Political risk represents the degree to which social and governmental environments may change in the future. This risk may manifest itself in events over which a government has no control – such as riots, new elections. Other events may be caused by a government, such as an embargo on imports or exports, increases in tariffs, new prohibitions on transactions with specific countries.
Political risk may arise from actions of the home government of the enterprise. For example, when India and Pakistan were engaged in border skirmishes and India exploded what appears to have been a nuclear device, the United States considered (but did not adopt) restrictions on trade with India. Such restrictions could have had devastating effects on U.S. companies relying on Indian service providers.
In international outsourcing transactions, political risks need special attention due to the long-term nature of the relationship. There are a number of techniques that can mitigate, but not eliminate, such risks.