International Financial Management

Alan Shapiro and Peter Moles

1st Edition
John Wiley & Sons, Inc.

1 www.wiley.com/college/shapiro
CHAPTER 6

Country Risk

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THE MEASUREMENT OF
POLITICAL RISK
I. MEASURING POLITICAL RISK

A. Country-specific perspective
focuses on the country from a “top-down” view
i.e. macroeconomic variables to industry-
specific analysis

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THE MEASUREMENT OF
POLITICAL RISK
B. Political stability

1. Measured by:

a. Frequency of government changes.

b. Level of violence.
c. Number of armed insurrections.
d. Conflict with other states.

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THE MEASUREMENT OF
POLITICAL RISK
C. Economic factors

1. Indicators of political unrest:

a. Rampant inflation.
b. Balance of payment deficits.
c. Slowed growth of per capita GDP.

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THE MEASUREMENT OF
POLITICAL RISK
D. Subjective factors

1. Ease of doing business

2. Political risk and uncertain property rights

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THE MEASUREMENT OF
POLITICAL RISK
3. Capital flight
a. Definition:
the export of savings by a nation’s
citizens because of safety-of-capital fears.

b. Measurement:
use the balance-of-payment account.

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THE MEASUREMENT OF
POLITICAL RISK
c. Causes of capital flight
1. Inappropriate economic policies.
2. Expectation of devaluation.
3. High political risk.

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ECONOMIC AND POLITICAL
FACTORS
I. ECONOMIC AND POLITICAL FACTORS
Primary focus: how well is the country doing
economically?
Negative factors:
A. Fiscal irresponsibility
‒ high government deficits.
B. Monetary instability.
C. Controlled exchange rate system
– currency usually overvalued.
D. Wasteful government spending
‒ inability to service foreign debt.

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ECONOMIC AND POLITICAL
FACTORS
I. ECONOMIC AND POLITICAL FACTORS
(cont’d)

E. Resource base
– lack of strong work ethic.
F. Country risk and adjustment to
external shocks
1. What are the impacts of
external shocks?
How well a nation responds varies.

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ECONOMIC AND POLITICAL
FACTORS
II. KEY INDICATORS OF COUNTRY RISK

A. Relative size of government debt.

B. Money expansion.
C. Existence of government-imposed barriers to
market forces.
D. Level of tax rates.
E. Amount of government-owned firms.
F. Political and fiscal responsibility.
G. Amount and extent of corruption.

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ECONOMIC AND POLITICAL
FACTORS
III. KEY INDICATORS OF ECONOMIC HEALTH

A. Structural incentives.
B. Legal structure.
C. Clear incentives to save.
D. Open economy.
E. Stable macroeconomic policies.

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COUNTRY RISK ANALYSIS IN
INTERNATIONAL LENDING
I. COUNTRY RISK AND THE TERMS OF
TRADE
What ultimately determines a nation’s ability to
repay foreign loans?
‒ the speed of adjustment.

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COUNTRY RISK ANALYSIS IN
INTERNATIONAL LENDING
II. THE GOVERNMENT’S COST/BENEFIT
CALCULUS

* Debt to wealth ratio.

* Cost of default.
* Fluctuations in the terms of trade.

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COUNTRY RISK ANALYSIS IN
INTERNATIONAL LENDING
III. LESSONS FROM THE INTERNATIONAL
DEBT CRISIS OF 1982

Economic reforms that work have:

A. Strong head of state.
B. Viable economic plan.
C. Competent economic team.
D. Support “at the top”.
E. Sell the program to all levels of
society.
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