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Country and Political Risk

Analysis
Background
The internationalization of financial landscape.
Financial transactions involving residents of different countries are
subject to risks that would not otherwise be present.
International economic and financial activity is organized around
concept of national sovereignty

Each country has its own economic, financial, political and legal
organization that determines resource allocation and income
distribution within the geographic area it controls

Events, or anticipated events at the national level have a profound


effect on the performance of individual resident economic and
financial agents.
Definitions and methods in cross
border risk assessment
Sources of cross boarder risk
It is often called political risk or country risk
They include all aspects of countrys
economic, financial, social, and political
organization as well as geographic location
and strategic importance
A comprehensive checklist of risk
sources by Pancras Nagy
War
Occupation by foreign power
Civil war, revolution, riots, disorders
Takeover by an extremist government
Politically motivated debt default, renegotiation
or rescheduling
Unilateral change in debt service terms
State takeover of the enterprise
Indigenization (forced relinquishment of control
by foreign owners of enterprise)
A comprehensive checklist of risk
sources by Pancras Nagy
Natural calamities
Depression or severe recession
Mismanagement of the economy
Credit squeeze
Long term slowdown in real GNP growth
Strikes
Rapid rise in production costs
Fall in export earnings
Sudden increase in food and energy imports
Over extension in external borrowing
Devaluation or depreciation of the currency
A note on transfer risk and sovereign
risk
Transfer risk- a risk that government might
impose restrictions on debt service payments
abroad
Sovereign risk- is broader than transfer risk. It
includes the idea that even if the government
is willing to honor its external obligations, it
might not be able to do so if the overall
economy can not generate necessary foreign
exchage.
Factors associated with countrys
economic and financial situations
Refer to countrys economic and financial risk and
depend on a countrys dotation in human and
natural resources and how these resources are
managed.
The reflect the countrys ability to honor its
external financial obligations and this is always
determining factor in whether or not they are
honored.
Many of the other risk associated with political or
sovereign risk are simply manifestations of the
underlying economic and financial problems.
Variables and ratios for economic risk
assessment
Economic risk refers to development in the national economy that
can affect the outcome of an international financial transaction.

For example- a currency devaluation in a country where investment


is held will reduce the value of the cash flows and returns from the
investment in the investors home currency.

Same type of effect for recession or economic slowdown

Economic risk analysis involves an assessment of the countrys


ongoing and prospective economic situation as well as an estimate
of the accuracy of the assessment itself.
Economic variables for assessing cross
boarder risk

These factors are those that are commonly used in domestic


macroeconomic analysis. They can be subdivided into variables associated
with domestic economy and balance of payments
The principal domestic variables are:
GNP or GDP
Gross domestic investment
Private and public consumption
Gross domestic savings (GNP total domestic consumption)
The resource gap ( difference between gross domestic savings and gross
domestic investment- these two equals the current account balance)
The money supply
The government budget deficit
The GNP deflator
The consumer price index
The principal variables associated with
balance of payments are
Export of goods and services in dollars
Imports of goods and services in dollars
The trade balance
The current account balance
The export price index in dollars
The import price index in dollars
The exchange rate
Foreign reserve
Significant indicators of the ongoing and prospective
economic situation (after combining these two sets of
variables)
Gross domestic fixed investment/GDP or GNP
(it measures economys propensity to invest
Gross domestic savings/GDP or GNP
Marginal capital/output
Net capital imports/gross domestic fixed
investment
Gross domestic savings/gross domestic fixed
investment
Variables and ratios for financial risk
assessment
A countrys financial risk refers to the ability of
the national economy to generate enough
foreign exchange to meet payments of interest
and principal on its foreign debt.
Financial risk analysis involves an assessment
of countrys foreign financial obligations
compared to its ongoing and prospective
economic situation.
Variables for financial risk assessment
Total external debt (EDT) which can be broken down
into:
1) Long term public and publicly guaranteed outstanding
and disbursed
2) Long term private non guaranteed
3) Short term
4) Use of IMF credit
Total debt service (TDS) which can be broken down
into:
1) Interest payment (INT)
2) Principal payments
Political Risk
Political risk in international investments exists when
discontinuities occur in the business environment, when
they are difficult to anticipate, and when they result from
political change- Robock and Simmons
Roots makes a distinction between transfer risk: potential
restrictions on the transfer of funds, products, technology
and people)
Operational risks: uncertainty about policies, regulations or
governmental administrative procedures which would
hinder results and management of operations in the
foreign country
Risks on control of capital- discrimination against foreign
firms, expropriations, forced local shareholding etc.
Political Risk
More distinctions on political risks
Firstly,
Global political risk- related to firm with
several foreign subsidiaries
Specific political risk-inherent to one
particular investment in a given country
Political Risk
Secondly
Macro risk- sometimes called country risk and
includes all events or measures likely to affect
foreign investment in general.
Macro can be divided into soft and hard
Soft refers to blacklisting, ecological protest
movements, strikes in a particular industry or the
incorporation of a competing firm by a public
authorities etc
Hard refers to expropriations or nationalizations
Political Risk
Micro risk concerns a particular firm in given
economy- it depends on factors such as
Nationality of the foreign firm
Its previous history in the country
Its sector of activity etc
Political Risk
Political Risk - the probability of politically
motivated change that affects the outcome of
foreign based transactions