Country Risk Evaluation

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Country Risk 2018: A Mid-Year Update

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International Country Risk Guide (ICRG)

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Fortunately, a great deal of relevant information is available on the Internet, and this article points to a number of helpful Web sites. Prior to the s, the political risks associated with interventionist governments were considerable. They included government expropriation, regulations that imposed inefficiencies, and foreign-investment restrictions. Many countries pursued the goal of economic self-sufficiency through extensive tariff and non-tariff barriers to both trade and investment. Bribery often influenced government decisions.

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In many countries today, such political risk has been reduced and replaced by a new acceptance of free markets and a belief that international trade and investment are the bases for economic growth. Nevertheless, political risks still remain. The Index of Economic Freedom ranks countries according to the impact that political intervention has on business decisions, while the Corruption Perception Index indicates the extent of corruption in each of 91 countries.

To the degree that a government has the power to regulate and intervene in matters that affect businesses, bureaucrats may be tempted to provide the desired approvals in return for bribes. As a result, these indexes can be closely related. The Index of Economic Freedom, which must be considered in a risk-return analysis, points to the various ways in which a government may take away potential profits. Canadian and U.

Furthermore, new control and audit practices may have to be implemented to operate in a culture where corruption is common, and where employees may therefore not automatically adhere to the standards of honesty expected by the corporation. For natural resource sectors, in particular, political risk may still be a showstopper, since the risk of nationalization, special taxes or new regulations is particularly severe.

Managers in these sectors must consider whether the risks may be too high to justify investment. It remains helpful to seek the views of local political experts. One technique involves circulating a questionnaire to these experts, compiling the results, and returning them to the respondents for further commentary.

It is not automatically true that country risks are greater abroad than they are in Canada. In this respect, certain less-developed countries may offer a competitive advantage. International investment agreements attempt to limit political risks. Both Canada and the United States have signed investment agreements with many other countries that promise financial compensation for corporations based in Canada or the U. These agreements promise that the amount of compensation will be determined in a fair and just manner. However, it is not clear how far Chapter 11 or other investment agreements go in protecting corporations from new government regulations that increase costs or restrict prices.

The Enron dilemma in India illustrates the potential seriousness of political risks. Political risk insurance may be purchased as additional protection against specific outcomes such as capital repatriation difficulties, expropriation, or war and insurrection. Economic risks may be particularly important in regard to exchange rates, economic volatility, industry structure and international competitiveness. Many countries have been experiencing ongoing fiscal deficits and rapid money-supply growth. Consequently, inflation rates remain high in these countries, and devaluation crises appear from time to time.

Competitive domino devaluation pressures are intensified because of the reliance of many countries on primary product exports and their price volatility. Recent crises—especially the Asian crisis of , the Mexican devaluation of , and the Russian crisis of —have created a new risk of heightened foreign exchange volatility for some countries. Today exchange rates may be maintained at unrealistically high levels as a result of considerable inflows of foreign capital. Yet, these capital inflows may slow or even reverse abruptly. Foreign investors now recognize these risks of foreign exchange volatility.

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Future surges in capital flows may translate into increased volatility of foreign exchange rates for some countries. But how can foreign investors protect themselves from these exchange rate risks? Hedging mechanisms offer some hope for reducing foreign exchange risks, though generally not without some cost. Here are some other ways managers can cope with these country risks:. Consider the timing of your investments. Investors should restrict capital transfers to a country to those times when the foreign exchange rate is in equilibrium. If the difference in cumulative inflation rates exceeds the percentage change in the foreign exchange rate, then devaluation is a real possibility.

For example, this calculation would suggest that the Mexican peso is currently substantially overvalued.

Country Risk Evaluation & Simulation Tools (CREST)

Borrow domestically to do business domestically and avoid foreign exchange rate exposure. Focus on the devaluation risk when choosing among countries as investment sites. From this perspective, Chile is currently a less risky region for investment than Argentina or Mexico. Consider the amount of capital required by those activities that are being developed in a country subject to devaluation risk.

The significance of a foreign exchange risk may be relatively low for a business that requires little capital investment, like one in the service sector or fast-food industry; it may be high for a firm in the manufacturing and natural resource sectors, where considerable capital is required.

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  6. Spread the purchase price over as long a time period as possible. This allows domestic currency to be purchased at a lower cost if devaluation occurs.

    Economic Studies

    Alternatively, gear the purchase price to a weighted average of the exchange rate over future years, with projected future payments adjusted in accordance with the exchange rate. Economic stability depends upon a strong banking sector; without it, a foreign exchange crisis may have a particularly severe impact.

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    5. An ongoing challenge for financial institutions everywhere is that the time profile for liabilities is not the same as the one for assets. Banks borrow short-term from depositors and lend long-term. This exposes the banks to the risks that fixed assets may fall quickly in price and that depositors may make sudden withdrawals. With dramatic reductions in land and stock prices, bank loans made on the security of real estate and stocks suddenly may be at a major risk of default, further exacerbating the effects of a foreign exchange crisis, and transforming it into a general crisis in the economy.

      Managers must analyze the domestic situation for industry risks such as the strength of competitors, the potential for substitutes, the capabilities of suppliers and customers, and the risk of new entrants. For many foreign corporations, one example of industry risk may be the difficulty in finding suppliers who can offer the required level of quality and service. Public utility disruptions may also be risky, especially for firms dealing in perishable commodities. In some countries, for example, electricity outages are common. For some Canadian corporations, one solution has been to encourage other Canadian or U.

      Further, the process of developing a matrix of industry risks leads to strategies and solutions unique to each country and, indeed, to regions within countries as well. Findings in the World Competitiveness Yearbook provide some critical data on the competitiveness factors of 49 countries. Managers would do well to consider risk differences within each country. Many countries contain a high-growth region with strong competitive attributes. In many countries, bank loans have been granted as favours to political leaders and their friends, often without due diligence.

      The Asian foreign exchange crisis revealed that a very high percentage of bank loans were non-performing. As a result, many Asian banks had a negative net worth and financial systems were in disarray. A democratic political system generally does not experience the spread of a foreign exchange crisis to its financial sector and its general economy, since politicians are accountable to the public. For some countries, this has not been the case. Unless there is a basic shift in the political paradigm, such financial-sector disasters may occur again.

      Economic reform requires political reform. The development of alternative financial instruments could result in a reduction in deposits at domestic Chinese banks. Here, a change in the political system with new financial accountability for state-owned enterprises is necessary before a sound financial system can emerge.

      Many commentators have argued that future growth in Japan and Korea will depend on the restructuring of corporate organizations, with a breakup of the conglomerates that have dominated many Asian economies. Only with such a dismantling of huge organizations will entrepreneurial initiative and innovation be released. Closing businesses that are suffering ongoing losses or even restructuring such businesses will require clearer lines of responsibility and ownership. Furthermore, bankruptcy laws will need to be rewritten in order to achieve such restructuring.

      Changes in trade and investment agreements can substantially change the economic conditions under which a corporation operates. Foreign corporations that invested in China prior to WTO membership may suddenly face much less expensive import competition; those required to accept a joint venture partnership with a state-owned enterprise will face competition from new foreign wholly owned subsidiaries.

      In managing country risks that involve linkages among various political and economic forces, a particularly helpful Web site is the Economist Intelligence Unit. The site offers analyses of broad categories of risk as well as risk exposure associated with specific types of investment.

      For corporations that are searching for foreign suppliers and customers, as well as those that are evaluating investment opportunities, the analysis of country risks has attained a new importance and a new complexity.