Diversification could be key to withstanding political risk

Experts advise companies to set up in different regions and to take out insurance if possible
Tahrir Square 2011: the Arab Spring left many foreign investors stumbling © Reuters

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Investors in South Africa knew that the country faced a rockier future than they might have hoped for when Nelson Mandela became the first democratically elected president in 1994. But even they were taken aback in December when Jacob Zuma, the current president, dismissed two successive finance ministers in a matter of days.

Mr Zuma began by firing the highly regarded Nhlanhla Nene and replaced him with the little-known David van Rooyen. South African shares plunged, government bond yields rose and the rand fell to all-time lows against major currencies. Over the following weekend, Mr Zuma rapidly changed direction, appointing Pravin Gordhan, a previous finance minister who, like Mr Nene, was much respected.

Local experts were only partially reassured. “The return of Mr Gordhan is likely to have some short-term benefit only in regard to local assets: stocks, bonds and the currency. However, the switcheroo will do nothing to reassure investors and business of the long-term viability of South Africa under the current administration,” Gary van Staden, an analyst at NKC African Economics, was quoted as saying by Bloomberg.

Many aspects of South Africa remain reassuring for business. While there are frequent power cuts, much of the physical infrastructure is of high quality. There is impressive local financial expertise, contracts are enforced and the judiciary remains independent. But bewildering events such as the dismissal of Mr Nene and the reappointment of Mr Gordhan, which many commentators thought illustrated power struggles within and between the ruling African National Congress and its business associates, demonstrate the business uncertainty that local political convulsions can cause.

Local political changes, such as South Africa’s shenanigans, the rise of the rightwing National Front in France or the crackdown on corruption in China, are hard for companies to read and understand.

This is true of regional upheavals too. The Arab Spring left many foreign investors stumbling. In the last days of Hosni Mubarak’s rule in Egypt in 2011, the government ordered Vodafone, the UK-headquartered telecommunications company, to shut down its network and then used it to send out propaganda. The company was heavily criticised for doing so, but said it needed to ensure the welfare of its local staff.

Many thought that the Arab Spring would introduce democratic rule to the region, with a more open environment in which business could thrive. That it did not turn out that way shows how hard it is for business leaders to understand what is happening, or about to happen, in the countries in which they operate.

There has been a significant change in companies’ relationship with political risk, Richard Fenning, chief executive of Control Risks, the consultancy, said in an interview with the Financial Times in 2015. Companies increasingly operate internationally. Their businesses and supply chains cross borders. They often no longer view their national subsidiaries as discrete entities.

“They see the world as a global market place and they plan their business strategy accordingly,” Mr Fenning said. “But for governments and individual countries, their preoccupation now is increasingly insular, introspective and nationalistic.” The result is that companies, thinking internationally, “are inherently at odds with governments whose interests are much more short-term”.

However internationally companies operate, local political risks cannot be ignored. “Sometimes entering Egypt or Argentina or Nigeria can be very seductive,” says Tazeeb Rajwani, associate professor at Cranfield School of Management. “You know, let’s go to Nigeria, 180m people. But some organisations fail to capture an understanding of political risks.” These can include terrorist attacks.

Events such as the fall of the Berlin Wall and the Arab Spring appeared to herald a world of greater opportunity, democracy and reduced risk. Instead, the number of political crises appears to have multiplied in recent years: the rise of Isis, fighting in eastern Ukraine and tension between Russia and Turkey. There are non-violent political risks too, such as the apparent unravelling of the Schengen border-free area in Europe, the continuing Euro crisis and the UK’s possible exit from the European Union.

Prof Rajwani advocates a multi-pronged strategy for dealing with political risk. In a Cranfield paper, he argues for companies to put political risk co-ordination in the hands of a senior executive, rather than leaving it split between different departments.

He says companies should consider insuring against political risk. It can be expensive but might be necessary. And, as with any investment strategy, he advises diversification.

Some regions might look attractive because of the low cost of raw materials, but might carry relatively high political risks. Some may be more expensive to operate in but offer greater certainty and political stability. Companies should ensure they are not tied to one country that may turn out to be dangerous. “I think they should not put all their eggs in one basket,” he says.

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