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Country Risk Refers to the Risk of Investing in a Country

Country Risk Refers to the Risk of Investing in a Country

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Published by: saurabhsharma2143 on Feb 11, 2010
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09/26/2010

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Country risk refers to the risk of investing in a country, dependent on changes in the business environment that may adversely affect operating profits or the value of assets ina specific country. For example, financial factors such as currency controls, devaluationor regulatory changes, or stability factors such as mass riots, civil war and other potentialevents contribute to companies' operational risks. This term is also sometimes referred toas political risk, however country risk is a more general term, which generally only refersto risks affecting all companies operating within a particular country.Political risk analysis providers and credit rating agencies use different methodologies toassess and rate countries' comparative risk exposure. Credit rating agencies tend to usequantitative econometric models and focus on financial analysis, whereas political risk  providers tend to use qualitative methods, focusing on political analysis. However, thereis no consensus on methodology in assessing credit and political risks.Country risk relates to the likelihood that changes in the business environment will occur that reduce the profitability of doing business in a country. These changes can adverselyaffect operating profits as well as the value of assets.A. Types of country risk 1. Political changes: governments may change economic policies. Changes in the ruling party (brought about by elections or even wars) may results in major policy changes.What are the specific events that may occur due to political changes and how do theyaffect the MNE?- expropriation (loss of assets, termination of operations)- currency inconvertaibility (inability to repatriate profits, import)- higher taxes (less after tax revenues)- higher tariffs (higher import costs)- elimination of FDI incentives (higher costs)- domestic ownership requirements (loss of revenue, loss of proprietary info, moredifficult management)- local content requirements (higher costs)2. Macroeconomic mismanagement: Governments may pursue unsound monetary andfiscal policies.What economic events occur when a country rapidly increases the money supply?- inflation (higher costs, difficult planning, currency depreciation)
 
- what economic events occur when a country runs a fiscal deficit?- higher interest rates (higher borrowing costs in host country)- recession (lower demand in host country)- hard currency shortage (must use hard currency earnings to pay debts to foreigners)3. Other - war (general disruptions)- labour unrest (higher costs, work stoppages) TYPEEVENTEFFECT ONMNEPolitical change (due to elections, revolution, secession, etc.)expropriationloss oassets, termination of operationshigher taxesless after-tax revenueshigher tariffshigher import costselimination of FDI incentiveshigher costs, other domestic ownership requirementsloss of revenue, loss of proprietary info, moredifficult managementlocal content requirementshigher costscurrency inconvertilityinability to repatriate profits, importMacroeconomic mismanagementinflationhigher costs, difficult planning,currency depreciationhigh interest rateshigher borrowing costs, recessionOtherwarsgeneral disruptionlabour unrest (strikes)higher costs, production stoppageB. Measuring country risk 1. Country risk ratings: Euromony Magazine's Country Risk ratings and the BusinessEnvironmental Risk Index (BERI) rank countries according to the weighted average of alarge number of factors. How can an MNE use this information? A single measure may be of limited use when a MNE's exposure depends on its particular business.2. Credit ratings (Moody, Standard and Poor): These rate the creditworthiness of thegovernment. Why is this information useful to business?C. Responses to country risk 1. Project evaluation: when deciding on new projects, require higher returns oninvestments in risky countries (or discount future profits at a higher rate).
 
2. Insure: a MNE might buy insurance for specific events. The Overseas PrivateInsurance Corporation (OPIC) (U.S.) and the Economic Development Corporation (EDC)(Canada) are government agencies providing insurance. Why will the private market bewilling to provide the insurance? What events will be difficult to insure against?a. Three criteria for the provision of insurance(1) large number of customers with less than perfectly correlated outcomes(2) Ability to predict future payouts (define loss and loss amount, calculate probability of loss occurring)(3) Loss must be accidental from point of view of insured. b. Private country risk insurance market is small (limited coverage in terms of countries/"events" covered) and costly for customers.3. Reduce the likelihood that host country governments may act in a way that harmsMNE. Potential strategies that an MNE may adopt include:- An MNE can maintain alternatives to producing in a foreign country. This allows thefirm an escape and lowers the incentive for the foreign government to impose controls,since the MNE is likely to move to alternative locations.-Maintaining control over intangible assets--management know-how, technicalskills, product development, etc.--will create an economic loss to the hostgovernment if the MNE leaves.
Financial risk 
is normally any risk associated with any form of financing. Risk is probability of unfavorable condition; in financial sector it is the probability of actualreturn being less than expected return. There will be uncertainty in every business; thelevel of uncertainty present is called risk.Contents [hide]1 Investment related2 Business related3 Credit Risk 4 Insurance related5 Market risk 6 Liquidity risk 7 Operational Risk 8 See also

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