Geopolitical Risk

Geopolitical Risks (GPRs) refer to risks arising out of potential conflicts between countries due to a nation's involvement in international affairs. It may be geographical, political, social, economic, or military. These conflicts can leave serious impact on business relations between countries and global companies.

These issues impact trade and business between nations and the global economy. Factors such as governmental policy changes, political unrest, trade conflicts, terrorism, and regulatory adjustments contribute to the emergence of geopolitical risks. Disrupted operations and supply chains, job losses, negative effects on the growth rate, and reputational damage are all outcomes of such risks.

• Geopolitical risk refers to the potential negative impact of political, social, and economic factors on interactions between two countries.
• These events can disrupt operations and impact profitability and the environment suitable for investments. This may eventually harm the growth of the nation.
• Businesses may suffer reputational harm if they are linked to political regimes portrayed negatively for human rights violations or unethical behaviors. Other negative impacts include supply chain disruption, stifling innovation, financial loss etc.
• Companies can manage geopolitical risk through risk assessment, diversification, flexibility, and stakeholder engagement, among other things.

Geopolitical risk (GPR) is the potential for crises like wars, terrorist attacks, and conflicts that can impact international relations between countries significantly. It includes the likelihood of these risks occurring and the additional risks resulting from the intensification of current events. The potential conflict of geography, economics, and demographics impacts politics and international relations between states. They can affect trade between the borders of different countries.

GPRs are cited as one of the major variables affecting decisions related to consumption and investment. GPRs and uncertainty may lead to businesses delaying investments and consuming more due to the precautionary saving drive.

Political instability, such as conflicts, regime transitions, or changes in government policy, is a factor that causes geopolitical risks in business. These events can disrupt operations and impact profitability and the environment suitable for investments. This may eventually harm the growth of the nation. Protectionism and trade conflicts, such as tariffs or government-imposed restrictions, can increase costs, disrupt supply chains, and limit market access.

Sudden shifts in power or direction can result in regulatory uncertainty, tax changes, the nationalization of assets, or the establishment of trade barriers, all of which can harm business. These risks could increase, leading to actions that would affect cross-border trade and corporate operations.

Similarly, geopolitical risks involve changes in regulations, legal systems, and compliance requirements, which can be costly and time-consuming for businesses. Regulations include governments imposing economic sanctions on countries or entities to exert political pressure or address human rights concerns. These sanctions can restrict trade, financial transactions, and resource access, impacting businesses in the targeted regions. Additionally, geopolitical risks include terrorism, political violence, and security threats, which can disrupt business operations and undermine consumer confidence.

Let us look at a few examples:

Example #1

Let us look into a hypothetical example to get an insight into the concept:

Suppose Dan owns a manufacturing company, ABC Ltd. He significantly relies on international supply chains. Suddenly, new tariffs and trade restrictions were enacted due to the escalating geopolitical tensions between two significant trading nations. As a result, Dan's company had to deal with rising expenses and disrupted supply chains due to the closure of borders between these two countries. It was also observed that there was a drop in demand for his goods abroad due to negative market conditions, which affected his profitability.

Even though the conflict is between two nations, their border shutdown hinders the free flow of goods and services. This is why Dan's company and business were affected, despite being a third party to the conflict. The risk index by country can be segregated and analyzed for global analysis as a preventive measure to sustain losses. Analyzing geopolitical risk data thus can help Dan devise alternative strategies.

Example #2

A study provided a clear picture of the geopolitical risks facing multinational companies worldwide, particularly in Europe, due to the conflict between Russia and Ukraine. It focused on the impacts it had on the energy sector of Europe. The study aimed to quantify the impacts of energy risks on international tensions in European Union member countries at the micro level. Using data from Eurostat, it developed an integrated research model that examined the links between micro-level operations in EU member states. 

The model included four independent and dependent variables: supply, transformation, and consumption. It shined the light on energy crises and how consumption is influenced by supply factors, which shape energy markets' demand and supply, affecting costs and prices. Energy supplies positively impact consumption and productivity in businesses, while shortages can negatively affect growth and international relations.

The findings emphasize the importance of addressing micro-level operations to cope with changes brought about by geopolitical shifts or risks, particularly in the energy sector. It also provides practical guidance and managerial implications for policymakers, stakeholders, and business managers in the energy sector. The model serves as an attempt to urge collaboration and participation in developing crisis management strategies to mitigate the negative effects of geopolitical risks in today's risky and uncertain reality.

Some of the impacts of geopolitical risk on business are given below:

#1 - Disrupted Operations And Supply Chains

Geopolitical risks can interrupt supply chains, distribution networks, and business operations, resulting in delays, higher costs, and inventory shortages. Analyzing geopolitical risk data can help with planning and setting up preventive measures.

#2 - Stifles Innovation

It is seen that when geopolitical risk rises, R&D spending of businesses declines. However, the turnover of scientists and inventors in charge of the patents increases. These two elements have a detrimental effect on businesses' overall levels of innovation.

#3 - Financial Losses And Market Volatility

Market volatility and financial losses can result from trade disputes, political unrest, or economic restrictions for enterprises operating in the impacted areas.

#4 - Damage To Reputation

Geopolitical factors can pose reputational risks to businesses. Being linked to politically controversial regimes, human rights abuses, or unethical practices can damage brand image and consumer perception and potentially lead to market share loss. 

Businesses can navigate the period of geopolitical turmoil by adopting the following measures:

#1 - Risk Analysis And Monitoring

Businesses should do in-depth risk analyses, looking at the political and economic environment prevailing at that time. It involves looking into the legal frameworks and potential geopolitical indicators. Monitoring these factors aids in proactive geopolitical risk management.

#2 - Flexibility

Flexibility and diversification are important because they help lessen geopolitical concerns' impact on business operations. Supply chain management flexibility enables companies to respond swiftly to changing conditions. Similarly, thinking about alternative product-selling route aid in diversification and saves the company or business from plunging into a total loss.

#3 - Planning

Organizations can effectively manage geopolitical risks by developing short-term, mid-term, and long-term response strategies. This enables them to handle rapidly changing situations and make necessary investments for opportunities to seize and enhance resilience and in geopolitical risk management.

#4 - Stakeholder Participation 

Companies can better understand local dynamics and regulatory laws and develop relationships that can be supportive during periods of geopolitical turmoil. This can be made possible by interacting with local stakeholders, governments, and relevant associations.

This has been a guide to what is Geopolitical Risk. Here, we explain its examples, impact on business, and how companies can manage it. You can learn more about it from the following articles –

• Qualitative Risk Analysis
• Foreign Exchange Risks
• Political Risk