. Fernandez and David Bamberger, ‘Infrastructure Projects in Developing Countries’ [1995] Proceedings of the Annual Meeting (American Society of International Law) 89 (5-8) 19 – 36

[70] Stephan Dreyhaupt, Ivan Nimac, Kusi Hornberger, Political Risk: The Missing Link in Understanding Investment Climate Reform? (1st, World Bank, Washington D.C. 2012)

[71] Ibid

[72] Ibid

[73] ibid

[74] Ibid, Edith Brown Weiss, Leo H. Phillips, Jr., Hugh G. McCrory, Jr., Gregory E.McGowan, Jose W. Fernandez and David Bamberger, ‘Infrastructure Projects in Developing Countries’ [1995] Proceedings of the Annual Meeting (American Society of International Law) 89 (5-8) 19 – 36

[75] Ibid

[76] Ibid

[77] Douglas A. Paul, ‘New Developments in Private Political Risk Insurance and Trade Finance’ [1987] The International Lawyer 21 (3) 709-718 <http://www.jstor.org/stable/40705936> accessed 15 January 2015

[78] Ibid

[79] OPIC, ‘Applicant Screener: Insurance Eligibility Checklist’ (OPIC.gov) <http://www.opic.gov/doing-business-us/applicant-screener/insurance-eligibility-checklist> accessed 15 January 2015

[80] Douglas A. Paul, ‘New Developments in Private Political Risk Insurance and Trade Finance’ [1987] The International Lawyer 21 (3) 709-718

[81] Saul Levmore and Kyle D. Logue, ‘Insuring against Terrorism — and Crime’ [2003] Michigan Law Review 102 (2) 268-327 <http://www.jstor.org/stable/3595383> accessed 15 January 2015