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Country Risk Analysis

Risk analysis

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Nishant Talwar
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133 views11 pages

Country Risk Analysis

Risk analysis

Uploaded by

Nishant Talwar
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© All Rights Reserved
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COUNTRY RISK ANALYSIg “ence iending’s na country whether to the government, a ban All cross“ bor ‘ge or an individual are exposed to country tisk, Country ti ; nl gg in cross-border lending, caused by events in a parti sure toa an must, to some extent be under the control of the TI ied hie country. Example, a loan in US dollars to a Bahamian governne the Nassau branch of a foreign bank is exposed to a country risk, borrower i events that are, at least to some extent, under the control of the een lead to the materialization of country risk. A default caused by Serpe is the result of the mismanagement of the economy by the government; it is commercial risk if it is the result of the mismanagement of the firm. Natural calamities, if unforeseeable, cannot be considered as country risks, But if past experience shows that they have a tendency to recur periodically. such as typhoons in Southeast Asia- then the government can minimize their effects. Country Risks Analysis Country risk is the uncertainty associated with government continuity, | regional politics, ineffective legal and regulatory systems, currency instability convertibility, and home-host country relations. Political risk is specific to the commercial interests of companies involved in trade or international investments: Itis defined as, the possibility that political decisions, events, or conditions ina country will affect the business environment such that companies will suffer financial or material losses. An MNC is concerned with expropriation of foreign assets, physical and intellectual security, trade restrictions, labor relations, procurement systems licensing, costs of trade, and transactional difficulties such as constraints Profit repatriation and convertibility of currency. ; At the macro level, “country” risks include international ral ideological differences, host-country economic systems, war and = a Political risk addresses macro issues and factors such as cultura a os ate systems important to a firm's success. At a micro level, politic ulation? more apparent: operational issues, trade restrictions, governmen vighs. foreign business, duties, foreign taxes, and intellectual property country: | Scanned with CamScanner ingot isk analysis importance of country risk an, alysis v It can be used by MN with excessive ri: CS a8 a screenin i i ‘ ive risk 18 device to avoid countries v It can be used to monit pa for countri engaged in international business ‘where the MNC is Presently y To assess particular forms . Of ris for a foreign country, Sk for a proposed project considered political Risk Factors y Attitude of consumers in the host country vy Attilude of host government y Blockage of fund transfers y Currency inconvertibility vy War : y Bureaucracy. Financial Risk Factors vy Current and potential state of the country’s economy y Financial distress in a country can encourage a government to implement policies that could limit the MNC’s market penetration there Additional host government restrictions may be enforced after an MNC establishes a foreign subsidiary v Interest rates, exchange rates and inflation can also have an impact on each other, which makes the overall assessment of their impact on the economy more complex Itincludes an assessment of all factors related to the foreign country that influence the cash flow of the MNC. < < Sources of Country Risk ¥ Macro Risks affect all firms in the host country. Y Micro Risks are specific to an industry, firm or project in a country Whether a particular country risk is micro or macro, it affects the diversification ability of the tisk. Need For Risk Evaluation costly exercise. people aon : d Assessment of country risk is a tedious an exerc * ofthe opinion that fe lene of assessment do not justify the costs. ountry risk evaluation 1s to achieve above aya, bank can perform better than its competi dof the market and moves into countries lory wit The purpose of ct mance. AN international rovided it anticipates risks ahea Jower risk perceptions. / Proper evaluation of country risk requires the following qualifications, wv Deep awareness of the factors influencing country risk. . y Analytical ability to judge how these factors interact in affecting 4, repaying, capacity of the borrower. ie v Indepth knowledge ©! conditions in the country techniques of economic forecasting and long-term, f the political, socio-cultural and econom; concerned. . y Expertise in the projections. ¥ Skills and experience in rating and drawing conclusions. Considerable training and experience are required to acquire the above mentioned qualifications. The expertise ofall the internal staff should be pooleq er, Outside experts may also be employed for country risk assessment whenever necessary. Use of Country Risk Assessment 1. Incorporating country risk in capital budgeting ount rate: The higher the perceived risk, the 2, Adjustment of the disc higher the discount rate that should be applied to the project's cash flows. 3. Adjustment of the estimated cash flows: By estimating how the cash flows could be affected by each form of risk, the MNC can de termine the probability distribution of the net present value of the project 4. Application of Country Risk Assessment: Alerted by its risk asses sor, Gulf Oil planned to deal with the loss of Iranian oil, and was able te avoid major losses when the Shah of Iran fell four months a eee while the risk assessment of a country can be useful of Kore ways detect upcoming crises. For example Iraq's invasion nd twas difficult to forecast. Nevertheless, many MNCs ones a peter their exposure to country risk and revised theit tena 1997-98 Asian crisis also showed that MNCs ha the potential financial problems that could occur in Scanned with CamScanner — | ¥ Substantial government spending yielding low rate of returns y High taxes wv Vast state-owned firms y Pervasive corruption. ssification of Country Risk 4, Default: In this case, the creditor notifies the debtor that he will definitely cease ‘making any further service payments because he cannot or does not want to pay (default) or because he does not recognize the debt (repudiation). 2 Renegotiation 3 Indicates that the lender will receive less than originally ed because the interest rate is lowered, the spread narrowed and/or because rt of the principal will not be repaid. Refinancing not covered by a penalty use has similar consequences to the lender. 3, Rescheduling or Moratorium : This implies that the terms of the loan are lengthened either because annual repayments of principal are lowered and gpread over a great number of years than originally agreed or because there will be grace period for the repayment of principal. The interest or spread remains the same as originally agreed. 4, Technical default : Technical default arises when the borrower fails to meet one or several terms for debt service payments because of temporary inability to pay administrative delays, or inefficiency. Loans are made from one day toa maximum of 10-12 years; the country tisk evaluation encompasses these periods. It is extremely rare to contemplate a direct investment for less than five years. This is thus the minimum time horizon for risk assessment. The maximum is around 30 years; for example for oil exploration, plantations or mining. Country risk assessment is a complex, tedious and costly exercise. Following qualifications are required for proper assessment of country risk : 1. Conceptual awareness of factors that have a bearing on country risk; 2, Analytical ability to assess how these factors interact inaffecting debt serviceability 3. In-depth knowledge of the country under scrutiny; its political & economic structure, the institutional and regulatory framework, recent political and economic developments etc. 4. Specialized expertise to predict political variables; familiarity with economic forecasting to make short and long-term projections. pal dat Types of Country Risk Assessment 1. Micro-assessment of country risk : A micro-assessment of country risk is the risk assessment of a country as related to the MNC's type of business, Companies differ in their susceptibility to political risks: Therefore extractive Scanned with CamScanner financial services, manufacturing (heavy industrieg) financial s mis a ay, industries, utilities, different levels of risk. 4 ati face ice multinationals service m' to assess country risk (Micro-assessment) 0 Techniques udes undertaking following steps ; ibinel 5 ist Approach: it inc “a - oon @ — values and weights to political and financial risk facton iar ing the factor values with their weights, and summing hs ae ihe political and financial risk ratings. J (0) Assigning weights to the risk ratings, and (a) Multiplying the ratings with their weights and summing up to Bive the country risk rating. ind i ique ii llecting various independent 9. ii) The Delphi Technique involves col ¢ v ndent opin, ions x then averaging and measuring the dispersion of those opinions, (ii) Quantitative Analysis techniques like Tegression analysis can bea, plied to historical data to assess the sensitivity of a business to various tis, factors. (i) Inspection Visits involve traveling to a country and meeting wit, government officials, firm executives, and/or consumers to clarify uncertain. ties, 2. Macro assessment of country risk: A macro-assessment of country risk is an overall risk assessment of a country without consideration of the MNCs business. It is an aggregate subjective assessments - expert opinion- generated, ¢g., BERI, (explained later in this chapter). Techniques to assess country risk (Macro-assessment) 1. Intuitive Assessment Methods : All com; i including Political stability, Currency factors, labor isan ty controls, home-host country relations, “chance” circumstances, The nomic Policies, technological factors, and ally a brainstorming approach with Companies Such as G) Xerox, Exxon, and S to i low Si inges They do this eal JOM assign letter Sracies or im in the “4” cate, ch year, op More often, and may rate a ' ry, and Columbian Zaire gs Japan slightly higher ask in e intuitive ‘acceptable in the “2” h understand the on®,*PPtOach has itations, the “Z” category. lim: broad view, PANY’s operations beyond than omen he ge rarely ; they Scanned with CamScanner 2. Advisory Assessment Methods : Multinational corporations supplement intuitive methods with published tisk-rating services, consulting reports, and government advisory services that provide a tremendous amount of data on foreign affairs. Such as v US. State Department, for example, publishes a country guide for nearly every nation and territory in the world. These are updated regularly, and in many instances, v One of the largest data services is provided by Euromoney which regularly publishes an index of Country Risk Ratings based on six primary criteria: analytical indicators of economic performance, country political risk, debt indicators, default records, credit ratings, and access to international finance. Euromoney’s list is a numerical rank-ordering of approximately 170 countries and territories. v The U.N, O.E.C.D,, ministries of nearly every major nation, and specific agencies of government (like Department of Agriculture) have huge data bases with report profiles on economics and country activities, political agendas, and trends, Several try to track terrorism and patterns of social changes. v Nearly all international banks have risk assessment reports or data on key indicators. The Economist publishes data and country ratings regularly. Fee-based reports are also provided by Price Waterhouse, Andersen Consulting, Political Risk Services, Chase Econometrics, and Dataquest, among others. 3. Analytical Assessment Methods : Many corporations generate their own systems for analyzing political risk, These are proprietary studies that attempt to quantify information. For example, GE has created a weighted-index of factors that are used in conjunction with reports from foreign managers. Exxon uses panels of experts and survey techniques to generate risk probability I tables. Most companies contract forecasting services, such as DRI and Dataquest. 4. The Economist Approach : Created by The Economist, the method assigns risk to a country based on a 100-point scale, Risk is evaluated on three \d categories, each with specific variables. “Economic Factors” can contribute 4 maximum of 33 points on 6 variables; “Political Factors” has a maximum of 50 points on 6 variables; and “Social Factors” can contribute a maximum of 17 Points using 4 variables. The model is simple to use and very practical. An xpert panel rates each variable according to predetermined guidelines and . The scores are then tallied, and a general report is provided with relative change effects from past periods and statistics to support the scoring, 5. Business Environmental Risk Intelligence (BERI) Model : The BERI @ssessment is called the Political Risk Index (PRI), based on a composite score Scanned with CamScanner — orment tween 70 and 100 ex, 2 Jobal experts on ten val aoe eaeeeaimately 100 ae from 3g es in three ca oory each of the ten vatiables py < jed on ssigned sco! ; in a maximum j ‘ Bel Sn ie in zero (oaigh eelues mean 1OW See ae ciaaiad scale. The forecaa'® ints (hi ‘i ints for %, 7 "Sa, eefondents ca assign ee anal 10 year ae aes Provide, | for “caren easel forecasted conditions so that cliei MPute th, detailed descr 3 t F PRI does not assess broad socja} i isk ratings. The : ‘ own meanings a "does not include economic or financial data needeg “ cultural issues a decisions. Political Risk Services (PRS) Index : The PRS assessment jy. 6. Polit i subscribers with a comprehens proprietary report ae aee Wis aed on probabilities of losses rather th, risk analysis bgeeeaeie 18-month and five-year forecasts for as many , neue ae subseriber would also receivea monthly report ti, nave specifically for that company’s industry (eg, “financial services") 7, PRS index is based on evaluations from more than 250 specialists in the Us and abroad who are selected from diverse backgrounds in academic, business and government positions. The final index of probabilities is classified into categories and projects probable changes in future governments and influene from political factions. Although the results are speculative, the index és considered superior to others. The PRS models outperform the BERI and the Economist models. MACRO ENVIRONMENT RISK ASSESSMENT Political Factors Affecting Country Risk il'at, occupation by foreign power, riots, disorders caused by territor! claims, ideological differences, conflict of economic interests, regionalism. Political polarization, etc. are the many of the critical factors of country rit analysis of a political nature, DOMEsTic ___ A. The political System (a) Its basic strength ) Us resiliency. a Fu S*Y-