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Managing exposure to country-specific risks: The case of FDI project of Litostroj Power in Republic of Macedonia

Seminar project for Risk Management in International Business
by

Nataša Urukalo

on 16 January 2013

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Transcript of Managing exposure to country-specific risks: The case of FDI project of Litostroj Power in Republic of Macedonia

Name of company: Litostroj Power, a company for design, power plant engineering and manufacture of power generation and industrial equipment, d.o.o.
Abbreviated name: Litostroj Power d.o.o.
Company address: Ljubljana, Litostrojska cesta 50
Activity: Other technical project design and consulting

The companies of the Litostroj Power Group provide development, design, manufacture, supply, commissioning and after-sales service of water turbines, hydro-mechanical equipment, pumps.

More than 600 employees of the associated companies in Slovenia, Canada, Egypt and Czech Republic. CONCLUSION Economic risk Financial risk Political risk Currency risk Managing exposure to country-specific risks:
The case of FDI project of
Litostroj Power in Republic of Macedonia Milana Majkic
Kseniya Miantsiuk
Biljana Savic
Nataša Urukalo Risk Management Ljubljana, 2013 RESPONSE PLAN PROPOSAL Overview of political system

Political leaders

Independence: referendum the 8th of September 1991

Political instability: 2001 ”Ohrid Framework Agreement”- Albanian ethnic minority protests

FYR Macedonia from the international perspective (UN, WTO, CEFTA, the EU candidate) Government and Political conditions in Macedonia The EU accession process as the main direction

The Roadmap of the reforms in April 2012

The revised National Programme for the Adoption of the Acquis for 2012

Main goals:
1) to achieve the progress in the decentralization of government (based on the Ohrid Framework Agreement) and local self-government
2) to arrange the dialogue between the coalition partners for the future stability Government stability Picture 1: Government stability Positive trend in the judicial, legislative and institutional systems:
1) counseling
2) legal aid for asylum seekers

Lack of the enforcement of human rights

Violations of the European Convention on Human Rights Voice & Accountability Development in the field of freedom of expression and the media:
- the dialogue between government and the Association of Journalists

The need of the finance reallocation to civil society organizations

The discrimination and violation of women’s rights:
1) low participation in politics
2) high rate of unemployment among women Voice & Accountability Voice and Accountability, Comparison across selected countries 2012: Violence incidents on the base of ethnic clashes

No reforms & limited funds for the support of minorities (for ex. in schools)

No representation & equal treatment of the minorities (Roma & Turks)

External level:
1) participation in international org-s(+)
2) bilateral agreements (+)
3) long-term conflict with Greece over the name (-) Political Stability and Absence
of Violence Political Stability/Absence of Violence The new Action Plan for 2011-2015

Investigation & Prosecution of corruption are very low

No transparency in government & its spendings

2011 ‘’Illegal financing of election campaign’’ case

New means of collecting statistics are needed Control of Corruption Control of Corruption - Total external debt is the sum of public, publicly guaranteed, and private non-guaranteed long-tern debt, use of IMF credit, and short-term debt

- Total amount of Macedonian's external debt for the year 2011 is 6,286,400,000$ Total External debt (TED) Republic of Macedonia -Country located in the central Balkan peninsula in Southeast Europe
-Country's capital is Skopje
-Its terrain is characterized with massive mountains, intersected with wide valleys and lowlands. It has more than 50 lakes and sixteen mountains higher than 2,000 m (6,562 ft)
-Naturally rich country
-Being a central Balkan country neighboring with five countries diverse in their potential and development
-Republic of Macedonia has a population of 2.022.547, out of which 600.000 live in the capital of Skopje
-Official language is Macedonian
-State Currency is Macedonian Denar (MKD) Thank you for your attention! -The stability of the domestic financial system is mostly determined by the stability of the banking system as its predominant segment

-In 2011, although the activities of banks grew at a slower rate than in 2010, the contribution of the banking sector to the economic activity of the country increased

-High proportion of non-performing loans (9 %) Banking sector DISADVANTAGES ADVANTAGES Most problematic factors of doing business in Macedonia are:

1. The still unsolved name dispute with Greece, that has an impact on Macedonia’s international relations and ability to join international organizations;
2. Government instability and need for decentralization of the government, as well as dialogue between coalition partners;
3. High rate of corruption and slow implementation of anti-corruption laws;
4. Economic growth, although positive for the last years are still behing expectations and lower than those of the regionʼs most dynamic countries. In spite of its small size and modest domestic market, the Republic of Macedonia presents a number of truly remarkable advantages:

1. Macedonia has developed a highly-liberalised foreign trade policy and has signed various Investment Protection and Trade Agreements. Among those who have signed this agreements is Slovenia, which gives our company easy access to Macedonian market;

2. The Constitution of Macedonia guarantees equal treatment for all market participants and the right for foreign investors to freely transfer and repatriate investment capital and profits if they have registered their direct investments and paid all legal obligations relating to taxes and social insurance contributions;

3. Over the past years, the various governments have successfully reduced the fiscal deficits and they have focused on maintaining a low inflation rate, a stable Denar exchange rate and low interest rates. 4. Investors in Macedonia benefit from a very favourable tax environment with one of the lowest corporate income tax rates in Europe (only 10%); in addition, Macedonia has several Investment Zones with up to 10 years tax holidays for corporate profits, employment income, VAT, custom duties and others;

5. Macedonia has a highly qualified workforce and one of the most competitive
labour costs in Europe;

6. There has been an increased sence of urgency to develop indigenous energy generation since Macedonia imports more than 40% of its electricity. One of the major government priority is constitution of 2 Hidro Power Plants (Cebren and Galiste) with a capacity of 526 MW. ADVANTAGES (CONTINUED) Reserves of foreign exchange and gold Current account balance In recent years, Macedonia has strived to achieve a high level of foreign trade liberalization. In part, this has been achieved as a result of following:



•Membership of the World Trade Organization since 2003

•Macedonia is a signatory of three multilateral Free Trade Agreements:
-SAA (Stabilization and Association Agreement) with the EU member-states;
-EFTA (Switzerland, Norway, Iceland and Liechtenstein) and
-CEFTA (Macedonia, Albania, Moldova, Serbia, Montenegro, Bosnia and Herzegovina and Kosovo).

•In addition to the multilateral, Macedonia has also signed two bilateral Free Trade Agreements with the following countries:
-Bilateral Free Trade Agreement with Turkey and
-Bilateral Free Trade Agreement with Ukraine Foreign Direct Investment (FDI) was negligible pre – 1998 (e.g. registering less than € 10 million in 1995). Since then, FDI has been steadily growing.

Macedonia has recently become a tax heaven in Europe. The new Government introduced a flat tax of 10% for corporate and personal income. With the recent economic reforms, Macedonia has created the most attractive tax package in Europe. Structure of total external debt Historical ties (Yugoslavia and its impact)
Slovenian investments in Macedonia
Forbes Top Business ranking
Litostroj Power and its expansion
Existing subsidiaries and branches
Future enlargement of Litostroj Power Great opportunity to catch for Litostroj Power:

-Macedonia’s hydro-energy potential= self-sufficiency in electrical energy
-Construction of 2 Hydro-Power Plants in Cebren and Galiste
- Technical improvement of the old power plants
- Benefits from the Law of Technological and Industrial Development Zones
- Reduction in taxes, VAT and custom duties exemptions up to 10 years

Overall conclusion: researches, estimated risks, interview and other additional information= high chance of success General review of
‘’Slovenia - Macedonia’’ relations Introduced on April 26, 1992 (subdivided into 100 deni).

Money supply and interest rates are dictated by the exchange rate target, which (as of mid-2005) is set at 61 denars to 1 Euro, and has remained more or less constant at that level.

Goal => to maintain a stable denar exchange rate against the Euro. Macedonian denar (MKD) De facto fixed exchange rate, but there are still small fluctuations in it
Implemented by the National Bank of the Republic of Macedonia
The maintenance of Macedonian denar exchange rate stability serves as an intermediate target for achieving price stability.
Since January 2002 the ER has been pegged against Euro (before against Deutsch Mark) Exchange rate regime No restrictions on the purchase of foreign currency => the most popular Macedonian Denar exchange rate is the MKD to USD rate

Euro/MKD ER:
The highest ER: 17 September 2012 (64.5161 MKD)
The lowest ER: 17 July 2012 (60.2363 MKD)
Average: 61.7841 MKD

Macedonian denar has been depreciating against Euro for 3, 51% over that period, so we see that MKD is losing value against the Euro. Exchange rate (ER) •Transaction exposure
•Translation exposure
•Economic exposure

Reason: opening of a new subsidiary in another country and doing the business in foreign currency (MKD).

To ensure against different risk exposures Litostroj Power has decided to use forward contract technique for hedging against the currency risk.

For doing business with local companies we suggest doing it in a local currency so they don’t have to hedge against currency risk. Exposure to currency risk
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