CountryRiskAnalysis16

ChapterSouth-Western/ThomsonLearning?2003Seec16.xlsforspreadsheetstoaccompanythischapter.ChapterObjectivesToidentifythecommonfactors usedbyMNCstomeasureacountry’spoliticalriskandfinancialrisk;Toexplainthetechniquesusedtomeasurecountryrisk;andToexplainhowtheassessmentofcountryriskisusedbyMNCswhenmakingfinancialdecisions.CountryRiskAnalysisCountryriskrepresentsthepotentiallyadverseimpactofacountry’senvironmentontheMNC’scashflows.CountryRiskAnalysisCountryriskcanbeused:tomonitorcountrieswheretheMNCispresentlydoingbusiness;asascreeningdevicetoavoidconductingbusinessincountrieswithexcessiverisk;andtoimprovetheanalysisusedinmakinglong-terminvestmentorfinancingdecisions.PoliticalRiskFactorsAttitudeofConsumersintheHostCountrySomeconsumersmaybeveryloyaltohomemadeproducts.AttitudeofHostGovernmentThehostgovernmentmayimposespecialrequirementsortaxes,restrictfundtransfers,subsidizelocalfirms,orfailtoenforcecopyrightlaws.PoliticalRiskFactorsBlockageofFundTransfersFundsthatareblockedmaynotbeoptimallyused.CurrencyInconvertibilityTheMNCparentmayneedtoexchangeearningsforgoods.WarInternalandexternalbattles,oreventhethreatofwar,canhavedevastatingeffects.BureaucracyBureaucracycancomplicatebusinesses.CorruptionCorruptioncanincreasethecostofconductingbusinessorreducerevenue.PoliticalRiskFactorsCorruptionPerceptionsIndexTheindex,whichispublishedbyTransparencyInternational,reflectsthedegreetowhichcorruptionisperceivedtoexistamongpublicofficialsandpoliticians.In2001,91countriesarerankedonacleanscoreof10.RankCountryScore 1 Finland 9.9 3 NewZealand 9.4 4 Singapore 9.2 7 Canada 8.9 13 U.K. 8.3 14 HongKong 7.9 16 Israel 7.6 16 U.S.A. 7.6 18 Chile 7.5 20 Germany 7.4 21 Japan 7.1RankCountryScore 23 France 6.7 26 Botswana 6.0 27 Taiwan 5.9 38 SouthAfrica 4.8 42 SouthKorea 4.2 46 Brazil 4.0 51 Mexico 3.7 57 Argentina 3.5 57 China 3.5 79 Russia 2.3 88 Indonesia 1.9OnlineApplicationFinancialRiskFactorsCurrentandPotentialStateoftheCountry’sEconomyArecessioncanseverelyreducedemand.FinancialdistresscanalsocausethegovernmenttorestrictMNCoperations.IndicatorsofEconomicGrowthAcountry’seconomicgrowthisdependentonseveralfinancialfactors-interestrates,exchangerates,inflation,etc.Whatarethepoliticalandfinancialoutlookforvariouscountries?OnlineApplicationRefertotheCIA’sWorldFactbookat/.Visit/ifc/TypesofCountryRiskAssessmentAmacro-assessmentofcountryriskisanoverallriskassessmentofacountrywithoutconsiderationoftheMNC’sbusiness.Amicro-assessmentofcountryriskistheriskassessmentofacountryasrelatedtotheMNC’stypeofbusiness.TypesofCountryRiskAssessmentTheoverallassessmentofcountryriskthusconsistsof:Macro-politicalriskMacro-financialriskMicro-politicalriskMicro-financialriskNotethattheopinionsofdifferentriskassessorsoftendifferduetosubjectivitiesin:identifyingtherelevantpoliticalandfinancialfactors,determiningtherelativeimportanceofeachfactor,andpredictingthevaluesoffactorsthatcannotbemeasuredobjectively.TypesofCountryRiskAssessmentTechniquesof

AssessingCountryRiskAchecklistapproachinvolvesratingandweightingalltheidentifiedfactors,andthenconsolidatingtheratesandweightstoproduceanoverallassessment.TheDelphitechniqueinvolvescollectingvariousindependentopinionsandthenaveragingandmeasuringthedispersionofthoseopinions.Techniquesof

AssessingCountryRiskQuantitativeanalysistechniqueslikeregressionanalysiscanbeappliedtohistoricaldatatoassessthesensitivityofabusinesstovariousriskfactors.Inspectionvisitsinvolvetravelingtoacountryandmeetingwithgovernmentofficials,firmexecutives,and/orconsumerstoclarifyuncertainties.Often,firmsuseavarietyoftechniquesformakingcountryriskassessments.Forexample,theymayuseachecklistapproachtodevelopanoverallcountryriskrating,andsomeoftheothertechniquestoassignratingstothefactorsconsidered.Techniquesof

AssessingCountryRiskDevelopingACountryRiskRatingAchecklistapproachwillrequirethefollowingsteps:Assignvaluesandweightstothepoliticalriskfactors.Multiplythefactorvalueswiththeirrespectiveweights,andsumuptogivethepoliticalriskrating.Derivethefinancialriskratingsimilarly.DevelopingACountryRiskRatingMultiplytheratingswiththeirrespectiveweights,andsumuptogivetheoverallcountryriskrating.Assignweightstothepoliticalandfinancialratingsaccordingtotheirperceivedimportance.Achecklistapproachwillrequirethefollowingsteps:DevelopingACountryRiskRatingDifferentcountryriskassessorshavetheirownindividualproceduresforquantifyingcountryrisk.Althoughmostproceduresinvolveratingandweightingindividualriskfactors,thenumber,type,rating,andweightingofthefactorswillvarywiththecountrybeingassessed,aswellasthetypeofcorporateoperationsbeingplanned.DevelopingACountryRiskRatingFirmsmayusecountryriskratingswhenscreeningpotentialprojects,orwhenmonitoringexistingprojects.Forexample,decisionsregardingsubsidiaryexpansion,fundtransferstotheparent,andsourcesoffinancing,canallbeaffectedbychangesinthecountryriskrating.ComparingRiskRatings

AmongCountriesOneapproachtocomparingpoliticalandfinancialratingsamongcountriesistheforeigninvestmentriskmatrix(FIRM

).Thematrixmeasuresfinancial(oreconomic)riskononeaxisandpoliticalriskontheotheraxis.Eachcountrycanbepositionedonthematrixbasedonitspoliticalandfinancialratings.UnclearZoneAcceptableZoneUnacceptableZoneFinancialRiskRatingPoliticalRiskRatingAcceptableUnacceptableStable

UnstableTheForeignInvestmentRiskMatrix(FIRM)ActualCountryRiskRatingsAcrossCountriesSomecountriesareratedhigheraccordingtosomeriskfactors,butloweraccordingtoothers.Onthewhole,industrializedcountriestendtoberatedhighly,whileemergingcountriestendtohavelowerriskratings.Countryriskratingschangeovertimeinresponsetochangesintheriskfactors.OnlineApplicationHowriskyisyourcountry?Lookup:IncorporatingCountryRiskinCapitalBudgetingIftheriskratingofacountryisintheacceptablezone,theprojectsrelatedtothatcountrydeservefurtherconsideration.Countryriskcanbeincorporatedintothecapitalbudgetinganalysisofaprojectbyadjustingthediscountrate,orbyadjustingtheestimatedcashflows.AdjustmentoftheDiscountRateThehighertheperceivedrisk,thehigherthediscountratethatshouldbeappliedtotheproject’scashflows.AdjustmentoftheEstimatedCashFlowsByestimatinghowthecashflowscouldbeaffectedbyeachformofrisk,theMNCcandeterminetheprobabilitydistributionofthenetpresentvalueoftheproject.IncorporatingCountryRiskinCapitalBudgetingApplicationsof

CountryRiskAnalysisAlertedbyitsriskassessor,GulfOilplannedtodealwiththelossofIranianoil,andwasabletoavoidmajorlosseswhentheShahofIranfellfourmonthslater.However,whiletheriskassessmentofacountrycanbeuseful,itcannotalwaysdetectupcomingcrises.Applicationsof

CountryRiskAnalysisIraq’sinvasionofKuwaitwasdifficulttoforecast,forexample.Nevertheless,manyMNCspromptlyreassessedtheirexposuretocountryriskandrevisedtheiroperations.The1997-98AsiancrisisalsoshowedthatMNCshadunderestimatedthepotentialfinancialproblemsthatcouldoccurinthehigh-growthAsiancountries.OnlineApplicationReducingExposure

toHostGovernmentTakeoversThebenefitsofDFIcanbeoffsetbycountryrisk,themostsevereofwhichisahostgovernmenttakeover.Toreducethechanceofatakeoverbythehostgovernment,firmsoftenusethefollowingstrategies:UseaShort-TermHorizonThistechniqueconcentratesonrecoveringcashflowquickly.ReducingExposure

toHostGovernmentTakeoversRelyonUniqueSuppliesorTechnologyInthisway,thehostgovernmentwillnotbeabletotakeoverandoperatethesubsidiarysuccessfully.HireLocalLaborThelocalemployeescanapplypressureontheirgovernment.BorrowLocalFundsThelocalbankscanapplypressureontheirgovernment.PurchaseInsuranceInvestmentguaranteeprogramsofferedbythehomecountry,hostcountry,oraninternationalagencyinsuretosomeextentvariousformsofcountryrisk.ReducingExposure

toHostGovernmentTakeoversOnlineApplicationImpactofCountryRiskonanMNC’sValue

E(CFj,t) = expectedcashflowsincurrencyjtobereceivedbytheU.S.parentattheendofperiodt E(ERj,t) = expectedexchangerateatwhichcurrencyjcanbeconvertedtodollarsattheendofperiodt k = weightedaveragecostofcapitaloftheparentExposureofForeignProjectstoCountryRisksWhyCountryRiskAnalysisIsImportantPoliticalRiskFactorsAttitudeofConsumersintheHostCountryAttitudeofHostGovernmentBlockageofFundTransfersCurrencyInconvertibilityWarBureaucracyCorruptionChapterReviewChapterReviewFinancialRiskFactorsCurrentandPotentialStateoftheCountry’sEconomyIndicatorsofEconomicGrowthTypesofCountryRiskAssessmentMacro-AssessmentofCountryRiskMicro-AssessmentofCountryRiskChapterReviewTechniquesofAssessingCountryRiskChecklistApproachDelphiTechniqueQuantitativeAnalysisInspectionVisitsCombinationofTechniquesChapterReviewDevelopingaCountryRiskRatingExampleofMeasuringCountryRiskVariationinMethodsofMeasuringCountryRiskUsingtheCountryRiskRatingforDecision-Making