ECONOMIC RISK MANAGEMENT

ECONOMIC RISK MANAGEMENT 

To learn how to manage economic risks 

Key Learnings from the Video

1. Economic Risk 

The economic/investment risks occur due to changes in business conditions or government policies and this is called economic risk. There are two types of economic risk:

i. Macroeconomic Risk 

This refers to the risk arising due to global economic changes such as economic policy changes by the US, UK, etc. 

This type of risk occurs due to the factors that are outside the control of a country and impact your business operations in that country.

ii. Microeconomic risk 

This refers to the actions/events in your country that affect your business operations. 

For example, if you are in steel trading business, then fluctuation in the price of the steel is a microeconomic risk.

This type of risk affects the foreign operations of your company.

Economic risks can "suddenly make your business unsustainable."

For example, Jet Airways' business was adversely affected due to the global rise in crude oil prices (macroeconomic risk). 

2. Investor's Point of View 

An investor considers economic risks on the following occasions:

i. Loan 

Investors keep economic risk in mind while providing loans. 

For example, if you are operating a company in India, and you want to take a loan from investors from the US or UK, the investors will first evaluate the risk of the Indian economy. 

Investors approach rating agencies to evaluate the risk involved in a country's economy. "Standards & Poor's [S&P]" and "Moody's" are the two most popular rating agencies of the world. 

Rating agencies like S&P and Moody's provide different ratings to a country on the basis of economic risk. 

ii. Business With Other Country 

When an investor wants to do business with another country, then he evaluates that country's economic risk. 

iii. Sending Supplies to Other Country 

Any businessman or investor checks the economic risk of a country when he sends supplies to that country without taking advance payment. 

3. Economic Risk -Factors 

Economic risk occurs due to two types of major factors -- domestic and international.

Following are the "sub-factors" that lead to economic risk:

i. Government Debt 

This means the amount of debt/loans that a country owns.

For example, many countries like Zimbabwe and Sri Lanka have very high debt. 

When a country's government faces loss, it takes loans from other countries. 

If the country does not repay the loan on time, then it can create an economic risk for the country.

ii. Unemployment 

Unemployment is also a major factor behind the economic risk. 

If unemployment is very high in a country then it can cause various problems.

The countries, which provide unemployment allowance like the US, feel economic pressure due to high employment.

On the other hand, countries, which do not provide unemployment allowance like India, may see an increase in crimes. To handle crimes, those countries have to spend money. 

 iii. Energy and Agriculture Prices 

Energy and agriculture are very important components for the development of any country. 

In the case of high energy or agriculture prices, the economy of a country may collapse. 

Fluctuation in energy prices may also adversely affect the economy. 

iv. Sudden Decline of an Economy 

A sudden economic crash/decline in a country causes a ripple effect across the world economies. 

Many countries having trade relations with that country face huge problems. 

Today, all countries are dependent on other countries in terms of trade; therefore, any country's economic decline affects others. 

v. Currency Failure 

Failure or devaluation of any country's currency can create huge economic problems.

For example, in 1997, all Asian currencies had failed at the same time, which caused a systematic failure, and many companies had to shut down their operations. 

vi. Prolonged Infrastructure Negligence

Negligence towards infrastructure can result in economic risk. 

Developing infrastructure leads to an increase in trade. 

For example, developing roads and highways reduces the cost of transportation and increases trade activities. 

vii. Liquidity Crisis 

This is a financial situation characterized by the lack of cash in hand among the financial institutions in a country. 

viii. Widening Income Disparity 

This means the rich are becoming richer and the poor are becoming poorer. 

This also puts huge stress on the economy and creates unemployment and social upheaval.

Widening income disparity also increases the chance of civil war in a country. 

ix. Change in Government Regulation 

A sudden change in government policy or regulation also affects a country's economy.

For example, the Indian Government's GST and demonetization move harmed the Indian economy. 

These types of moves can give "knee-jerk reactions" which can pressurise the economy. 

x. High Inflation 

A sudden rise in goods prices creates an economic risk; for example, in Zimbabwe, you have to pay Z$1 billion (local currency) for bread. 

High inflation leads to an economic crisis in a country. 

xi. Political Instability 

Political instability in a country discourages foreign investors to invest in it. 

xii. Introduction of Economic Sanctions 

Economic sanctions are commercial and the financial penalties, which are applied by one or more countries against a country. 

For example, the US sanction on Iran in which the US has restricted all its allies to buy oil from Iran. 

Economic sanctions can deteriorate a country's economy. 

xiii. Unseen Conditions 

Some unseen events like COVID-19 can adversely affect a country's economy.

4. Economic Risk- Mitigation

No risk can be completely diminished to "zero." No business can be completely risk-free. 

You can mitigate economic risks by using the following tips:

i. Create Reserves 

You should create some financial reserve, which is also called a "rainy day fund."

A rainy day fund to deal with any future financial risk in your business. 

ii. Build Global Supplier Network 

You should not deal with only 2-3 suppliers as they can put you in trouble.

You should always try to deal with multiple suppliers by improving your global supplier network to deal with economic risk.

iii. Refinance 

If you can get the option of a cheaper loan then you should refinance the existing loans. 

For example, if you have taken a bank loan at 10% interest rate and you get an opportunity to get a loan at 8% from any other bank, you should immediately refinance the loan.

iv. Continuous Monitoring 

You should have a team in your company to monitor economic risks.

You can also monitor risks if your company is small. 

v. Diversification 

You should diversify your business and personal wealth. For example, you can expand your business in other countries and invest in other countries' mutual funds.

Golden Statement

Don't put all the eggs in one basket.

As per the above saying, you should have a diversified portfolio. 

vi. Get Insured 

You should buy the required insurances to deal with any economic risks.

vii. Hedging 

You can hedge your currency for any future transactions. 

All the banks provide this facility.

Hedging protects you from economic risks caused by fluctuations in currency rates. 

viii. Hire a Financial Advisor 

You should hire some financial advisors/consultants to guide you on how to deal with the current economic conditions.

ix. Check Customer's Profile 

Many customers have a poor credit score and do not repay loans at times.

To avoid such people, you should check your customers' profiles. 

x. Diversify Your Business 

You should not focus on one or two clients/products; you should have multiple clients/products.

You should diversify your business to protect yourself from economic risk.

xi. Design Products Based on Customer's Need

You should design your products and services based on your customers' needs to retain them.

Key Outcomes of the Video 

Create financial reserve to deal with economic risk

Design products based on customers’ needs

Diversify your business to protect yourself from economic risk

Hire a financial advisor to guide you on how to deal with the current economic conditions