6 Country Risk

Country Risk Analysis

Why Country Risk Analysis Is Important?

• Country risk represents the potentially adverse impact of a country’s environment on an MNC’s cash flows.

Why Country Risk Analysis Is Important?

• Country risk analysis can be used: ¤ ¤

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to monitor countries where the MNC is currently doing business; as a screening device to avoid conducting business in countries with excessive risk; and to revise its investment or financing decisions in light of recent events.

Political Risk Factors

• Attitude of consumers in the host

country ¤ Some consumers are very loyal to locally manufactured products.

• Actions of host government ¤

The host government may impose special requirements or taxes, restrict fund transfers, and subsidize local firms. MNCs can also be hurt by a lack of restrictions, such as failure to enforce copyright laws.

Political Risk Factors • Blockage of fund transfers ¤

If fund transfers are blocked, subsidiaries will have to undertake projects that may not be optimal for the MNC.

• Currency inconvertibility ¤

The MNC parent may need to exchange earnings for goods if the foreign currency cannot be changed into other currencies.

Political Risk Factors • War ¤

Internal and external battles, or even the threat of war, can have devastating effects.

• Bureaucracy ¤

Bureaucracy can complicate businesses.

• Corruption ¤

Corruption can increase the cost of conducting business or reduce revenue.

Corruption Index Ratings for Selected Countries Maximum rating = 10. High ratings indicate low corruption.

Financial Risk Factors • Indicators of economic growth ¤

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The current and potential state of a country’s economy is important since a recession can severely reduce demand. A country’s economic growth is dependent on several financial factors - interest rates, exchange rates, inflation, etc.

Types of Country Risk Assessment • A macroassessment of country risk is an overall risk assessment of a country without considering the MNC’s business.

• A microassessment of country risk is the risk assessment of a country with respect to the MNC’s type of business.

• The overall assessment thus consists of macropolitical risk, macrofinancial risk, micropolitical risk, and microfinancial risk.

Types of Country Risk Assessment • Note that there is clearly a degree of subjectivity in: ¤ identifying the relevant political and financial factors, ¤ determining the relative importance of each factor, and ¤ predicting the values of factors that cannot be measured objectively.

Applications of Country Risk Analysis • As a result of the crisis that culminated in the Gulf War in 1991, many MNCs reassessed their exposure to country risk and revised their operations accordingly.

Applications of Country Risk Analysis • The 1997–98 Asian crisis caused MNCs to realize that they had underestimated the potential financial problems that could occur in the high-growth Asian countries.

Applications of Country Risk Analysis • Following the September 11, 2001 attack on the United States, some MNCs reduced their exposure to country risk by downsizing or discontinuing their business in countries where U.S. firms may be subject to more terrorist attacks.

Reducing Exposure to Host Government Takeovers • The potential benefits of DFI can be offset by country risk, the most severe of which is a host government takeover.

• To reduce the chance of a takeover by the host government, firms often:

Use a short-term horizon ¤

This technique concentrates on recovering cash flow quickly.

Reducing Exposure to Host Government Takeovers Rely on unique supplies or technology ¤

In this way, the host government will not be able to take over and operate the subsidiary successfully.

Hire local labor ¤

The local employees can apply pressure on their government if they are affected by the takeover.

Reducing Exposure to Host Government Takeovers Borrow local funds ¤

The local banks can apply pressure on their government if they are affected by the takeover.

Purchase insurance ¤

Investment guarantee programs offered by the home country, host country, or an international agency insure to some extent various forms of country risk.

Reducing Exposure to Host Government Takeovers Use project finance ¤

Project finance deals are heavily financed with credit, thus limiting the MNC’s exposure. The loans are secured by the project’s future revenues and are “nonrecourse.” A bank may guarantee the payments to the MNC.