0Political Environment

The Political Environment can be simply described as the laws and regulations that
business has to follow in order to make sure the business owners do not get
arrested, or have the business fined for noncompliance of some regulation.
Laws are made by politicians - who enact these laws based on the likelihood they
will get re-elected. The political environment is affected and effected by politicians
who in turn are influenced by changes and challenges in the social - cultural
environment (languages, ethnicity, immigration etc.), challenges in the economic
environment (currency exchange rates, corporate activity, unemployment rates)
and also to some extent the geographic environment in terms of how the region is
laid out, rivers, mountains, proximity to other countries, weather, seasons etc.
This includes the political system, the government policies and attitude towards the
business community and the unionism. All these aspects have a bearing on the
strategies adopted by the business firms. The stability of the government also
influences business and related activities to a great extent. It sends a signal of
strength, confidence to various interests groups and investors. Further, ideology of
the political party also influences the business organization and its operations. For
e.g. Coca-Cola, a cold drink widely used even now, had to wind up operations in
India in late seventies. Again the trade union activities also influence the operation
of business enterprises. Most of the labor unions in India are affiliated to various
political parties. Strikes, lockouts and labor disputes etc. also adversely affect the
business operations. However, with the competitive business environment, trade
unions are now showing great maturity and started contributing positively to the
success of the business organization and its operations through workers
participation.

The ‘Indian Political Business

Complex’
The decade and a half following India’s economic reforms of 1990-91 has been an
exciting and transformational one for India and its people, and has also had a
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significant impact on the entire world. Much good has happened, with increasing
growth and prosperity benefiting millions. The world has observed the rise of a
large and vibrant middle-class, an aggressive and innovative private sector, and the
growth of a soft culture. It is true that severe challenges still remain, caused mainly
by massive disparities in income and access to resources, which mean that over
300 million people remain desperately poor and large parts of the country not
benefiting from growth.
A lot of India’s growth and stability today has been credited to its overall political
structure and institutions. This is what has kept the nation united through the
numerous challenges it has faced, and continues to face. The federal nature of the
government, coupled with the presence of an independent judiciary and a powerful
media have all combined to create the unique phenomenon that is Indian
democracy. There are notable flaws, such as weak law enforcement, and an
excessive bureaucracy, but, for better or for worse, Indian democracy has worked.
However, over the past few years, a major development has occurred in India,
almost silently, which illustrates the uglier side of this system. While the growth
rates clocked by the economy over the years have been impressive, most of the
major policy changes benefited big established business houses. This has resulted
in the India of today being a highly oligarchic economy; with a relatively small
population enjoying disproportionate power, wealth and influence (four of the
world’s ten wealthiest individuals are from India). Actual market friendly policies,
which would help the middle-class and poor by boosting entrepreneurship would
often be to the detriment of this group, and are often inhibited. In the 1950’s,
Eisenhower warned the Americans of a “military-industrial” complex which could
skew American priorities. His fears might have been unfounded, or at the very
least, quite exaggerated. However, India today does face the danger of a big
political business complex distorting its priorities.
This phenomenon was partly displayed during the debate over the Indo-US nuclear
deal. A seemingly innocuous bilateral treaty, it created frenzied debate, polarized
the polity and the nation, and forced the government through a no-confidence
motion. To a complete outsider, it all seemed a lot of action for something which
appeared quite a routine. To Indians though, it all seemed wearingly familiar. The
nuclear deal holds many ramifications for India, and the general consensus

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amongst the scientific, business and intellectual community is that it would be
beneficial, if negotiated properly. Power generation is one area where the deal is
said to have probable benefits. India remains critically deficient in power
generation, with large parts of the country, including metros, suffering from severe
power shortages. This has had a major impact on the growth of small business
units, especially in manufacturing. Since nuclear energy can be used to generate
power, it appears that the deal could help meet the shortage, and thus, presents a
huge opportunity for big business houses. Each major political alliance in India has
its support base comprised of various business houses, and each alliance feels the
pressure to make sure the deal goes through when it is in power, to ensure the
maximum benefit for its support base. Simultaneously, policy changes such as
decentralizing power production, removing subsidies or limiting power theft are
often prevented, as those would enable the entry of other players into the sectors. It
is like a double whammy effect.
Two other areas where the impact of the political-business nexus can be seen are
agriculture and retail. Organized retail presents a massive opportunity for India to
broad base its growth, and help kick start the agriculture sector, with estimates
ranging from $ 500 billion to over $ 1 trillion. A large amount of agricultural
produce in India is wasted each year due to the lack of cold storage, to the tune of
$ 7 billion. Investments, both foreign and domestic, should be welcomed in this
sector, as well as initiatives to promote local small businesses. Yet, the whole
sector has been dominated by big players, who would rather establish consolidated
supply chain which would squeeze prices all along the retail chain.
On a broader governance level, the negative impact of the political business nexus
can be observed. Running for public office in India is an incredibly expensive
proposition and campaign financing remains murky, with virtually no
accountability. This works perfectly to the advantage of the business lobbies, in
exercising control over political parties. The labor market also remains highly
informal and unorganized, as this keeps labor prices cheap. Another good example
is the real estate sector, where acquisition of land for commercial or private
purposes remains incredibly difficult, for businesses which want to establish
themselves. It needs to be pointed out that these phenomena were not the creation
of the big players today, but it works to their benefit today to ensure that the status
quo remains.
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It is entirely likely that the influence of this group would diminish with the passage
of time, and that fears about it would prove unfounded. Yet, in the Indian context,
there needs to be a greater awareness of the dangers posed by such developments,
and how they could impact the overall growth story.

Factors Affecting the Political Balance

1.Stability of the government.
2. Government type (dictatorship, democratic, monarchy, etc).
3. Economic policy of the government.
4. Trade policy.

5.Diplomatic events in surrounding countries.

All of the above factors affect the business environment and whether or not
business will thrive.

Growth and political stability

To say that economic growth would lead to equality of income distribution has
became a myth today, though it was an accepted belief during the 50s. Recent
research suggests that income distribution is a key factor to promote economic
growth.

2008-09-24 13:24
There exists a strong relationship between a country’s development
strategy and its political system. Authoritarianism or democracy has an unfailing
influence on the pace of development and justice. Political institutions always
dominate the fate of nations in many ways. The strategy of economic development
pursued by a country is the outcome of its political system, which, in turn also
determines its success or failure.

The rate of economic growth and the level of economic and social development
represent the well-being and prosperity of an economy and political stability
indicates the well-being of its political institutions. When one looks at the
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economy and politics of a country, there arise a number of questions. For example,
what is the role of political institutions in development? Which kind of political
institutions (democracy or dictatorship) help or hinder economic growth and
its’trickle-down’ effect? Is there a trade-off between economic, political and civil
liberties and economic growth? What is the role of income distribution, poverty
alleviation and other social welfare provisions in determining economic
performance?
The conventional economics, somehow, fails to answer these questions mainly
because it is devoid of the role of the state or that of political institutions, which
are treated exogenously in all discussions. The answer can only emerge if the role
of the state is treated endogenously. This is done in what is termed as the ’New
Political Economy’, which is, in fact, a revival of what, at one time back in history,
was known as political economy.

The ’New Political Economy’ unlike the mainstream conventional economics,

incorporates government’s impact on the economic system and its components,
without going into the questions of the development of political systems,
constitutions and their processes. In essence, it accounts for the behavior of the
electorate, the legislatures and the bureaucracy. It is only then that we are able to
answer various questions related with the behavior of the state and its impact on
the economic functioning of a given system.

There is a strong relationship between economic growth, capital accumulation and

democracy on the one hand and between political instability and income inequality
on the other.
Let us now find answers to the question with regard to the linkages between the
well-being of an economy and its political set-up. These answers emerge from the
experience of different countries and take the form of distinct hypotheses as given
below:
• Democracy retards economic growth (India’s experience up to the eighties)
• Democracy helps achieving high rates of economic growth
• Authoritarian regimes lead to faster economic growth (East Asian
experience)

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 • Dictatorial regimes lead to poor economic growth (African and Latin
American experience)

As the hypotheses are contradictory and inconsistent, the picture is hazy and no
categorical conclusion can be made. Nonetheless, the fact remains that political
institutions play a crucial and relevant role in the process of economic growth and
development. The way political institutions influence the pace of economic growth
is not something which is quantifiable nor is it a matter of trade-off between
economic and civil liberties and economic growth. It is something, which is not
easy to notice, understand, or explain in concrete terms. It is, in fact, a subtle
relationship, which has to be qualitatively analyzed and that too with great caution.

An attempt to reconcile the first two hypotheses and last two again makes it clear
that both democratic institutions and dictatorial regimes are practiced in different
countries in different ways and it is this variation that makes all the difference to
the attainment of economic growth. Countries can be more democratic or less
democratic in terms of the basic democratic tenets of regular and reasonably free
and fair, multi-party elections and dispensation of economic and civil liberties. It
therefore, follows that in democratic countries, where these two conditions are
partly met, other things being given, the pace of economic growth gets retarded
and where these two conditions are honored and economic growth gets
accelerated. We can make similar statements for dictatorial regimes.

All this leads to the conclusion that whether it is a democracy or a dictatorial

regime, what matters is its political stability. The degree of political stability
cannot be measured directly. It depends on a number of factors like, political
upheavals; riots, strikes and lockouts; crime and (political) assassinations; coups
and change of power; infighting amongst political parties; scams including rent-
seeking and directly unproductive profit seeking activities; lack of people’s faith in
the government; poverty and income disparities.

One may use these indices to work out the degree of political stability in different
countries/regions over different periods. This would lead to a number of interesting
hypotheses establishing a link between the indices of political stability and

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economic growth. For example, during the periods of political unrest, or coups, or
change of power, or even intense infighting within the ruling party, the rate of
growth has been seen to slow down and even become negative, essentially through
lower savings and investment rates and also through a lack of vision in the part of
the bureaucracy.

It is now understood that the magnitude of these activities and political instability
reinforce and strengthen each other to quite a great extent with the result that taken
together, they work against the growth process. They require being neutralized,
weakened and counter-acted.

Beyond ’rent-seeking’ and ’directly unproductive activities’, there are two other
explanatory socio-economic factors of political instability that require our
attention. These are poverty and inequality of income distribution. There is a two-
way relation between poverty and political instability in the sense that they lead to
each other and are mutually reinforcing. It is a known fact that poor countries are,
by and large, politically unstable. It is also known that political instability is not
conducive for saving and investment, and thus adversely affects growth efforts,
which in turn, perpetuate poverty. The two-way cause and effect link between the
two traps the economy into an acute vicious circle.

To say that economic growth would lead to equality of income distribution has
became a myth in recent times, though it was an accepted belief during the fifties,
when it was thought that in the initial stages of economic growth, inequalities
would rise, but eventually they would fall. During that era, countries, therefore,
depended on the growth process to attain equality of income distribution. Recent
research suggests that income distribution is a key factor to promote economic
growth. There are two ways, in which this happens. Income distribution influences
growth via its impacts on political stability, and also through other means. For
example, unequal income distribution leads to social unrest, which in turn, creates
demands for changes in the status quo. In such situations, savings and investment
are adversely affected, which imply low growth. Inequality of income distribution
has a dampening effect on economic growth through other means as well. It

7
encourages private rent-seeking activities creating distortions in the market-
behavior, which results into poor investment and thus low growth.
It therefore, means that apart from adopting an appropriate macro strategy for
growth with implications for poverty alleviation, employment generation and
social justice, we will have to devise direct programmes targeted at the poor and
the lower income groups and aimed to provide them with entitlements,
employment and (productive) assets, and also to pursue welfare-oriented minimum
needs programmes, which aim at improving the social consumption of essential
goods and services by the poor and the downtrodden, notably in the areas of
health, education, housing, drinking water and also in a number of other areas
through discriminatory pricing and subsidies.

We also have to evolve an optimal mix of new and strong (economic, political,
social, and legal) institutions to provide the necessary support for the promotion of
growth, prosperity, and social justice. For example, a strong legal system, with an
authoritarian regime within the framework of democratic traditions, will play an
important role to provide the required built-in mechanisms to correct distortions
and malfunctioning in the government as and when they occur. Equally important
would be the integrity and political honesty of the people who are at the helm of
political affairs.

Political stability to positively impact

India's rating: S&P
Formation of a stable government at the Centre will have positive implications for
India's sovereign rating, global agency Standard and Poor without indicating when
it would review country's rating.
"Generally speaking political stability is a positive factor for the sovereign ratings.
Because of strong mandate, next government will have a better opportunity to
execute its policy agenda". Pointing out that it was too early to comment on the
impact of formation of a stable government at the Centre, it was said, "a better
political environment itself will not warrant to progress in the areas such as fiscal

8
consolidation, deregulations and public sector reforms, to improve main
constraining factors for sovereign ratings of India."
Earlier in January, the decision of the global agency to change the outlook for long
term ratings, which was pegged at BBB, from 'stable' to 'negative' in January
evoked sharp reaction from the Finance Ministry, which questioned the rationale
behind the move.
Credit rating BBB indicates that adverse economic environment could impair the
capacity to meet financial obligations. While 'stable' outlook implies that rating
would remain the same, the 'negative' outlook suggests likelihood of a downgrade.
Standard and Poor's Ogawa further said that in absence of the economic and fiscal
policies of the new UPA government, it would be too early to comment on the
impact of the victory of the coalition at the general elections on India's sovereign
ratings.
The Congress-led UPA, which won over 260 seats in the general elections for the
15th Lok Sabha, is slated to form the government on Friday and come out with a
budget in July which will spell out its economic policies.
Answering question on the weight that rating agency assigns to political stability,
it was said that "highly rated sovereign tends to have a strong and stable political
system and environment and those rated lower tend to have weak or unpredictable
political systems."
However, the relative importance of political stability for our sovereign
consideration could change, depending on the country's situation.
"If the country's political situation is very volatile and current government and
opposition has significantly different views on the economic, fiscal or foreign
exchange rate policies, then political stability is very important for such
sovereigns."
Political factor, Ogawa added, could be less important in case a country has an
acute problem in areas like balance of payments, fiscal deficits, inflation or debt
payments.

9
Economy trapped by continued
political instability
The economic recovery is subject to political stability and an environment
conducive to investment and doing business. The Pakistani economy is trapped by
the political scenario and deteriorating law and order in the country. This is
primarily because of the decision from the SC to disqualify the central leadership
of PML (N), Sharif brothers, from taking part in elections by the SC and
imposition of governor’s rule in the largest province of the country by the
president. Furthermore, the attacks made my militants on the Sri Lankan cricket
team in Lahore on 3rd March, 09 has brought the economy in the line of a cross
fire. The damage is two-fold: further erosion in the confidence of investors,
particularly foreign investors, and the government’s inability to resolve political
conflicts and disorder in economic activities.
All this does not auger well for the economy. An economic recovery is subject to
political stability and environment conducive for investment and doing business.
Their political scenario defies both the requisites. Immediate effects of the political
turmoil were visible in the fall of KES 100-share Index by 4.0 per cent with a scare
among foreign and domestic investors. Terrorism coupled with political instability
would create bleak chances of early economic revival; therefore the country might
not be able to meet even the IMF (International Monetary Fund) targets, which
will bring the whole situation back to square one.
Implications of political instability
Pakistan embraced the free market economy regime in the early 90s and has been
managing it since then within the framework of the American model of capitalism,
with substantial support from the IMF, WB (World Bank) and the ADB (Asian
Development Bank) in the form of technical advice and credit inflows. Since 9/11
they have been over enthusiastic to help Pakistan to build a robust economy
because of its strategic geographical location and its commitment to the war
against terrorism, which is now being fought on the country’s soil. Since the 90s
the country has traversed a long way towards building a free market economy by

10
taking concrete measures such as privatization of public assets, encouragement of
private investment and strengthening the corporate sector through various fiscal,
monetary and governance measures. Yet, it did not reap the benefits as did some of
the far eastern economies which have various different reasons. Two of them are,
however, conspicuous in different timeframes. During the 90s it was political
instability that obstructed economic growth that averaged to around 3.5 per cent
instead of higher and sustainable economic growth. After the governments change
in 1999, it was political stability, till 2007 sans the vision to structure the economy
on sound economic fundamentals. The economy posted a high economic growth of
more than 7.0 per cent between 2002 and 2007 but it hardly developed capacity to
absorb internal and external shocks for a sustainable high economic growth.
The year 2008 came like a storm with internal and external shocks for the
economy that exposed its weaknesses to the hilt. Fiscal and monetary gains made
during past seven years were lost in the shortest possible time of hardly one year.
Fiscal issues pertaining to fiscal and current account deficits along with monetary
issues of high interest rates on commercial loans, FX reserves, managing high cost
of imports and trade deficit and reducing aggregate demand in the midst of
indiscrete consumer financing emerged as an extremely delicate issue. From 2007
onwards illusive political stability had started giving in to political instability
because of two factors, fully involving the country in the war against terrorism
over a period of six years that fuelled militancy in the country, and the ill
conceived decision on 9 March, 2007 of sacking the sitting chief justice of
Pakistan by the then president for reasons of political expedient.
Political instability coupled with hike in oil and food prices in international market
that touched the highest by mid-2008 and ill conceived expansionary fiscal policy
particularly from November 2007 onwards, quickly eroded macroeconomic
stability that rested on certain illusive parameters like a strong external financial
sector mostly supported by remittances, proceeds of privatization, credit inflows
and lessening of the foreign debt recovery, this was because of rescheduling of
foreign debt of $12.5 billion by the donor countries and agencies. The view point
was that if there had been political stability in the country during 2007 and 2008,
the economy despite some structural flaws would have withstood the pressure of
hiked prices of oil and food in the international market. Perhaps, the government

11
too would have not resorted to indiscrete expansionary fiscal policy out of sheer
expediency.
The newly installed government inherited a troubled economy. It had a number of
fiscal and monetary issues to resolve on priority basis. Political stability was sine
qua none for it but ironically this little hard fact did not go well with the two
largest political parties that formed a coalition government at the center, which
lasted hardly a few months. Collapse of the coalition, was the first sign for the
beginning of chronic political instability, it created many doubts in the minds of
business communities. The IMF stepped in November, 2008 to help by injecting
$7.6 billion within 18 months with an initial credit of $3.1 billion in November,
2008. And a number of friendly countries expressed the will to help Pakistan to
overcome the economic crisis. The current political crisis must have raised many
questions among donor and friendly countries about the usefulness of the financial
assistance to a country that is not showing the maturity and ability to put its own
house in order. Wrong signals must have also been sent to foreign investors who
invested more than $2.588 billion during the first seven months of the current
fiscal year, 1.3 per cent higher than the corresponding period of the last fiscal year.
State of economy
The current state of the economy, not withstanding assertion by the government
which is on the road to revival, has a long way to go before it is stable enough to
stand at its own or meet IMF conditionalities. The few points which are of real
concern, which can be addressed only if there is political conflict, resolution and
improvement in the law and order of the country. Theses points are: stubborn
inflation, FX reserves, LSM (large scale manufacturing) and liquidity crunch in the
real estate business. Furthermore, inflation continues to remain stubborn, the SPI
(sensitive price index) recorded an increase of 0.6 per cent to 24.49 per cent for the
week ending on 26 February 09, over the previous week. Food inflation was
pushed up during the second consecutive week, according FBS (Federal Bureau of
Statistics). The core inflation also remained stubborn at around 18.5 per cent. It is
feared that if the current trend in prices persisted it might become difficult to
achieve the target of reducing inflation to 12.0 per cent by the end of the current
fiscal year. The IMF might track back from its inclination of reducing high interest
rate during first economic review held in mid-February, 09.
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The FX reserves have been hovering a little over $10.0 billion since the injection
of inflows from foreign sources like the IMF, WB, ADB, the US, and China. The
government in November 2008 had expressed optimism that with the financial
assistance of friendly countries it would be possible to increase FX reserves to
around $14.0 billion by the end of the current fiscal year. Estimated projection is
unlikely to materialize unless IMF obliges the government to meet its new request,
likely to be made in March for yet another injection of $4.5 billion to meet FX
needs by the end of current fiscal year. Trade deficit has already touched $11.62
billion mark by the end of first eight months of the current fiscal year. An
ambitious programme of privatization for the remaining national assets is on hold
because of domestic political turmoil and violence and liquidity crunch in
international and domestic market.
LSM in general and textile industry in particular have registered negative growth
(the former has registered a negative growth of 5.6 per cent during first five
months of current fiscal year compared to 6.90 per cent growth during
corresponding period of last fiscal year) during first eight months of current fiscal
year compared to the corresponding period of last fiscal year. It has resulted in
laying-off of around one-third work force creating more unemployment. Brokerage
houses have laid-off around work force of around 2000 out of 10000 during past a
few months.
Similarly, slide in real estate and construction business has forced lay-off a large
number of unskilled and semi-skilled work force in the country with the result that
poverty is on the increase. Trend to lay-off workforce is on the increase because of
economic crisis that could worsen further because of political turmoil. One simply
can’t be complacent to state that economic meltdown is a global phenomenon and
there is not much that can be done in these circumstances. The argument will hold
partially but a lot can be done provided political stability is the first priority of
political role players and the government alike.

Conclusion
A shaky economic recovery being executed by managers of the national economy
mostly on borrowed money has got a sever jolt from the recent political crisis and

13
militants attacks. Its cost is enormous in terms of the confidence in business
communities, the government and political leadership, a further loss of confidence
of foreign investors. It is high time for political rivals to sit together to provide
political stability for economic recovery which will not be on track even with the
assistance of IMF, WB, ADB and the Friends of Pakistan.

Political instability has hit Pakistan

economy: WTO
The World Trade Organization (WTO) has noted that political instability and weak
governance have had an adverse effect on Pakistan's economy along with
structural problems such as direct State intervention and protectionist policies.
While stressing the importance of continuing the country's Comprehensive
Economic Revival Programme, it said that the economic slowdown of the last
seven years had social consequences and led to a rise in incidence of poverty.
In a report on trade policies and practices of Pakistan, the WTO secretariat pointed
out that with population growing, the country's real GDP per capita dropped
gradually below its early 1990s level. Nearly one third of the population,
especially in rural areas, was below the poverty line compared with one-fifth a
decade ago.
On the brighter side, the report says there are signs that the economy may be
improving including a rise in the local stock market. These developments are
perhaps partly due to the perceived improvement in Pakistan's prospects of
obtaining substantial debt relief from its international creditors. Such relief will
reduce the cost of servicing the country's large foreign debt. This will also help to
tackle the current fiscal imbalance and provide more scope for the Government to
deal with social problems and the presence of three million refugees.
Significantly, the report does not dwell much on the impact of refugees from
Afghanistan and the consequent problems faced by the Pakistan economy. There is
also no comment on Pakistan not providing most favored nation status to India as
is mandated under WTO rules.
In fact, the report says ``Pakistan's trade policies have been based on the principles
of multilateralism and non- discrimination''. As for Pakistan's role in the SAARC
14
Preferential Trading Arrangements (SAPTA), it observes that its commitments
have remained ``limited''. This is attributed to concern about proliferation of
regional trade agreements and initiatives.
The WTO report emphasizes that Pakistan's long-term economic growth depends
largely on the continued implementation of the revival programme especially in
reduction of direct State intervention in the economy and improvements in the tax
base. This is also dependent on Pakistan's success in diversifying its exports which
in turn depend on its trading willingness to keep markets open despite the present
global economic slowdown.
Referring to the fiscal imbalance in the South Asian country's economy, the report
says net public debt reached an estimated 92.6 per cent of GDP in 2000-01, of
which over half involves external liabilities.
It notes that economic growth in the country has moderated relative to that in the
period prior to the last trade policy review in 1995. After accelerating in 1993-96,
real GDP growth fell from five per cent in 1995-96 to 1.2 per cent in 1996-97 and
1997-98 and has since fluctuated around four per cent.
Natural factors including a severe drought, financial imbalances, especially fiscal
and structural weaknesses, are cited as important elements in this reduced
economic performance.
Trade policy reviews are an exercise mandated in the WTO agreements in which
member countries' trade and related policies are examined and evaluated at regular
intervals. For the review, the WTO secretariat prepares a detailed report while a
policy statement is submitted by the member country concerned.

Gulf War II: India may not take a

direct hit
THE reverberations of Gulf War II are sure to be felt on the Indian economy
sooner than later. While the war does have the potential to bring about far-reaching
structural changes in the world economy (like the emergence of newer trading
blocs) and significantly affect certain sectors (such as construction and healthcare
services), the impact will be most on oil economics, especially of India. What
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would be the impact of war-impacted oil prices on India's import bill, inflation,
industry and interest rates?
India's economic concerns arising of out Gulf War II are understandable, given the
country's experiences of Gulf War I (1991). However, the two situations are not
strictly comparable, insofar as the macro-economic conditions then and now.
Macro-economic situation in 1991...
During the 1980s rose the specter of fiscal deficit and it quickly worsened through
the decade. As the Government resorted to borrowing to finance this deficit, the
consequent interest liability exerted a further upward pressure on the deficit. With
macro-economic imbalances worsening through the decade, the Gulf War of 1991
was the last straw that precipitated a balance of payments crisis. In terms of macro-
economic imbalances, in 1990-91, India's current account deficit had touched 3 per
cent of its gross domestic product (GDP). Besides, the foreign exchange reserves
had dipped to less than $1 billion (adequate for less than a month's imports), the
external debt service ratio was 35 per cent, and the annual rate of inflation had
ballooned to 17 per cent.
... And in 2003
In contrast, the macro-economic conditions in 2002-03 are largely favorable. The
foreign exchange reserves are now at a record high $75 billion (adequate for 15
months imports), the current account is in surplus, the external debt service ratio is
14.1 per cent, and the annual rate of inflation is at 5.6 per cent. Clearly, the Indian
economy is now more resilient, than in 1991, to absorb the impact of a war.
Impact on India's oil economics
While Gulf War II has raised fears of an imminent rise in oil prices, it may not
happen if the war is not long drawn. Also, in January, the total spare capacity (for
crude production) of the Organization of Petroleum Exporting Countries (OPEC)
was as much as 2.3 million barrels per day (excluding Venezuela and Iraq). This
indicates that there is sufficient scope to increase the supply of oil in the market, if
required. Further, oil prices are seasonal; they tend to be slightly higher in winter
as the demand for oil (mainly for heating purposes) is heavy in the West.
Interestingly, a day after the war broke out, oil prices actually declined, though
they have been inching up since.
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The next question is whether a possible increase in oil supply can be sustained if
the war is long drawn out. Recent production estimates suggest that though
production by OPEC could rise quickly by 2.5-3 million barrels per day, increases
over this level would be difficult to obtain. However, given that there is excess
supply in the market now, only a prolonged conflict would exert an upward
pressure on oil prices. As for the possible impact of a sharp rise in oil prices on
India's oil import bill, estimates shows that for a 1 per cent increase in oil prices,
India's oil import bill will go up by $100-150 million. But such an increase should
be manageable, given India's large foreign exchange reserves.
One way to cushion the impact of an "oil price shock" is to set up strategic
petroleum reserves. In this regard, the Government of India has already announced
its intention to set up a 45-day reserve. This may, however, appear slightly
inadequate, given the OECD's reserves of 90 days' net imports and the EU's 90
days' domestic consumption.
Oil prices and inflation
In the event of a war-impacted rise in crude prices, the current level of inflation in
India at 5.6 per cent may be expected to climb up, given that domestic oil prices
are now linked directly to global prices. Currently, the oil group has a weight of
14.2 per cent in the domestic price index, and hence a 1 per cent increase in oil
prices would push up the index by 0.14 per cent, on a direct and indirect basis.

17
... And industry
As for the domestic industry, the aviation sector would be hit the hardest by any
increase in oil prices (domestic air fares have already been raised). Air-India and
Indian Airlines may also have to pay a higher insurance cover for flying over the
war-affected areas.
... And interest rates
In case the current level of annual inflation is pushed beyond 5.6 per cent by an
increase in oil prices, there would be upward pressure on the interest rates. Also,
notwithstanding the comfortable $75-billion foreign exchange reserves, any
disturbances in the Forex market can find its echo in the money market (that is, the
interest rates may be pushed up by the Reserve Bank of India). However, the
impact of international events on interest rates is likely to be countered by the
general elections (and polls in some States in late 2003) in 2004; elections usually
prompt the Government to go soft on interest rates. Overall, the prevailing
economic conditions in India do have the potential to cushion much of the possible
adverse consequences of Gulf War II, at least in the short term. But if the conflict
lingers on, a blend of newer political and economic considerations — which are
difficult to predict at the moment — would have to be factored into any impact
analysis.

Political instability adds to business

risk

Iran became the number one country in terms of risk concern for business after the
disputed re-election of president Mahmud Ahmadinejad led to violent protests and
fears of political meltdown.

18
According to a monthly survey of the users of Control Risks’ who comprise more
than two thirds of the Fortune 500, interest in Iran surged between May and June.
Before the elections in May the country received only 718 hits on CRF, but this
rose to 5,495 in June, 30 per cent more than received by May’s top country.
The oil and gas sector is likely to be affected by the most significant outbreak of
political instability the country has seen since the early 1980s because it provides
further ammunition for those who have supported additional sanctions against Iran
since the deterioration in Iranian relations with the west in Ahmadinejad first term.
The post-elections unrest attracted even greater interest for a variety of reasons,
ranging from concerns about the safety of travel to the country to questions about
its implications for US President Barack Obama’s plans to attempt to engage Iran
diplomatically and the prospects for the stability or even survival of the regime,
given apparent serious rifts within the political establishment itself over the
election.
China maintained its position at fifth but attracted nearly 30 per cent more hits as a
result of the arrests of four Rio Tinto employees and unrest among Uighur
separatists, which raised new questions about the business climate. The detention
of the Rio Tinto employees was followed by the arrest of a senior executive of
local steelmaker the Shougang Group. This kind of event prompts debate about the
rule of law and the extent to which lines are blurred between the business sphere
and the realms of politics, national interest and security. Information around the
cases remains scarce but some in the business community fear they could
constitute a warning to foreign companies’ employees and will be watching for a
pattern of more aggressive tactics in dealings with foreign companies. Meanwhile,
the eruption of violence between Han and Uighur ethnic groups in Guangdong and
Xinjiang was bloody but should represent a minor concern for most businesses.
Peru and Yemen rose up the risk agenda to enter the top ten in June. Interest in the
former was sparked by the demonstrations in the Amazon region of the country
that turned violent on 7 June, with clashes between demonstrators and the security
forces leaving at least 31 dead, including 22 policemen. The country has
experienced a serious increase in incidents of social unrest over the last two years,
with 238 social conflicts reported in March 2009, up 20 from the previous month

19
and just over 50 in August 2007. However, most cases had passed off peacefully,
which highlights the impact of the violence.
Again the oil and gas sector stands to feel the impact, since exploration in the
country has increased considerably over the last two years, with some of these
operations falling in environmentally sensitive areas or close to indigenous
communities, which has led local activists and domestic and international non-
governmental organizations to increase their monitoring of developments.
Growing instability in Yemen, significant for its liquefied natural gas reserves, has
prompted speculation that a ‘perfect storm’ of risks will result in the state’s
collapse. The spike in hits this month was driven by the murder of three foreign
women shortly after they were taken hostage in the north of the country. Tribal
kidnaps of foreigners are common but victims have almost always been treated as
honored guests and released after a short period in captivity.

Political instability and economic

growth
India is going through a period of not just political uncertainty, but economic
instability as well. But are the two connected? Prime Minister Manmohan Singh
made a prestige issue of clinching the nuclear agreement with the US in the teeth
of opposition from the Left, at the risk of shortening the term of his government.
At the same time, inflation, as measured by the official wholesale price index, had
exceeded 11% after a gap of thirteen years, interest rates were hardening, and oil
prices the world over had touched record highs.
Politics and economics are often sought to be separated. But the two disciplines are
intimately interlinked. Yes, politics intrudes into every household, in power
relations between spouses and among siblings. So does economics, by determining
what individuals eat and how they live. To return to the questions formulated
earlier: Is there a connection between the country going through political turmoil
and economic upheaval? Or is it just a coincidence? While it is true that political
stability is invariably welcomed by industrialists, it is also correct that political

20
uncertainty is not necessarily accompanied by a slowing down of economic
growth.
India is by no means unique among democratic nations in having coalition
governments. This country has borrowed and adapted from the United Kingdom a
form of democracy often called ‘first-past-the-post, winner-takes-all,’ which has its
own set of advantages and disadvantages. In France, which has a system of
proportional representation, and in Germany, which has a combination of
proportional representation and constituency or seat based direct elections,
coalition governments have been more a rule than an exception after the
conclusion of the Second World War in 1945. In both these countries, coalition
governments have not usually brought about political instability.
For instance, there is in Germany a legal provision that an incumbent government
cannot be voted out of power without simultaneously voting in an alternative
government in between general elections. In recent years, for obvious reasons,
many have suggested that India could adopt a similar system to avoid frequent
elections that are expensive to conduct. Those opposed to this suggestion have
argued that even if political instability results in frequent elections having to be
conducted, this is a ‘small price’ to pay to ensure the existence of a vibrant and
dynamic democratic polity. These arguments and counter-arguments came to the
fore in discussions on Indian politics for the simple reason that between May 1996
and October 1999, the country for the first time witnessed three general elections
in quick succession.
If the experience of countries like Germany and France shows that coalitions and
instability do not necessarily go together, Japan and Italy are proof of the fact that
even unstable coalition governments do not automatically result in declining
economic progress. Japan has had a series of coalition governments since 1976,
when the Liberal Democratic Party lost its monopoly on power for the first time
after the Second World War. That certainly did not prevent Japan from marching
swiftly ahead of most of the world to become arguably the strongest economy in
the world after the US, till the slowdown of the 1990s robbed it of some of the
sheen.

21
The Italian experience is even more remarkable. In the 50 years since the World
War ended, Italy had an equal number of governments. Thus, governments in Italy
lasted on average barely a year. Yet, Italy today is among the most industrialized
countries in the world. This, if nothing else, should make us wary about drawing
any facile conclusions about the effects of political instability on the economy.
In India, the country’s gross domestic product grew by more than 7% a year, two
years in a row, for the first time during a period of considerable political
instability: GDP went up by 7.3% in 1995-96 and by 8% in 1996-97. Between
April 2005 and March 2008, for the first time in the more than the six-decade-long
history of independent India, the country’s GDP grew by an average of over 9%
each year, three years in succession. The structure of the country’s polity was as
stable or as unstable as it is at present, the difference being that the next general
elections are scheduled to take place on or before April 2009. The months before
any election comprise a period of political acrimony. The situation is no different
this time round.
The final point that needs to be made relates to economic growth itself. An
economy can grow fast but the fruits of this growth can be unevenly distributed
and benefit only a small section of the population. Economic growth has to be
inclusive if it is to yield political dividends. Jobless growth is politically disastrous.

Instability in EMs to benefit India

India is set to benefit from political and security instability in other key emerging
markets during the course of the year, according to the international business risk
consultancy, Control Risks. In Risk map 2008, its annual study of levels of global,
political and security risks, Control Risks rates 57 per cent of emerging markets at
Medium political risk or above, indicating significant threats to foreign investment.
India is rated at Low political risk. Control Risks, which is an independent,
specialist risk consultancy founded in 1975, provides advice and services that
enable companies, governments and international organizations to accelerate
opportunities and manage strategic and operational risks. In many cases, trends
towards economic nationalism, a retreat to authoritarianism and reform fatigue are
prompting concerns that politics will increasingly impinge on investment
22
decisions. Investments in countries as wide ranging as Russia, Pakistan, Nigeria
and Ecuador, could be at increased risk. By contrast, Control Risks believes that
political maneuvering in India ahead of early elections in 2008 will have only a
superficial impact on the business environment and will not check the overall pace
and direction of economic reform It foresees continued strong economic growth,
but voices concerns about the state’s inability to suppress Naxalite and tribal
violence in the mineral-rich eastern states where many foreign mining companies
are eyeing opportunities Commercial exploitation of these areas is problematic,
and MNCs need to fully appreciate the political, security and social complexities
involved,” said Steve Wilford, Control Risks country manager for India. Given
their importance in relation to natural resources and manufacturing, the fact that 60
per cent of emerging markets are rated, in whole or in part, at medium, high or
extreme security risk should also be of concern to investors.

Economic and Political Impact of the

Iraq War on Asia (Japan, China and
India)
The war in Iraq would impact the key players in Asia as much as any other major
economy. Asian economies account for about 25% of US$31.5 trillion World
GDP and clearly they are one of the major players in the global market place. Prior
to the war, the uncertainty was when the war was going to start, and that was being
factored into the markets including the oil market. Now the market sentiment is
centered on when the war is going to end. This kind of uncertainty continues to
discourage consumers and investors to undertake their planned expenditure at this
time.

What are the channels of transmission of this kind of shock to the economy?

Essentially there are two kinds of impacts. The direct or first order impacts of this
shock will be the same as what happened in the last Gulf war. In the last Gulf war,
oil prices increased sharply – a concern to all the oil-importing countries, equity
23
prices fell sharply, both business- and consumer-confidence were hit as a result of
the uncertainty that in turn depressed capital markets and slowed down economic
growth. Besides, certain sectors also suffered particularly badly including tourism
and aviation industry. The combination of higher oil-prices, weaker confidence
and lower equity prices therefore contributed to slower growth, in the aftermath of
the last Gulf War. We have already seen the similar kind of impact so far in this
Gulf War: the oil price has jumped to its highest level since the last Gulf War. New
records could be broken in the course of this war, if oil supplies are substantially
reduced into the medium or long term. Besides, there is one direct positive impact
that could come from higher defense spending which can offset a part of the
negative knock-on effects and stimulate economic growth. But that cannot be
significant relative to the negative effects.

The second order impact would depend on the outcome of the war and whether the
war achieves its objective of getting rid of weapons of mass destruction and regime
change in Iraq. There are obviously negative impacts of any war. If the war
escalates into a large-scale prolonged conflict, it carries the risk of putting the
global economy in depression. For example, prior to the last Gulf War, the US and
other economies were already weak but the war pushed these economies into
recession. This time since the global economy is already weak; a long-term
uncertainty as a consequence of a prolonged conflict could create a similar
recession.

How the policy makers should respond to this kind of negative shock? In terms of
monetary policy, there is little room for additional easing in the US, as the Fed
funds rate is already at its record low level. Japan being in a deflation trap has little
scope for additional monetary and fiscal stimulus to offset any negative economic
impact of the war. But in the Euro zone given the currency appreciation, and in the
UK, there is some room for further policy easing to counteract any negative shock
coming out of the war.

War is usually understood to be a temporary phenomenon, but the efforts to deal

with terrorism has been more of a long-term one since the 9/11 event erupted. This
24
long- term nature of this war adds huge amount of uncertainty into economic
behavior that suggests a more faltering global economy. Even before 9/11, the
global economy was slowing down since the technology bubble burst in March
2000. Now it is already in recession, although not in a technical sense, with highly
volatile consumer and business confidence.

Higher oil prices will certainly intensify the problem. Japan, China and India are
no exception, since all the three countries are oil importing-countries and they are
mainly dependent on the Middle East for their oil supply. China is the world’s
third- largest consumer of crude, after the US and Japan. It imports one-third of its
oil requirements, 60 percent of which comes from the Middle East. With regard to
the long-term impact on oil prices, it would depend on how badly the oil
infrastructure gets damaged in any kind of extended war and to what extent the oil
supply gets squeezed.

In the short term, this uncertainty in the Middle East will make the oil prices
volatile, but a long-term rise in oil prices is more likely to cut global economic
growth. So the long-term strategy then should be to diversify the source of oil
supply rather than relying heavily on the Middle East. For example, China is
already looking to diversify including Russia as a source of its supply. It is always
a good strategy to diversify, no matter whether it is with regard to the export
markets or the sources of foreign investment or the foreign exchange earnings such
as tourism. Over-dependence on any one source is risky.

In terms of growth effects, despite this negative shock, China and India are more
likely to outperform all of their neighbors. Both are very different economies in the
world. One common characteristic of those two economies is their strong domestic
demand. Although China has been relying on an export-led development strategy
recently, still domestic demand remains quite robust supporting growth.

For India, one major source of foreign exchange comes from non-resident deposits
and, private transfers by Indian residents working abroad, particularly in the
Middle East. If the war spreads beyond Iraq, it is possible that this source of

25
inflows could dry up as it happened in the last Gulf war that aggravated India’s
balance of payments problem giving rise to a crisis in July 1991, although severe
fiscal and external imbalances were the main reason. At that time India just had
under US$4 billion, which is currently over US$74 billion. So India is not likely
to encounter such a crisis this time.

Outside investor confidence is crucial for the capital flow to both China and India,
given the economic arbitrage. For example, although in general China could be a
risky market, the reality is that foreign direct investments have increased over 50%
year-on-year in the first two months of this year at a time when there was a huge
risk of war. This could partly suggest China as a safe heaven at a time of
uncertainty.

In terms of exchange rate effects, China actually benefits from this war uncertainty
in the sense that Chinese Yuan being pegged to the US dollar becomes more
competitive in line with the falling dollar, while Japan is being hit hard by the
dollar weakness that makes the Yen less competitive.

To sum up, there can be three scenarios.

Pessimistic (war goes badly): if the cost of war turns out to be much greater than
anticipated and the West does not find weapons of mass destruction. This would
suggest that there could be continuing global instability with regional
consequences and the recession could get deeper.

The longer the war goes, the more destructive it becomes. In addition, Saddam
Hussein’s best chance of survival is to escalate the conflict beyond Iraq, possibly
by attacking Israel or by portraying the war as an attack on Islam rather than on his
regime.

Intermediate: if war goes well (victory but with significant cost), which means
that the extent of disruption to oil-supply stays within control, and the global
economy gets a boost. Money in the frozen accounts and annual oil revenues of
US$20 billion can be used to rebuild Iraq.
26
Optimistic: if war goes very well (victory with a contained war). This scenario
suggests that the West finds weapons of mass destruction, reinforcing their
rationale for the war. There is a perception that the next move could be after Iran
or North Korea. If something like that happens, we would continue to live in a
world of long- term uncertainty and that in turn would keep the markets range-
bound. Settlement of the Iraq crisis could, by removing ‘geopolitical uncertainties’,
give the global economy time to recover.

The Impact of Government Policies on

Business
Once upon a time economists thought government policies has no impact on
business. But after the great depression it has proved that government policies
have a direct impact on business. For example if government impose more taxes &
duties on a particular sector than profit margin of this sector will go down even
businessmen can lose their interest to this sector and they can give up this
business. Similarly if government give some taxation / duty facilities for any
particular sector then businessmen will fell encourage investing in this sector as a
result this sector will grow up. Not only this, if government ensure availability of
loan with a reasonable interest though the monetary policy of the central bank than
investment will go up and vice versa.

Similarly current world order has a tremendous impact on a country's business. It

may be legal or illegal. For example USA manipulates UN to impose sections on
Iraq illegally. But this section destroyed Iraqi business environment. They lost
billions of dollars business even their deposited money in the USA & its alliance.
Now USA is the world leader as a result there is no country in the world that can
do successful international business without having a good relations with USA. In
this case Iran may be another good example. USA is trying to impose section on
Iran also. Their propaganda may be wrong like the propagandas against Iraqi
Saddam Hosen government. There is no balance of power in the world now. By
taking this chance USA in destroying huge resources of their competitors countries
or the countries are not giving them their expected illegal salute.
27
The Impact of Government Policy on Business can be explaining from two points
of views. Such as:

i. From Political point of view.

ii. From Technical point of view.

i. If we describe the impact of government policies on business from political pint

of views then we will have to think about inland political parties (ideologies) as
well as world politics. Because international business never depends upon any
particular government's policy it depends on the local as well as world order. We
will discuss it elaborately later.

ii. If we describe the mater from technical points of views then we will have to
consider the following things:
“taxation
“subsidies
“interest rates
“exchange rates
“public-private partnerships.

How businesses are affected by

government policy
Governments create the rules and frameworks in which businesses are able to
compete against each other. From time to time the government will change these
rules and frameworks forcing businesses to change the way they operate. Business
is thus keenly affected by government policy. Key areas of government policy that
affect business are:
Economic policy
A key area of government economic policy is the role that the government gives to
the state in the economy. Between 1945 and 1979 the government increasingly

28
interfered in the economy by creating state run industries which usually took the
form of public corporations. However, from 1979 onwards we saw an era of
privatization in which industries were sold off to private shareholders to create a
more competitive business environment.
Taxation policy affects business costs. For example, a rise in corporation tax (on
business profits) has the same effect as an increase in costs. Businesses can pass
some of this tax on to consumers in higher prices, but it will also affect the bottom
line. Other business taxes are environmental taxes (e.g. landfill tax), and VAT
(value added tax). VAT is actually passed down the line to the final consumer but
the administration of the VAT system is a cost for business.
Another area of economic policy relates to interest rates. In this country the level
of interest rates is determined by a government appointed group - the Monetary
Policy Committee which meets every month. A rise in interest rates raises the costs
to business of borrowing money, and also causes consumers to reduce expenditure
(leading to a fall in business sales). .

Government spending policy also affects business. For example, if the government
spends more on schools, this will increase the income of businesses that supply
schools with books, equipment etc. .

Government also provides subsidies for some business activity - e.g. an

employment subsidy to take on the long-term unemployed.

Legal changes
The government of the day regularly changes laws in line with its political
policies. As a result businesses continually have to respond to changes in the legal
framework.
Examples of legal changes include:
i. the creation of a National Minimum Wage which has recently been extended to
under-18.

ii. The requirement for businesses to cater for disabled people, by building ramps

29
into offices, shops etc.

iii. Providing increasingly tighter protection for consumers to protect them against
unscrupulous business practice.

iv. Creating tighter rules on what constitutes fair competition between businesses.

Today British business is increasingly affected by European Union (EU)

regulations and directives as well as national laws and requirements.

Political factors play key role in trade

decisions
Protection to domestic industry is never given on the basis of economic reasons
alone. It is becoming clear that nomenclatures such as developed, developing and
least developed need to be redefined.

FOR A FAIR TRADE: Trade ministers at the Hong Kong ministerial

conference during December 13-18.
EVEN AFTER a week since the Hong Kong ministerial meet under the WTO
ended, there has been no unanimous verdict on the outcomes. Official Indian
negotiators who are coming back home are either claiming success or at the least
not admitting outright failure. This is only to be expected.
30
Trade negotiations have more to do with politics than economics. For a start, at
international forums, negotiations are presumed to be effectively conducted when a
country identifies itself with and lobbies on behalf of a sub-group with which it has
a commonality of interests. Recent experiences of India and other developing
countries at WTO bear this out.
Welcome solidarity
Those developing countries were able to forge groupings such as G-20, G-33 and
the much larger G-110 has been considered an achievement at Hong Kong. What
is of greater relevance is the fact that these groupings seem to have held in the face
of some intense negotiations and counter proposals from the developed countries.
The outcome of the agricultural negotiations is a prime example. The EU finally
agreed to do away export subsidies on agricultural products by 2013 thereby
contributing to the most visible result.
Safeguard for farm sector
Reportedly India and Brazil, two large countries deeply involved in agricultural
issues, led the discussions on behalf of all developing countries. Again in
agricultural trade, developing countries were able to ensure that a mechanism will
be created to counter low priced agro-imports that can hurt the interests of their
farmers. This major safeguard could not have been institutionalized but for the
widespread support from many other countries besides India acting as a bloc.
Again, developing countries won an important concession in being allowed to
reduce tariffs on industrial goods less than the developed countries. This principle
of less than full reciprocity in NAMA (non-agricultural market access) is a positive
outcome made possible by some group work.
While group-based approaches have worked, clearly they are not the panacea in all
the cases. Much before Hong Kong it was realized that there were more
differences within each group than was conventionally believed. India has been a
major proponent of opening up of services. Some other developing countries did
not share its enthusiasm. And in agricultural negotiations, the E.U. and the U.S.
had major differences over the modalities of reducing subsidies.
Besides, it is becoming clear that the nomenclatures — developing, developed and
least developed — need to be constantly redefined. In some respects India may

31
already have the characteristics of a developed country. Its strengths in IT area and
in research and development are evidently more relevant to the U.S. and the E.U.:
India gets much of the outsourced business from them.
In trade negotiations especially, it is important to recognize and leverage the
known strengths and not be carried away by emotional attachments of the past.
More evidence of political factors influencing trade decisions is to be found in the
structure of multilateral trade negotiations. In almost all countries politicians have
to carry key, well-entrenched, domestic constituencies with them before they
negotiate abroad for freer trade. Protection to domestic industry or services is
never given on the basis of economic reasons alone.
It follows that a successful outcome at the WTO, implying freer trade, will
definitely affect one special interest group or the other. That is why politicians
negotiating trade deals have the unenviable task of having to defend their actions
against concerted opposition in specific fields without being able to prove that the
trade pact is for the common, larger good.
Apart from these are the issues connected with the time frame. Most decisions,
such as those in the ministerial text, will be implemented after a long time. In most
democracies, the political horizon cannot possibly stretch beyond five years or so,
hence any talk of abolition of export subsidies for agriculture in 2013 —four years
from now — sounds so far into the future as to be of only academic interest (which
it most certainly is not). Benefits, if any, from the abolition of subsidies on
agricultural products will not be reaped by the present generation of politicians.
This also partly explains why the more difficult portions of the trade agenda have
been shelved into the future instead of being taken up now. These will not become
easier to tackle with the efflux of time but the political costs are such that it is
more expedient to proceed slowly.

Effect of Diplomatic Events on the

Business
1. Nuclear tests by India and Pakistan

32
Parliamentary elections in India resulted in the March inauguration of a coalition
government dominated by the Bhartiya Janta Party, and the National Agenda for
Governance was announced, which referred to reviewing India's nuclear policy
and exercising the option of introducing nuclear weapons. Neighboring Pakistan,
on the other hand, conducted a trial launch of an intermediate-range Ghauri missile
on 6 April. Concerned over the heightening tension in South Asia, Prime Minister
Ryutaro Hashimoto sent a letter to Indian Prime Minister Atal Bihari Vajpayee,
calling for India's prudence in regard to its nuclear policy, while the Pakistani
Government was also requested to refrain from any missile or nuclear
development. However, India went ahead with two nuclear tests on 11 and 13 May
respectively.
In the wake of India's nuclear tests, domestic pressure rose in Pakistan to conduct
similar tests. Despite the critical stance taken by the entire international
community toward India's nuclear tests, as shown in the G8 Joint Communiqué
issued at the Birmingham Summit of the Eight on 16 May, and such diplomatic
efforts as Japan's dispatch of a special envoy of the Prime Minister to urge
Pakistan to exercise self-restraint over nuclear testing, Pakistan conducted two
nuclear tests on 28 and 30 May respectively.
The nuclear tests by those two countries not only negatively affected the peace and
stability of the South Asian region, but also posed a serious challenge to the
international nuclear non-proliferation regime centered around the Nuclear Non-
Proliferation Treaty (NPT) and the Comprehensive Nuclear Test Ban Treaty
(CTBT), running counter to those international efforts for nuclear disarmament
toward a world without nuclear weapons. Japan conveyed its position to India and
Pakistan: namely, that it viewed both countries' nuclear tests as intolerable, as well
as regrettable, and therefore was adopting stringent measures such as the
suspension of new grants (excluding emergency and humanitarian assistance and
grassroots grants) and new yen loans.
As for the international forum, the Permanent 5 (P5) Foreign Ministers' Meeting
held in Geneva on 4 June issued a Joint Communiqué. United Nations Security
Council Resolution 1172 (proposed jointly by Japan and a number of other
members) was adopted on 6 June, and a Joint Statement was adopted on 12 June at
the G8 Foreign Ministers' Meeting held in London. This string of declarations and

33
resolutions enumerated the benchmarks the international community was
requesting that both India and Pakistan fulfill, such as the suspension of further
nuclear tests and the adherence to the CTBT by both countries.
In addition, as Japan's initiative, Foreign Minister Keizo Obuchi proposed at the
above-mentioned G8 Foreign Ministers' Meeting that a task-force be established to
review the efforts by India and Pakistan with regard to the nuclear non-
proliferation regime and also to consider concrete measures for relieving tensions
and confidence-building between the two countries. This task-force met twice in
London. The Tokyo Forum on Nuclear Non-Proliferation and Nuclear
Disarmament was also held in Tokyo in late August, with the second forum in
December in Hiroshima, both jointly hosted by the Japan Institute of International
Affairs and the Hiroshima Peace Institute, with the aim of issuing
recommendations on nuclear non-proliferation and nuclear disarmament by key
intellectuals participating from Japan and abroad.
In response to these moves by the international community, India and Pakistan
seemingly changed their stance on nuclear non-proliferation in the desired
direction, with Prime Minister Nawaz Sharif of Pakistan announcing in his general
address at the UN General Assembly in September the intention to adhere to the
CTBT before September 1999, while comments by Prime Minister Vajpayee of
India also suggested a forward-looking approach to the conclusion of the CTBT. In
addition, both countries announced their intention to participate in the negotiations
on the Fissile Material Cut-Off Treaty.
Japan also stressed dialogues with both countries, and State Secretary for Foreign
Affairs Masahiko Komura thus met with Deputy Chairman of the Planning
Commission of India Jaswant Singh during the Ministerial Meeting of the ASEAN
Regional Forum (ARF) at the end of July. Foreign Minister Komura subsequently
held talks with Foreign Minister S. Aziz of Pakistan during the United Nations
General Assembly in September, and when Foreign Minister Aziz met with
Foreign Minister Komura again during his November visit to Japan, he reiterated a
clear commitment, on behalf of Pakistan, to adhere to the CTBT by September
1999 and to bring into law tighter nuclear and missile-related export regulations.
Given these commitments, and the fact that the deterioration of the Pakistani
economy in the wake of the nuclear tests could trigger regional destabilization,

34
Japan announced its support for the financing by international financial institutions
that was necessary for the International Monetary Fund's support program for
Pakistan, and also announced that consideration could be given to partial re-
launching of bilateral economic assistance with regard to Pakistan's commitments.
In the wake of those nuclear tests, the international community also witnessed
reopening of dialogue between India and Pakistan. The tenth South Asian
Association for Regional Cooperation (SAARC) Summit in July brought about the
first India-Pakistan Summit talk after their nuclear tests, and the leaders met again
on the occasion of the UN General Assembly in September, agreeing upon
reopening vice-ministerial level consultations. As a result, vice-ministerial level
consultations on the Kashmir issue and peace and security were held in October,
followed by other bilateral vice-ministerial level consultations in regard to
respective areas such as economy and culture.

2. Missile launch by North Korea

a) Facts of the situation and Japan's response
At around noon on 31 August, North Korea launched a ballistic missile. In the
evening of 31 August, the Chief Cabinet Secretary issued a statement condemning
this missile launch from the perspective of the security of Japan and the peace and
stability of Northeast Asia, as well as the prevention of the proliferation of
weapons of mass destruction, noting that Japan strongly opposed this action by
North Korea. On the same day, condemnation of the missile launch was also
communicated directly to the North Korean Government. On 1 September, the
Chief Cabinet Secretary also stated that the Government had decided to take the
following measures in response to the North Korean missile launch.
• Promotion of exchanges of views and information between Japan, the ROK and
the United States
• Investigation of the possibility of raising the issue in an appropriate form at the
United Nations
• Communication to North Korea of Japan's condemnation of the launch, lodging
of a strong protest for an explanation, as well as a demand for the suspension of
missile development and export

35
• Provisional suspension of the resumption of Japan-North Korea normalization
talks, of food and other support, and of KEDO progress
• Consideration of measures to increase Japan's own information-gathering
capacity, such as promotion of surveys on the use of visual image satellites.
• Continued research on ballistic missile defense, as well as the early formation
and approval of bills related to the Guidelines for Japan-U.S. Defense
Cooperation
In addition to these measures, on 2 September, Japan also withdrew the permission
which had been granted to North Korea's Air Koryo for nine charter flights
between Pyongyang and Nagoya, and decided not to permit any further chartered
flights. Regarding the Korean Peninsula Energy Development Organization
(KEDO) as the most realistic and effective framework for preventing North Korea
from developing nuclear weapons, and judging that Japan should not give North
Korea an excuse to resume nuclear weapons development by causing the collapse
of this framework, the Government announced on 21 October that it would reopen
cooperation in KEDO. Japan simultaneously made clear that it would maintain the
above-mentioned measures other than those related to KEDO so as to avoid any
misunderstanding by North Korea.
b) Approach of the international community
Japan's concern over the North Korean missile launch was widely echoed by the
international community. At the request of Japan, the President of the UN Security
Council released a press statement on 15 September. This statement noted the
concern of Security Council members that the action taken by North Korea in
August had harmed the regional fishing industry and maritime freight activities
and run counter to confidence-building among countries of the region;
condemnation was also expressed over the fact that the launch had been conducted
with no prior notification. Moreover, at the 22 September Japan-U.S. Summit
talks, leaders noted that the North Korean missile launch was not only directly
related to Japan's security but was an extremely grave action in terms of the peace
and stability of Northeast Asia. They affirmed that they would use various
occasions to place strong pressure on North Korea not to launch, develop or export
missiles. Two days later, tripartite talks were held among the foreign ministers of
Japan, the United States and the Republic of Korea in regard to the North Korean
36
issue, producing a joint statement. The joint statement leveled clear criticism at
North Korea's missile launch and affirmed the importance of maintaining the
Agreed Framework and KEDO, expressing the resolve of the United States to use
the U.S.-North Korea missile consultations to prevail upon North Korea to suspend
the launching and development of missiles and the export of related materials and
technology. Further, at the Japan-ROK Summit talks on 8 October, both leaders
shared the concern and condemnation expressed by the President of the UN
Security Council, and also agreed that a laissez-faire attitude to North Korean
missile development would impact negatively on the peace and safety of Japan, the
Republic of Korea and the entire Northeast Asian region. At the September
Montreal Assembly of the ICAO and also the October Budapest Plenary Meeting
of the MTCR, members shared concern over North Korean missile-related
activities, with various chairman's statements and resolutions adopted in regard to
the North Korean missile launch.

3. Economic situation in Asia and the world

a) The Asian economic situation
The Asian currency and financial crisis triggered by the crash of the Thai baht in
July 1997 subsequently spread to such countries as Indonesia and the Republic of
Korea, with a negative impact on the world economy as a whole. Thailand and the
Republic of Korea avoided a crisis situation through such measures as the steady
implementation of their IMF agreements, but Indonesia was to see a slowdown in
exports and imports, the collapse of the distribution system, which had depended
on the Chinese-Indonesians, and soaring prices and shortages of food and
medicine. The growing severity of these problems gradually escalated to social
unrest and then riots, creating the political instability that led to the resignation of
President Soeharto in May. This turmoil drove foreigners working in foreign
subsidiaries in Indonesia out of the country for the duration of the crisis, with
many Japanese companies having to temporarily suspend their activities.
Characteristics of the recent Asian currency and financial crisis include the fact
that the crisis was engendered by rapid and massive outflows of short-term capital.
Furthermore, one of the direct causes was the excessive rise in the level of pressure
for the repayment of private foreign debt. Other elements missing from previous

37
economic crises included the weakness in financial systems, political instability
and psychological factors.
Currency and financial markets later settled down due to the efforts by the Asian
countries themselves and support from various countries, with Japan playing the
central role, as well as from international institutions such as the IMF and the
World Bank. Current account balances and other macroeconomic indicators also
improved to a certain extent, and by late 1998 most countries could be said to have
generally broken free of their currency crises. On the real economy side, however,
there were marked economic slowdowns and unemployment increases, and even
the Philippines, Malaysia, Viet Nam and other Asian countries, which initially had
only been lightly affected, are now feeling the impact.
In terms of the tasks facing these Asian countries, where the biggest challenge at
the outset of the crisis was the defense of currencies, the focus is now shifting to
economic revitalization, structural reform and human resources development,
relief for the socially vulnerable and medium- to long-term currency stability.
Overcoming such challenges will depend first and foremost on the efforts of these
countries themselves, but support from the international community will also be
necessary. Recognizing this, immediately after the outbreak of the crisis, Japan
announced that it would coordinate with the IMF to provide a total of US$19
billion in assistance, and subsequently announced various other support measures,
amounting to an unequaled total of around US$80 billion up until the end of 1998,
and has been steadily implementing them. Japan has been utilizing these funds to
address the challenges as described below.
• Economic revitalization
Capital shortages and a loss of confidence have made it difficult for the Asian
countries to independently implement adequate economic stimulation measures
and employment measures, including the reinstatement of private capital.
Responding to this situation, Japan has announced various assistance policies for
Asia and launched cooperation. For example, in October, Japan announced the
New Miyazawa Initiative, amounting to about US$30 billion, followed by the joint
announcement with the United States of the Asian Growth and Economic
Recovery Initiative at the November APEC Ministerial and Economic Leaders'
Meetings, and then in December the establishment of Special Yen Loans up to 600
38
billion yen over three years as an additional support package contributing to
economic recovery, employment and structural reform in the Asian countries.
• Structural reform and human resources development
While the Asian countries are working on financial system development, including
settlement of private sector debt and non-performing loans, structural adjustment,
development of laws and fostering of industries, they lack the necessary human
resources and know-how. Japan is providing support in this regard through, for
example, the Japan-ASEAN Program for Comprehensive Human Resources
Development, local training for 10,000 personnel and the dispatch of experts to
technical development centers operated jointly by governments and private
sectors.
• Relief for the socially vulnerable
One issue of great concern to all the Asian countries is relief for the socially
vulnerable, who have been the most severely affected by the economic crisis.
Should the destitution of the socially vulnerable trigger social unrest and lead to
political instability, resolution of the economic crisis would be significantly
delayed. Japan noted this risk at a very early stage, and, in addition to such
assistance as rice and medicine, has been actively implementing support measures
for the socially vulnerable using fast-disbursing yen loans.
• Currency stability
The recent crisis resulted in widespread recognition of the problems associated
with speculative currency transactions and other large-scale rapid capital
movements. It has also become clear that the current IMF-centered international
financial system needs reform. In September, Malaysia adopted various emergency
measures, including measures to control exchange rates and regulate capital flows,
seeking to contain the impact of hedge funds and other such instruments. While no
other country in Asia has followed suit, there has been a growing call for enhanced
monitoring of capital movements and some form of hedge fund surveillance and
regulation. Japan is now addressing the urgent task of reform of the international
financial system.
The Asian countries have expressed great appreciation and great expectations for
the massive support provided by Japan in facing the crisis. At the same time, with
similarly strong expectations that the Japanese economy, which comprises two-
39
thirds of Asian GDP, will again become the "leading goose" for the Asian
economy, drawing other regional economies along, it is becoming even more
important that Japan make positive contributions to the development and growth
of the Asian economy.
b) The world economic situation
The 1997 Asian currency and financial crisis subsequently sparked the Russian
financial crisis and spread to emerging markets in Latin America and elsewhere in
1998. This affected not only the Japanese economy but also the economies of the
United States and Europe, raising serious concerns about worldwide deflation.
First of all, in the Russian Federation, plunging crude oil prices led to the
deterioration of economic fundamentals such as maladjustment of the current
account balance and expansion of the fiscal deficit, which in turn seriously
undermined confidence in the banking system. This uncertainty spread through the
entire financial system, including the foreign exchange and stock markets, and in
August, the Russian Government and central bank announced a series of
countermeasures such as effective tolerance for ruble devaluation and freezing of
some foreign debt repayments. The plunge in exchange rates and stock prices
eventually leveled out temporarily, but the failure of consultations with the IMF
left financing on ice, and the Russian economic situation remains bleak.
Struggling with current account and fiscal deficits which left them dependent on
foreign capital even for foreign debt repayments, many Latin American countries
nevertheless experienced massive outflows of capital. For example, Brazil was
placed in a critical position when around US$25 billion in foreign-denominated
capital flowed out of the country over August and September alone. To combat
this situation, the Government announced a succession of different measures, such
as a high-interest policy and a fiscal adjustment program, and the G7, the IMF and
other parties announced support of more than US$41 billion in total (excluding aid
through international institutions, Japan provided US$1.25 billion in bilateral
assistance), avoiding large-scale economic turmoil. However, given its close ties
with the U.S. economy, the destabilization of the Latin American economy has the
potential to rock the world economy as a whole, and Latin American economic
trends will continue to merit close scrutiny.

40
In addition, the economic and financial crises experienced by emerging markets
also affected developed countries, with temporary downturns in stock prices and
other signs of economic slowdown emerging not only in Japan but also in the
United States and Europe. For example, at the end of August, stock prices in the
United States had fallen close to 20% from the mid-July peak, while in late
September the collapse of Long-Term Capital Management (LTCM), a major
hedge fund, became apparent, with economic prospects becoming increasingly
opaque. Developed country governments responded to these signs with concerted
interest rate cuts and other countermeasures.
The recent Asian economic crisis and the subsequent global-scale chain reaction
clearly revealed the weakness of the existing international economic system.
Addressing this will require immediate review of the existing system, not only in
the financial area but also in areas such as trade, investment and development.
Moreover, the economic crisis has not only developed into a political issue in some
countries, causing, for example, changes in political leadership, but has also
impacted particularly heavily on the socially vulnerable in these countries, and
efforts are also needed from a social perspective.
The experience of providing various types of support in the face of the Asian
economic crisis has led Japan to believe that carefully-planned country-specific
responses are vital in terms of avoiding crisis, designing feasible measures for
crisis-hit countries, providing fast and effective international support and
determining the conditionalities which countries receiving support should be
required to meet. Japan is working to contribute to discussions on these matters.
Moreover, while remaining sensitive to the socially vulnerable; technical
cooperation needs to be enhanced in areas such as macroeconomic policy
management, financial technology and fostering of supporting industries.

The Balance of Economic, Political

and Social Systems
Aside from direct incentive and leverage of political guanxin, a strong government
relationship is made possible through obtaining positive support of the people.
This public image can be obtained through direct public contact or the influence of
41
newspapers, television and other forms of media. When relationships with the
public are supported by the media, marketing channels that exist from the present
bureaucracy become useful—of course permission to use these marketing channels
requires cooperation and assistance from the Chinese government.
Middle Kingdom Group (MKG) LLC, a marketing company comprised of
experienced Chinese and Western business and government consultants, makes the
point that by efficiently balancing these interdependent relationships, efficiency in
business will result. In MKG’s business proposal for market penetration into
China, four key components are recognized: strong government relations,
cooperative use of media, and cooperation with social culture and synergism with
existing marketing channels (“Who Will Help Her Find Her Way around China”?
2003). In meeting with representatives from a Utah-based MLM company, Dan
Mabey, former Director of International Economic Development for the State of
Utah and member of MKG, recognized that existing MLM companies are making
use of the previously mentioned key aspects of successful business in China, but
very few, if any, are doing a very good job of it (personal communication,
November 21, 2003).
Government Relations
The inseparable relationship of business and government in China places
government relationships at the forefront of importance. The mounting pressure
from the WTO and the growth of retail based MLM companies in China are
creating an environment in which the government may respond with additional
legislation and direction. Although the Chinese-MLM environment has drastically
changed in the past 22 years, the government’s role has not. To secure product
registration, product protection and operation expansion, support from the
government is imperative. These relationships can be built by direct government
interaction or indirect leverage of guanxin.
Media
Media have tremendous influence in China. To gain a positive image in the public
eye is extremely helpful. Negative press was one of the key factors that led to the
ban on direct selling (“When the Force is Against You,” 1998). Positive press
could have helpful effects. An example of helpful media coverage can be found in
one of China’s most prominent papers, Xinhua. Recent articles highlighted
42
Amway’s successful social-improvement donations programs and praised a
publicly announced US$120m increase in their China operation’s investment
(“Amway Supports Welfare Causes in China,” 2003; “US Businessman Values
China’s Investment Environment,” 2003). This type of media hype is excellent for
gaining positioning and placement of public support in the Chinese marketplace.
Media are especially effective when used to highlight the less ostensible
characteristics of a company, such as the number of employees, their attitudes
towards the company and products and the help of the company itself to its
immediate community.
Social Culture
China is losing its ant capitalist sentiments of the past and now opening to Western
capitalist ideologies and culture. Companies that can be perceived by the people as
being a benefit to society will help to create an image of cooperation and
progressiveness. This mentality is in conjunction with words of Deng Xiaoping,
Mao Zedong’s influential successor, “It doesn’t matter whether the cat is black or
white, as long as it catches mice.”(“Who Will Help Her Find Her Way around
China,” 2003) This expression can be applied to the role of capitalism in helping
society (i.e. it does not matter whether one uses communism or capitalism, but
what does matter is that society is helped).
Amway has been very active in demonstrating its benefit to China. In 2002
Amway sponsored more than 246 public welfare programs, totaling over
US$1.8m. One of Amway’s more recent programs includes a simple program
where donation boxes will be set up in nearly 100 of its national branches. The
donations are distributed toward children’s education and other welfare programs
(“Amway Supports Welfare Causes in China,” 2003).
Marketing Channels
China’s communist government relies on extensive hierarchy and committees to
function. Geographic and ethnic differences in the Chinese system require a unique
network of administration throughout the country. The close relationship of
government and business, coupled with the practice of guanxin, create several
exclusive networks throughout China. Many of these quasi-business/government
marketing channels provide a strong and well-defined foundation to be utilized in
the market.
43
These market channels can be illustrated in the distribution of cellular phones in
China. China now claims to have over 250 million mobile phone users (“China’s
Cell-phone Users,” 2003). Dan Mabey, former Director of International Economic
Development for the State of Utah, is keen to point out that the price of phones and
service is far more than even the above average Chinese citizen can afford. Rather
it is through the ministry of communication and the budgets of other budgets of
government ministries and large firms that such pecuniary consumption is
possible. The citizens do not buy the mobile phones; the government does (Dan
Mabey, personal communication, November 21, 2003). Tapping into other markets
that have strong ties to government ministries provides a large market base with
enough capital to purchase the products.

Indian Political Landscape and its

effect on doing business in India
In 2004, after a long lay-off, Congress returned to power in India (after coalition
with left parties) - when they were least expected to! At that time BJP (Bhartiya
Janta Party) was nearly sure of coming back to power on back of rising economy,
opening of markets, liberal policies and popularity of Prime Minister Atal Bihari
Vajpayee. However, in a convincing verdict, the world’s largest electorate inflicted
a massive defeat on the country’s longest-lasting coalition of disparate political
parties, the National Democratic Alliance headed by the Bhartiya Janta Party. It
was an outcome that upset all calculations of pollsters and media pundits and one
that went beyond Congress’s own expectations.
What was the reason for this upset Victory – It were the same reasons why people
expected them to win – most of the urban people that is, like us, thought that AB
Vajpayee was making “India Shining” a reality. What every one of us forgot was
the opinion of the rural people, who accounted for more than 70% of voters. These
voters were in rage that BJP was only making urban people richer, whereas the
situation of rural villagers was getting progressively poor.

44
Long story short- In India, Politics is governed by rural population and the leaders
like Lalu Prasad Yadav and Rabri Devi! When it comes to effect of Politics on
doing business in India – it is not all that rosy either...The two main factors are the
corruption and Red tape/ bureaucracy both of which are attributed to the Political
landscape in India. Every time, you bribe a low level government officer, be sure
that some part of that bribe goes to the local corporator and even the ministers.
It may be a proprietary business, a partnership or a corporation, each of them has
to tackle corruption and bureaucracy to a large extent, especially when they are
starting something afresh, involving government approvals and paperwork. They
either survive or succumb.
For small businesses, they have to face local corporators and government officers,
whereas for big corporations or multinationals, it is the leftist political parties and
local lobbies.
Here are some facts about corruption in India:
• India ranks 70 in the corruption index 2006
• In all public services; police are perceived to be the worst, followed by
judiciary
• Bribe Payer Worst performer among 30 countries in Bribe Payer Index
If you are a corporation or a multinational the things just get better, now not only
do you have to deal with corruption but also the politics. Recently there have been
tons of examples of left parties putting hurdles on multinationals entering India.
The one that immediately come to mind is the entry of Wal-Mart in India. Wal-
Mart had to fight an uphill battle for nearly couple of years before it had a tie-up
with Bharti to make an entry. But even after that left parties argued that Wal-Mart
had a “back door entry” in India. The left parties are not only opposed
multinationals coming to India, but also strongly opposes Free Trade and
privatization of public sector companies.

India Risk: Perceptions and Reality

45
One of the prime drivers of an international investment decision is the investor’s
perception of the country risk involved. Risk in the context of investment means in
common parlance, the uncertainty of return. By its very nature ‘Country Risk’ is
measured not in absolute terms but more in terms of a comparison between
potential investment destinations.

‘India Risk’ denotes perception of the outside world about India – and such
perception may be different from our domestic understanding of what we believe
to be the reality! Different political and economic systems of international markets
impart varying degrees of risk and reward. Risks to international investment
projects are mostly posed by political events. Violent political conflict can have
profound negative effects on foreign direct investment. Unstable governments that
cannot take strong decisions, corruption, inconsistent institutional reforms and
shifts in public policy have a major adverse influence on investment environment.
Government policy can have an enormous impact on investment activities and
investment value. By taxation, regulation, enforcement, litigation, publicity and
even the threat of action, a government erects or lowers barriers, imposes or
relaxes costs, dictates or ratifies standards, relieves or imposes risks of liability —
and thereby — furthers or impedes the course of an investment initiative. This can
affect the future cash flows of a project in that country in a variety of ways. Thus
political developments affect the life and the terminal value of foreign investment.
The international perception of India's riskiness
A look at some snapshots of recent surveys reveals that political stability,
bureaucratic hurdles and the legal environment are the key detriments in
international perception about India.
Political instability

Based on their poll of a panel of expatriate business executives on their perceptions

of the political and economic risk of the Asian countries, Hong Kong based
Political and Economic Risk Consultancy has rated India 8.22 on a scale of zero to
10, with 10 the worst possible grade. India is perceived as the ‘most vulnerable
country in Asia' in terms of external threat, while Australia, Hong Kong, Malaysia,
China and Vietnam are perceived to be the least exposed. The factors considered
are regional security, direct military threat, diplomatic relations with neighbors,
46
fallout from political instability in neighboring countries, and relations with major
trading partners.

In fact, the very success of democracy itself spells a perceived risk in India.
Consider the hindrances, the politically motivated protests and the Public Interest
Litigations. Not all the political hurdles to privatization have yet been crossed.
Apart from populism, there is an increasing sense of lawlessness that the political
institutions seem not only incapable but also unwilling to contain. At a
fundamental level, these political and democratic institutions have failed to
provide a fair environment and efficient systemic protection to basic human rights
when we look at the horrific events in Gujarat.

Significantly foreign investors may well see Gujarat not as an aberration but as a
confirmation of fears that have helped keep foreign investment in India at
relatively low levels.

Bureaucratic hurdles

The Political and Economic Risk Consultancy also highlighted how the human and
regulatory dimensions of Asian bureaucracy posed major frustrations. Investors
dislike systems with a multitude of rules, where decisions are open to
interpretation by different authorities. Several Asian countries such as China,
India, Indonesia and Vietnam fall into this category. Taiwan, Korea and Malaysia
pose bureaucratic hurdles as well. India has been placed at the bottom of the pile.
A recent FDI audit by AT Kearney supports the same perception. Investors in
particular from the power and utilities and the industrial products sectors cited
bureaucratic hurdles at both the central and the provincial government levels in
approvals as well as subsequent implementation. When considered together with
other investment obstacles that have an impact on the regulatory environment -
including slowdown of the reform process, excessive government involvement in
the economy and corruption – the FDI confidence audit results suggest that India's
regulatory environment is perceived to be the main obstacle for FDI in the country.
The audit surmises: "In the long run, excessive bureaucracy could act as the

47
greatest barrier… by undermining India's capability to materialize investor
interest".

Significantly, the World Bank's World Business Environment Survey finds that in
India managements spend as much as 16 per cent of their time for dealing with
government officials. Despite its ranking on the economic front having improved
considerably from 33 in 2001 to 24, India has slipped down a rank to No. 42 out of
the 49 countries surveyed in the annual World Competitiveness Report. Areas that
have been identified as particularly in need of reform: curbing corruption,
improving the effective implementation of government policies and infrastructure.
In terms of government efficiency, India has slipped rather drastically from 37 in
1998 to 44 this year. India is in the bottom class in terms of assessment on public
finance, the institutional framework, business legislation and education, all areas
that involve government intervention. The lesson to be learnt is consistent: stable
governments and better public policy would go a long way towards putting India
on the world map as a viable investment destination.

Legal environment and judicial system

Responses in the AT Kearney FDI Audit reflect a perception of uncertainty due to

protracted nature of legal disputes. Whilst our judicial process is considered to be
somewhat slow, it is a matter of pride that the fairness of the judiciary is beyond
reproach and any perception of national bias is absent. Foreign investors have little
or no control over regulatory and political events, which can adversely affect the
commercial viability of their investments and future business plans in India. These
may include political instability leading to delays in decision making; adverse
changes or unpredictability on policy issues; bureaucratic inefficiency and
corruption; disruption of normal business due to social and political unrest; or
dilating judicial and dispute resolution processes.

The total outstanding foreign investment in the country is declined by three per
cent over the past year. This was mainly due to gradual withdrawal of foreign
companies from power and other infrastructure projects. Lacunae such as the lack
of independent regulators or even dispute settlement mechanisms in existing legal

48
framework have constrained commercialization of infrastructure. Two highly
visible cases of governance failure have been in the electricity and financial
sectors, resulting in an adverse climate for reforms.

While our legal system and an independent and fair judiciary has for long been one
of our hallmarks, systemic delays in judicial process for dispute resolutions have
led to some not unexpected results. Absent means of expeditious legal remedies to
enforce rights behavioral modes and culture develop where there is no respect for
law as the retribution is too late and in the context too little. A market economy
requires a cultural infrastructure of norms – mere laws alone are not adequate. An
efficient justice delivery system can provide powerful impetus to creating an
environment of business behavior, which respects legal obligations.
Public interest litigation, sequential legal proceedings, injunction orders against
implementation of projects, CBI enquiries - lead to a frustrating experience –
strong enough to drive away many investors who can use their money and time
more productively elsewhere.

While the Hon’ble Supreme Court has in a long series of judgments, commencing
in 1995 (Mahadeo Versus Pune Municipal Corporation) and until recently –
December 2001 (Balco Case), has made several observations on the ill effects of
delays caused by injunction orders and limitation on judicial review of economic
policy decisions, the examples of Cogentrix, Narmada Dam and several other
projects in legal quagmire still haunt the investors.

The clear pronouncements made by the Hon’ble Supreme Court in such matters,
do not appear to have percolated down to the other levels of judiciary. Post the
Balco Judgment over a dozen PILs were filed in various High Courts – 8 against
ITDC privatization. There PILs were not dismissed in liming but notices were
issued. Eventually, the Hon’ble Supreme Court in April 2002 transferred to itself
all the PILs against ITDC divestment so that there could be dealt with once for all.

Risk mitigation

49
Foreign investors view India as a very attractive destination in terms of the huge
opportunities that this market (product as well as factor market) offers. But, they
will hold back till their key fears are addressed in the areas of political instability,
bureaucratic inefficiency and ambiguity in regulations are mitigated and there is a
clear movement towards greater reliance on market mechanisms for resource
allocation. The most desirable duty that the government can perform is to put in
place policies that reduce risks, increase returns and ensure safety of investments.
The government can improve private investors' ability to forecast and plan for his
investments and thus reduce perceived riskiness of projects by making relevant
public information available. By encouraging competition, there can be a reduction
in political pressure on governments to intervene in markets. In instances where
monopolies may still be unavoidable, government can reduce risk by establishing
laws and regulations that protect property rights and by enforcing them in a fair
and consistent manner.

There is a need to establish expert regulatory agencies that have a significant

degree of independence from the rest of the government and are thus somewhat
insulated from popular pressure to keep prices below costs. Moreover,
strengthening the judicial system to ensure timely and efficient resolution of
disputes must be achieved by introducing procedural changes expedite litigations,
appointing special Judges to deal with infrastructure related disputes, sensitizing
the judiciary to the economic and social costs of delays in infrastructure projects.
In particular, there is a clear need for designing and writing better contracts,
bringing clearer and transparent rules, besides the critical but of neglected need to
avoid internal contradictions in policy and laws.

Private infrastructure projects particularly sensitive to actions or the lack of

actions on the part of public authorities in their host country
• The monopoly characteristics of many infrastructure activities expose their
operations to easy influence of public supervision through a strong role of
Governments and regulators in regulation of entry, prices as well as quality
of services.
• Infrastructure services (power, water, transport, and telecom) are both
widely consumed and deemed essential. This increases political sensitivity

50
 to the prices charged, as pressure from consumers to keep prices low makes
it difficult to cover costs. It is natural to expect broad popular protest when
prices raise or services deteriorate. Their facilities may become obvious
targets for expressions of other kinds of discontent as well.
• In many cases government-owned companies may be key suppliers to, or
purchasers from, private infrastructure firms. Private infrastructure projects
are particularly prone to receive public criticism and public intervention.
• Infrastructure projects involve typically large investments that require long
gestation periods to bring the projects to revenue stream and thereafter very
long payback periods. The sheer time scale introduces risk of uncertainty
and exposure to changes in circumstances, laws and policy.
• Infrastructure projects are also characterized by high leverage ratios.
Financing of these projects is different from the traditional method of
financing based on the balance sheet support. These projects are often
financed through Special Purpose Vehicles (SPVs) and are structured on a
limited/non-recourse basis. Once investors are committed to projects, they
can pull out only by taking a huge loss. Investors and lenders are typically
unwilling to make investments without adequate and often complex
contractual protection. While negotiation of such contracts is tedious and
costly, enforceability of these contracts although essential, is tough.
Investors are faced with the possibility of changing contractual agreements
or failure by the government to implement such agreements because of
political considerations.
• Arbitration and settlement of disputes tend to be very time consuming and
add to project cost. Infrastructure projects are highly capital-intensive
projects and the costs of delay in resolution of disputes could be extremely
high.

Socio Political Risk

The business literature speaks about socio political risk in many ways. For
example, Weston and Sorge have posited that risk arising from actions of
governments or political forces which interfere with or prevent foreign business
transactions, or change the terms of agreements, or cause the confiscation of
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wholly or partially foreign owned business property are called socio-political risks.
These arise from the uncertainty of social and political events that affect business,
rather than with the events themselves. Friedmann and Kim define it as business
risk brought by non economic and broad social factors to the business. A socio-
political risk event is any outcome in the host country which if it occurs, would
have a negative impact on the success of the venture and investment flow. So we
can summarize the socio-political risk as foreign investors’ risk or probability of
occurrence of some social and political event (s) that will negatively change the
prospect for the profitability of a given investment in the host country.

Socio Political Risk and Tourism Promotion

Socio-Political risk always plays a negative role to reduce the availability of

factors and opportunities of tourism promotion. Investment in destination
promotion, infrastructure development to connect the destination, accommodation
facilities, food service, transportation services and retail investments will be
discouraged, as the risk of capital loss will tend to rise, primarily because social,
political and economic rules governing investments are likely to fluctuate, thereby
increasing the uncertainty in the future net return associated with investment
projects. Such increased risks would also raise the cost of capital, as the likelihood
of loan defaults would go high and the period of completion of various projects
will also rise. Both domestic and international inbound tourism would be
discouraged due to such risks. Indeed, capital flight and leakage might be
additional outcomes as well. As socio-political risk introduces additional elements
of uncertainty into the rules governing tourism investment projects, the risk of
capital loss is raised for longer- term projects. Hence, overall productivity in an
economy is likely to be lowered via a shift in the marginal efficiency of investment
schedule.

Socio-political risk also negatively influences the timing and pricing of the tourism
production process. For example, the tourism destination planned and promoted
with an expected period of launching will not work due to delay in the process of
completion of the facilities. So the huge capital invested by intermediaries in
promoting destinations in international market will go hay wire due to this
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problem. The traffic planning of the airlines will also be largely affected by this
process. Tourism marketing is a circuitry exercise where multiple sectors are
dependent on each other. In a combination they build up a whole tourism product.
The increased expectations of changes and uncertainties in the rules of operation of
airlines diminish reliability, but they would also produce erratic stops and starts in
other tourism investment projects. The economy as a whole would therefore
experience a lack of optimal growth path. Thus, it can be argued that political risk
increases the uncertainty of the environment in which successful foreign tourism
promotion should take place, and hence decrease the incentive to save and invest
in tourism by an individual tourist to a particular country destination.

Global imbalances and the Indian

economy

Any large adjustments in major currencies and global interest rates would have a
significant impact on the economy, though it might not be as big as in other
emerging markets. In a speech at the United Nations last week, Reddy said India,
which began opening up its economy in 1991, had a large stake in the process of
unwinding global imbalances and was willing to play its part in ensuring a
successful outcome .
“While India by itself hardly contributes to the current global financial imbalances,
any large and rapid adjustments in major currencies and related interest rates or
current accounts of trading partners could indirectly, but significantly, impact the
Indian economy,” . Some economists say the United States is responsible for part
of the global imbalances as it consumes too much, running up unsustainable
current account and fiscal deficits, while others charge that China's unfairly low
exchange rate is the problem .

India's economy, Asia's third largest, is mainly driven by domestic demand and the
government restricts foreign investment in government and corporate bonds and in
53
the banking sector. The government borrows from the local bond market to fund a
large part of its fiscal deficit and analysts say that helps cushion the economy from
swings in global markets. Indian policy makers are increasingly focusing on
Beijing as China takes over from the United States as the biggest source of imports
for India .

India's bilateral trade with China reached $13.6 billion in 2004. China and Hong
Kong together accounted for 9 percent of India's total foreign trade; although the
United States and the euro zone are India's largest trading partners. Reddy said
India was likely to maintain a modest, sustainable current account deficit in the
near future. India's current account registered a $5.4 billion deficit -- nearly 0.9
percent of gross domestic product — in the fiscal year to March 2005, the first
shortfall in four years.

How managing political risk helps

improve business performance
Globalization and political change have a greater impact on business risk and the
rewards of globalization. As the interrelation and interdependency of global
markets continues to increase, firms are taking on greater international exposure
than ever before. Conflict in the Middle East, terrorism, and pandemic diseases
threaten the safety, security, and continuity of global business operations. And the
recent surge in published and unpublished incidents involving business setbacks—
contract renegotiations or cancellation by host countries, increases in taxation
driven in part by political agendas, or impromptu exits from countries after
significant investment—have been influenced by political agendas.

What’s new today is a crucial and growing gap between the willingness of
corporate executives to accept rising levels of political risk in search of greater
economic rewards and their ability to adequately protect business performance and
economic value by managing this risk in a consistent, efficient, and systematic
54
manner. By integrating political risk into your firm’s investment decisions and
Enterprise Risk Management (ERM) processes you can better understand your
global exposures and balance the company’s risk appetite against achievement of
corporate objectives.

If this is your situation

• You are entering into a merger or alliance with a foreign company and need
to evaluate political risk factors that will impact your investment.
• You are outsourcing or off shoring critical business operations or managing
global supply chain and distribution channels, and need to understand the
country-specific governmental, economic, and societal forces that will
impact performance results.
• You are making global investment decisions and need better insight into key
issues such as the impact of regime change or local elections on investment
timing, how nationalization impacts your ability to operate in a region, or
how mid-stream changes to regulations will impact your compliance
posture.
• You want to better understand global compliance issues, including bribery
and corruption, in high risk countries. Global regulatory requirements across
safety, environmental, security, and privacy have resulted in investigations
and fines, increasing the overall cost of doing business.
• You need an early warning of a problem or opportunity presented by
political shifts, and you need to put in place contingency plans to protect
your company from potentially extreme consequences of political risk.

How PricewaterhouseCoopers and

Eurasia Group can help Industries
At PricewaterhouseCoopers and Eurasia Group, we know from experience that,
because political risk can be anticipated, it can also be measured and managed.
55
Corporations can proactively manage the risks of globalization by taking the
following actions:
• Assess your current political risk exposure and determine your level of
preparedness. Examine the quality of your existing controls and the
adequacy of your risk mitigation plans relative to the business risks you’ve
identified.
• Develop methods for risk-adjusted evaluation of international risks and
opportunities through scenario planning that leverages comprehensive
political risk information to weigh investment and operating opportunities
and develop associated risk mitigation steps.
• Embed political risk considerations into your strategic decision-making and
risk management frameworks and ongoing business operations to make
better and timelier decisions about international investments and operations.
Incorporate the components of political instability into your capital allocation
assessment process and ongoing management of your global operations.

Impact of Global Political Instability

Global economic recession is likely to cause increasing geopolitical instability that
may pose problems for international businesses. Political risk is not new and
threats, such as piracy and civil unrest, have been around for centuries. However,
in the current economic environment these risks are being re-defined and (are)
evolving in response to the global financial crisis and general economic downturn.
Among the "threats to business" we can single out threats "of expropriation,"
which "could increase as the deepening recession causes a surge in political
populism. Falling commodity prices have caused some hostile governments to take
a more emollient tone with international businesses. But these governments'
attitude could harden if their domestic economic situations worsen, putting their
national coffers under increasing strain."
The risks are higher in Latin America than in Africa, "particularly where a 'victim
culture' pervades national politics, such as in Venezuela, Bolivia and Ecuador, in
56
which international firms are characterized as plunderers of local natural
resources." By contrast African states "may lack the infrastructure to take control
of a company, but a form of 'creeping expropriation' could occur, in which
contracts governing joint ventures are continually reviewed. In the process, foreign
firms may see their managerial control, ownership stakes and profits whittled
away."
Third world countries aren't the only ones who face an uncertain future. The
"deteriorating economic climate has caused simmering discontent to overflow on
to the streets of some European cities, and triggered demonstrations around the
world." However, such events are "unlikely to pose a major threat to international
businesses."
These concerns are nonetheless real, as tension between business and labor
increases due to the prolonged recession. In addition, "the deteriorating economic
climate could sour relations between international and local partners in joint
ventures." Piracy also remains a problem. If piracy levels continue, companies
everywhere will pay a growing 'piracy tax' to maintain their global trading
networks over the next few years, adding an extra strain to the burden created by
the recession. Somalia and Nigeria account for more than half of the piracy
incidents in 2008. Somali pirates have seized 60 merchant vessels in the past 15
months.
Moreover, it is likely that the audacious tactics of the Somali pirates, which have
been widely reported, will be mimicked in other parts of the world that have been
ravaged by the recession. In addition to the ongoing threats from pirates may also
result in greater numbers of hijackings, armed robberies and kidnappings.
"With political instability heightening and the global political risk map likely to
change, it is more important than ever that businesses undertake thorough risk
assessments across all their global operations and investments and plan thoroughly
for future potential instability," Ward wrote. "To enable companies to do this it is
vital they understand the dimensions and nature of the threat they face and the key
trends and issues in political risk."
No matter how effective a company's risk management strategy is, "it cannot
prevent an act of expropriation, a robbery from one of its ships or factories or the
kidnapping of a member of staff. Insurance offers firms a valuable backstop in
57
such circumstances and can allow global trade to take place where otherwise
uncertainty and mistrust would cause commerce to break down, the report
concludes."

Tackling imbalances in global

economy
GLOBAL OIL prices might have softened very recently on the back of a lower
stock piling by the U.S., most parts which are witnessing relatively mild winter.
But they still remain at near historically levels. More significantly nobody
predicts a dramatic decline. Many factors that have underpinned the high prices
— global demand, geopolitical uncertainties, strong refining demand and
supply disruptions — have by no means abated. Some countries including India
have, through administrative action, insulated the consumers for the time being.
However the realization that a large part of the oil price increase will remain
permanent will force authorities to pass on the burden to consumers at least
over the medium term. Domestic inflation is bound to go up whenever the
government starts reducing the subsidy portion.

High oil prices have also contributed to the high global macroeconomic
imbalances. Oil exporters have built up huge surpluses in their current account.
This has exacerbated the phenomenon of excess savings in some countries
feeding the deficits in others. Other than the oil producing nations several
Asian countries have accumulated savings far in excess of their immediate
investment needs. Effectively they were funding investment avenues in
developed countries, notably the U.S. There is no way such a major imbalance
between global savings and investment will remain forever. Some stage it has to
unwind. The consequences for the global economy will be profound and painful
unless there is an unprecedented degree of co-operation and understanding
among central banks and governments of different countries in synchronizing
their respective policies.

58
For emerging market economies (EMEs) the global imbalances have deep
implications. Dr. Y. V. Reddy, the Reserve Bank of India Governor, pointed out
that EMEs are not a homogenous lot. Neither their contribution to the global
imbalance nor the consequences they will face when it winds down can be
discussed as if they are part of one group with identical economic and political
characteristics.

The Government of India does not depend on the international capital market
for financing the fiscal deficit. A limited amount of external resources is
provided by bilateral and multilateral agencies. Although there could be a
spillover effect of global developments on domestic interest rates, the critical
factor to be watched would be a possible rise in domestic nominal interest rates.
Cost of government borrowing will go up. Global volatility will however affect
the RBI's balance sheet adversely. Reserve management will take a hit as
currency values fluctuate violently. Then there is the interest rate risk arising
out of the Bank's holding of fixed income securities.

Corporate in India might have to pay more. Spreads can widen abruptly due to a
shift in investor confidence in the international markets. Those companies that
have borrowed at variable rates will naturally suffer more compared to those,
which have taken loans on a fixed rate basis. As a rule, corporates that have
heeded sound advice, including from the RBI, its hedge against currency and
interest rate risks will come out better. Banks in India will naturally face the
consequences of the macroeconomic imbalance. Their exposure to international
markets is limited in a traditional sense. Their deposit base is predominately in
rupees. Their investment in foreign currency stocks is insignificant. Nor can
they — because of regulatory rules — borrow freely in foreign currency.

59
The Impact of Political Change and
How to Protect Your Business against
It
Political risk insurance cannot be a panacea for every conceivable political risk
that can confront an international trader or investor. But in a world filled with
political change, obtaining political risk insurance can make the difference
between operating a profitable business and making a costly mistake.

Almost any event can trigger political change. An unexpected resignation, a

terrorist act, or a currency collapse can completely transform the political and
economic landscape. Politics and economics are forever entwined, as was
dramatically demonstrated with the collapse of the Thai Baht in 1997. The collapse
of the Thai currency set off a chain of events that ultimately led to the economic
meltdown of many of Asia’s economies and impacted most of the rest of the
world. It took Asia and the world 18 months to recover from that crisis, and much
of Asia has yet to fully recover. It could be argued that one of the disadvantages of
globalization is that the impact of political change is felt instantaneously. There is
less time to react, as someone else has or will already have reacted while we were
sleeping, by the time we receive the news. Perhaps the impact of the collapse of
the Thai Baht would not have been so dramatic if the international marketplace
were not so interconnected—if currency and stock trading didn't occur 24 hours a
day. This trend toward seamless international financial transactions will continue
at an even faster, even more breathtaking pace in the new decade.

Consider the impact that political change has had on us all. The Islamic Salvation
Front, which is fighting for political change against the government of Algeria, is
an organization few North Americans had ever heard of before the end of 1999.
Yet this group, which has been fighting the Algerian government for decades,
apparently decided to export its version of political change to the United States by
attempting to smuggle bomb-making equipment into the United States around the
New Year. The actions of perhaps three or four individuals from this organization
had a huge impact on the New Year’s celebration plans of tens of millions of
60
people. In tandem with the expected (but unrealized) Y2K impact, about 70
percent of Americans decided to stay home on New Year's Eve. The incident also
underscores the need for closer scrutiny of Canadian immigration practices, which
is sure to have an impact on the manner in which Canadians and Americans can
cross each other's borders in the future.

Consider what impact Turkey's accession to the European Union may have on
Europe and beyond in the coming decade. For decades, Turkey has tried to join the
European Union (and previously, the EEC), but strenuous objections from Greece
and other members kept it from succeeding. Germany, for example, has long
expressed concern about the impact that Turkish immigrants have had on the
composition of the country's ethnic composition. Now it appears that Turkey will
soon become an E.U. member. Turks will have the right to travel freely throughout
the European Union (as all other E.U. members do), but Turkey is Europe's only
primarily Muslim nation. There will undoubtedly be a corresponding rise in the
influence of Islam in European life and, because the United States has close ties to
European politics, economics, and culture, what impacts Europe, could impact the
United States.

What about the Panama Canal? When President Carter granted ownership of the
Canal to Panama in 1978, which imagined that in 1999, when ownership was
transferred, a Hong Kong company (Hutchison Whampoa) would spread enough
money around the power brokers in Panama City to buy itself control over the
ports at both ends of the canal. As a result, some argue, Chinese political influence
has a strong foothold in Central America. In granting the concession to operate the
ports to Hutchison, Panama, which has no national army, has virtually assured that
U.S. military influence will be present in Panama for decades to come. This, in
turn, will impact how future U.S. military budgets are allocated and how tax
dollars are spent.

The Impact on International

Businesses

61
The impact of political change on businesses is no less significant than it is on
individuals—perhaps even more so. At stake are trillions of dollars of revenues
derived from trading and investing abroad. For a business, the political risks
associated with political change are multifaceted. For instance, the question of
whether China is admitted to the World Trade Organization certainly has an
implied impact on U.S. consumers (cheaper imported goods), but consider what is
at stake for businesses operating in or with China. If China is admitted, businesses
operating in and with China will be given a new level playing field. Suddenly,
China will have to play by everyone else's rule, rather than its own. However, if
China is not admitted to the WTO, there is likely to be a backlash against foreign-
owned businesses. China could make them pay for failure to secure its place in the
organization. If the U.S. Congress fails to approve the entry, U.S. businesses could
endure serious hardships. New laws restricting access to the Chinese market by
U.S. investors could be one result.

In general, an international investor often faces the risk of expropriation of assets

when a new government takes power or an existing government changes its stance
toward foreign investment. The risk of not being able to convert local currency
into hard currency or to transfer hard currency out of a country because of a
shortfall in the national foreign exchange supply or a change in law is ever-present.
And, depending on where an investment is located within a country, the risk of
damage to a facility or an interruption of business operations because of political
violence can arise without warning.

For international traders, political risks are every bit as real. Imagine exporting
goods to a government buyer only to discover after the fact that it doesn't pay its
bills or the United Nation has just imposed an embargo on the country or your own
government has just cancelled your export license. Wrongful calling of on-demand
guaranties (for bid bonds, performance bonds, or advance payment guaranties) by
governments happens all the time. Political change only accentuates the political
risks inherent in trading abroad.

Political Risk Insurance

Surprisingly, many international businesses are unaware that they can protect
themselves against political risk through insurance. Political risk insurance has
62
been in existence for decades and is now more widely used than ever. Whatever
the risk, an insurance product should exist to protect a business against
government actions that impact the ability to trade or invest across borders.

The key test for whether a risk can be covered by political risk insurance is
determining whether the occurrence was caused by a government action (a
"political" risk) or was the result of a commercial risk. Insurers make a distinction
between the two types of risk because a political risk is presumably not within the
control of the trader or investor, and a commercial risk is. For example, a provider
of electricity should be able to determine the nature of market demand for
electricity and a realistic price for providing it. A loss derived from inaccurately
assessing market demand or a realistic price for electricity is a commercial risk the
power provider accepts by engaging in a project. However, it may not be within
the provider's control to be able to ensure that the supply of coal required to
operate the plant remains uninterrupted or that the government doesn't arbitrarily
change the tariff arrangement between the provider and the national power
company. Usually, answering the simple question of whether an action was in an
insured's control or a government's control will answer the question of whether a
risk can be covered by political risk insurance.

Since more businesses are trading and investing abroad than ever before, it is
important that they realize that protection against government-inspired risks is
available and that increasingly more underwriters are providing the coverage.
Political risk insurance cannot be a panacea for every conceivable political risk
that can confront an international trader or investor. But in a world filled with
political change, obtaining political risk insurance can make the difference
between operating a profitable business and making a costly mistake.

Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author's employer or IRMI. This article does not
purport to provide legal, accounting, or other professional advice or opinion. If
such advice is needed, consult with your attorney, accountant, or other qualified
adviser.

63
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