Analyzing Country Risk

Expropriation Currency controls Trade controls Tax and labor laws Regulatory restrictions

Types of Political Risk

Political Stability Economic Factors Subjective Factors Capital Flight Culture

Political Risk Analysis

Country risk refers to the risk of investing in a country, dependent on

changes in the business environment that may adversely

affect operating profits or the value of assets in a specific country.

Country Risk

Over-regulated economies Inflexible labor markets Overly expansive social

welfare programs

Country Risk: Europe

Litigation risks Employment laws Environmental laws

Country Risk: United States

Rigid business system Extensive government

regulation Strong social traditions

Country Risk: Japan

Country Risk Measures

“Excessive Government Spending” Risk Indicator: Government deficit as a

percentage of gross domestic product. Higher the figure higher is the fiscal irresponsibility.

One of the measure to cure fiscal irresponsibility is to monetize the deficit. But it would lead to monetary instability, high inflation, high interest rates and currency depreciation.

Fiscal Irresponsibility

Fiscally Irresponsible and monetarily

irresponsible government compound their irresponsibility by having a controlled exchange rate system, whereby currency controls are used to fix the exchange rate.

A controlled exchange rate system goes hand in and with an overvalued currency. Taxing exports and subsidizing imports.

Leads to capital flight.

Controlled Exchange Rate System

Another indicator of

potential increased country risk

Amount of unproductive spending in the economy

Capital from abroad is used to subsidize consumption or is wasted on showcase projects

Resort to exchange controls, higher taxes and the like.

Wasteful Government Spending

Other things being equal, a nation with substantial natural resources, such as oilor copper, is a better economic risk than is one without these resources. Quality of human resources and the degree to

which these resources are allowed to be put to their most efficient use.

A nation with highly skilled and productive workers will have steady growth and development

Additional factors : A stable political system that encourages entrepreneurs A flexible labour market: most productive jobs A free market system: prices people respond to correctly

signal the relative desirability of engaging in different activities.

Resource Base

In a market economy, also known as

capitalism, economic decisions are made by individual decision makers based on prices – of goods, services, capital, labour, land and other resources.

In a command economy, often termed socialism, people at the top decide what is to be produced, how it is to be produced and where it is to be produced and then command others to follow the central plan.

Market oriented VS Statist policies

Core distinction: Different ways in which they harness information and incentives

Given that resources are scarce, economic decisions involve a series of trade-offs

In order to make successful trade-offs, sufficient knowledge is necessary

Why capitalism works?

Statist policies are those policies in which markets

are combined with heavy government intervention in their economies through various regulations, tax and spending policies.

In addition so-called critical industries like aerospace, telecommunications, oil, power generation etc. are typically owned or controlled by the state.

As a result, economic power is often heavily centralized with the state, usually with harmful consequences on wealth creation.

Meaning of Statist Policies:-

Statist Policies Constraint Growth

Why Statist Policies Persist?

It is far easier to regulate and extend the state’s reach than to deregulate it.

Process of reform is greatly complicated by Egalitarian Ideologies that challenges private success.

Statist policies favor people who are politically strong and are backed by power.

Key Indicators Of Country Risk And Economic Health

• A large government deficit relative to GDP• Substantial government expenditure

yielding low rate of return.

• Price controls, interest rate ceilings, rigid labor laws, trade restrictions.

• High tax rates

• The absence of basic institutions of government

• Pervasive corruption that acts tax on legitimate business activity.

Positive indicators of nations long run

economic health:-

• A structure of incentives that rewards risk taking.

• A legal structure that stimulates growth.

• Minimal regulations and economic distortions.

• Clear incentive to save and invest.

• An open economy.• Stable macroeconomics policies.

Market Oriented Policy is an art which is geared to the governance, keeping in mind the condition of market place. The most successful economies demonstrate the importance of aligning domestic incentives with world market conditions.

Market Oriented Policy

Nations must make their way in an increasing competitive world economy that puts a premium on self-help and has a little time for the in inefficiency and pretension of statism, as the road to economic success.

Market oriented reforms in Latin America

Reform of the public sector probably went the furthest In Latin America , where shocked by the severe miseries of the 1980s (known as the Lost Decade in Latin America), many of these countries abandoned the statism, populism, and protectionism that have crippled their economies since colonial times.

Populism- A political doctrine or philosophy that proposes the rights and powers of ordinary people are exploited by privileged elite.

Protectionism- A system or policy of protecting the domestic producers from competition by imposing tariffs, quotas, etc.

Statism - Belief that centralization of power is the best way to organize humanity i.e., substitution of state owned enterprise for the private sector.

Terms

Chile and Columbia have embarked on fairly comprehensive reform programs, emphasizing free markets and sound money.Despite some backsliding and significant problem with corruption, Mexico has made surprisingly good headway.Argentina also undertook radical reforms of its economy, highlighted by privatizing major activities and galvanizing the private sector.

Countries replaced inflation with new taxes on the poor, high tariffs with regional trading blocs, and, especially, state monopolies with government sanctioned private monopolies.Moreover, the courts were subjected to the whims of those in power, widening the divide between official institutions and ordinary people.

The resulting disappointment brought leftist governments to power in several countries, including Argentina, Brazil, and Venezuela, with Predictable results.

Some of the political obstacles which are difficult to overcome are as follow :• Labor Union facing job and benefit losses• Bureaucrats fearful of diminished power

and influence• Local industrialists concerned about

increased competition and reduced profitability

Obstacles in economic reform

• Reducing state subsidies on inefficient

industries• Privatizing bloated state enterprises• Removing trade barriers and price

controls• Freeing interest rates and the

exchange rates

Solutions ?

1.Deregulating Agriculture2.Privatizing small businesses3.Manufacturing low technology goods4.Direct investment in local production

Strategies for success

COUNTRY RISK ANALYSIS IN INTERNATIONAL BANKING

• This explores country risk from a bank’s standpoint, the possibility that borrowers in a country will be unable or unwillingly to service or repay their debts to foreign lenders in a timely manner.

• Countries that default will lose access, at least temporarily, to the international financial markets.

A nation’s ability to repay foreign loans is

determined by the nation’s ability to generate U.S. dollars and other hard currencies.

This ability, in turn, is based on nation’s term of trade.

In general, if its term of trade increase, a nation will be a better credit risk.

Alternatively, if its terms of trade decrease, a nation will be a poorer credit risk

Country Risk and the Terms of Trade

During the 1970s and early 1980s, international banks

lent hundred of billions of dollars to less-developed countries and communist countries.

Lessons from the International Debt Crisis

This crisis began in 1982, when Mexico announced that it was unable to meet its regularly scheduled payments to international creditors.

By spring of 1983, about 25 (two-thirds of international bank’s claims on this group of countries) less-developed countries were unable to meet their debt payments.

Onset of the Crisis

By late 1983, the intensity of the international

debt crisis began to ease as the world’s economic activities picked up-boosting LDC’s export earnings-and as the orderly rescheduling of many overdue international loans was completed..

During 1991, net international bank lending turned positive again, following the on the heels of dramatic economic reforms under way in many LDCs.

Reform Takes Hold

Many of the LDCs pushed for debt relief, i.e.,

reducing the principal or interest payments, or both on loans.

Many middle-income debtor countries were neither very poor nor insolvent.

In addition, many of these countries possess considerable wealth-much of it invested abroad.

Debt Relief

Ten years after it began, the decade long Latin

American debt crisis ended in July 1992 with the signing of an agreement with Brazil to restructure the $44 billion it owed foreign banks.

Mexico and Chile, hopelessly mired in debt, so thoroughly reformed their economies, spurring economic growth in the process, that they were able to raise new money from the international capital markets.

The examples of Mexico and Chile led others, such as Argentina and Venezuela, to change their policies as well.

The Crisis Ends

From the standpoint of a multinational corporation,

country risk analysis is the assessment of factors that influence the likelihood that a a country will have a healthy investment climate.

A favorable business environment depends on existence of stable political and economic system in which entrepreneurship is encouraged and free markets predominated.

From bank’s standpoint, country risk-the credit risk on loans to a nation-is largely determined by the real cost of repaying the loan versus the real wealth that the country has to draw on.

SUMMARY AND CONCLUSIONS

International debt crisis suggests that others

in a similar situation can get out only if that institute broad systemic reforms.

Their problems are caused by government spending too much money they do not have to meet promises they should not make.

Debt forgiveness or further capital inflows would only tempt these nations to postpone economic adjustment further.

Thank You!