Lecture 4

Country Risk Analysis

Dr. Sangeeta Yadav

Definition
Country Risk Analysis is an assessment of potential risks and rewards from doing business in a country. Country risk represents potentially adverse impact of a countrys environment on the cash flow of the firm. Country risk analysis can be used
to monitor countries where the MNC is presently doing business; As a screening device to avoid conducting business in countries with excessive risk; And to improve the analysis used in making long-term investment or financing decisions

Awareness of Country Risk

Trend Economic Crises in Emerging Markets
External Debt Crisis
Argentina (1983, 2001) Indonesia (1998) Mexico (1999) Pakistan (1983) Russia (1998) Venezuela (1985)

Financial Crisis
Argentina (1982, 2001) Brazil (1982, 1998-99) Ecuador (1986, 1999) Egypt (1981, 1989-91) India (1991, 1993) Indonesia (1986, 1998) Mexico (1982, 1994-95) Nigeria (1987, 1999) Philippine (1983, 1997) Russia (1998) Turkey (1994) Venezuela (1984, 1996)

Banking Crisis
Argentina (1989, 1995) Brazil (1987, 1990, 1994) Hungary (1991) India (1984, 1999) Indonesia (1997-98) Korea (1981, 1998) Mexico (1989, 1995) Nigeria (1989, 1996) Turkey (1982, 1999) Venezuela (1994, 1999)

Country Risk Analysis

Area Study
Sources and Materials
Country Risk Agencies (S&P, Moodys, ICRG) International Organizations (IMF, World Bank, OECD) Area Study Institutions (EIU, IIF, Economist, KIEP, KOTRA) Major Newspapers (FT, WSJ, NYT, WP) Internet and Broadcasting (Bloomberg, CNN, BBC)

Referred Information
Overseas Representatives

OECD CRE Meeting Outcome

ECA Developments

Local/Regional Authorities

Field Survey

What is at Risk?
Lending
What is at Risk? Money Ability of debtor to service the debt Max. time horizon What can go wrong? 12 Yrs. Destruction of debtors assets interruption of production

Direct Investment
Real Assets and money Ability of plant to produce and/or sell product 30 Yrs. Destruction of subsidiarys assets interruption of production

(Caused by war, revolution, occupation by foreign power, natural calamities, disorders, strikes)

Exproration, Indigenization of debtors assets Impossibility of transferring funds

Exproration, indigenization of subsidiary Impossibility of repatriating capital and/or remitting earnings Fall of earnings, bankruptcy of subsidiary

Fall of earnings, bankruptcy of debtor

(Caused by mismanagement of the economy, credit squeeze, long-term slowdown in GNP growth, strikes, rapid rise in production costs etc.) Detirioration of the balance of payments of debtor/host country; Overextension in external borrowing by debtor/host country (These can be caused by a great number of political, social & economic factors)

Political Risk Factors

Domestic

The Political System

Its basic strength, Capacity to change without conflict

The Group in Power

Philosophy, Policies, Government officials, Strength, capability of implementing plans

Opposition Groups
Strength, philosophy

The Government system

Efficiency, red tape, flexibility, responsiveness

Political Risk factors

International
Likelihood of system disrupting conflict arising from outside the
country
Due to Countrys own problems

Due to treaty or other obligations

Relations with major trading partners Relations of the companys home country with other alternatives

Country Risk Measurement

Political Factors
Attitude of host government
War Currency inconvertibility Bureaucracy Blockage of fund transfers Corruption

Hazards based on Government action

Confiscation:
Is a process of a Government taking ownership of a property without paying any compensation E.g.: Chinese confiscation of American Property after coming to power in 1949.

Country Risk Measurement

Political factors
Expropriation Nationalization
Involves government ownership and it is the Government itself that operates the business being taken over.

Domestication
Foreign companies offer voluntarily or are asked to offer control to a Nations Citizens. Eg:Pepsi,Coke,GM sold stake to locals.

General Instability Risk

the uncertainty of the future viability of the host country

Country Risk Measurement

Political factors
Ownership/Control Risk
Possibility that a host countrys Government might take action to restrict investors risk.

Operation risk
Possibility that a host countrys government might constraint an investors business operation in anyone or all areas like production, marketing, finance etc.

Transfer risk
Any future act by a government that might constraint the ability of a subsidiary to transfer payments, capital, profits out of a host country.

Country Risk Measurement

Economic Factors
Domestic
Economic Growth, investment trends Cyclicality of economy, economic diversification Inflation
Monetary Policy Fiscal Policy, budget deficits

Strength of local financial markets, portion of local investment financed locally

Country Risk Measurement

Economic Factors International
Balance of Payment International Trade
Importance of trade in GNP Stability of trade earnings
Diversity of exports Elasticity of export demand Elasticity of import demand (capital equipment, necessities, reliance on imported energy, luxuries)

International trade ties to major markets Extent of trade controls

Country Risk Measurement

Economic Factors
International capital
Currency (Strength, stability, quality of exchange markets, control) Debt (total, short term, debt service ratio, debt service schedule) International financial resources (international reserves, international borrowing capacity, credit rating, autonomous capital inflows) Share of total investment financed from abroad

Country Risk Measurement

Socio-cultural Factors
Domestic Social Groups (ethnic, religious, linguistic, class, extent of cohesiveness or divisiveness ) General psychology of population ethic Unemployment Political activism of population Extent of social unrest (strikes, riots, insurgency)

Country Risk Measurement

Socio-cultural Factors
International Cross Border ties
Ethnic, religious, linguistic, historical

Cross Border antagonism

Ethnic, religious, linguistic, historical

Need for Risk Evaluation

Country risk assessment is a complex, tedious and costly exercise A respectable body of opinion holds that the benefits do not justify costs
International financial market is near perfect Knowledge is near perfect The market knows best

Need for Risk Evaluation

But, events of last decade - International financial market short term disastrously wrong
Financial market take a long term prospect Market is less perfect spreads may not reflect an unbiased market consensus of country risk Individual investor can have a superior insight particular countrys condition Superior techniques superior analytical ability

Proper assessment of country risk

Six Qualifications
Conceptual awareness of factors bearing on country risk Analytical ability to assess these factors interaction In depth knowledge of the country under scrutiny Specialized expertise to predict political variables Familiarity with economic forecasting techniques short term projections of relevant variables Experience and skills debt servicing ability observed and predicted variables

Relationship of firm to host Government

Objectives and Strategy Most Governments actively set objectives for National Economy MNCs contributing towards these objectives are welcome Identifying and understanding host Government strategy important aid in forecasting action Few common National strategic approaches towards multinational can be described
Indigenous industrialization Leapfrog favourable tax and other incentives to achieve high level of industrialization Infant industries only few select firms in high technology areas allowed e.g. Japan, India Open door Equal treatment to foreign investors very few countries

Managing Country Risk

Before investing
Internal hedging
Maximization of local equity, local borrowing, management contract International integration (production, marketing, international supply sourcing)

External hedging
Govt. insurance Private insurance Host govt. guarantees

Managing Country Risk

After investing
Internal hedging
Good citizen policy Increase in technical contribution Negotiation & arbitration

External Hedging
Private insurance International investment codes Divestment

Thank You!
Dr. Sangeeta Yadav