Political Risk Ratings Research Articles

The Asymmetric Effect of Political Risk and Exchange Rate Fluctuations on Foreign Direct Investment Inflows in South Africa

Most developing countries rely heavily on foreign direct investment (FDI) inflows for economic growth and stability. However, political risk and the foreign exchange rate could direly affect FDI inflows as investors seek stable markets. The most recent example of political risk interactions, the exchange rate and FDI has been the trade war between the United States (US) and China, where the US increased tariffs on Chinese goods worth over $16 billion. A crucial debate is needed regarding the importance of FDI inflows in developing countries, such as South Africa. FDI is observed as a crucial component in providing resources, and it is critical in facilitating globalisation and providing financial assistance to countries in need, especially developing countries such as South Africa. This study aimed to examine the long- and short-run effects of political risk ratings and foreign exchange rate fluctuations on FDI inflows in South Africa. The literature review provided evidence of long- and short-term relationships between political risk ratings, the real effective exchange rate, and the GDP's balancing variable on the dependent FDI inflows. The study utilised both the autoregressive distributed lag (ARDL) and non-linear autoregressive distributed lag (NARDL) models to analyse quarterly data from 1995 to 2020. The Variables included in the study were political risk, the real effective exchange rate, FDI inflows and GDP. The study revealed that political risk ratings and the real effective exchange rate have long-run effects on FDI inflows. The real effective exchange rate has an asymmetric long-run effect. It was also found that FDI inflows respond more to real effective exchange depreciations than real effective exchange rate appreciations, implying that the exchange rate is an important economic factor in explaining the investment inflows. Consequently, the study recommends that policymakers deploy responsive policy measures to deal with currency fluctuations and political instability. In South Africa, the negative effect of political risk affects FDI and impacts the overall country risk ratings and the country's ability to borrow. The study also recommends that further research be employed to understand other impacts on FDI inflows and the interaction of political risk and the real effective exchange rate on other critical economic factors.

External Debt Default and Foreign Direct Investments

Abstract We analyze the effect of a country’s defaults and restructuring its’ official and private external debt on its ability to attract foreign direct investment. We use different types of foreign direct investments: FDI Flows, Horizontal FDI, vertical FDI, cross-border mergers & acquisitions, and greenfield FDI. Using the Poisson-Pseudo Maximum Likelihood (PPML) estimation method, which has never been used in the literature to do a similar analysis, we find that external debt default decreases all types of FDIs. Furthermore, we also conduct a more granular sensitivity analysis by analyzing the effect of political risk ratings, effect on non-advanced economies, and effect on highly indebted poor countries (HIPC). We find that cross-border mergers and acquisitions (M&A) decrease as corruption risk decreases and increases as law and order improve. For HIPC countries, official external debt restructuring increases greenfield FDI. JEL classification number: C1, C33, D72, F21, H63, O57. Keywords: Debt Default, Restructuring, Foreign Direct Investment (FDI), External Debt, ICRG, Poisson-Pseudo Maximum Likelihood (PPML), Political Risk.

Terror, Political Risk, and Effect on Foreign Direct Investment

ABSTRACT Terrorist attacks have important social, political, and economic effects. One of the effects of terrorism involves the impact on foreign direct investment (FDI). While existing research suggests that terrorism negatively impacts FDI by increasing political risks, it is unclear how the effects of terrorism are conditioned by host country institutions. Political institutions may affect investors’ perceptions of political risk following a terrorist attack by shaping expectations of future political risk. We argue that the conditional effect of institutions and terrorism is non-linear: Terrorism has a negative effect on FDI inflows to countries with a medium level of institutional effectiveness only. Using quantitative analyses of FDI flows and political risk ratings, we show that terrorism has no effect on FDI in host countries with very high or very low levels of political institutional effectiveness. In a qualitative analysis of FDI and terrorism during the civil wars in Algeria and El Salvador, we demonstrate that concerns about institutional effectiveness played an important role in producing disinvestment by foreign investors. This research contributes to the literature on the determinants of FDI, effects of terrorism and political risk, and suggests that institutions play an important role in affecting how investors perceive political risk.

The political determinants of country crises

PurposeCountry crises can provoke damages to a country's economic activity and citizens in a way that will always demand a deeper understanding of their determinants. Political issues are commonly mentioned as an important factor boosting these crises. This paper investigates the political factors behind financial crises and recessions.Design/methodology/approachUsing variables from the ICRG rating system, logistic panel regressions are run to determine whether or not the political risk variables explain country crises.FindingsResults disclose the importance of socioeconomic conditions to financial crises and recessions with no influence from the political arena. Against expectations, political instability does not help to explain crises. Political risk ratings also show their importance, demonstrating that the higher is the risk, the higher is the probability of debt and currency crises occurrence.Originality/valueThe findings in this paper contribute to a growing literature of political risk and crises, enhancing the value of political risk assessment and increasing the application of its consequences.

Contingencies in the relationship between trade and internal conflict in Nigeria: the role of the quality of the political institution

PurposeThis paper empirically tests the relationship between conflict and trade in Nigeria from 1986 to 2017.Design/methodology/approachThis study made use of secondary data. Time-series data were collected from CBN Statistical Bulletin, WDI of the World Bank, MEPV of the Centre for Systemic Peace database, Stockholm International Peace Research Institute, political risk ratings of the ICRG, Freedom in the World Country Ratings of Freedom House, and ACLED database. This study used descriptive and econometrics techniques to analyze the data. It adopted the IV-GMM techniques.FindingsThe study found that domestic trade has a negative and significant effect on internal conflict in Nigeria. International trade, on the other hand, does not affect internal conflict. In addition, the interaction of trade and institutions shows that more civil liberties (CL) and lower corruption (COR) complement the effect of domestic and international trade in reducing hostilities in Nigeria over the study period.Research limitations/implicationsThe main limitation of this study is the inaccessibility of data. This study could not access the data on the volume of domestic trade in Nigeria. The study employed value-added tax on all domestic transactions in Nigeria as a proxy for domestic trade in the country. The study recommends that further studies should access the data on the volume of domestic trade as this could help further understand the relationship between domestic trade and internal conflict in Nigeria.Practical implicationsSince the improved domestic trade reduces internal conflict in Nigeria, the government should formulate policies that facilitate trade. Improving anti-graft efforts and CL will ease the process of formulating trade policies and increase the impact of domestic trade on internal conflict. Furthermore, these will reduce trade barriers and transaction costs. This can be achieved if the government strengthens its anti-COR agencies by making them more autonomous. CL can also be increased by enhancing voice and accountability in the country.Originality/valueThis study advances the literature by examining the role political–institutional quality plays in the relationship between trade and conflict.

Towards the Sustainable Development Goal of Zero Hunger: What Role Do Institutions Play?

Empirical research has aimed to substantiate the institution–food security nexus. However, institutional literature has largely overlooked the relationship between institutions and the sustainable development goal of zero hunger (SDG2). SDG2 is a multidimensional goal that extends beyond food security and requires comprehensive investigation. Therefore, this study explored the role of institutions in promoting SDG2 achievement using a panel dataset spanning 108 countries from 2000 to 2019. The institutional impact was evaluated using worldwide governance indicators, and the International Country Risk Guide (ICRG)’s political risk ratings. Simultaneous equation modeling was used as the estimation technique. According to the results, institutions showed a positive and highly significant association with SDG2 performance. All the dimensions of good governance promoted SDG2 performance. Except for maintaining law and order, all other dimensions of political risk indicators were found to improve SDG2 performance. This study also discovered significant evidence that voice and accountability, as well as the settlement and the prevention of conflicts, had the most substantial influences on SDG2 achievement. In developing countries, improving both the quality of governance and political stability had a comparatively higher impact on SDG2 performance than in developed countries. Furthermore, institutions showed a significant mediating impact on SDG2 performance via agricultural productivity and economic growth. Based on these findings, this study concluded that the pursuit of good governance and inclusive institutions could be instrumental in achieving SDG2.

A Novel Measure of Political Risk and Foreign Direct Investment Inflows

This paper proposes a novel measure of political risk that confirms some of the findings documented in the Foreign Direct Investments (FDI) literature. Particularly, we confirm the positive relationship between political stability and its components on FDI inflows, and the moderating effect of natural resources on this relationship. The proposed political risk measure contains relevant, unique and incremental information not observed in the literature. For example, although this measure is highly correlated with the political risk rating of the International Country Risk Guide (ICRG), it contains unique information that explains FDI inflows beyond what is explained by the ICRG rating. A link to the database for our political risk rating for 150 countries covering 2000 to 2015 has been provided.

Does bureaucracy affect the outcome of logistics performance? Empirical evidence from South Asia

PurposeThe purpose of this paper is to develop and test theory-driven hypothesis on trade costs’ effect of logistics performance (LP) and bureaucratic efficiency, primarily from SAARC (South Asian Association for Regional Cooperation) perspective.Design/methodology/approachThe paper develops hypothesis based on the review of the literature and theory linking LP, trade costs and institutions. The authors test the hypothesis using secondary data sources: World Bank-UNESCAP trade costs database, World Bank Logistics Performance Index (LPI) and Political Risk Service's Political Risk Rating. Fixed-effect approach is used to test the hypothesis.FindingsThe influential role of bureaucratic quality on relationship between LPI and South Asian trade costs (inter-SAARC and intra-SAARC) is evident. The results also point out that bureaucratic quality also conditions the effect of different dimensions of LPI on South Asian trade costs. Further, it is found that bureaucratic inefficiency mitigates the effects of LPI on South Asia's trade costs with its proximate trading partners APEC (Asia–Pacific Economic Cooperation) and ASEAN (Association of Southeast Asia Nations).Research limitations/implicationsThe analysis is conducted using short span of data. With the availability of long span of data, the understanding of the relationship studies in this paper will improve.Practical implicationsThe results suggests policymakers to improve bureaucratic efficiency for utilizing the full potential effect of LPI in deceasing trade costs. The study inspires businesses to act and advocate in favor of reforms in governance system.Originality/valueThis paper is among the first, which investigates the possibility that the relationship between LPI and trade costs depends on the bureaucratic efficiency. It provides a more detailed description of the LPI-trade costs relationship.

Ecological footprint, tourism development, and country risk: International evidence

This research empirically explores the economic-, tourism-, and country risk ratings-induced Environmental Kuznets Curve (EKC) hypothesis by employing ecological footprints (EFs) as indicators of international environmental degradation. To account for distributional heterogeneities across countries as well as possible asymmetric relationships among variables, we apply a quantile regression approach by using panel data from 123 countries spanning 1992–2016. Our findings partially support that income, tourism, and country risk EKCs (i.e., inverted U-shape relation) exist in grazing land and forest land, signifying that these 2 types of land are sacrificed (increased) and then shift toward enhancing more environmental protection lifestyles as GDP, tourism revenues, and country risk ratings further rise. Conversely, U-shape relations generally exist in carbon-absorption land, cropland, and fishing ground, implying that growths of tourism, GDP, and country risk ratings have shifted from enhancing more environmentally protective policies to encouraging EF-consuming lifestyles for these EF components. In addition, we uncover that income development is largely responsible for increases in EF, while tourism generally and salient decreases forest land and grazing land. We also confirm the income EKC hypothesis in European countries. Tourism increases (reduces) fishing ground at lower (higher) fishing quantiles, suggesting the asymmetric impacts of tourism across different quantiles. The political risk rating shows a mostly positive impact on EF than those of economic and financial risk ratings, denoting the important impact of a country’s political rating on environment degradation. Overall, the findings herein advocate the need for analysis that considers heterogeneities across countries, different EF quantiles, and different EF components in the tourism-, economic-, and country risk-induced EKC estimations.

A Novel measure of Political Risk and Foreign Direct Investment Inflows

This paper proposes a novel measure of political risk that is used to confirm some of the findings documented in the Foreign Direct Investments (FDI) literature. Particularly, we confirm the positive relationship between political stability and its components on net FDI inflows, and the mitigating effect of natural resource exports on this relationship. The proposed political risk measure contains relevant, unique and incremental information not observed in the literature. For example, although this measure is highly correlated with the political risk rating of the International Country Risk Guide (ICRG), it contains unique information that explains net FDI flows beyond what is explained by the political risk rating of ICRG.

Country Risk Ratings and Stock Market Returns in Brazil, Russia, India, and China (BRICS) Countries: A Nonlinear Dynamic Approach

This study examines the linkages between Brazil, Russia, India, and China (BRICS) stock market returns, country risk ratings, and international factors via Non-linear Auto Regressive Distributed Lags models (NARDL) that allow for testing the asymmetric effects of changes in country risk ratings on stock market returns. We show that BRICS countries exhibit quite a degree of heterogeneity in the interaction of their stock market returns with country-specific political, financial, and economic risk ratings. Positive and negative rating changes in some BRICS countries are found to have significant implications for both local stock market returns, as well as commodity price dynamics. While the commodity market acts as a catalyst for these emerging stock markets in the long-run, we also observe that negative changes in the country risk ratings generally command a higher impact on stock returns, implying the greater impact of bad news on market dynamics. Our findings suggest that not all BRICS nations are the same in terms of how they react to ratings changes and how they interact with global market variables.

An analysis of the relationship between foreign direct investment (FDI), political risk and economic growth in South Africa

A country’s political stability and trends in economic growth are important factors to attract foreign investment. Most developing countries struggle to achieve political stability and high levels of growth. Due to these issues, developing countries attract limited foreign investment. Applying the Bounds test for cointegration, an ARDL model was utilized using time series data from 1995 to 2016, this study examined the potential impact of political risk and gross domestic product (GDP) on foreign direct investment (FDI) flows to the South Africa. Findings of the study revealed that in both short and long run, political risk and economic growth affect the level of foreign direct investment. The political risk rating was found to have a higher impact on FDI flow if compared to GDP. The lower the political risk level (resulting in a highly rated index), the higher the level of FDI inflows. Using the Granger causality approach, empirical results indicated a bi-directional causal relationship between FDI and economic growth, while it was found that political risk causes changes in FDI. In other words, individually, political risk and gross domestic product cause changes in FDI. Based on the study findings, it is imperative for the South African government to reduce the level of political risk in order to increase foreign investment into the country which, in return, could assist in economic growth and welfare.

To engage or not to engage with host governments: Corporate political activity and host country political risk

Research summary: We analyze how a host market’s institutional context can influence a multinational enterprise’s (MNE’s) senior management’s choice and deployment of corporate political activity (CPA). First, we argue that a non‐engaged approach to CPA is likely to be chosen when senior management perceives high host country political risk, arising not only from host country political institutions, but also from the distance between home and host government relations. Second, we propose that the deployment of this approach can require active adaptation through four political strategies: low visibility, ensuring a minimal degree of general attention from other actors; rapid compliance, entailing high speed actions to obey the rules; reconfiguration, involving rearranging the MNE’s structure and processes for competitiveness; and anticipation, implying the prediction of public policy and analysis of interest groups to anticipate responses. Managerial summary: Senior managers of multinational enterprises often examine when and how to engage, or not to engage, with host governments. We argue that senior managers are likely to choose to evade engagement with a host government when they perceive high host country political risk, not only through public political risk ratings, but also via their home and host government relations. We show that this choice can require senior managers to lead active adaptation through four strategies: low visibility, enabling the MNE to operate under the radar of host governments; rapid compliance, entailing high speed actions to obey the rules; reconfiguration, involving rearranging the MNE’s structure and processes for competitiveness; and anticipation, implying the prediction of public policy and analysis of interest groups to anticipate responses.A video abstract is available at https://youtu.be/DL1LlQEhGU0.

Political risk and the cost of capital in the MENA region

We examine the impact of political risk in the MENA region on the cost at which firms can raise capital. Using the implied cost of equity as a measure of the cost of capital and ICRG's political risk rating as a proxy for political risk, we find that political risk results in a higher cost of capital. Economically, our results suggest that a one standard deviation increase in the political risk index is associated with a 450 basis points increase in the cost of equity capital of MENA firms. Our results are consistent across a battery of robustness checks. Our findings have important policy implications that are relevant to the MENA region and beyond.

Do political risks matter in the financial markets?: evidence from Turkey

Understanding political risk and its effect on financial markets is an important issue for both policymakers and investors, as capital flow tends to be confidence-based across financial markets. Using both dollar-based monthly returns from the BIST100 index and the total political risk rating, including four political risk subcomponents, for the period of January 1997 to June 2013, this paper investigates the long-term relationship between financial markets and political risk in Turkey applying cointegration tests and causality tests to data obtained from Borsa Istanbul (BIST) and the International Country Risk Guide (ICRG). Our findings indicate that, a long-term relationship of equilibrium exists between financial markets and political risks in Turkey, revealing the importance of considering political conditions when making decisions regarding financial markets in Turkey. The research is expected to contribute to the literature, especially in the context of trading in emerging financial markets and how political acts reflect financial markets, as shown by the evidence from Turkey.

Political Risk and Foreign Direct Investment in Africa: The Case of the Nigerian Telecommunications Industry

Foreign direct investment (FDI) flows are expected to be influenced by political risk factors. However, studies that evaluate the relationship between political risk and FDI flows in sub-Saharan Africa (SSA) are scarce. This study examines the impact of political risk on FDI flows in an SSA context using the 12 political risk components published as the International Country Risk Guide (ICRG) by the Political Risk Services (PRS) Group with the Nigerian telecommunications sector as a case study. The study finds that political risk has a significant influence on the inflow of FDI into developing economies in SSA such as Nigeria and that the 12 components affect FDI in different ways. Irrespective of the political risk rating, a consistent improvement in composite political risk enhances FDI inflow. Among the 12 components, corruption, law and order, democratic accountability, and investment profile were found to have significant influences on FDI inflow into the Nigerian telecommunications sector. Corruption, in particular, explains nearly two-thirds of the FDI inflow. © 2015 Wiley Periodicals, Inc.

Political Risk and Expected Government Bond Returns

Political risk relates to both the ability and the willingness of governments to repay debts. We find that bond prices only slowly adapt to changes in political risk. The expected bond returns for countries whose political risk ratings have improved are higher than those for countries whose political risk ratings have deteriorated. This change in political risk premium cannot be explained by the risk factors default premium, term premium, and liquidity, or by momentum, changes in credit ratings, economic risk or financial risk. The risk-adjusted performance is 7.6% per annum for emerging bond markets and 0.8% per annum for euro government bonds.

Political risk and expected government bond returns

Political risk relates to both the ability and the willingness of governments to repay debts. We find that bond prices only slowly adapt to changes in political risk. The expected bond returns for countries whose political risk ratings have improved are higher than those for countries whose political risk ratings have deteriorated. This change in political risk premium cannot be explained by the risk factors default premium, term premium, and liquidity, or by momentum, changes in credit ratings, economic risk or financial risk. The risk-adjusted performance is 7.6% per annum for emerging bond markets and 0.8% per annum for euro government bonds.

Political risk spreads

We introduce a new, market-based and forward looking measure of political risk derived from the yield spread between a country’s U.S. dollar debt and an equivalent U.S. Treasury bond. We explain the variation in these sovereign spreads with four factors: global economic conditions, country-specific economic factors, liquidity of the country’s bond, and political risk. We then extract the part of the sovereign spread that is due to political risk, making use of political risk ratings. In addition, we provide new evidence that these political risk ratings are predictive, on average, of future risk realizations using data on political risk claims as well as a novel textual-based database of risk realizations. Our political risk spread measure does not make the mistake of double counting systematic risk in the evaluation of international investments as some conventional measures do. Furthermore, we show how to construct political risk spreads for countries that do not have sovereign bond data. Finally, we link our political risk spreads to foreign direct investment. We show that a one percent point reduction in the political risk spread is associated with a 12 percent increase in net-inflows of foreign direct investment.

Risk ratings and stock prices: the causal nexus in BRICS countries

This paper investigates the nature of causal relations between risk (economic risk, financial risk and political risk) and stock prices in five BRICS countries (Brazil, Russia, India, China and South Africa), applying the Granger causality test over a period of 20 years from 1992 to 2012. The study bridges a gap in the literature, as prior macroeconomic empirical investigation has been limited to a possible link between risk ratings and stock prices. Our modelling includes BRICS stock price indices and three risk ratings, namely economic risk ratings, financial risk ratings, and political risk ratings. To achieve our objective, two econometric methodologies were adopted: cross-country regressions and time series regressions. The empirical results of this study indicate that for Russia and China (and the BRICS counties as a group), there is a unidirectional causality between political risk and economic risk. Another noteworthy result was the fact that a unidirectional causality between economic risk and share prices were found for India and China (and the BRICS countries as a group), but not for the other countries under review. This indicates the important role that the stock market plays in the economies of India and China and hence provides an extra caution for prospective investors in these countries.