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.
