Country Risk Analysis-Meaning,Definition,Factors Effecting Country Risk

Posted on Mar 21 2016 - 2:11pm by Preeti

Country Risk Analysis-Meaning,Definition,Factors Effecting Country Risk

Meaning

All business transactions involve some degree of risk. When business transactions occur across international borders, they carry additional risks not present in domestic transactions. These additional risks, called country risks, typically include risks arising from a variety of national differences in economic structures, policies, socio-political institutions, geography, and currencies. Many of the individual events investigated by country risk analysis fall closer to uncertainties than well defined statistical risks.

Country Risk may be classified as a specific type of environmental risk i.e. its source is the general business environment of a country that one is operating in.

In International Business one is often operating across different countries. Socio-political and economic environment in these different countries is therefore of concern to International Business. Change in these parameters may put an International Business to various kinds of risks.

Examples of situations where Country Risk could play an important role:

  • Portfolio investment done in another country may suffer loss if the Share prices tumble because a certain party came to power in general elections
  • A military dictator after coming to power announced that all foreign nationals should be deported within 24 hours. The management of MNC had to leave in haste and did not find time to sell FDI invested in the country take out the funds.
  • A country suffered Balance of Payment Crisis as a result of which the currency depreciated sharply. Profits in that currency therefore lost value when converted to another currency.

 

Definition

 Assessing the potential risks and rewards associated with making investments and doing business in a country.

 Study of business environment in different countries with an objective of predicting the likelihood of various kinds of risks that businesses operating in those countries may face.

Factors Affecting Country Risk

Factors affecting Country Risk may be classified as:

(i) Economic

(ii) Political

(iii) Social

(i) Economic Factors

Certain specific economic parameters are analyzed while evaluating Country Risks. Here the basic issue is to examine the

  • Ability of a country to honor its external obligations and
  • The possible strain it would put on the exchange rate.

It is important to note here that both the above issues would directly depend on the external sector situation. However, external sector of any country cannot be examined in isolation. It is equally important to understand the domestic economy by means of various GDP, Fiscal Policy and Monetary policy related parameters.

Again depending upon the time horizon that one is looking at it is important to focus not only on the immediate values of these parameters but also on long term trends as also on the long term sustainability of these trends.

The internal economic situation as reflected by the GDP, Fiscal and monetary variable becomes more important if one is considering a long term involvement by way of FDI in the country.

These can be grouped as –

(a) GDP related parameters

(b) Fiscal sector parameters

(c) Monetary policy parameters

(d) External sector parameters

(a) GDP related Parameters:

(1) GDP in nominal and real terms

(2) GDP growth rate and its trend over long term

(3) Per Capita GDP

(4) Sectorial distribution of GDP – Contribution of Primary, Secondary and Tertiary sectors

(5) Saving / GDP ratio

(6) Investment / GDP ratio

(7) Investment / Saving ratio

(8) Investment/GDP growth ratio

(9) Unemployment

(b) Fiscal sector parameters:

(1) Deficits – Fiscal, Revenue, Monetized

(2) Deficits as % of GDP

(3) Tax collection as % of GDP

(4) Tax buoyancy

(5) Internal Debt / GDP ratio

(6) Debt maturity profile

(c) Monetary policy parameters:

(1) Inflation

(2) Interest rate

(3) All other monetary policy tools such as CRR, SLR, Bank rate – different countries would have different monetary policy tools.

(d) External sector parameters:

(1) Balance of Trade

(2) Balance of Payments

(3) Composition of Exports and Imports

(4) Trends in import and export growth

(5) Terms of Trade

(6) BOP Deficit /GDP ratio

(7) External Debt – quantum and maturity profile

(8) External Debt / GDP

(9) Debt Servicing / export earnings

(10) Capital flows

(11) Exchange rate stability

 

(ii)Political Factors

The political risk is the risk that a foreign government will significantly alter its policies or other regulations so that it significantly affects one’s investment. More broadly, it can apply to the risk that a nation will refuse to comply with an agreement to which it is a party, or that political violence will hurt an investment or business. For example, if one exports goods to a foreign nation, and that nation elects a new government that enacts protectionist tariffs, this will negatively impact the export business

A change in political situation of a country is likely to change the business environment. Some of the important political factors to be looked into would include –

(a) System of government – democratic, authoritarian, etc.

(b) Major political parties and their ideologies

(c) Party in power, it vision, succession plan, etc.

(d) Leading opposition parties and their ideologies and visions

(e) Maturity of political institutions

 

(iii) Social Factors

(a) Culture and history

(b) Values

(c) Educational levels

(d) Major fault-lines / dividing lines in the society

(e) Attitudes towards foreigners, change, technology, profits, etc.

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