By Ismail Ertürk - The Banking Expert at Alliance Manchester Business School, The University of Manchester.

Political risk, also referred to as country risk and studied as subset of country risk, is a subject that multinationals and international banks have developed analytical skills for over the years to evaluate and manage. There is a sizeable body of academic literature in economics and management studies on the subject that aims to scientifically study political risk in order to manage its impact on the financial performances of multinationals and international banks. The risks that are identified as political can have adverse impact on foreign currency earnings, ownership of foreign assets, tax management, repatriation of foreign earnings, and benefits from free capital and trade flows. 

The countries that have been the subject of political risk analysis, until the Eurozone sovereign debt crisis of 2010, were almost exclusively the developing countries or emerging economies.  However, since the Eurozone crisis of 2010 when smaller European countries like Greece, Ireland and Portugal needed bailing out due to their inability to service sovereign debts and bigger countries like Italy and Spain were seen to be similarly at risk, multinationals, especially in the US, Japan and the newly industrialised countries like China and South Korea, have realised that political risks are no longer confined to the developing countries. Multinationals started to pay more attention to the political developments and electoral processes in Europe. 

Then came the year 2016 when the biggest political risk in the world erupted in the most economically liberal country in Europe, the United Kingdom, when the referendum in May 2016 was unexpectedly won by those who wanted to leave the European Union. Donald Trump’s similarly unexpected victory in the US presidential elections followed. The political developments in the UK and the US in 2016 and the upcoming elections in France and other European countries in 2017 have started a radically different era in global economy where political risk management by multinationals in rich countries, rather than poorer countries, will dominate corporate investment decisions. 

Uncertainty is the biggest enemy of business as long term investment and trade decisions cannot be made under uncertainty and increases the cost of doing business through purchase of hedging products and development of hedging capabilities. The biggest source of uncertainty due to political risk in 2017 is going to be the US as it is the largest economy in the world, its currency is the vehicle currency in trade and investment, and it has the largest financial industry. President-elect Trump has announced radical economic and international policies for the US where the raw economic and political interests of the US will be pursued at the expense of creating damages in the rest of the world.  

Since the US economic interests are very closely tied to the prosperity of the global economy it will be interesting to see to what extent Donald Trump’s populist policies are likely to be implemented.  But one thing is pretty definite: the US economic and international policies will create significant uncertainties for the global economy. 

Federal Reserve’s independence is no longer guaranteed by Trump. This is going to be a major source of long-term risk for multinationals everywhere including the US.  How far higher the interest rates in the US will go, for example, is going to be a major uncertainty. It will create volatility in exchange rates and have a negative impact on corporate borrowing decisions and on the fund management industry’s global investment decisions. The shape of Trump’s protectionist trade policies is unknown. This will be another fundamental source of risk for multinationals and other countries. 

The already weak global economic growth is unlikely to improve as a result of uncertainties that the US political risk has unleashed. This means countries that are mostly emerging economies, with high fiscal deficit, high private and public debt levels, and high current account deficits are likely to suffer most and become new sources of country risk for multinationals. 

Will the promised investment in infrastructure in the US counteract the negative impacts of Trump’s economic policies?  After all, a growing US economy is good for the rest of the world as the US is the major market for most exporting countries. This was true in the past but under the new economic policies announced by Trump, the US is not likely to share the benefits of its economic growth with the rest of the world. 

But like most populist policies we have witnessed in history, Trump’s policies too are disconnected from the harsh realities of global economy and politics. Therefore Trump’s populist policies are almost certainly going to create negative uncertainties in the global economy and international political relations, but there is no guarantee that they are going to create more prosperity and less inequality in the US. In this kind of environment, multinationals must learn more about the management of political risks in rich countries, as well as revisit their tools in managing it in low income countries. 

Of course, multinationals in rich countries, as promoters and beneficiaries of globalisation, need to fast develop new governance mechanisms and business models to share their high profitability and cash balances with their workers and with society at large. Otherwise the rising tide of populism, to which they tend to contribute through socially harmful business models, cannot be resisted purely by political risk management practices. By re-thinking their business models, multinationals and businesses in rich countries need to be part of the solution not the problem in this new era of populist politics. Rich countries need more socially responsible businesses, not more populist politicians.

Biography

Ismail Ertürk - The Banking Expert at Alliance Manchester Business School, The University of Manchester.

Ismail is a regular commentator in the broadcast and print media. He has taught corporate finance, bank financial management and international finance on both the School’s MBA and Executive Centre programmes. His research interests are in financialisation and financial innovation.