Geopolitics is the study of how a country’s geography inclusive of location, terrain, land size, climate, soil and raw materials affect its foreign, economic, military policy and positioning strategy. The word geopolitics comes from the words “geography” and “politics”. The term geopolitics means a broad analytical framework in international relations, encompassing different phenomena such as political instability, tensions and military conflicts between countries, terrorist threats or geographical events that can have regional or global impacts.

Globalisation has increased scope for trade and economic growth due to cross-border trade, and cooperation. However, over the last few years, global trade and the geopolitical landscape are rapidly changing because of chaotic results of geopolitical events. The chaotic landscape of geopolitics is hindering global trade.

Geopolitical risk adversely affects the global economy and triggers financial instability through a variety of channels. On the macro and micro economy side, geopolitical risk impacts the economy negatively affecting GDP growth, inflation, trade, investment, consumption and savings. The factors of geopolitical economy include, climate, topography, demography, natural resources, and applied science of the region being evaluated. Geopolitics focuses on political power linked to geographic space, in particular, territorial waters and land territory in correlation with diplomatic history.

Macroeconomic network of geopolitics can affect the outlook on the government’s fiscal position as well as inflation dynamics. History suggests that war has a detrimental effect on inflation and economic growth. As we have already seen, conflict in the Middle East has a direct impact on the cost of trade, the prices of imported goods and, ultimately, economic growth.

Israel-Palestine War, Terrorist Insurgency in Iraq, Ethnic Violence in South Sudan, border disputes in India, Russia’s invasion of Ukraine have resulted in havoc in terms of human lives and to the economies of the countries and regions. Geopolitical risk, which has increased of late, is threat to financial stability. Recent conflict in the Middle East, fears of rise in US-China tensions over Taiwan and the Russian invasion of Ukraine have all raised concerns about geopolitical stability. Adverse geopolitical events can trigger rapid shifts in market sentiment and sharp increases in uncertainty, exposing existing vulnerabilities in financial institutions and markets.

Moreover, they can reduce consumption and investment plans, with knock-on effects for economic growth, and activate adverse feedback loops between the real economy and the financial world. This special feature starts by providing a conceptual overview of the channels through which geopolitical risk can affect euro area financial markets, the economy and the financial sector. It then goes on to present empirical evidence on the effects of geopolitical risk on euro area non-banks and banks.

Let’s look at how the present geopolitical elements are affecting India: 

Raised stakes in Kashmir

Increased global cooperation with India, and thus its rise in geopolitical value, comes at potential costs for its neighbour Pakistan. The most immediate threat is control in the Kashmir dispute. Washington’s hinge away from Pakistan and towards India is visible in its different levels of engagement with the two South Asian nations. United States recently defended its military maintenance package to Islamabad. However, this material expression of support appears to be the exception instead of the rule. Messages from the past and present Presidents of US have historically been subtle signs of Washington’s aspirations in the region. Shrinking support in Washington considering India’s rising status means that Pakistani leverage in the Kashmir border dispute is at risk now more than ever. Despite recognizing recognition both sides in the Kashmir conflict, the United States has increasingly shown biased support to India. Pakistan has not curbed terrorism, it is on ever increase in many parts of world.  This not only raises the stakes in the Kashmir conflict but also adds a new layer to the region’s already tense security architecture.

Increased risk of Chinese revenge

India’s geopolitical rise has also increased the chance of an escalation with China by directly putting its interests at risk. For instance, Japan’s expanded partnership and alignment with India has focused on building resilience against Chinese presence in the East and South China Sea. China’s sweeping claims of sovereignty over the sea and the sea’s estimated 11 billion barrels of untapped oil and 190 trillion cubic feet of natural gas have antagonized competing claimants Brunei, Indonesia, Malaysia, the Philippines, Taiwan, and Vietnam. On July 12, 2016, the arbitral tribunal adjudicating the Philippines’ case against China in the South China Sea ruled overwhelmingly in favor of the Philippines.

India’s increased influence is also repositioning its leverage on border disputes with China. For instance, recent independent investigations exposed that the United States shared crucial satellite imagery of Chinese military positions during a December 2022 border clash, helping to give India an edge. Such intelligence sharing was a direct result of US-India joint initiatives those were confirmed. A dispute over the boundary is critical since it is a major determining factor for the two nations. China cannot give away its claims to their lands without having a weakened claim on the sovereignty threat over Tibet forcefully taken away in the 1950s.

The regional response

Considering these developments, China and Pakistan will adjust their strategic calculations, accordingly, bringing along risks of big tensions and acceleration in warlike situation. China’s assertiveness in Taiwan is an expected consequence. While traditionally this has come as a reaction to the United States, recent Indian strategic gains bring an added element of risk for Beijing. Whether rightly perceived or not, these heightened fears in China will impact its confidence in what it regards as its territories, and the region and West will have to compete with those developments. 

Beijing’s current hostility in the region in response is an active sign of these adjustments. China is asserting its strength in the region. It has also directly responded to the border dispute risks, given India-US collaboration, by seeking support elsewhere. In renewed talks with Bhutan earlier this year, Beijing pushed an exclusive border deal that could build leverage against India, if it loses strategic ground in the disputed Doklam plateau. Beijing’s attempted renaming of several areas which India disputes have also accompanied a similar policy of counter response. As such, increasing pressure on China by the West via India has pushed China in unexpected ways, leading to strong responses from Beijing that Washington may not be expecting.

Likewise, Pakistan is expected to insist itself in Kashmir in fear of its diminishing international value. irrespective of the subject matter being discussed or the theme of the forum and fails to get any support or traction. India has previously rejected Pakistan’s attempts to raise the Kashmir issue at international forums, asserting that the “Union Territory of Jammu and Kashmir and the Union Territory of Ladakh have been, are and will always remain integral and inalienable parts of India.”

 India has dismissed Pakistan’s attempt to inject Kashmir into a discussion of the workings of the Security Council as an undignified misuse of the General Assembly forum. Pratik Mathur, a minister at India’s UN mission, reacting to Pakistan bringing up Kashmir, said that it “misused this forum to spread baseless and deceitful narratives, which is not a surprise.”

“I will not dignify these remarks with any response just to save valuable time of this august body,” he added witheringly. Mathur, who did not name Pakistan and referred to it as “one delegation” was reacting to Pakistan’s Permanent Representative Munir Akram’s suggestion to set up a Security Council body to monitor the implementation of its resolutions on Kashmir. But the target of his condescending dismissal was clear. Regardless of the topic under discussion or its relevance, Pakistan consistently brings up Kashmir.

Given the nuclear capabilities of both nations, the international community should remain on high alert, especially considering Pakistan’s expanding military and economic cooperation with China. Pakistan and China may “lock” both India and the United States out of counterterrorism efforts in the region, which poses not only risks to their national security but also to regional stability; terrorist attacks have brought India and Pakistan to the brink of war on numerous occasions. 

Moving forward

Overall, India’s rise cannot simply be viewed from the lens of Delhi gaining global ground. The crucial question is one of threat perceptions on the Pakistani and Chinese sides which whether legitimate or not risk destabilizing the region. Members of the international community who are giving increased value to India as a geopolitical anchor must beware of unrest and consequences. External shocks have aggravated Nepal’s economic vulnerabilities too. Decreasing external remittances, inflation, and the increasing trade deficit have contributed to low forex reserves. This has impacted its already scarce foreign investments and has also persuaded the import-dependent country to regulate or ban the import of certain commodities, including fuel. Although not as catastrophic as Sri Lanka and Pakistan, Nepal’s crisis is a recipe for a perfect disaster, considering the history of its political instability and governance.

In all above cases, China’s complicity has also been critical. China’s less conditioned and easily available loans motivated these countries to continue borrowing without promoting any structural reforms, making them more economically and politically vulnerable. In addition, China’s high-rate interest loans and employing its capital goods and labor has accumulated debts rather than reaping economic benefits for the host country.

Neighbourhood Risk includes spillover effects caused by problems in a region, in a country’s trading partner, or in countries with similar perceived characteristics.

The role of banks in international trade is crucial. The banks provide financing products such as letters of credit, forex and helps to reduce risks and allow transactions to go smoothly for importers and exporters worldwide. Because of the worldwide trade, commerce, and finance, forex markets tend to be the world’s largest and most liquid asset markets. Nostro and Vostro accounts helps ease foreign exchange in international trade.   

NOSTRO

A nostro account refers to an account that a bank holds in a foreign currency in another bank. Nostros, a term derived from the Latin word for “ours,” are frequently used to facilitate foreign exchange. The opposite term “vostro account” derived from the Latin word for “yours,” is how a bank refers to the accounts that other banks have on its books in its home currency.

A Nostro account is an account maintained by a domestic bank with a foreign bank in foreign currency. For example, State Bank of India has opened an account with Bank of America in New York for dealing in US Dollars, this account is called as the Nostro account for the State Bank of India. In the Nostro account, the domestic bank acts as the facilitator – in this case SBI is the facilitator.  A Nostro account with debit balances is considered an asset because domestic banks are often used as custodians to manage the bank’s operations regarding foreign exchange transactions. A bank recognizes the Nostro balance in the account as a debit balance with other banks and hence recorded as the bank’s assets on the balance sheet.

Nostro accounts are usually held by banks and large corporations that are involved in international trade. By holding funds in another bank in a foreign currency, the bank can conduct international trade transactions and foreign exchange without having to convert its local currency into foreign currency. Nostro accounts work by allowing one party to hold money in a bank in a foreign country in that country’s currency. When transactions are conducted through a nostro account, the bank that holds the account aids in completing transactions involving different currencies.

VOSTRO

A Vostro account is an account maintained by a foreign bank with the home currency of that bank. In the Vostro account, the foreign bank acts as the facilitator. Hence SBI’s opening   Vostro account with Bank of America, makes Bank of America facilitator. Vostro means yours. A Vostro account with a credit balance is considered a liability, and a vostro with a debit balance (a loan) is an asset. Another example of such an account is SBI holding a vostro account in HSBC. Several banks, including HDFC Bank and UCO Bank, have opened as many as 30 special vostro accounts to facilitate overseas trade in the rupee. Sberbank and VTB Bank — the largest and second-largest banks of Russia, respectively are the first foreign lenders to receive the approval from RBI. The move to open the special vostro account clears the deck for settlement of payments in rupee for trade between India and Russia, enabling cross-border trade in the Indian currency, which the RBI is keen to promote. RBI announced the guidelines on overseas trade in the rupee in July 2022.

The Government of India has allowed 20 Russian banks, including Rosbank, Tinkoff Bank, Centro Credit Bank and Credit Bank of Moscow have opened Special Rupee Vostro Accounts (SRVA) with partner banks in India. All major domestic banks have listed their nodal officers to sort out issues faced by exporters under the arrangement.

Additionally, it is anticipated to facilitate trade with Russia and other nations subject to sanctions. The RBI’s finalized mechanism allows authorized dealer banks in India to open special rupee vostro accounts on behalf of partner banks. The authorized dealer bank will then need to present the specifics of the arrangement to the central bank for approval.

Domestic banks use Vostro account to provide international banking services to their clients who have global banking needs. Vostro is an integral offshoot of correspondent banking that entails a bank or an intermediary to facilitate wire transfer, conduct business transactions, accept deposits and gather documents on behalf of the other bank. It helps domestic banks gain wider access to foreign financial markets and serve international clients without having to be physically present abroad.

The SRVA is an additional arrangement to the existing system that uses freely convertible currencies and works as a complimentary system. For perspective, freely convertible currencies refer to currencies permitted by rules and regulations of the concerned country to be converted to major reserve currencies like U.S. dollar or pound sterling and for which a fairly active market exists for dealings against major currencies. The existing systems thus require maintaining balances and position in such currencies.

Functioning of SRVA

The framework involves three important components: invoicing, exchange rate and settlement.

The framework entails three important components – invoicing, exchange rate and settlement.

1. Invoicing entails that all exports and imports must be denominated and invoiced in INR.
2. The exchange rate between the currencies of the trading partner countries would be market-determined.
3. The final settlement also takes place in Indian National Rupee (INR).

How much money do you think is in nostro vostro accounts worldwide?

There are $27 trillion dollars resting in nostro and vostro accounts to fulfill payments. Let that sink in for a moment, there is $27 trillion of “dead capital” laying idle for days on end in these accounts.

Country risk analysis has been defined and studied by different analysts in many diverse ways. There are varied approaches adopted by financial institutions and rating agencies such as Goldman Sachs, Merrill Lynch, Standard & Poor and Fitch Ratings looking into external sector like exports, imports, debt services, direct investments, and loans, repayment of loans, external debt and flow of foreign reserves. Internal sector such as interest rate, public debt and its service, level of investments, budget stability, internal savings, consumption, GDP/GNP, inflation rate, money supply etc and other variables like population, life expectancy, rate of unemployment, level of literacy, etc. are taken into account to analyse a country’s risk for selected emerging markets. Three models were used to estimate country risk: in the first model the relation between country risk and essential economic variables was tested; in the second model the external component are added to the group of explanatory variables; and the third model is based on tested relation between specific country risk and the economic fundamentals.

Country risk refers to the uncertainty associated with investing in a particular country, and more specifically the degree to which that uncertainty could lead to losses for investors. This uncertainty can come from any number of factors including political, economic, exchange-rate, or technological influences. In particular, country risk denotes the risk that a foreign government will default on its bonds or other financial commitments increasing transfer risk. In a broader sense, country risk is the degree to which political and economic unrest affect the securities of issuers doing business in a particular country. The risks are discussed as follows:

Political risk

Determine a country’s political stability, either internally or externally. For instance, a recent military coup would increase a nation’s internal political risk for businesses as rules and regulations suddenly shift. Other risks in this category could include war, terrorist’s attack, corruption and excessive bureaucracy which means red tapism in host country government is preventing certain fund transfers or other transactions.

The World Bank ranks China from point of view of its governance, authoritarian style of governance making political process very weak, uneven application of the rule of law and corruption. China scores in the lowest quartile for voice and accountability. China is flexing its muscles because of which investors in the country are feeling the heat. A series of interventions by policymakers and regulators in recent months has unnerved many of the country’s fastest-growing companies and their shareholders.

Political risk can affect a country’s attitude to meeting its debt obligations and may cause sudden changes in the foreign exchange market.

Sovereign Risk

There is little difference between political and sovereign risk, although the latter which is also known as sovereign default risk primarily examines amount of debt. Specifically, this risk category measures the built-up of debt that is the obligation of a government or its agencies to repay. It also measures how much the said government is anticipated to fulfil these obligations.

Since the subprime crisis began in 2008, the various European authorities and private investors have loaned Greece nearly 320 billion euros. It was the biggest financial rescue of a bankrupt country in history.  As of January 2019, Greece has only repaid 41.6 billion euros. It has scheduled debt payments beyond 2060. The Greek debt crisis is due to the government’s fiscal policies that included too much spending. While the economy boomed from 2001-2008, higher spending and mounting debt loads accompanied the growth. The financial crisis was largely the result of structural problems that ignored the loss of tax revenues due to systematic tax evasion. Investors do not have an appetite at the moment investing in Greece other than properties.

If a government agency refuses to carry out debt refunding, it impacts local lenders leading to losses. This would of course have roll-on effects to local businesses and any nation undertaking to trade with them.

Sovereign credit ratings, independent assessments of the creditworthiness of a country or sovereign entity, are essential resources for international investors – offering an easy way to analyse country risk. The three most-watched rating agencies are Standard & Poor’s, Moody’s Investor Services and Fitch Ratings which are famous for sovereign risks. 

Neighbourhood Risk

Also known as location risk may not be the direct fault of the country. This can have spill over effects on other sovereign nations, creating turmoil in the foreign market or putting pressure on local lenders and businesses. Neighbourhood risk can be caused by geographic neighbours, trading partners, co-members of certain institutions or organisations, strategic allies and nations with similar perceived characteristics.

For example in India, Kashmir issue remains volatile and a source of potential conflict. India-China relations have also deteriorated recently due to border disputes. India is a vast country with sub-continental dimensions, with its land border touching Pakistan, Afghanistan China, Nepal, Bhutan, Myanmar and Bangladesh along with the maritime border with Sri Lanka. With socio-cultural identities cutting across the borders and colonial legacy it is a bit obvious that there are some combative issues with the neighbours.  Among all the neighbours India’s northern neighbour China along with its ‘all-weather ally’ Pakistan presents the biggest threat perception for India’s national security. The recent clashes have once again attracted the attention of the world towards a possible nuclear war.

Subjective risk

It is not a term that is used everywhere, but it measures factors that are common to most risk assessments and they could greatly impact foreign business owners trading with a host nation. Subjective risk is about attitudes, and can include social pressures and consumer opinions to certain types of goods or certain types of enterprise.  

Subjective risk is the perceived chance of something bad based on a person’s opinion, emotions, gut feeling, or intuition. It is not a mathematical review of the situation, but rather a quick assessment based on a person’s, groups’, nation’s feelings at the time.

Mountain landslides occur regularly in Italy. Because of this, policies that would reduce landslide fatality risk need to be carefully formulated by the government of Italy. As a first step in the exploration of preferences for these risk-reducing policies, the government appointed an outside agency to examine public perceptions of risk for landslides and related events. Subjective probabilities for others who might die in a landslide, as well as one’s own subjective probability of death, are provoked for a sample of visitors and residents of a region in Italy prone to landslides. Government of Italy presented one portion of the sample with scientific information to allow to update their risk estimate if they so choose, allowing the role of such information to be tested. The subjective probabilities were then used to construct risk-related attributes in a pivot-design (an agency in Chicago) version of a conventional stated choice model. Larger risk changes as departures from the baseline risk are found to be significant in explaining choices. Foreigners in Italy are mainly employed in low-skilled manual jobs where there is a greater exposure to the risk of injury.

Economic Risk

Economic risk encompasses a wide range of potential issues that could lead a country to renege on its external debts or that may cause other types of currency crisis (i.e. recession). A major factor here is economic growth which is considered  the health of a nation’s GDP and the outlook for its future. For instance, if a country relies on a few key exports and the prices for these are dropping, this creates a negative outlook and may increase the economic risk for foreign trading partners.

Economic risks also include exchange rate fluctuations, a shift in government policy or regulations, political instability, or the introduction of economic sanctions. Image created by Market Business News. Doing business and investing money always comes with an element of risk.

Deng Xiaoping’s introduction to economic reforms, China has what economists call a socialist market economy one in which a dominant state-owned enterprises sector exists in parallel with market capitalism and private ownership. Falling birth rates and a rapidly ageing population spell trouble for China’s future economic growth. And, income inequality, regional economic divides, and wide gaps in opportunity between rural and urban citizens are some prominent issues China is fighting.

Exchange Risk

Any predicted loss created by sudden changes in exchange rate is generally covered under the exchange risk factor. This is another all-encompassing term as fluctuations in the foreign exchange can be caused by a wide variety of factors. Economic and political factors such as those mentioned above can be significant drivers of exchange risk, although currency reserves, interest rates and inflation are also potential factors. Exchange-rate risk may be the single biggest risk for holders of bonds that make interest and principal payments in a foreign currency. 

Currency demand of any country is driven by tourism, international trade, mergers and acquisitions, speculation, and the perception of safety in terms of geo-political risk. For example, if a company in Japan sells products to a company in the U.S. and the U.S.-based company has to convert dollars into Japanese yen to pay for the goods, the flow of dollars into yen would indicate demand for Japanese yen. If the total currency flow led to a net demand for Japanese yen, the Japanese currency would increase in value.

China is now the number one trading partner for most African countries. In an effort to make the buying and selling of goods much easier, some states introduced the Yuan into their foreign exchange system. In 2011, the Nigerian Central Bank pledged to store between 5%-10% of its foreign reserves in Yuan, alongside dollars and euros.

Transfer Risk

This risk is defined as the threat that a local currency can’t be converted into another nation’s currency due to changes in nominal value or because of specific regulatory or exchange restrictions. The host government becomes unwilling or unable to permit foreign currency transfers out of the nation. Sweeping controls such as these may be a side effect of a nation in crisis attempting to prevent creditor panic turning into significant capital outflow.

A major example of this factor is the Malaysian credit controls after the 1997-98 Asian currency crisis; during the Asian financial crisis, Malaysia faced a large depreciation of the ringgit (its official currency) and massive capital flight, even though it raised domestic interest rates. But at the same time, it also resorted to monetary instruments, via sterilisation and its reverse, to smoothen out the effects of capital flows.

The 1997–98 Asian financial crises began in Thailand and then quickly spread to neighbouring economies. It began as a currency crisis when Bangkok unpegged the Thai baht (official currency of Bangkok) from the U.S. dollar, setting off a series of currency devaluations and massive flights of capital.

Conclusion

Organizations conduct country risk analysis before entering another country because conditions or events taking place in any country is outside the scope of any company’s control. Knowing a country’s risk, can help an organization make better decisions when trading internationally.