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ECONOMIC

ECONOMIC RISK MANAGEMENT 118.Gourav Kumar Ganguly 139.Gaur Hari Pal Group 7| PGDM-B | SIMSR
RISK MANAGEMENT
RISK
MANAGEMENT

118.Gourav Kumar Ganguly 139.Gaur Hari Pal 151. Siddhant Sethia

ECONOMIC RISK MANAGEMENT 118.Gourav Kumar Ganguly 139.Gaur Hari Pal Group 7| PGDM-B | SIMSR

Group 7| PGDM-B | SIMSR

ROADMAP FOR ECONOMIC RISK

1.Economic risk

2.Principal economic risks in international markets

  • 3. Exchange Risk Management

    • a) Exchange rate risks

    • b) Exchange risk management

    • c) How foreign investors can protect themselves

from these exchange rate risks

  • d) Standard methods of hedging an exposed

dollar liability

  • 4. Economic Freedom Index

  • 5. Uncontrollable Risks

ROADMAP FOR ECONOMIC RISK 1.Economic risk 2.Principal economic risks in international markets 3. Exchange Risk Management
ECONOMIC RISK

ECONOMIC RISK

ECONOMIC RISK

Economic risk:

An economic risk can be defined as the likelihood that economic mismanagement will cause drastic changes in a country's business environment that hurt the profit and other goals of a particular business enterprise.

Countries often impose restrictions on business activities on the grounds of national security, conserving natural resources, scarcity of foreign exchange, to curb unfair trade practices, to provide protection to domestic industries.

Hence it is essential to know whether potential risks outweighs the benefits.

Economic risk: An economic risk can be defined as the likelihood that economic mismanagement will cause

Principal economic risks in international markets are:

Exchange controls Local content requirements Import restrictions Restrictions on fund flow Run away inflation High Debt Balance of payment Trade deficit

Exchange controls:

Scarcity of foreign exchange exchange control measure in a country. Adverse affects:

repatriation of profits and repatriation of sales proceeds to the home country

Principal economic risks in international markets are:  Exchange controls  Local content requirements  Import

Local content requirements:

Local content requirements for - extending export incentives or putting a country-of-origin label. Examples:

EEC termed assemblers as “screw driver operations” and imposed a local content requirement of 45 percent. NAFTA imposes 62.5% as local content requirements for cars manufactured in member countries.

Import restrictions:

To protect domestic industry, governments often impose selective ban on import. Such restrictions vary from total ban on imports to quota restrictions. This leads to higher product costs and comprise on the product quality.

Local content requirements: Local content requirements for -  extending export incentives or  putting a

Exchange rate risks

Many countries have been experiencing ongoing fiscal deficits, rapid money-supply growth, high inflation rates. So devaluation crises appear from time to time.

Recent devaluation episodes includes:

Mexican crisis of 1994, Asian crisis of 1997, Russian crisis of 1998 These events have shown what heightened foreign exchange volatility can cause.

Capital flows have become more sensitive - country’s financial system and economic conditions than they have been in the past

Exchange rate risks Many countries have been experiencing  ongoing fiscal deficits,  rapid money-supply growth,

How foreign investors can protect themselves from these exchange rate risks ?

Here are some ways managers can cope with these country risks:

1.Host country currency Devaluation assessment:

The theory of “Purchasing Power Parity” provides a guide to likely exchange rate changes. Compare a country’s cumulative inflation over a number of years with the cumulative inflation rate of its major trade partners. If the difference in cumulative inflation rates exceeds the percentage change in the foreign exchange rate, then devaluation is a real possibility.

How foreign investors can protect themselves from these exchange rate risks ? Here are some ways

2.Purchase price spread over a long time period:

This allows domestic currency to be purchased at a lower cost if devaluation occurs.

How foreign investors can protect themselves from these exchange rate risks ? Here are some ways

3.Negotiate a lower price with the supplier:

The extent to which this can be done will depend upon the relative bargaining power of the buyer and the seller and the profit margin of the seller. Price revision based on a band e.g. ± 10% for exchange rate and raw material rate.

4.Absorption of the price increase:

The extent possible by the buyer and pass on the rest to the consumer. The extent to which this can be done will depend on the profit margin the buyer enjoys and the competitive and the demand conditions prevailing in his market.

5.A third and complementary, approach is to take steps to minimize exchange risk.

The four most common ways of doing this are

  • A. exchange risk avoidance,

    • B. changing sourcing,

    • C. exchange risk adaptation and

    • D. currency diversification. Of these four approaches , exchange risk adaption is most commonly used.

3.Negotiate a lower price with the supplier:  The extent to which this can be done

5 A. Risk avoidance

Exchange risk avoidance strategy - avoids foreign currency transactions. applicable - firm which makes all its purchases and sales with local buyers only. Expose the business to the possibility of interest rate increases as a result of a central bank’s response to foreign exchange rate devaluation. For foreign-owned financial institution:

Possibility of a “run” on deposits if the depositors seek to withdraw funds in order

to

transfer them aboard. impractical strategy as most industries:

use imported materials, export some of their output, compete with imported products

5 B. Changing/ Diversifying sourcing:

Another strategy is to change the source of purchasing. For e.g. If the US goods becomes costlier due to dollar appreciation, then change the source from US to some other countries where the product is cheaper either due to depreciation of their currencies or other reasons. A no. of companies have diversified the countries of sourcing to spread and

5 A. Risk avoidance Exchange risk avoidance strategy -  avoids foreign currency transactions.  applicable

5

C. Currency Diversification

Currency diversification is a strategy- don’t put all of your eggs in one basket firm to hold assets and liabilities in several currencies to reduce the impact of unexpected exchange rate changes.

  • 5 D. Risk adaptation

Exchange risk adaptation strategy includes- calls for protecting all liabilities denominated in foreign currency with equal-value, equal- maturity assets denominated in that foreign currency Example:

Assume an Indian firm has contracted to buy $100,000 of machinery from a foreign supplier for use in its manufacturing operations. The purchase is payable in six months in US dollars. Firm may obtain some equal-value dollar asset maturing in 180 days. depositing funds in a dollar-denominated bank account for six months arranging a swap of the dollar liability for some other firm’s India rupee liability.

5 C. Currency Diversification Currency diversification is a strategy-  don’t put all of your eggs

Standard methods of hedging an exposed dollar liability include:

  • 1. Obtaining a dollar-denominated financial asset (e.g., a time deposit or a CD) that matures when the liability comes due.

  • 2. Hedging foreign exchange risks with a forward contract.

  • 3. Finding a buyer for your firm’s products and agreeing to receive payment in US

dollars for the same value and time as the liability.

  • 4. Agreeing with a American firm to exchange your dollar liability for their Indian

operations rupee liability.

Standard methods of hedging an exposed dollar liability include: 1. Obtaining a dollar-denominated financial asset (e.g.,

ECONOMIC FREEDOM INDEX

ECONOMIC FREEDOM INDEX
ECONOMIC FREEDOM INDEX

ECONOMIC FREEDOM INDEX - RANKINGS

ECONOMIC FREEDOM INDEX - RANKINGS
ECONOMIC FREEDOM INDEX - RANKINGS
ECONOMIC FREEDOM INDEX - RANKINGS
ECONOMIC FREEDOM INDEX - RANKINGS
ECONOMIC FREEDOM INDEX - RANKINGS

INDIA’S EFI

INDIA’S EFI
INDIA’S EFI

PARAMETERS CONSIDERED

PARAMETERS CONSIDERED

IMPLICATIONS FOR COMPANIES

Countries with higher EFI scores have had higher rates of Long term economic growth and highest living standards

Government control and ownership of FOP decreases the risk affinity of Entrepreneurs and Companies and vice-versa

Innovation stimulation in high EFI countries Less risk of Nationalisation, Adverse Taxation

IMPLICATIONS FOR COMPANIES  Countries with higher EFI scores have had higher rates of Long term
UNCONTROLLABL E / HAND OF GOD RISKS

UNCONTROLLABL

E /

HAND OF

GOD RISKS

UNCONTROLLABL E / HAND OF GOD RISKS

LIST OF UNCONTROLLABLE RISKS

Natural disasters Terrorism

LIST OF UNCONTROLLABLE RISKS  Natural disasters  Terrorism

NATURAL DISASTERS – MITIGATING RISK

Natural disasters often lead to lower economic growth and a worsening in fiscal and external balances. They can also have a significant impact on poverty and social welfare.

NATURAL DISASTERS – MITIGATING RISK  Natural disasters often lead to lower economic growth and a

WAYS TO STRENGTHEN DISASTER RISK MITIGATION AND RESPONSE

Identify risks and integrate them explicitly into macro frameworks to help determine how much to self insure and how much to spend on mitigating impact;

Ensure sufficient fiscal space, and flexibility within fiscal frameworks, to help redeploy spending rapidly;

Improve transparency to bring about effective use of disaster assistance and limit contingent liabilities to the state;

Strengthen coordination ex post among multilateral institutions, donors, the authorities and civil society organizations, particularly where administrative capacity is limited;

Use reconstruction as an opportunity to accelerate broader growth-enhancing structural reforms; and

Looking further ahead, explore ideas about how to promote insurance coverage, since insurance penetration reduces the real costs of disasters without raising fiscal burdens

WAYS TO STRENGTHEN DISASTER RISK MITIGATION AND RESPONSE  Identify risks and integrate them explicitly into

TERRORISM – THE WILD CARD

Protecting employees and corporate assets is the responsibility of operating managers throughout any corporation. In most organizations, few people are fully cognizant of exposures such as kidnapping and extortion. But terrorism, crime, and political instability risks are facts of life, and corporate leaders must deal with them in transacting business in our increasingly global economy

TERRORISM – THE WILD CARD  Protecting employees and corporate assets is the responsibility of operating

CURRENT RISKS – OF PARTICULAR CONCERN TO MULTINATIONALS

Leftist guerrillas who kidnap foreign corporate employees in rural Colombia and in neighbouring Ecuador and Venezuela.

Criminal gangs that target executives in Mexico, Guatemala, El Salvador, Honduras, Haiti, Brazil, and elsewhere in Latin America.

Tribal gangs that attack multinationals and kidnap their personnel in Nigeria’s oil- rich Niger Delta.

Aggressive, organized-crime groups that run protection rackets in Russia, other parts of the former Soviet Union, and eastern Europe.

Vendors, distributors, and joint-venture partners who threaten and even employ violence to resolve business disputes in Russia, China, and other countries with primitive judicial systems.

Islamic zealots who target foreigners and foreign business interests as part of their jihad.

CURRENT RISKS – OF PARTICULAR CONCERN TO MULTINATIONALS  Leftist guerrillas who kidnap foreign corporate employees

COMPANY’S RESPONSE

Well-managed corporations respond by:

(1) carefully analysing risks and weighing them against potential rewards of a particular project;

(2) fully informing employees of the hazards they face;

(3) supplying the wherewithal to enhance their safety through training, technical means such as armoured cars and, in some cases, protective details; and

(4) planning the company’s response in the event of a kidnapping or an extortion.

COMPANY’S RESPONSE  Well-managed corporations respond by:  (1) carefully analysing risks and weighing them against

A CRISIS MANAGEMENT TEAM

Company’s core crisis management team should consist of at least three individuals:

The ultimate decision maker—the CEO or his or her designee; The coordinator, often the corporate security director, risk manager, or chief of international operations; and The general counsel. The team also might include:

A finance officer (to arrange for the ransom);

A human resources specialist (to oversee the care of a hostage’s family); and

A public relations specialist (to handle press inquiries).

A CRISIS MANAGEMENT TEAM  Company’s core crisis management team should consist of at least three