lecture iv country risk assessment methodologies: the qualitative, structural approach to country...
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Lecture IV
Country Risk Assessment Methodologies: the Qualitative, Structural Approach to Country Risk
–The Welfare and Social Dimension-
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Risk Analysis: Why?
The globalisation of the world’s trade, financial and technology markets and the emergence of new economies have created a new world environment, full of opportunities, but fraught with uncertainty and spill-over risks.
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Country Risk: DEFINITION
It’s the possibility that a foreign country’s: borrower (financial investment); Importer/producer (trade and sub-contracting) Corporate partner (FDI)May be UNABLE or UNWILLING to fullfill its
contractual obligations toward a: Foreign lender; Exporter; Investor.
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Risk Analysis and Investment Decision
Two possible way to include Risk in our investment decision (NPV): Expected Value of Profit (EV)
probability of a negative event; Adjust the Discount Rate risk
premium. Which are the sources of risk? How can we measure it?
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Sources of Risk (1)
Natural Disasters; Tsunami; Earthquake;
Socio-Political Risks: Social Risk;
• Boycott;• Terrorism;• Strikes;• Religion and racial problems;
Government Policy Risk:• Trade restrictions;• Legal enforcement;• Loan repudiation;• Foreign exchange controls;• Expropriation.
Political Risk:• War;• Nationalisation.
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Sources of Risk (2)
Country-Specific Economic risk Macroeconomic Risks:
• Exchange rate;• Hyperinflation;• Terms of Trade;• Debt Service.
Microeconomic Risks:• Market Failure;• Market Inefficiency.
Supranational Level risk of contagion!
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How can we measure Country Risk?
The Quantitative ApproachThe Quantitative Approach (Lecture VII): Ratio, indices and ratings; Reduces a complex situation into a number/letter; Cross-country and cross-time comparison; Shortcomings:
Similar ratio and financial indicators BUT different socio-economic structure;
Quantitative data not available on time, incomplete, wrong or distorted;
Interpretation is difficult;
SOL: integrate with qualitative data to account for volatility and regional contagion.
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The Qualitative Approach (1)
Qualitative Approach (SWOP):Qualitative Approach (SWOP): Assessment of the economic, financial
and socio-political fundamentals that can affect the investment return prospects in a foreign country;
Describes/identifies the structure of a country’s development strategy/process by shedding light on:
Strengths and opportunities; Weaknesses and threats.
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The Qualitative Approach (2)
A robust qualitative approach leads to comprehensive country risk report that includes the following six elements:
Social and welfare dimension of the development strategy;
Macroeconomic fundamentals; External indebtedness evolution, structure
and burden; Domestic financial system situation; Assessments of the governance and
transparency issues; Evaluation of the political stability.
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Social and Welfare Dimension
Development: Definition; Measurement;
Poverty: Definition; Measurement;
Inequality: Definition; Measurement;
✔ ✔ Impact on Country Risk AssessmentImpact on Country Risk Assessment
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What is Development?
Adam Smith (1774) “Wealth of Nations”;
Recent years distinctive analytic and methodological identity:
NARROW INCOME Def BROADER BASIC NEED
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A Narrow Definition of Development
“The capacity of a national economy, whose initial economic condition has been more or less static for a long time, to generate and sustaingenerate and sustain an annual increase in its gross national product (GNP) at rates of perhaps 5% to 7%”;
OR “ rates of growth of income per capita or per capita GDP”.
ADVANTAGES: easily to measure and understand DISADVANTAGES: experience 1950s 1960s:
“growth without human development”
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The Broader Basic Needs Approach
Three basic components: Ability to meet basic needs;
(food, shelter, health and protection) Self-esteem;(self respect and cultural identity) Human Freedom(emancipation from material conditions,
ignorance, misery)
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Three objectives of Development
Increase the availability and distribution of basic goods;
Raise the living standards: higher income; better jobs; better education; cultural and humanistic values.
More economic and social choices.
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Development: Income measurement
GDP = Gross Domestic Product; final output
GNP = Gross National Product; total income
GDP and GNP per capita; Purchasing Power Parity (PPP):
DEF: This purchasing power rate equalizes the purchasing power of different currencies in their home countries for a given basket of goods.
Different purchasing power of US$1 in different countries;
better than Exchange Rate (underestimate real value of income in LDC).
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Countries Classification (per capita GNP in 2000)
Low-Income: < 755 US$ Lower Middle Income:
[$756 - $2995] Upper Middle Income
[$2996 - $755]
High Income OECD and other Countries
> $ 9265
Developing Countries
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Development: Non-Income Measurement (1)
A long and Healthy Life Life expectancy at birth (age);
Knowledge: Adult Literacy Rate (% aged 15 and above); Gross enrollment ratio in education (%)
A decent Standard of Living: GDP per capita (PPP US$)
Composite Indicator UNDP Human Development Index: Low Human Development [0.00 – 0.49]; Medium [0.5 – 0.799]; High [0.8 – 1].
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Development: Non-Income Measurement (2)
Are there other useful development indicators? Urban population % (urbanisation) Percentage under 15 years old (age
structure); Gender structure;
Gender-Related Development Index (GDI); Gender Empowerment Measure (GEM)
Number of computers per 1,000 inhabitants; Health care.
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Social and Welfare Dimension: Development
Economic Growth VS Development Not only GDP growth but also:
Self-sustaining development; Enlarging people’s choice/rights;
Democracy; Robust and stable institutions;
Decent standard of living: Access to education; Nutrition and health; Political and cultural freedom.
Basic components of country risk and close close correlationcorrelation between HDI and country risk (ex. Sierra Leone) but not the reverse (ex. Cuba!)
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What is Poverty?
Poverty is a complex and multi-dimensional concept: Material aspects; Non material aspects; Personal features (age, gender, race); Location
cannot be fully captured by the income level!
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Three Perspectives on Poverty
Income Need Perspectives: Being below a defined poverty line;
Basic Need Perspective: no minimal acceptable fulfilment of
human needs; Capability Perspective
physical; non-physical needs and functionings.
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Measuring Poverty
1st STEP: IDENTIFICATION 2nd STEP: AGGREGATION
i.e. how identify the poor people in society and once identified how summarise (aggregate) the information on them into an useable and meaningful measure of poverty
(Amartya Sen)
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Identification
A) Objective indicators of poverty: Income or Expenditure? Unit of analysis: Household, Families or
Individuals? Adjusting for differences in household
size and composition: equivalence of scale
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B) Subjective Indicators of Poverty
Basic needs: adequate clothing, food and shelter, health and education;
Measure: Human Poverty Index (HPI):Human Poverty Index (HPI): Decent Standard of Living:
% of pop not using an improved water source; % of chinldren under weight for age;
Knowledge/Adult Illiteracy Rate: % of illiterate people aged > 15;
A long and healthy life: Prob at birth of not surviving to age 40 (60 in OECD
countries); HDI Achievements Weak relationship between objective indicator of
poverty and HPI.
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Aggregation:The Poverty Line
1° step: choose and indicator of well-being;
2° step: define a threshold or poverty line; 3° step: population below the PL are poor. Absolute (Sen) Poverty as an concept Relative (Atkinson)
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Growth & Poverty
Growth reduces poverty;
BUT it depends on two factors:
The type of growth; The initial level of inequality (share of population just below the poverty line
VS extreme poverty).
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Poverty and Growth
Poverty may be a barrier to growth: Vicious circle and poverty traps: high
poverty leads to low growth and low growth leads to high poverty!
Which channels? Poverty deters investment and growth
especially where the degree of financial development is limited;
But also through a negative impact on education, health and innovation!
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Millenium Development Goals
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References
Bouchet, Clark and Groslambert (2003): “Country Risk Assessment”, Wiley finance (Chapter 4).
Human Development Report –UNDP web site-
McCulloch, N.; Winters, A. and Cirera, X. (2002): “Trade Liberaliation and Poverty: an Handbook”, Chapter3 “Poverty and the poor”, eds. CEPR
Perry, G. et all (2006): ”Poverty Reduction and Growth: Virtuous and Vicious Circles”, World Bank Report