What Is Political Risk And How Does It Impact Trade Credit?
What is political risk?
In terms of trade credit, political risk is an assessment of a country's political stability both externally and internally. We'll look at the most important factors that make up political risk below, but the concern from a business perspective is that big changes (for example, a military coup) could significantly impact markets or a country's attitude to paying foreign debt.
Here are some examples of the most common forms of political risk in international trade:
1. Government interference
Foreign governments have the power to confiscate companies' investments, and this can happen at any time without warning. A classic example of government interference is when a new political party comes into power and seeks to nationalize industries, which can often come without private organizations receiving fair compensation. The result of such expropriation measures is that the businesses affected can lose their assets or investments.
2. War, civil unrest, and terrorist attacks
The outbreak of war, civil unrest, or a terrorist attack can hamper an organization in a number of ways:
- Destruction or closing of premises.
- Damage or loss of assets.
- Inability to conduct operations.
Some companies, as was the case following an outbreak of protests in Ethiopia in 2017, may even be targeted if they're seen to be aligned with the wrong political factions. The cash flow problems that such incidences cause can mean that companies risk defaulting on payments to their business partners.
3. Embargoes and sanctions
If you're dealing in a country under trade embargoes or sanctions, this can quickly put the brakes on your imports and/or exports. Sanctions are the type of political risk you're most likely to encounter. Embargoes and sanctions can be implemented very quickly and without prior notification, literally stopping businesses in their tracks. If your company was trading with a partner in a newly sanctioned company, you could expect to experience significant losses even though you entered into business before the situation changed.
4. Climate risks
The worsening forecast for the planet's future means that environmental considerations are being increasingly factored into political risk assessments. Think about how rising seas, desertifcation and industrial pollution could impact businesses' operability in the years to come. As different countries will experience the effects of climate change to varying extents, and at different points in time, it's important to view this factor on a nation-by-nation basis, not something that will impact the globe in a blanket manner.
How is political risk identified?
At COFACE, we use macroeconomic, financial and political data to establish a country's risk – all of this information is usually freely available for our experts to analyze and produce reports on. With political risk, in particular, it's vital that these details are updated regularly, as situations change rapidly and occurrences in one country can easily cause a knock-on effect to the wider region. We make 160 frequently revised country evaluations, and estimate the overall risk on a scale ranging from Very Low (A1 rating) to Extreme (E rating) to ensure our customers are up to date with all the latest political information on the countries in which they operate.
How to protect against political risk with trade credit insurance
Trade credit insurance (TCI) is one of the best ways to protect against political risk. If you're owed money by a business in a country that's going through domestic or foreign policy turmoil, this may lead to unpaid invoices and bad debts, as they might be unable to meet their obligations. For your company, this can lead to problems ranging from cash flow issues to insolvency.
Importantly, TCI from Coface isn't just a protection policy but also includes customer research. This way, you can gain additional insights on prospective partners and make an informed decision before signing any contracts. This means that hopefully, you'll never find yourself in a situation where you're on the wrong end of bad debt. However, if you are owed money and not receiving it, with TCI you'll be able to recoup some of your losses, leaving your business in a stronger financial position going forward. No matter the size of your company, and the value of the deals you're planning to enter into, there is likely a TCI solution out there that can give you peace of mind to make partnerships with confidence.
If you don't want to invest in TCI but are still concerned about a potential business relationship, you could opt instead for a customized credit opinion. With this service, we will present you with an assessment of investment safety, based on a specific amount you request. This will highlight the risks of your customer's non-payment, based on an analysis from our expert team.
Coface has over 70 years' of experience in helping businesses avoid falling victim to bad debt and unpaid invoices. If you have concerns about a country where you plan to do business, get in touch with our team to find a TCI solution or customized credit opinion that works for you.