Political And Economic Risk Analysis: Macedonia

Abstract: Bhalla (1983) developed Foreign Investment Risk Matrix (FIRM) as you step of the political risk analysis process, where he uses political and economical risk measures in the foreign direct investment decision making. However, countries with population significantly less than 5 millions or income per capita less than $500 are excluded from consideration due to insufficient market size. Understanding that Macedonia has population around 2 million and $9. 000 income per capita, this research will attempt to determine its position in the chance Matrix by using available and reliable data on internet.

Keywords: political risk, financial risk, Foreign Investment Risk Matrix.

1 Introduction

In this paper we will analyse Macedonian risk position in the two-dimensional matrix, using readily available measures of political and economical risk. Bhalla (1983) described a four-step process you can use for country risk analysis and the first rung on the ladder is called the Foreign Investment Risk Matrix (FIRM). This matrix allows a multinational company to rate countries basing on the chance and only using political and economical risk measures. A lot of the researchers do not include countries with less than 5 million population or less than $ 500 income per capita. Macedonia is area of the first group with population around 2 million. This paper will use the theory for country risk analysis from Bhalla's model and the extended version from McGowan Jr. and Moeller.

Talking about country risk, we can say that it is related to changes that might occur available environment in a single country that will likely reduce the profitability of the foreign investment. The primary two the different parts of country risk that investors need to consider are political risk and monetary risk for that country.

2 Literature review

2. 1 Risk categories

Many researchers have tended to separate country risk into categories. A few of them decided on six major risk categories that are shown below. Lots of the categories overlap with each other, knowing the interrelationship between your domestic economy and political system in the countries and with the international community. Although many risk analysts do not trust this list, and think that the main two categories include economical risk and political risk. These are the six major categories:

Transfer Risk

Exchange Rate Risk

Location Risk

Sovereign Risk

Economic Risk

Political Risk

Transfer Risk is the chance arising from a decision with a foreign government to restrict capital movements. This sort of restrictions might make a situation where it'll be difficult to repatriate profits, dividends, or capital. The right of the federal government to change capital movement rules anytime can affect all types of investments in the united states. This risk is analyzed as a function of any country's ability to earn forex and quantifying it remains difficult, since it can be forced with a purely political response to another problem.

Exchange Risk is the chance that will affect the investment by changes in exchange rates. This risk, basing on the monetary theory guides can be analysed in a one or two year period, since the short time exchange risk is driven by forex trading momentum and can be eliminated through various hedging mechanisms and futures arrangements.

Exchange risk can be discovered with transfer risk, since a sharp depreciation of the currency can reduce a few of the imbalances that lead to increased transfer risk.

Location Risk is the risk caused by spillover effects caused by problems in an area, in a country's trading partner, or in countries with similar perceived characteristics. This risk can be defined from country's trading partners, international trading alliances, country size and borders, and the distance from economically/politically important countries.

Sovereign Risk is the probability that government will won't comply with the terms of financing agreement during economically difficult or politically volatile times. It could be related to transfer risk when the government runs out of foreign exchange, or political risk when the government will decide never to respect its obligation because of political reasons.

Economic Risk is the chance whenever we have major change in the economic structure, that will bring changes in the expected return of investment. This risk can arise from changes in fundamental financial policy goals or country's comparative advantage. It's connected with the political risk, since both deal with policy in the country.

Political Risk originates from the changes in a country's political structure or its policies, such as tax laws, tariffs, expropriation of assets, or restriction in repatriation of profits. It can occur because of attitude of consumers in the host country where some consumers are very loyal to locally made products. The most frequent action is the one from the host government, where they can impose special requirements or taxes, restrict fund transfers, and subsidize local firms. Or the contrary, governments lack of restrictions. Another actions that may lead to political risk is the blockage of fund transfers for the MNCs or currency inconvertibility when the MNC parent might need to exchange earnings for goods if the forex cannot be became other currencies. War or even the threat of war, can have devastating effects and represent political risk. Also bureaucracy and corruption can complicate business, raise the its cost or reduce revenue.

2. 2 Foreign Investment Risk Matrix

Bhalla's country risk analysis process has four-steps. The first step is to set-up the foreign investment risk matrix where we can determine the countries that provide a stable political environment and have economic potential for a investment. Second step will create country risk profile for the selected countries in the first step. From then on, he suggested to make a foreign investment risk analysis for each and every project for every single country in the 3rd step. The fourth step will generate risk audit that will monitor and re-evaluate the surroundings on a continuous basis and also to inform the MNC for changes in monetary and political stability in the united states.

Bhalla's previously mentioned two-dimensional matrix has four categorical variables for each political/economical risk. Country political risk is categorised into four categories: A being stable, B being moderately unstable, C being volatility unstable, and D being substantially unstable. Economic risk is categorised into four categories: category one indicates acceptable risk, category two indicates moderate risk, category three major risk, and category four specifies unacceptable risk. Measures that he uses for the political risk are government stability, frequency of changes in government, and the attitude of the public for the government leaders and institutions. For the monetary risk Bhalla used market potential for the business's products, demographic characteristics and infrastructure of the country, the economical breadth of income, GNP per capita, and the monetary growth potential.

Bhalla (1983) argues that income per capita and the distribution of income per capita are the most important variables in deciding both financial and political risk because income per capita reflects both underlying economy and the potency of the political management. Both degree of income per capita and the distribution of income per capita effect financial and political risk. More evenly distributed income per capita reduces both financial and political risk.

Using this four by four two-dimensional matrix, Bhalla rated countries in sixteen different categories. Countries with political stability and acceptable economical risk would maintain the top left corner and those with political instability and unacceptable financial risk would be in the low right corner.

In this paper, we will demonstrate how to use Bhalla's matrix and the extended version by McGowan Jr. and Moeller where they only use easily available measures that may be easily entirely on internet.

3. Case study of Macedonia

This research is conducted for Macedonia, country that in the majority of the cases is left out of the united states risk analysis as a result of population number that is around 2 million citizens. Basing on the prior research from McGowan Jr. and Moeller, Macedonia was ranked employing this variables for the political risk: attitude of the government toward foreign direct investment (FDI), conflict degree of the country, and perceived corruption within the country. Also three variables were used to gauge the financial risk: gross national income per capita, inward FDI potential, and the inflation rate. All those variables can be found on internet and are reliable since they all come from dependable and respected sites that rank countries annually and use reliable methods.

The Attitude of Government toward FDI can be measured by the Index of Economic Freedom, with the sub-index for Capital Flows and Foreign Investment. Some information can be found on Heritage web page (heritage. org). The sub-indexes must be subtracted by five, because the Indexes of economical freedom are highest at one and lowest at five. Regarding Macedonia, this measure index is 2.

Conflict Barometer published by the Heidelberg Institute of International Conflict, available on site (http://hiik. de), gives information about the degree of country conflict. This variable for Macedonia is 2.

Perceived corruption is calculated by Transparency International on a yearly basis, using the Corruptions Perceptions Index. The index is a weighted average of a number of indexes and surveys of perceived corruption. The CPI is transformed by dividing the published value by two. Perceived corruption for Macedonia is 1. 6, knowing that the starting value is 3. 8.

Gross national income per capita data are available from World Development Indicators report which is published by the earth Bank and are available on (http://web. worldbank. org). Here we assign:

five for a higher income economy,

four for an upper middle class economy,

three for less middle income economy,

two for a minimal and middle class economy,

one for a minimal income economy.

Macedonia's GNI per capita rating is 3.

FDI Potential is measured by using UNCTAD's Inward FDI Potential Index (www. unctad. org) which is an equally weighted average of the values (normalized to yield a score between zero, for the cheapest scoring country, and one, for the highest) including 12 different variables:

GDP per capita,

Growth rate of GDP for a decade,

Exports to GDP,

Average quantity of telephone lines per 1000 citizens,

Commercial energy use per capita,

R&D spending to GDP,

Proportion of tertiary students in the population,

Country risk,

World market share in exports of natural resources,

World market share of imports of parts and components for automobiles and electronic products,

World market share of exports of services, the share of world FDI inward stock.

Since this index has value from zero to one, it could be transformed by multiplying the published values by ten and dividing them by two. Macedonia's value is 0. 6.

Inflation Rate can be measured by the Index of Economic Freedom, sub-index for Monetary Policy. Here the sub-index is subtracted by five, because the index is highest at one and lowest at five. The Monetary policy index is dependant on the inflation rate for the prior ten years in the united states. This variable for Macedonia is 0. 5% but subtracted from 5 is 4. 5.

After we determined the values for economical and political risk, we used them to find the total political and economical risk for Macedonia.

Following the Bhalla's model and the extended model by McGowan Jr. and Moeller we created a two dimensional graphic. One dimension is monetary risk and the other dimension is political risk, both of them scaled from one to five. After that we used the values from Table 1 to get the position of Macedonia. Like we can see in Figure 1, Macedonian position is in the lower left corner, simply for comparison with the countries that are acceptable for foreign direct investment and are in the top right corner.

After we had calculated the political risk dimension and economical risk dimension, we positioned Macedonia in the Foreign Investment Risk Matrix. (Figure 1. ) Its position in the uncertain region tells us that Macedonia might represent a country for a direct foreign investment only in a case when there are no other countries that exist for FDI or in a case when the MNC wants to participate in this market no matter what. This position can be easily changed by further analysing of this country, that will assist in your choice making for investment. The closeness to the unacceptable region might represent a threat, but understanding that the country is certainly going trough massive economical and political changes, it can be expected to see Macedonia's risk position in FIRM to be nearer to the acceptable region in the next years.

4. Conclusions

Foreign investment is of great importance for a little country like Macedonia. Being in the Balkan part of Europe, for a few MNC's means a lot, in particular when they have to make investment decision and they have in mind the war past and instability of this region. Although that is history and Macedonia, like some other countries for the reason that region, has moved far forward from that image, still this country is not part of any risk analysis, due to number of the populace.

With the value of investment, the need for political and economical risk analysis comes too. Many countries are open for FDI, a few of them have just opened, and also there are the ones that are hostile to foreign direct investment. Regardless MNCs need specific ratings of the risk of the countries, rather than the general ratings that may be found from some assessment services. Knowing that there exists available home elevators internet, and having in mind the main risks - economical and political, any MNC can analyse country risk, following Bhalla's country risk analysis process and extended version of FIRM from McGowan Jr. and Moeller.

Multinational corporations have to be in a position to determine the countries offering the best economic conditions and political stability that ensures production and sale for a long run. Political risk usually can derive from government actions and monetary risk can derive from changes in the micro or macroeconomic stability. For both of them, MNCs desire less instability.

The Foreign Investment Risk Matrix used in this research represents a good framework and any MNC can use it to investigate both, political and monetary risk. Any MNC can specify its values, that are more likely connected with their specific investment in a particular country. Because of this research, as a guidance we used values that are specific for initial country research and previously recommended by other researchers. Basing on those six independent variables found in this paper, we can rate countries as acceptable for foreign direct investment, unacceptable, and countries that provide uncertain environments and need further study before accepting/rejecting them from our financial commitment. In the long run, FIRM helps MNC decision maker to remove countries and make the right financial commitment.

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