Political & Economic Risks: Types, Impacts & Mitigation Strategies

TAKEAWAYS:

• Political risks (e.g., expropriation, war) and economic risks (e.g., inflation, currency devaluation) can cripple international businesses unless managed proactively.
• Nepal’s Nepal Rastra Bank (NRB) faces currency risk from USD fluctuations, while NEPSE (Nepal Stock Exchange) is vulnerable to economic instability during political transitions.
• Google’s exit from China (2010) due to censorship laws is a classic political risk case, while Daraz’s supply chain disruptions in Nepal during COVID-19 show economic risk in action.
• Risk mitigation strategies include hedging, insurance, joint ventures, and political risk analysis (PRA)—each suited to different scenarios.
• Transfer pricing (Unit 12) and trade barriers (Unit 10) are directly influenced by political/economic risks, making this unit critical for global strategy.
• Exam questions often ask for definitions + real-world examples (e.g., "Describe five political risks" → link to Nepal-India trade disputes or Google’s China exit).

1. Definitions: Political vs. Economic Risks

Political and economic risks are non-market forces that disrupt international business operations. They differ in origin and impact:

2. Real-World Examples: Risks in Action

A. Political Risks in Nepal

B. Economic Risks Globally

• Google (USD → INR Fluctuations): Google’s Indian subsidiary faced currency risk when the Indian Rupee (INR) depreciated by 12% in 2022. To mitigate this, Google used forward contracts to lock in exchange rates for ad revenue payments to Indian publishers. Worked Example:

  • Scenario: Google earns ₹100 crore (≈$1.2M) from Indian ads but must pay US-based engineers in USD.
  • Risk: If INR weakens to ₹85/$1, Google loses ₹15 crore (~$180K).
  • Solution: Google hedges by converting 70% of revenue to USD upfront via a bank.

• Daraz (Nepal’s Supply Chain): During COVID-19, Nepal’s lockdowns disrupted Daraz’s warehouse operations in Kathmandu and Lalitpur. The company:

  1. Diversified suppliers (shifted from China to India for 30% of inventory).
  2. Used local micro-fulfillment centers (partnered with Nabil Bank’s logistics arm).
  3. Offered "essential goods priority" to avoid government penalties.

3. How Risks Work: A Trace Through Nepal’s NEPSE

Nepal Stock Exchange (NEPSE) is highly sensitive to political and economic risks. Let’s trace how risks propagate:

Key Takeaways from the Trace:

• Political risk (elections) → Monetary policy change → Cost inflation → Stock market crash.
• Mitigation: NEPSE introduced "circuit breakers" (automatic trading halts during extreme volatility).

4. Risk Assessment Frameworks

Companies use structured methods to evaluate risks. Two key models:

A. Political Risk Analysis (PRA) Matrix

5. Mitigation Strategies: What Companies Do

6. Case Study: Google vs. China’s Political Risk

Scenario: Google launched Google.cn in 2006 but exited in 2010 due to censorship laws.

sequenceDiagram
  participant Google as Google
  participant China as Chinese Govt
  participant Baidu as Baidu (Local Competitor)
  Google->>China: Launches Google.cn (2006)
  China-->>Google: Demands censorship of search results (e.g., Tiananmen Square)
  Google->>Google: Refuses (ethical stance)
  China->>China: Blocks Google (2010)
  Baidu->>China: Gains 90% market share
  Google->>Google: Shuts down Google.cn; redirects to Hong Kong

Lessons for Nepal:

• Ethical risks: Google prioritized free speech over market access.
• Alternative: Bing (Microsoft) entered China by complying with censorship—now holds 2% market share.

7. Exam Tip: How to Score Full Marks

1. Define + Classify:

   • Always start with definitions (e.g., "Political risk refers to the potential losses arising from political changes or instability in a host country").
   • Use bullet points for classifications (e.g., "Five political risks: expropriation, sanctions, war, regulatory changes, corruption").

2. Link to Nepal:

   • NEPSE: Use 2022 election-year volatility as an example.
   • NRB: Discuss currency hedging strategies for banks.
   • Daraz/Pathao: Mention supply chain risks during COVID-19.

3. Real-World Examples:

   • Google vs. China: Political risk.
   • Nabil Bank’s loans: Economic risk (inflation).
   • Himalayan Java: Expropriation risk.

4. Mitigation Strategies:

   • Match strategies to risk type:
     • Political risk → Joint ventures, insurance.
     • Economic risk → Hedging, diversification.

5. Avoid Common Mistakes:

   • ❌ "Political risk is only about war." → Include sanctions, corruption, regulations.
   • ❌ Ignoring Nepal-specific examples (e.g., India trade disputes, NRB policies).

Final Visual Summary: