EASWARAKUMAR N

Roll No: PP15101

COUNTRY RISK ANALYSIS

INTRODUCTION

Country Risk Analysis is assessment of potential risks and rewards from doing business
in country. Country risk represents potentially adverse impact of a countrys environment
on the cash flow of the firm.
Country risk represents the potentially adverse impact of a countrys environment on the
MNCs cash flows.
Country-specific risk arises from factors unique to the debtor country. The sovereign
debtors political stability, natural-resource endowment, structural (i.e. supply-side) and
development strategies, open-economy demand-management policies and external assetliability management are important areas of focus to gauge this risk.
For example, a recession in a country that reduces the revenues of exporters, and labor
strikes also qualify as country risks, Clashes between rival ethnic or religious groups that
prevent people in a country from shopping can also be considered country risks, Concern
about a countrys banking system that may cause a major outflow of funds, The
imposition of trade restrictions on imports.
Country risk can be used to:

monitor countries where the MNC is presently doing business;

as a screening device to avoid conducting business in countries with excessive

risk;
And to improve the analysis used in making long-term investment or financing
decisions.

IMPORTANCE

Used to monitor countries where the firm is presently engaged in international business

Used by the firm as a screening device to avoid countries with excessive risk

Used to assess particular forms of risk for a proposed project considered for a foreign
country

FINANCIAL AND ECONOMIC RISK FACTORS

The capacity to repay foreign debt and, consequently, the probability of default ultimately
depend on the countrys ability to generate foreign exchange. Nevertheless, governments
sometimes refuse to pay their debts, even when they have foreign exchange available. This lack
of willingness to pay is a form of political risk.
Investors use a number of economic variables to discriminate between financially sound and
financially troubled countries including the following:

The ratio of a countrys external debt to its gross domestic product (GDP)
The ratio of a countrys debt service payments to its exports
The ratio of a countrys imports to its official international reserves
A countrys terms of trade (the ratio of its export to import prices)
A countrys current account deficit or its current account deficit to GDP ratio

These variables are directly related to the ability of the country to generate inflows of foreign
exchange. Factors such as inflation and real economic growth are useful as well. A countrys
economic health directly affects the cash flows of a multinational firm, and it may also be
informative about political risk in a narrow sense. The better a countrys economic situation, the
less likely it is to face political and social turmoil that will inevitably harm foreign (and
domestic) companies.

POLITICAL RISK FACTORS

There are many political risk factors in the following lists the most important factors a
multinational corporation (MNC) should be aware of in assessing political risk.
A. Expropriation or Nationalization
B. Contract Repudiation
C. Taxes and Regulation
D. Exchange Controls
E. Corruption and Legal Inefficiency
F. Ethnic Violence, Political Unrest, and Terrorism
G. Home-Country Restrictions
The most extreme form of political risk is the possibility that the host country takes over an
MNCs subsidiary, with or without compensation. This is the worst-case scenario for firms.
Outright expropriations used to be common: Regimes in Eastern Europe (after World War II)
For example recently In 2010, the Venezuelan government expropriated the equipment of the
U.S. oil services company Helmerich & Payne, the Venezuelan operations of Owen-Illinois, a
U.S. glassware manufacturer, and the Spanish agricultural firm Agroislea.
A. Contract Repudiation
Governments sometimes revoke, or repudiate, contracts without compensating companies for
their existing investments in projects or services. Governments default on the payments
associated with the contracts, cancel licenses, or otherwise introduce laws and regulations that
interfere with the contracts to which the government and the MNC agreed.
For example, In 2010, Pakistani authorities halted all operations of the $3 billion Reko Diq
copper and gold project, citing that the contract substantially undervalued the value of the
project.

B. Taxes and Regulation

Government can made dramatically changes in the economic environment, Examples include
unexpected increases in taxes, restrictions on hiring and firing local workers, and sudden stricter
environmental standards.
Effects of these changes differ from project to other that is depending on local competition.
MNCs are also sometimes forced by governments to sell their equity stakes in local subsidiaries
because of foreign ownership restrictions.
Regulations that MNCs find particularly problematic are regulations restricting the transfer of
their profits earned abroad back to their home countries. Governments not only have the power
to change the tax rates on these earnings, but they can also completely block their transfer. This
essentially forces the MNC to invest its funds locally, even if doing so is less profitable. Finally,
governments often make decisions that can indirectly affect the cash flows of MNCs.
C. Exchange Controls
Governments have been known to prevent the conversion of their local currencies to foreign
currencies. In general, doing business in countries with inconvertible currencies puts an MNC at
considerable risk.
That case was happened in the Argentine in 2002, where The Argentine government curtailed
bank deposit withdrawals and prohibited the unauthorized export of foreign currency from the
country.
D. Corruption and Legal Inefficiency
Highly inefficient governments with large bureaucracies can increase a companys costs of doing
business. Governments may also be corrupt and demand bribes.
A countrys legal system is an important factor in determining the overall quality of its
institutions and how attractive it is for firms to do business there.

E. Ethnic Violence, Political Unrest, and Terrorism

Significant MNC losses can occur due to internal civil strife or wars. In war-torn regions across
the world, companies often hire their own private armies in order to try to function normally.
For example, piracy near the Somali coast has prompted some companies to hire private security
firms to protect their ships.
F. Home-Country Restrictions
The politics of a companys home country can affect its cash flows from foreign operations.

SUBJECTIVE FACTORS

Countrys attitude towards private enterprise

Risk of currency devaluation

Risk of government`s income reduction

External flows dependence,

Productivity restrictions

Social pressures

Attitude of consumers in the host country

TECHNIQUES TO ASSESS COUNTRY RISK

After determining all the macro &micro factors that affect in the country risk assessment , there
many techniques to evaluating and determining country risk rating , at the following some of the
more popular techniques ;A. Checklist approach
B. Delphi Technique: collecting independent opinions without group discussion.
C. Quantitative Analysis
D. Inspection Visits

E. Combination of Techniques

A.

Checklist approach
Checklist approach involves a judgment on all the political and financial factors that contribute
to a firm's assessment of country risk.rating are assigned to a list of various financial and
political factors, and these rating are than consolidated to drive an overall assessment of
country risk.

B.

Delphi Technique
The Delphi Technique involves the collection of independent opinions without discussion. As
applied to country risk analysis, the MNC could survey specific employees or outside
consultants who have same experiences in assessing specific country's risk characteristics. The
MNC receives responses from its survey and may than attempt to determine some consensus
opinions (without attaching names to any of the opinions) about the perception of the country's
risk. Then, it sends summary of the survey back to the survey respondents and asks for
additional feedback regarding its summary of country's risk.

C.

Quantitative Analysis
Depending on pervious measurements of the financial and political variables for a period of
time, model for quantitative analysis can be used to identify the characteristics that influence
the level of country risk.

D.

Inspection Visits
Inspection Visits involve traveling to a country and meeting with government officials,
business executives, and customers. Indeed, some variables such as intercountry relationships
may be difficult to assess without a trip to the host country.

E.

Combination of Techniques
Many MNCs use a combination of techniques to assess country risk.

RATING SYSTEMS
There are several agencies that could be seen as reliable sources like Standard & Poors,
Moodys, Economist Intelligence Unit, Euro money, Institutional Investor, Political Risk
Services, Business Environmental Risk Intelligence, Control Risks Information Services,
international banks in general and others institutions.
Some of them also provide information and analysis of economic sectors, companies and
operations assigning its related ratings. Such ratings, while an evaluation about the quality of the
assets or the transactions, according to their objective and terms also affect their pricing.
Nowadays, the rating system is wide known and used all over the world.
Moodys and Standard & Poors rating systems use to divide countries in categories as below and
the four first levels of each one are considered investment grades (better quality of the asset in
risk terms). Based on their
Evaluations of a bond issue, the agencies give their opinion in the form of letter grades, which
are published for use by investors.
For the typical investor, risk is judged not by a subjectively formulated probability distribution of
possible returns but by the credit rating assigned to the bond by investment agencies. In their
ratings, the agencies attempt to rank issues according to the probability of default.
Both agencies have a Credit Watch list that alerts investors when the agency is considering a
change in rating for a particular borrower.
Despite relevant opinions against the ratings, they remain useful and necessary, although it is
important to have a deeper evaluation of their methods and procedures. At least, it is forceful
recognizing that rating agencies have been providing a periodical and organized skill of data,
which remains as a powerful tool to deal with a cross-border analysis.

CREDIT RATINGS BY INVESTMENT AGENCIES

MOODYS (*)
Aaa

Best Quality

Aa

High quality

Upper medium grade

Baa

Medium grade

Ba

Possess speculative elements

Generally lack characteristics of a desirable investment

Caa

Poor standing: may be in default

Ca

Speculative in a high degree; often in a default

Lowest grade; extremely poor prospects

(*) Moodys uses notches (1,2 and 3) to better contrast risks among each rating

STANDARD & POOR`S (*)

AAA

Highest rating: extremely capacity to pay interest/principal.

AA

Very strong capacity to pay

Strong capacity to pay

BBB

Adequate capacity to pay

BB

Uncertainties that could lead to inadequate capacity to pay

Greater vulnerability to default, but currently has capacity to pay.

CCC

Vulnerable to default

CC

For debt subordinated to that with CCC rating

For debt subordinated to that with CCC- rating, or bankruptcy petition has been filed.

In payment default

(*) S&P uses notches (+,-) to better contrast risks among ratings
STRENGTH AND WEAKNESS CHART

Before defining the countrys grade risk, it is convenient drawing all relevant aspects that were
provided by the analysis. In order to clarify some of them, the chart below could be used as an
idea to combine each strength and weakness with the related possible prospects. Just to give an
example, the chart contains some variables that were built from combined experiences about an
imaginary country. It is a simulation of relationships among several variables (quantitative and
qualitative) to show how they are interdependent and how complex is any analysis.

In a direct way, the chart seeks to emphasize the risks pointed out during the analysis and it must
be evaluated in connection with the observed macro-economic performance provided by the
ratios above commented. Once more, it is important to enforce that those ratios must be analyzed
within a wide historical and interdependent approach, to ensure its consistency.

CONCLUSION

As could be seen, country risk analysis is not an easy task. It demands a holistic
vision, specialized skills and persistent approach. The analyst must follows standard procedures
to assure coherency in its studies, using reliable and useful sources of data, including rating
agencies, official institutions and other several sources.
After dealing with the macroeconomic, socio-political and financial aspects, the analysis has to
clearly show the strengths and weakness of a country, in order to define a risk level and,
consequently, a related price for the asset in risk.
Managing the risk of a portfolio demands a systematic follow up concerning to external and
internal environment, governmental policies, outlook provided by rating agencies, and so on.

COUNTRY RISK ANALYSIS SRILANKA

Taking example of srilanka for the Country Risk Analysis:

SRILANKA

Sri Lanka, a CRT-4 country, has high levels of economic, political, and financial system
risk. The five countries assessed in South Central Asia to be either a CRT-4 country

(India and Sri Lanka) or a CRT-5 country (Bhutan, Nepal and Pakistan).
In 2009, the country ended a 26 year civil war. The resulting political stability has been a
tailwind for the economy. Gross domestic product (GDP) growth is expected at 5.0% in
2016 and through the next few years. Growth will be driven by domestic demand and

public investment.
Sri Lanka faces the challenge of reducing corruption and increasing living standards
going forward.

REGIONAL SUMMARY: South Central Asia

The region of South Central Asia comprises the countries south of the Himalayans.

Economic activity in the region is expected to increase led by India, the regions largest
economy. Lower oil prices and foreign direct investment were the main catalysts for past

growth. Future growth in the region will increasingly depend on export performance and

strong investment.
Countries in South Central Asia tend to have very low levels of wealth. In 2015
approximate GDP per capita for Nepal, Pakistan, India and Sri Lanka was 750 USD,
1,450 USD, 1,600 USD and 3,900 USD respectively.

Risks facing the region include vulnerabilities relating to global economic conditions
including the effects of monetary policy normalization in the United States, the potential
for stagnation in Europe and the slowdown in the region. Domestic developments, such
as political turmoil and non-sustainable fiscal policies, could undermine stability and
investor confidence.

ECONOMIC RISK: High

Sri Lankas economy is dominated by manufacturing (particularly garment production)

and agriculture. Almost 60% of GDP is attributed to the services industry, while
manufacturing accounts for 17% of GDP.

Increasing debt levels have led the country to request assistance from the International
Monetary Funds (IMFs) financial assistance program. Under the program the country
hopes to increase revenues and foreign exchange reserves. Additionally, Sri Lanka

hopes to lower debt levels and enhance public financial management.

Foreign direct investment is an important component in the countrys plan to increase
economic growth in the coming years.

POLITICAL RISK: High

After a decade in office, former President Rajapaksa was defeated in the January 2015
presidential elections. Maithripala Sirisena won the election in a surprise victory.

The transition of power following the election was smooth despite the former
presidents strong hold on power. The unity government formed between Sri Lankas

two main political parties is likely to remain relatively stable.

International relations have improved dramatically (particularly with China, India and

the United States) since Sirisenas election in 2015.

From 1983 to 2009 the government was involved in a civil war against the Liberation
Tigers of Tamil EElam (LTTE). Due to alleged human rights violations, the United

Nations opened an inquiry in 2014.

In order to increase revenues and decrease expenditures, the government has proposed
increased corporate taxes and implementing deep cuts to investment spending.

FINANCIAL SYSTEM RISK: High

The insurance industry is regulated by the Insurance Board of Sri Lanka. The financial
sector has been broadened and supervision of the banking sector has improved in recent
years.

The off-cycle presidential election in 2015 resulted in increased government

expenditures and increased interest payments which have further weakened the

countrys public finances

Sri Lanka is vulnerable to global financial markets because of its large foreign currency

funding and foreign investments in domestic currency debts.

There is a high dependence on external financing for infrastructure development
projects which has contributed to high public external leverage.

REFERENCES

AMB Country Risk Report Srilanka, August 2016

Country Report : Srilanka, Euler Hermes Economic Research
Country Risk Analysis, GWU-IBI- MINERVA PROGRAM
Country Risk Analysis by M.A. Awad, Mohammed Ibrahim Al- Zaher
Country Risk Analysis A Handbook by Ronald L Solberg
http://globaledge.msu.edu/countries/sri-lanka/risk
http://iveybusinessjournal.com/publication/analyzing-and-managing-country-risks/
http://www.investopedia.com/articles/stocks/08/country-risk-for-internationalinvesting.asp