10:19 pm - Monday December 18, 2017

Country Risk is an Evolving and Dynamic Risk

Country risk analysis, as it is practiced is far from perfect. For example, the country risk of the United States fails to properly take into account the country’s aging population and strained Social Security system — as well as its huge foreign debt and financial turmoil.

Country risk is as old as civilization itself. Though it has such a long history, it is still an evolving risk discipline. Indeed, in the truest sense, country risk is a dynamic risk. Many authors and scholars have attempted to paint a comprehensive picture of country risk, but few have succeeded.

Country risk is the risk that a foreign entity, private or sovereign, may be unwilling or unable to fulfill its foreign obligations for reasons beyond the usual risks, which arise in relation to all lending and investment.

The risk that a foreign entity, private or sovereign, may be unwilling or unable to fulfill obligations for reasons beyond its control. The risk that repayments from foreign borrowers may be interrupted because of interference from foreign governments. In effect, investing in any form in a foreign country exposes the investor to country risk.

This risk can manifest itself in the form of restrictions or outright prohibitions on the return on the investments. For example, financial factors such as currency controls, devaluation or regulatory changes or stability factors such as mass riots, civil war and other potential events contributing to and/or compounding operational risks.

When funds move across international borders, uncertainty is created with regard to their receipts and payments and this uncertainty is defined as country risk. Normally country risk is very high in the case of countries with problems in areas like exchange reserves, balance of payments, management of resources, etc. Country risk is different from the usual credit and other risks associated with lending decisions and this should be clearly understood and appreciated.

In order to successfully measure and manage country risk, knowledge must be shared, because no single person or group has a complete solution to this evolving risk discipline.

Political risk analysts use qualitative methods, focusing on political analysis. Credit rating agencies tend to use quantitative econometric models and focus on financial analysis. Hence invariably there is no consensus on methodologies adopted.

Some of the political risk analysts are Economist Intelligence Unit, Business Monitor International and Political Risk Services Group. Some of the Credit risk rating agencies are Standard & Poor’s, Moody’s and Fitch Ratings.

Experience has shown that country risk impacts in three stages: short, medium or long term.

The short-term factors influencing country risk are normally classified as economic fundamentals, such as balance of trade/payment position, foreign exchange reserves, political stability and natural/manmade disasters.

Medium-term factors include political system, political parties, history, political forecast, economic forecast, economic structure, unemployment data and labor-cost data.

Long-term factors include a country’s population profile (e.g., aging population and gainfully employed population), the level of natural resources yet to be explored versus the present level of resources and the government’s commitment to retirement pensions. If a government provides no pension plan for its retiring population, any alternatives a government has for its elderly citizens must also be considered when assessing country risk.

The Euromoney Country risk March 2008 ratings reveal that United States still holds a very good standing at number 10 (the top ranking is held by Luxembourg and other eight rankings are held by Norway, Switzerland, Denmark, Sweden, Ireland, Austria, Finland and Netherlands)

Country risk analysis, as it is currently practiced, is far from perfect. This country risk analysis of the United States fails to properly take into account the country’s aging population and strained Social Security system — as well as its huge foreign debt and financial turmoil.

Sovereign risk is a sub category of country risk and this arises due to immunity enjoyed by the sovereign entity from legal and other recovery processes in which the lender has no legal resource against the sovereign entity, which fails to fulfill its obligations.

Sovereign risk can be overcome and avoided by inserting suitable disclaimer clauses in the documentation and also subjecting such sovereign entities to jurisdiction other than their own.

 At the threshold level, fixing country exposures can control country risk and this risk has to be constantly monitored, as it is a dynamic risk.

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