Risks in Foreign Direct Investment Projects - Case Study Example

International Business Table of Contents International Business Table of Contents 2 Introduction 3 Absence of favorable factors: Risk for the MNCs 3 Oil and Gas Sector: Risk Review in Norway 4 Political Risk 5 Social and Economic Risk 6 Environmental risk 7 Conclusion 7 Reference 9 Introduction In the period ranging from post World War II till 1980s, multinational companies were looked down with skepticism by many countries. This attitude has changed over the past few decades and now foreign direct investment (FDI) has become the buzz word of modern economy. During 1980s, the playing field of foreign direct investment (FDI) changed considerably. Apprehensions and restrictions have led way to acceptance and even encouragement. Indeed, companies are competing to attract more foreign direct investment flow. As a consequence, even multinational organizations, now a days, make trade-offs among the countries while deciding foreign investments. Despite the well developed strategies, certain inherent risks are associated with foreign direct investment which calls for additional caution when a company decides to invest in a host country. This report will attempt to assess social, environmental and political risk associated with foreign direct investment projects. Absence of favorable factors: Risk for the MNCs Political and macro-economic stability is often regarded as the most significant pre-requisite for foreign investors. A stable, transparent and non-discriminatory legal and regulatory environment encourages multinational organizations since it promises efficient and non-corrupt judicial system in case of conflict. Institutional rigidities and bureaucratic procedures are not intended as significant time is wasted in making strategies to fight with bureaucratic procedures and negotiations. Multinational organizations now require a free foreign exchange system with repatriation and a flexible labor market. An appropriate social and economic environment is also a prerequisite for the MNCs. A flourishing market, an efficient communication system, qualified labor, fiscal incentives and privatization programs are some of the ingredients that make a host country attractive to foreign investors (Michalet, 2000, pp7- 9) . As mentioned earlier, the foreign investors zero down on a specific country based on certain parameters. Earlier, organizations used to think the bureaucracy as a cost of getting entry into the domestic country. Now-a-days the foreign investors consider these as risk to their business. Apart from these, there can be certain political risks. Unfavorable political events and ambience of the host country can pose as a potential risk for the foreign investors. Changing relationships between the host and the home country as well as between the host and the third country are supposed to influence the economic well being of the multinational companies in that host country. Political risk can be divided into two segments: macro and micro political risk. Macro political risk is country specific and will have the same impact on all the foreign firms operating in the host country. Macro risk encompasses expropriations of all the foreign firms in a country, measures such as price controls, tax laws. Environmental regulations and constrains, specific to the foreign organizations (Sabac & Florin, 2000, pp 1-2). Some host countries have restrictions on repatriation of capital, local content regulations and restrictions on expatriate employment and foreign ownership. The micro portion of risk is more specific to a particular industry, organization or project. The social, economic and environmental risks too have significant influence on the cash flow of the company. In the wake of recent environmental consciousness, many industries face environmental risks as they have to align their operations as per the environmental norms of the host country. Oil and Gas Sector: Risk Review in Norway Norway’s production structure changed in 1970s, due to offshore oil and natural gas exploration. In 1992, the production of oil and natural gas accounted for more than 13 percent of Norway’s GDP. The two major players in Norway, government controlled Statoil and Norsk Hydro, had merged in the year 2007. Statoil is said to be the largest operator in Norwegian Continental Shelf (NCS). The Government of Norway has around 64 % share in the merged firm and it is expected to increase the stake to around 67 percent (USTR, n.d., pp 378). Right now, the country is the largest exporter of crude oil excluding the organization of the petroleum exporting countries (OPEC). Some 30 % of the Norway’s total earnings can be attributed to the export of petroleum. Report states that this sector is open to foreign investment; however the government prefers to have the larger stake in it. In recent years, serious effort has been made by Norway to integrate itself in the global free trade and investment area. The following segments will analyze the risk associated with foreign direct investment in the oil and natural gas sector of Norway. Political Risk The Norwegian government is open to foreign investment. However, there still exist doubts that need to be addressed. This is because state ownership in this specific industry remains significant. The multinational companies might not be willing to conform to the diktats of the state government (WTO, 2000). Norway does not offer any significant tax incentive to its foreign investors. Huge taxation will result in heavy cost for the foreign investors. There are certain regulations, practices and standards where the local stakeholders gain more than its foreign counterparts. Apart from this, direct investment in petroleum exploration and exploitation are subjected to license provided by the Norwegian government. Hence, it can be inferred that the state government exercises a strong control in this sector and does not intend to let it go in near future. Social and Economic Risk The economy of the country is hugely dependent on oil prices. As a consequence, the state and stability of the economy fluctuates with the changes in the oil prices. A slowdown in the oil and gas prices can adversely impact the Norwegian economy. In the oil and gas sector, the price factor can very well be considered as a risk both at micro and macro level. “Norway is already past the peak of its oil production” (Emporiki Bank, 2010). This has emerged as a weak point for the foreign investors interested in investing in the oil and gas sector. The transportation network of this country is also not smooth. As a consequence, the multinational companies may have to bear huge cost related to transportation and logistics. Poor infrastructure and telecommunication has resulted in additional expenses for the companies operating in Norway. The cash inflow in the company is supposed to be adversely affected due to high cost of operation and transportation. This, in turn, has increased the probability of financial risk in the company. Apart from this, the country has maintained relatively strict regulations in the field of employment. The salary cost is very high in Norway. Multinational companies are required to pay high salary to qualified employees in Norway. “Norway has attained high living standards and full employment through a skilful exploitation of its bountiful natural resources and the adoption of sound economic policies” (WTO, 2000). However, the country now faces a long term challenge of aging population. Particularly since the year 1998, a tight labor market has adversely affected the income policy management which has led to the rise in real wages beyond any productivity gain. Certain other risk like interest risk and exchange risk are also associated with it. These two risks are quite significant and common to any multinational business. A number of organizations have been adversely affected by the sudden fluctuation in interest rates that took place in the recent recession. Environmental risk The Norwegian government has established specific environmental standards for operating in this sector. ‘Exploration dealing’ is a significant way to prove the existence of oil and gas. Norwegian government has made it mandatory that all the drilling must be done in the safest possible way without causing any harm to human beings as well as environment. At the same time, the authority has allowed drilling for a specific period of time to avoid conflicts with fishing, fish spawning and environment. In some areas of Norway, zero physical discharge into the sea is the condition for all the oil companies. So, the foreign investors or multinational oil and gas companies are required to align their operation as per the environmental standards (Konkraft, n.d.). Apart from the specific risks, pertaining to Norway, there are certain other risks, which any multinational organization has to take into consideration while opting for investment in other countries. Sometime foreign investors are not welcomed by the local people; the inhabitants may boycott the products offered by the MNCs. Many foreign companies find it very difficult to raise capital in the host countries. However, Norway is not among them. The rising oil price has made Norway one of the leading capital sources of the world (Aggarwal, n.d.). Conclusion In the year 2009, Norway has experienced foreign direct investment inward flow of around 6,657 million USD (Emporiki Bank, 2010). A credit insurance company has stated that Norway has low political risk with medium business risk (Ducoire, 2010). As a whole the country can be an attractive option for foreign investors; however, the pitfalls cannot be ignored. “With globalization, competition for attracting FDI is now among host-countries; it is no longer among foreign firms trying to have access to domestic markets” (Michalet, 2000, pp 7). Global investors take into consideration certain key prerequisites before making an investment in a foreign country. Authentic assessment of political, social and environmental risk is thus of paramount importance. Reference Aggarwal, R. Raising Capital in Global Financial Markets. Retrieved from http://www.qfinance.com/contentFiles/QF02/g1xtn5q6/12/1/raising-capital-in-global-financial-markets.pdf. Ducroire. (June, 2010). Norway. Retrieved from http://www.ducroire.com/WebDucDel/Website.nsf/AllWeb/Norway?OpenDocument&Disp=1&Language=en. Emporiki Bank. (2010). Doing business. Retrieved from http://www.interex.gr/uk/countries-trading-profiles/norway/doing-business. Konkraft. Oil and Gas Activities in Northern Norway. Retrieved from http://www.olf.no/getfile.php/Konkraft/Dokumenter/090311%20KK%206-summary-webres.pdf. Michalet, C. (February, 2000). Strategies of Multinationals And Competition For Foreign Direct Investment. Retrieved from http://www.fias.net/ifcext/fias.nsf/AttachmentsByTitle/Strategies_of_Multinationals_and_Competition_for_FDI.pdf/$FILE/Strategies+of+Multinationals+and+Competition+for+FDI+-+Charles+Michalet.pdf. Sabac & Florin, M. (June, 2000). The Impact of Political Risk On The Foreign Direct Investmnet Decision. Retrieved from http://www.allbusiness.com/finance/593484-1.html. USTR. Norway. Retrieved from http://www.ustr.gov/sites/default/files/uploads/reports/2009/NTE/asset_upload_file402_15494.pdf. WTO. (June, 2010). Norway: June 2000. Retrieved from http://www.wto.org/english/tratop_e/tpr_e/tp135_e.htm. Read More