6 Country Risk

8/14/2019 6 Country Risk

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Country Risk AnalysisCountry 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.



• Country risk analysis can be used:

¤ 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 financingdecisions in light of recent events.

Why Country Risk Analysis Is Important?



Political Risk Factors• Attitude of consumers in the host

country

¤ Some consumers are very loyal tolocally manufactured products.

• Actions of host government

¤ The host government may imposespecial requirements or taxes, restrictfund transfers, and subsidize localfirms. MNCs can also be hurt by a lack

of restrictions, such as failure toenforce 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 currencycannot be changed into other currencies.



• 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.

Political Risk Factors



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



Financial Risk Factors

• Indicators of economic growth

¤ The current and potential state of a

country’s economy is important since arecession 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.



• Note that there is clearly a degree of

subjectivity in:

¤identifying the relevant political andfinancial factors,

¤ determining the relative importance of each

factor, and

¤ predicting the values of factors that cannot

be measured objectively.

Types of Country Risk Assessment



Applications of

Country Risk Analysis

• As a result of the crisis that culminated in

the Gulf War in 1991, many MNCsreassessed their exposure to country risk

and revised their operations accordingly.



• 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




• Following the September 11, 2001 attack

on the United States, some MNCs reduced

their exposure to country risk bydownsizing or discontinuing their

business in countries where U.S. firms

may be subject to more terrorist attacks.

Applications of




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 TakeoversRely on unique supplies or technology

¤ In this way, the host government will not be

able to take over and operate thesubsidiary successfully.

Hire local labor

¤The local employees can apply pressureon their government if they are affected by

the takeover.



Borrow local funds

¤ The local banks can apply pressure on their

government if they are affected by thetakeover.

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’sexposure. The loans are secured by the

project’s future revenues and are

“nonrecourse.” A bank may guarantee the

payments to the MNC.

Reducing Exposure

to Host Government Takeovers

6 Country Risk

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