Country Risk Analysis

Description
It explains various qualitative and quantitative methods used for country risk analysis. It also includes strategies for managing country risk.

Country Risk Analysis
Pratap C Biswal MDI, Gurgaon

Historical Background of CRA
• Started by World Bank in late sixties to examine the factors that affect a country’s BoP • Prior to oil price shocks (1973-74 & 1979-80) most developing countries depending on multilateral official sources for FX • The commercial banks stepped in to meet the increasing need of FX • As most countries were facing debt servicing problems, banks started looking at their repayment capacity

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Components of CRA
• Political Risk • Economic Risk • Financial Risk

Political Risk
• • • • • • • Government Stability Business Environment Economic Policy Social Stability International Diplomacy Legal System and IPR Tax System

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Economic Risk
• • • • • Macroeconomic performance Future prospects International transactions Government Finances Supportive foreign investment policy

Financial Risk
• • • • • Currency risk Inflation risk Unexpected changes in BoP Banking and financial system Fiscal deficit and sovereign debt

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Methods Used for CRA
• • • • Fully Qualitative Method Structured Qualitative Method Checklist Method Quantitative Methods
– Multiple regression analysis – Discriminant analysis – Logistic regression analysis

Fully Qualitative Method
• In-depth analysis of a country without a fixed format or method • General discussion on political, social, economic and financial health of a country • Difficult to compare between countries through this method • Benefit is that it could be adapted to unique strengths and problems

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Structured Qualitative Method

Checklist Method

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Checklist Method Cont.

Quantitative Methods
• Country Risk Rating Model • Erb, Harvey and Viskanta (1995) • Explore risk surrogates:
– Political Risk, – Economic Risk, – Financial Risk and – Country Credit Ratings

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Political Risk
P o litic a l E c o n o m ic e x p e c ta tio n s v s . re a lity E c o n o m ic p la n n in g fa ilu re s P o litic a l le a d e rs h ip E x te rn a l c o n flic t C o rru p tio n in g o v e rn m e n t M ilita ry in p o litic s O rg a n iz e d re lig io n in p o litic s L a w a n d o rd e r tra d itio n R a c ia l a n d n a tio n a lity te n s io n s P o litic a l te rro ris m C iv il w a r P o litic a l p a rty d e v e lo p m e n t Q u a lity o f th e B u re a u c ra c y T o ta l P o litic a l P o in ts P o in ts 12 12 12 10 6 6 6 6 6 6 6 6 6 100 % of I n d iv id u a l % of In d ex C o m p o s ite 12% 6% 12% 6% 12% 6% 10% 5% 6% 3% 6% 3% 6% 3% 6% 3% 6% 3% 6% 3% 6% 3% 6% 3% 6% 3% 100% 50%

Financial Risk
Financial Loan Default or unfavorable loan restructuring Delayed payment of suppliers’ credits Repudiation of contracts by governments Losses from exchange controls Expropriation of private investments Total Financial Points 10 10 10 10 10 50 20% 20% 20% 20% 20% 100% 5% 5% 5% 5% 5% 25%

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Economic Risk
Economic Inflation Debt service as a % of exports of goods and services International liquidity ratios Foreign trade collection experience Current account balance as a % of goods and services Parallel foreign exchange rate market indicators Total Economic Points Overall Points

10 10 5 5 15 5 50 200

20% 20% 10% 10% 30% 10% 100%

5% 5% 3% 3% 8% 3% 25% 100%

International Country Risk Guide Risk Categories
Risk Category Very High Risk High Risk Moderate Risk Low Risk Very Low Risk Composite Score Range 0.0-49.5 50.0-59.5 60.0-69.5 70.0-84.5 85.0-100.0

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Assessment of Country Risks
• • • • • • • • Bank of America Dun and Bradstreet Economist Intelligence Unit Euromoney Institutional Investor Moody’s Investor Services OECD Standard & Poor’s

Strategies for Managing CR
• Negotiate the environment with the host country prior to investment
– The investment environment – The financial environment

• Structure foreign operations to minimize country risk while maximizing return • Obtain political risk insurance

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Strategies for Managing CR
• Negotiate the environment with the host country prior to investment
– The investment environment
• • • • • • Taxes Labor issues Concessions and subsidies Obligations and restrictions Provisions for investment diversification International negotiation of disputes

Strategies for Managing CR
• Negotiate the environment with the host country prior to investment
– The investment environment – The financial environment
• • • • Cash flow remittance Access to capital markets Subsidized financing Corporate governance environment

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Strategies for Managing CR
• Structure foreign operations to minimize country risk while maximizing return
– Limit the scope of technology transfer – Limit dependence on any single partner – Plan for alternatives

Strategies for Managing CR
• Obtain political risk insurance
– Insurable political risks
• • • • War Revolution Civil disturbance Terrorism

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Strategies for Managing CR
• MNCs are self insured if they are well diversified • Obtain political risk insurers
– Government export credit agencies
• U.S. Overseas Private investment Corporation • U.K. Export Credits Guarantee Department

– International
• World Bank – Multilateral Investment Guarantee Agency

– Private
• Lloyd’s of London • American International Group (AIG)

Thank you!!!

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