Singapore businesses and hedging against political risk

A small domestic market prompts many businesses including Small and Medium Enterprises (SMEs) to venture overseas to expand their revenue base beyond Singapore's shore.

This often means venturing into emerging markets. With the growth of awareness and talks revolving around the lucrative returns in these emerging markets, Singapore businesses may be lured to plant their presence in them.

This sparks a growth of Singapore businesses in global footprints. While emerging markets present tremendous opportunities, risks are involved. Particularly political risks are an area which has been an increasingly difficult component in any business to hedge against.

How can political risks affect Singapore businesses?

For example, investment into emerging countries within Southeast Asia such as Myanmar has been a growing interest. Singapore SMEs such as those in the construction or Food and Beverage (F&B) sector may be keen to penetrate into the market to gain a first mover advantage.

For some Singapore SMEs, it may also be the case of purchasing franchisee license to operate in these emerging countries where potential risk and return are attractive. The effects of political risks can be transmitted through volatile currency fluctuation.

For example, political crisis in one country or social instability can result in outflow of investment and possibly confidence in a particular currency. This can result in rapid depreciation of the currency. A business caught in this business will find their real profit falls when repatriating the fund back to their home country, say Singapore.

Another possible transmission of risk is the restriction in capital outflow. This essentially means that businesses could face difficulty in repatriating cash back to a particular destination, regional HQ or main HQ.

For example, in the past few years, there has been a vibrant growth of F&B leaders such as Breadtalk and Old Chang Kee who have established their branding in Singapore and have substantial businesses in overseas market.

Similarly, other F&B SMEs have taken initiatives in exploring the regional markets. As such, there is a certain risk exposure on the local political economy that can potentially restrict the flow of capital or when there is a sudden imposition of capital regulation.

This may strain your business cashflow especially when the business requires huge amount of cashflow for daily operation.

Insured against political risks

The complexity of political implication on business makes business owners or companies ignoring the possible damages that political risks can inflict on any business.

In fact, while the number of underwriters for political risk may be few, there is often tailor-made insurance for political risks. The effects of the risk can be a currency inconvertibility whereby a government may potentially regulate the purchase or transfer of hard currency.

Furthermore, political violence can result in delaying of payment schedules. A more severe case is when a sovereign guarantee becomes invalid when there is a failure to honor the payment obligation.

All these resultant effects of political risks can affect the company’s daily operation, and tapping onto credit facility provided by bank can become costly.

Also the tapping of credit facility may project an image that the business faces going-on concerns and can face creditors’ demand to make early repayment on a business’s payable account.

This will deepen the cashflow woes. While some businesses may be able to tide over the first crisis, future credit terms by the creditors can be less favorable or borrowing costs by the firm may rise due to inbuilt risk premium by financial institutions lending to the respective business firms.

In an ever-changing and dynamic global economy, the impacts of political risks are diverse and asymmetric across different natures of business or countries of operation. This requires firms to hedge against the risks. The uncertainty and complexity of political risks present challenging negotiation and planning for insurance against such risks.

Often, companies may think of hedging one asset group over another. However, the second degree of asset group that was hedged can have innate risk that requires further hedging and the process can be never-ending.

The crux is to have a well thought plan through working with your corporate insurance firms and having a risk management team to be aware and acknowledge the potential risks in overseas operation.

Businesses in Singapore often have diverse operations and investment in emerging countries when there is higher exposure to risks in the initial phase or development.

As countries become more interconnected and integrated into different economic nodes of the global economy, the likelihood of risk contagion is high.

Instability and risk in one country or region can be spilled over to the respective neighboring entities, which further complicates the job or risk management.

Having said that, it is time for companies to look into risk management, perhaps even beyond political risks when business climate conditions can be volatile.