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:

¤ 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
¤ 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.