The effect of the global financial crisis on political and financial risks

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Introduction

The current global financial crisis is one of the worst financial crises in history. It has affected many businesses and individuals all over the world. Businesses have closed down and many people have lost their jobs. Uncertainty, political risk and financial risk have also increased (Global Economics Crisis Resource Center, 2009). The negative effects of the global financial crisis have been felt in most parts of the world i.e. in the advanced countries, the emerging markets and in the developing world (Yadav 2008).

The global financial crisis

According to Allen and Synder (2009), the global financial crisis is a disturbance in the economic environment which brings about a drastic drop in the value of assets, failure of financial institutions and a disruption of the stock exchange (p.36). Business organizations begin to cut costs so as to avoid liquidation therefore the unemployment rate escalates.

he purchasing power of many companies and households is reduced as prices of commodities soar. Interest rates, real estate, international investments and international business are also affected. The high cost of doing business in such an economic environment drives many companies to restructuring or closing down the company (p.37).

Toporowski (2009) asserts that International business operations have particularly been affected by the global financial crisis because most target markets have cut expenses due to the crisis (p. 162). Therefore the political and financial risk associated with international business has increased.

Multinational companies are unable to avoid the effects of the financial crisis and will have to succumb to the constraints in the markets that they operate in. However, different firms are affected to a varying extent depending on the markets that are targeted and where the finances are focused (Toporowski 2009)).

The effect of the global financial crisis on the tourism industry in Australia

As with most other industries, the tourism industry has been affected by the ongoing global financial crisis. The services sold can only be used on site therefore stable conditions are necessary. The tourism industry in Australia is at an all time low and this has increased the political and financial risks associated with the industry (Elks & Roberts 2008).

The Australian tourism industry depends heavily on international visitors therefore there are numerous challenges that are being faced due to the reduction in expenditure for luxury. Tourism globally has been exposed to increased political and financial risks due to the global recession.

Investment in the Australian tourism sector is very low as most investors are delaying, reducing or even canceling investment ventures. Therefore there is reduced business from foreign investors. In addition, investors are also careful because the political atmosphere in Australia may become volatile due to the recent elections and the effect of the financial crisis (Geoff Carmody & associates 2009).

Political risks

Political risk is the risk of financial, strategic or human loss due to political issues in a country. It is the likelihood that a business or investors will lose money or make less revenue than expected because of political decisions and events in a nation. Political risk that is most commonly experienced by the companies involved in international business is transfer risk which is a situation whereby it is not possible to send out currency from a country because of central bank restrictions (Hendrix 1991).

From history, it is evident that economic instability usually creates political instability. For instance, there was a decrease in the political instability of many countries since the end of the cold war. This means that the financial crisis can bring about problems such as riots, violence and increased criminal activity.

The increase in piracy activities at the Horn of Africa is has been largely attributed to the global financial crisis because of heightened poverty and costs of living. This situation could therefore worsen an already troubled economic situation. (Othieno 2008)

There have already been several cases globally of social unrest which have been linked to the financial crisis. In Bulgaria, anti-government protests were held in a bid to push the government to bring reforms in the economic and social sectors. Vehicles were damaged, windows smashed and businesses affected by the riots that ensued.

In Lithuania, protestors threw stones at parliament as they demanded that the government reduce its spending because of the economic crisis. One of the worst cases of civil unrest was in Madagascar where more than 100 people were killed when violence erupted during a demonstration. (Thinking Shift 2009)

In light of this, the global financial crisis has increased the political risk that organizations engaging in international business and international direct investment face. Hendrix (1991) asserts that a stable and safe political environment is important for the success of International business. If the environment is not stable, there will be a drop in the tourism and foreign direct investment in the tourism industry.

Financial risk

Financial risk in the international market has been transformed due to the global financial crisis. Problems that have arisen include inflation, intensified competition in the international market, uncertainty, crisis in the financial markets and increased market volatility. Financial institutions and international business are finding it difficult to increase profits, cut costs and to deal with financial risk.

According to Yadav (2008) financial risk encompasses other types of risk such as market risk, foreign exchange risk and credit risk (p. 40). Market risk is the possibility that a firm will loose money to a financial institution because of extreme price changes in the financial market. Foreign exchange risk is the possibility of financial loss due to changes in the money markets. Credit risk is due to non-payment by a borrower of the principal and interest according to the terms of agreement (Yadav 2008).

Toporowski (2009) asserts that foreign direct investment is subdued because of risk aversion, reduction in financial leverage and scarcity of capital (p. 162). Many companies are holding on to liquid assets such as cash and marketable securities instead of investing. Cutting capital expenditure is likely to impact the economy in a negative way because it will reduce the opportunities for earning revenue. In addition, if investment is restricted, the net profit of the companies will be reduced (Toporowski 2009).

The effect of the crisis on International trade

The world economy has been largely affected by the global financial crisis. Risk and uncertainty are at a very high level. Therefore, the economic forecasts are likely to have substantial errors. The confidence of consumers and investors has been shaken since the financial problem began. In addition, the attitude of the important players in the economy is unlikely to improve since most expect the situation to get worse (Allen and Synder 2009)

Difficulty raising capital

Raising capital has become very difficult in the wake of the current financial crisis. The banks and financial institutions have become very careful about lending while investors are reluctant to invest in risky markets. There is a lot of competition for finance against other industries which are deemed more profitable. Therefore many businesses suffer from insufficient capital to invest and expand business. (Elks & Roberts 2008).

The inbound tourists to Australia are much fewer than in previous years. Local tourism has also been affected by the financial crisis as people struggle to meet their financial obligations. The number of tourists from within the country is much less than in previous years. This is very discouraging to investors and players in the industry thus affecting the availability of capital. (Tourism Australia 2008)

Governments’ response to these risks

In order to cope with the financial crisis, many countries have had to restrict the capital flow. This is primarily aimed at stabilizing the financial systems of the country (Toporowski 2009). According to the Global Economics Crisis Resource Center (2009), many countries have employed protectionism as a means of dealing with the financial problem.

Protectionism is a situation whereby a country restrains trade activities with other countries (p. 21). The governments restrict imports of goods and services by imposing tariffs and quotas on imports. Governments also regulate the ownership of local companies by foreigners. By taking this measures a government will be able to protect is citizens and local businesses (Global Economics Crisis Resource Center 2009).

Most governments have employed the traditional monetary tools such as reducing the interest rate and putting in place specific reserve requirements for the banks. Some countries began schemes which were aimed at rescuing banks and financial institutions that are in trouble. The activities under these schemes include purchasing unprofitable assets and offering credit (Burakovsky 2009).

Burakovsky (2009), states that long-term plans to boost the economic situation have also been put in place so as to increase the demand of investments and consumption by households. Some countries plan to reduce tax for businesses and individuals in future. Research and development is being focused on investment opportunities and new technologies.

Burakovsky (2009) points out that regional development is being considered as a means to increase economic development (p.81). Cooperation amongst countries is been sought to prevent such a crisis in future. International forums such as the G-7 and G-20 are useful in ensuring that there is international coordination so as to reform the financial systems (Burakovsky 2009)

The international Monetary Fund has been offering financial assistance to countries that are in grave situations. They have provided emergency financial assistance in order to assist the countries to survive and to prevent an economic collapse of the nations. In addition, the IMF provides the advice to the affected governments as to how they can best curb the situation and come out of the financial problems.

Managing risks and operations appropriately will ensure that the companies in the Australian tourism industry endure the problems in the market. The governments and central banks of all the countries that have been affected by the crisis are taking unprecedented measures. The governments are giving a lot of support to the banks and financial institutions so as to stability the economy. In addition control measures have been put in place to monitor the economy (Burakovsky 2009).

Uncertainty of government policies

Although the interventions by governments are expected to yield positive results, there is uncertainty concerning the effectiveness of those policies in alleviating the problems faced due to the financial crisis. According to Carbaugh (2008), some policies adopted by government have negative effects (pg. 486).

For instance, if the government decides to rescue banks that are in financial problems it is a moral hazard because there is no consequence faced for mistakes. Therefore investors may avoid such an environment. If the government deals with a deficit by simply creating money, this will give rise to inflation. It is this issues which affect the credibility of government policies. (Carbaugh 2008)

Conclusion

Governments should work at reducing the problems faced by citizens and businesses in their country due to the economic crisis. It is important that businesses are offered support to reduce the closure of businesses due to financial problems. The governments should put in place policies that reduce political and financial risks so as to improve the business environment and attract foreign direct investment. However, policies with negative consequences such as protectionism should be avoided.

References

ABC News 2009, Financial crisis hits Australia zoo. Web.

Allen, R. & Synder, D. 2009, ‘New thinking of the financial crisis’, Critical Perspectives on International Business, vol. 5, no. 2, pp 36-55.

BBC 2008, Australia slashes interest rates. Web.

Burakovsky, I. 2009, ‘Coping with the effects of International financial crisis’, Problems of Economic Transition, vol. 51, no. 10, pp 78-96.

Carbaugh, R. J. 2008, International Economics, Ohio, Cengage Learning, 2008.

Elks, S. & Roberts, G. 2008, ‘Tourism fears a big hit from financial crisis’, The Australian. Web.

Geoff Carmody and Associates 2008, Tourism prospects as Wall Street crunches Main Street. Web.

Global Economic Crisis Resource Center 2009, Global Economic Crisis: Impact on Business, Cengage Learning, USA.

Hendrix, S. 1991, Political risk and international business. Web.

Othieno, T. 2009, The global financial crisis: risks for fragile states in Africa. Web.

Thinking Shift 2009, Global pandemic of unrest. Web.

Toporowski, J. 2009, ‘International business and the crisis’, Critical Perspectives on International Business, vol. 5, no. 1, pp 162-164.

Tourism Australia 2008, Tourism Australia global market monitor. Web.

Yadav, V. 2008, Risk in international finance, New York, Routledge.

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