Political risk is the potential for an investment to suffer due to political changes or instability in a country. This could include shifts in government, legislative amendments, foreign policy decisions, or military actions. As the investment time horizon lengthens, the relevance of political risk, also known as geopolitical risk, significantly increases. This type of risk falls under the broader category of jurisdiction risk.
Delving Into Political Risk
Quantifying political risk can be exceptionally challenging owing to limited datasets or case studies specific to a nation. In some instances, international agencies or government bodies offer insurance against certain political risks. Such risks can hamper investment returns or even lead to scenarios where investors are unable to withdraw their capital.
Variations of Political Risks
Political decisions have immense influence on businesses aside from factors emerging from the marketplace. Governments can implement an array of policies impacting individual businesses, industries, and overall economies. These include taxes, regulation, currency valuation, trade tariffs, labor laws (e.g., minimum wage), and environmental regulations. Policies, even at the draft stage, can significantly affect economic dynamics. Regulations can be set at multiple levels—federal, state, local, and international.
Insight into some political risks can often be found in a company’s filings with the Securities and Exchange Commission (SEC) or in mutual fund prospectuses.
Safeguarding Against Political Risks
Multinational entities can opt to purchase political risk insurance to alleviate certain political risks. Such insurance allows management and investors to concentrate more on core business activities, safe in the knowledge that potential losses from political risks are mitigated. Typical actions covered include war and terrorism.
Political Risk in Practice
Consider a large multinational retailer, which in its fiscal reports, might outline various political risks it confronts. These could involve political and economic instability in supplier countries, potential labor issues, and changes in foreign trade policies and tariffs.
In its reports, the retailer might also highlight risks related to legislation, compliance, reputation, and other factors like judicial, regulatory and economic policies. Such risk factors could include political instability, legal constraints, local product safety and environmental laws, tax regulations, local labor laws, trade policies, and currency regulations. The company could mention specific countries like Brazil, detailing the complexities of navigating federal, state, and local legislation.
Related Terms: country risk, market risk, economic risk, trade tariffs, regulation risk.
