How Political Risk Affects Capital Budgeting in Multinational Companies

The ever-changing dynamics of global politics can wreak havoc on economic conditions, turning what were once solid investments into financial disasters. As a result, multinational corporations (MNCs) must identify and mitigate political risks to avoid losses. Capital budgeting is about more than just calculations, however, and operating environments play a large role in where funds are invested.

Capital budgeting differs from the normal expenditures companies make during their operating cycle. The dissimilarities include the amounts of money spent and how long investments are expected to generate returns. Capital budgeting most often uses time periods greater than a year. Money invested in facilities or revenue-generating equipment requires capital budgeting calculations. MNCs may have capital assets in politically unstable countries, making accurate asset allocation decisions critical.

Sanctions have the power to cripple economies and reduce revenue for MNCs. For instance, international sanctions instituted against Iran because of its nuclear program have adversely impacted its economy and corporations operating within its borders. Companies looking to invest in countries affected by sanctions must take into account the risks to their bottom-line profit and capital assets.

The political stability of a country directly impacts borrowing costs, taxes and regulation for businesses. Kickbacks and other forms of corruption have serious repercussions for MNCs. For example, Turkey has experienced a number of economic and political setbacks that raised the cost of borrowing for the national government. Corruption allegations, tight lending conditions and financial volatility within the country made it more challenging for corporate entities to operate there effectively.

Political instability has the potential to turn into hostilities, which can devastate the infrastructure of countries and ruin their economies. Syria's civil war has decimated many parts of the country while impacting the economies of its neighbors. Volatile regions pose a risk to companies looking to set up profitable operations and place capital assets in service. Business leaders must look at political risks and perform a cost-benefit analysis as part of their capital budgeting processes.