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Country

RiskAnalysis

T.J. Joseph

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Country Risk Analysis

Country risk represents the potentially adverse

impact of a countrys environment on the

international businessMostly country risk is arising frompolitical and

economic factors

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Political Risk Factors

Attitude of Consumers in the Host Country

Some consumers may be very loyal to homemade

products.

Attitude of Host Government

The host government may impose special

requirements or taxes, restrict fund transfers,

subsidize local firms, or fail to enforce copyright laws.

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Political Risk Factors

Stability of the local political environment

Changing policies by successive political parties

Example: Case of Enron in India

Blockage of Fund Transfers

Funds that are blocked may not be optimally used.

Currency Inconvertibility The MNC parent may need to exchange earnings for

goods.

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Terrorism and War

Internal and external battles, or even the threat of

war, can have devastating effects.

Bureaucracy

Bureaucracy can complicate businesses.

Corruption

Corruption can increase the cost of conducting

business or reduce revenue.

Political Risk Factors

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Economic Risk Factors

Current and Potential State of the Countrys Economy

A recession can severely reduce demand.

Fiscal position of the government

BoP position

Macroeconomic instabilities

Examples: the crisis of Mexico, Russia, Brazil, Asia and,Argentina.

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Economic Risk Factors Indicators of Economic Growth

A countrys economic growth is dependent on several

financial factors - interest rates, exchange rates,

inflation, etc.

Resource Base

Consists of national, Human, and financial resources

Adjustment to External Shocks

How well a nation responds varies external shocks

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Measuring Political Risk

Country-specific perspective

A. Political Stability

Measured by: Frequency of government changes

Level of violence

Number of armed insurrections

Conflict with other states

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Measuring Political RiskB. Economic Factors

Indicators of political unrest

Rampant inflation

Balance of payment deficits

Slowed growth of per capita GDP

Intellectual Property Protection

C. Cultural and Institutional Factors

Cultural issues religious, language, tradition

Legal framework, IPRs, etc.

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Measuring Economic Risk Factors

How well is the country doing economically?

A. Fiscal Irresponsibility- high government deficits

B. Monetary Instability Money supply, inflation,

interest rate, Gross Domestic Savings

C. Controlled Exchange Rate System

- currency usually overvaluedD. Wasteful Government Spending

- inability to service foreign debt

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Key Indicators of Country Risk

Relative size of government debt

Money expansion

Existence of government-imposed barriers to

market forces

Level of tax rates

Amount of government-owned firms Political and fiscal responsibility

Amount and extent of corruption

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Key indicators of economic health

a. Structural incentives

b. Legal structure

c. Incentives to save

d. Open economy

e. Stable macroeconomic policies

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Techniques of Assessing Country Risk

Checklist approach

Delphi technique

Quantitative analysis

Inspection visits

Combination of techniques

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A checklist approachinvolves rating and weighting all

the identified factors, and then consolidating the

rates and weights to produce an overall assessment.

The Delphi techniqueinvolves collecting various

independent opinions and then averaging and

measuring the dispersion of those opinions.

Techniques of Assessing Country Risk

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Quantitative analysistechniques like regression

analysis can be applied to historical data to assess

the sensitivity of a business to various risk factors.

Inspection visitsinvolve traveling to a country and

meeting with government officials, firm executives,

and/or consumers to clarify uncertainties.

Techniques of Assessing Country Risk

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Often, firms use a combination of techniques for

making country risk assessments.

For example, they may use a checklist approach to

develop an overall country risk rating, and some of

the other techniques to assign ratings to the factors

considered.

Techniques of Assessing Country Risk

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Applications of Country Risk Analysis

While the risk assessment of a country can be

useful, it cannot always detect upcoming crises.

Iraqs invasion of Kuwait was difficult to forecast

The 1997-98 Asian crisis also showed that MNCs had

underestimated the potential financial problems

that could occur in the high-growth Asian countries.

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Reducing Exposureto Host Government Takeovers

The benefits of FDI can be offset by country risk, the

most severe of which is a host government takeover.

To reduce the chance of a takeover by the host

government, firms often use the following

strategies:

Use a Short-Term Horizon

This technique concentrates on recovering cash

flow quickly.

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Reducing Exposureto Host Government Takeovers

Rely on Unique Supplies or Technology

In this way, the host government will not be able

to take over and operate the subsidiarysuccessfully.

Hire Local Labor

The local employees can apply pressure on theirgovernment.

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Borrow Local Funds

The local banks can apply pressure on their

government. Purchase Insurance

Investment guarantee programs offered by the

home country, host country, or an internationalagency insure to some extent various forms of

country risk.

Reducing Exposureto Host Government Takeovers

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Raters of Country Risk

Rating of a countrys creditworthiness is mainly

compiled by two magazines:

Institutional Investorand Euromoney

Their analyses are based on a number of

macroeconomic political and financial variables

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Note that the opinions of different risk

assessors often differ due to subjectivities in: identifying the relevant political and financial

factors,

determining the relative importance of eachfactor, and

predicting the values of factors that cannot be

measured objectively (methodology)