Tuesday, October 19, 2021

Risk Factors of Cross Border Investing and How to Eliminate Them

Cross border investing refers to financial contracts carried out outside of a country’s borders and is used to facilitate international trade by giving businesses a source of funding. This enables them to establish themselves on a global map and extend their operational boundaries. Provision of immediate cash flow is one of the core incentives of investing overseas and can also be used to reinforce operations helping the organization grow.  

However, in the scenario of established corporations, cross-border investing can become quite tedious as almost all cross-border transactions are subject to tax deductions. Now, like most financial transactions, there is the involvement of a third party in cross-border investing as well. These third parties often take a cut from the receipts of these transactions. Foreign Direct Investment or ‘inward investment’ and Outward Direct Investment or ‘outward investment’ are quite common phenomena in such a transaction. 

Let’s take the example of the two major Asian countries- India and China. As companies in both these countries continue to grow and establish themselves domestically, entrepreneurs seek to acquire skills and assets outside of their domestic markets. There persists significant untapped potential for collaboration between both markets. Corporate collaboration through cross-border investments could help grow both domestic markets and at the same time strengthen the value proposition of corporations competing with foreign brands.

ALSO READ: Core Satellite approach of investing

What are the risks involved in cross-border investment?

In such a setup, one can expect two types of risks, namely currency risk and political risk.

Currency risk refers to the prospect of a company losing out on money due to fluctuations in currency rates while facilitating overseas trade.

The latter, political risk, represents the risk subjected to a company while doing business in another foreign country undergoing political instability. While fluctuating exchange rates may be a strong factor associated with currency risks, factors like social unrest or political elections are subject to political risk. 

Mitigating Risks of Cross-Border Investment

Once the risks are analyzed it needs to be followed by a depth study of the following parameters in order to make a secure overseas investment. 

  • Economic Conditions

When an organization first steps into a new market, its foremost plan of action is to study the economic condition of the prospective markets of that country. On the basis of the following study, an analysis is done to find out if an investment will flourish overtime or not. 

  • Societal and Cultural Conditions

People of different markets react to the products and services of a company differently. In multiple instances, people of different markets have reacted to a particular product differently. It shows the behavioral patterns vary as we cross borders and so it is extremely vital to consider the social and cultural factors of a selected market before making a cross-border investment. 

  • Political and Legal Conditions

Acceptance or attitude of leaders of a country is a very pivotal factor for foreign companies marketing their distinguished products. Legal factors also pose as a very strong driving force while making such an investment. A country that doesn’t levy legal formalities upon foreign direct investments tends to be hotspots for such companies.

  • Lucrative Markets

How lucrative a market is can be assessed by judging its potential in terms of the current sales, accessibility, and the existing competition in the market. A large market with a rapid growth rate is obviously more attractive and will induce bigger upfront investments while stagnant markets with substantial competition might take a toll on its attractiveness. 

  • Capability of a company 

Potentially, the most important factor of cross-border investing is the capability of a company to invest in a lucrative market that is favorable in terms of political, societal, and economic prospects. Audit of pre-existing resources and capabilities is a must before moving forward with such a large-scale transaction. Once the company establishes that they have a clear competitive advantage in terms of a portfolio of products, technology, market knowledge, etc. it should move ahead with the investment

Siddharth Kulkarni
Siddharth is an incoming FMV Analyst and B.Com Hons graduate from Delhi University. Siddharth holds several positions of authority at a college level at various societies namely The Young Entrepreneurs Society and The Hult Prize. He is an enterprising youngster who is passionate about learning and growing as a person with each successive day. He is a hardworking and self-confident individual who possesses zeal and grit and loves to work with details. Being a sportsperson as well as an academic achiever, he love to surround himself with healthy competition.

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