From the desk of Evdokia Pitsillidou, Risk Associate, easyMarkets
There are several types of risk that we encounter when trading the markets, one of the most fundamental of which is political risk.
Trading during times of political uncertainty can be a difficult task both emotionally and practically, so it is important to understand the various factors involved so as to be better equipped along with a thorough understanding of how your investments could be affected.
A simple definition of political risk would certainly be any adjustment in the political arena that may affect the value of an asset due to an economic action.
This type of risk changes the likelihood of business objectives being met and may affect companies both in a direct financial sense and likewise in the context of human resources.
As it happens, political risk can affect the decision-making of both government bodies and private businesses.
Businesses need to adopt a deep understanding of the government of whichever country they are operating within, but governments must likewise take into consideration its foreign neighbours and a diplomatic relationships that could be affected by a given political action.
Looking at things on the macro level we see the potential risks in everything within a specific local or even national political area.
Everything from credit defaults to inflation and even a declaration of war would certainly be considered macro-level political risk factors.
The instability of a currency within a given country or issues relating to its manufacturing sectors can alter the appeal and appropriateness of investments being made within that country.
This may produce ongoing political effects because the government of an affected country will need to adjust its policies and interactions both domestically and internationally.
Micro-level risk factors apply to specific projects, organisations, and industries within a given political area.
When assessing the potential impact of micro-level political risks it is important to consider the current political climate within a region and how this may affect a business.
This type of risk is more likely to affect smaller, more localised business interests as opposed to larger global organisations based within a country.
A Political Risk Scenario
Imagine for example that the company decided to buy a weapons manufacturer based in a rival economy.
The financial and diplomatic implications for this could be rather significant, so it would certainly be important for a relevant government body – for example, the Committee on Foreign Investment in the United States – to perform a full analysis of the situation.
Using the United States as our example, a further analysis of overall public opinion, not to mention congressional climate would certainly need to be made before such a transaction could take place.
This must hopefully serve to illustrate the lots of considerations that need to be made when trading during political uncertainty.
The various forms of political risk can have actually a major effect on your investments due to both macro and micro-level factors.