Country Risk - Latin America

International Finance
GROUP 4 PRESENTATION
Country Risk
Global MBA Centrum | Tulane University
Country Risk
Global MBA II Centrum | Tulane University
09 July 2009
July 9th, 2009
Country Risk
AGENDA OUR PROGRAM
1.
2.
3.
4.
5.
6.
7.
10 July 2009
Country Risk: Definition / Political vs. Financial Risks

Economic and Political Factors
Key Indicators
Relationship with the Cost of Capital
From International Banking Point of View
Survey of Country Risk for LatAm Countries
Summary and Conclusions
Country Risk
1. COUNTRY RISK THE BASICS
collection
of
risks
associated
with
investing in a foreign country.
Political,
exchange
rate,
economic,
sovereign, transfer risk
MNCs,
political
scientists,
economist:
no
unanimity what is and how to measure it
Country
some
risk
countries
varies
have
among
high
countries:
enough
risk
to discourage much foreign investment.
Can
investment
reduce
and
the
expected
must
return
be
taken
consideration whenever investing abroad

10 July 2009
on
an
into
Country Risk
1. COUNTRY RISK DEFINITION
The
assessment
and
of
rewards
investments
the
potential
associated
and
doing
risks
with
making
business
in
country
Represents
the
impact
of
potentially
countrys
adverse
environment
on
the MNCs cash flows.
What
the
measure
public
to
and
determinate
private
investors
which
countries
offer the best prospects for investments
Must
be
assessed
comprehending
economic and political policies
10 July 2009
MNCs invest- vs. banks debts-
its
Country Risk
1. COUNTRY RISK A POLITICAL OR ECONOMIC RISK?
Political
economic
considerations
policies
-so
lead
to
country
risk
countries
analysis
to
cannot
pursue
be
exclusively economic-
Political
economics.
economy:
It
is
done
interaction
in
Monetary & fiscal policies

Property
Currency & trade controls
Labor laws
Regulatory restrictions
Requirements for more production
10 July 2009
between
continuous
basis
politics
and
and
affects:
Country Risk
2. COUNTRY RISK APROACHES
From
country
indicators
affect
all
firms
specific:
country
in
macro
risk
analysis
host
country
non diversifiable
From
indicators
to
an
industry,
firm
individual
firm
or
specific:
micro
firm
specific
project
in
country: diversifiable
10 July 2009
Country Risk
2. COUNTRY RISK ECONOMICAL & POLITICAL FACTORS
Primary
focus:
country
country
How
doing
is
economically?.
offers
environment.
well
No
perfect
Countries
the
business
are
better
or worse from than an average.
Fiscal
Irresponsibility:
government
deficits
insatiable
appetite
expropriations,
printing
raising
money
(as
high
%
GDP),
for
money:
taxes
or
(monetizing
the
deficit)
10 July 2009
Country Risk
Monetary
high
Instability:
and
Lead
volatile
government
inflation:
deficits
that
to
large
central
bank monetizes
Controlled
System:
taxing
imports.
no
Exchange
Fixing
exports
lead,
reinvesting,
the
Rate
exchange
&
subsidizing
capital
flights,
negative
terms
of trade
10 July 2009
rate:
Country Risk
Wasteful
Capital
Government
from
abroad
subsidize
consumption
showcase
projects:
higher
taxes
&
Spending:
is
or
used
for
wasted
in
exchange
others.
Promote
controls,
capital
flights.
unproductive
spending
&
inability
service foreign debt:
10 July 2009
to
Country Risk
Resource
human
&
human
&
how
most
Quality
they
are
labor
free
put
workersin
use
investing,
market:
their
(political
flexible
well
market:
of
highly
productive
efficient
stability:
&
financial.
natural,
resources
skilled
and
Base:
allocated
wages).
Free
market do not afford mistakes
10 July 2009
10
Country Risk
Country
External
of
Risk
and
Shocks:
What
external
shocks:
responds
is
LatAm;
imitation&
Adjustment
are
how
not
the
to
the
well
same,
innovation
impacts
nation
Asia
vs
vs
import
substitution with export reduction
Market
Oriented
market
economy
Economic
freedom.
identify
factors:
nations
shocks:
vs.
vs
It
it
is
susceptibility
focus
on
the
Statist
Policies:
command
is
not
needed
economy.
enough
to
identify
to
financial
of
theses
policies
development strategies
10 July 2009
to
11
and
Country Risk
2. COUNTRY RISK - INTERNATIONAL BUSINESS
Political risk:
The
risk
unexpectedly
businesses
that
change
the
operate
-a
sovereign
rules
business
be constrained by the new policy (ies)-
Expropriation nationalization- risk
Disruptions in operations
Protectionism restrictions for foreign-
Blocked funds
Loss of intellectual property rights
Currency/trade controls
10 July 2009
12
of
host
the
foreign
game
government
will
under
which
investment
would
Country Risk
2. COUNTRY RISK - INTERNATIONAL BUSINESS
Financial
risk:
Refers
more
events in a countrys financial, economic, or business life
Currency risk
Interest rate risk
Inflation risk
Unexpected changes in the current

account balance
Unexpected changes in the balance

of trade
10 July 2009
13
generally
to
unexpected
Country Risk
3. KEY INDICATORS OF COUNTRY RISK
Relative size of government debt
Money expansion
High
government
expenditures
with
low rates of return
Government-imposed
barriers
to
forces
Tax rates
Number of state-owned enterprises
Political and fiscal responsibility
Amount and extent of corruption
Lack of basic institutions of government
10 July 2009
14
market
Country Risk
3. KEY INDICATORS OF ECONOMIC WEALTH
Structural incentives
Legal structure
Clear incentives to save
Open economy
Stable macroeconomic policies
10 July 2009
15
Country Risk
4. COUNTRY RISK RELATION TO COST OF CAPITAL
Cost
of
company
can
borrowing,
that
capital:
or
firm
The
raise
mix
would
cost
of
money
of
the
determines
(through
two).
receive
if
Cost of Capital
vehicle with similar risk (investopedia)
Equity
10 July 2009
capital
This
it
Debt
16
is
stock
the
invested
how
rate
in
issue,
of
return
different
Country Risk
Cost
(WACC)
interest)
debtholders
of
capital:
is
the
that
The
rate
(cost
weighted
(expressed
company
of
is
debt)
average
as
and
t = coporate tax rate

C
c = cost of debt (rate)
D
w = equity portion of value of corporation
e
09 July 2009
cY = cost of internal equity (rate)

17
expected
w = debt portion of value of corporation

d
equity) to finance its assets
cost
of
percentage,
to
shareholders
capital
like
pay
to
(cost
of
Country Risk
Cost of debt: The interest rate a company is paying on
all of its debt, such as loans and bonds. The cost of debt
is computed by taking the rate on a risk free bond (RF)
whose duration matches the term structure of the
corporate debt, then adding a default premium. This
default premium will rise as the amount of debt increases
10 July 2009
(since the risk rises as the amount of debt rises).

18
Country Risk
Cost
of
Equity:
The
return
that
a company.
Investors need to be compensated in two ways: time value of money and risk. The
time value of money is represented by the risk-free (rf) rate and compensates for
placing money over time. The other part represents risk and calculates the amount
of compensation the investor needs for taking on additional risk . This is
calculated by taking a risk measure (beta) that compares the returns of the asset to
the market over a period of time and to the market premium
10 July 2009
19
stockholders
require
for
Country Risk

Evidence
of
country
returns
An increase (decrease) in country risk tends to be

followed by a stock market fall (rise)
10 July 2009
Countries with high country risk have
more volatile returns
higher betas (systematic risks)
20
risk
and
investors
required
Country Risk
The country risk affects the companies Cost of Capital:
If the country is high risk, the banks will ask

a higher interest rate before lending money
If the country is high risk, the shareholders will

ask for a higher interest rate to invest their money
10 July 2009
21
Country Risk
5. COUNTRY RISK FROM INTERNATIONAL BANKING VIEW
Explores
repay
the
their
ability
debts
for
to
borrowers
foreign
lenders
to
in
a timely manner.
Countries
their
which
have
international
grade
of
debts
corruption,
defaulted
have
on
high
bureaucracy
and
uncompetitive industries.
Many
budget
of
these
deficits,
countries
leading
show
to
high
inflation.
09 July 2009
22
large
rates
Country Risk
5. COUNTRY RISK FROM INTERNATIONAL BANKING VIEW
Country
increase,
goods
will
more
Risk
will
and
nation
will
become
improve
dependent
Terms
and
on
of
be
less
trade:
better
expensive.
consumers
This
terms
credit
The
and
imports.
If
risk
and
standard
businesses
is
of
considered
of
will
trade
foreign
living
become
political
risk.
09 July 2009
The
Governments
Cost/
Benefit
23
Calculus:
The
cost
Country Risk
6. COUNTRY RISK ASSESERS
Standard and Poors
Moodys Investor Services
Fitch
Bank of America
Business Environment Risk Intelligence
Control Risks Information Services
Dun and Bradstreet
Economist Intelligence Unit
Euromoney
Org for Econ Co-operation and Development
09 July 2009
24
Country Risk
6. COUNTRY RISK STANDARD & POORS METHODOLOGY
Fiscal and Economic Key Indicators
Social, Politic and Regulatory Key Indicators
Real GDP (Gross Domestic Product)
Corruption
Growth rate per capita
Doing Business
Public sector balance a % of the GDP
(the
Competitiveness
National budgeting performance
Public sector debt
CPI (Consumer Price Index) = Inflation
Ability to service the foreign debt
Solvency
09 July 2009
Competitiveness
indicators,
from
GCI
Index
labor
law
to
Global
measure
those
100
referred
the governability of the countries).

Income equality (GINI = poverty index).
Human
Development
economics
literacy).
25
indicators,
(measure
30
social
from
technology
to
to
Country Risk
6. COUNTRY RISK
AAA:
The
obligor's
capacity
S&P RATING DEFINITIONS (SOVEREIGN BONDS)
to
meet
its
financial
commitment
on
the
obligation is extremely strong.
AA:
The
obligor's
capacity
to
meet
its
financial
commitment
on
the
obligation is very strong.
A:
Is
somewhat
circumstances
and
more
susceptible
economic
to
conditions.
the
The
adverse
effects
obligor's
of
capacity
to
lead
to
changes
meet
in
its
financial commitment on the obligation is still strong.
BBB:
Adverse
economic
conditions
are
more
likely
to
weakened
capacity of the obligor to meet its financial commitment.
BB,
B,
CCC,
CC,
and
C:
Obligations
rated
regarded as having significant speculative characteristics.
09 July 2009
26
'BB',
'B',
'CCC',
'CC',
and
'C'
are
Country Risk
6. COUNTRY RISK
BB:
Major
ongoing
economic
uncertainties
conditions
which
or
could
S&P RATING DEFINITIONS (SOVEREIGN BONDS)
exposure
lead
to
to
adverse
the
business,
obligor's
financial,
inadequate
or
capacity
to
meet its financial commitment.
B:
Adverse
business,
obligor's
capacity
financial,
or
or
willingness
economic
to
conditions
meet
its
will
financial
likely
impair
the
on
the
commitment
obligation.
CCC:
In
obligor
the
is
not
event
likely
of
to
adverse
have
the
business,
capacity
financial,
to
meet
or
its
economic
financial
conditions,
commitment
the
on
the
obligation.
CC: Is currently highly vulnerable to nonpayment.

C:
Highly
vulnerable
subordinated
debt,
to
nonpayment.
preferred
stock
The
or
other
have been suspended.
D: Is in payment default.
09 July 2009
27
'C'
rating
obligations
may
on
be
which
assigned
cash
to
payments
Country Risk
6. COUNTRY RISK S&P LATIN AMERICA, JANUARY 2009
09 July 2009
28
Country Risk
Strengths:
09 July 2009
Copper producer, abundant mining, agricultural, and forestry resources.
Benefited from economic expansion for the past twenty years.
Free trade agreements
Political stability, quality institutions and infrastructure, solid financial system.
Weaknesses:
Too dependent on copper exports (half total sales abroad).
Energy needs: The country remains dependent on foreign sources.
The income gap still among the world's highest due especially to disparities in
29
the education system has been a source of social tensions.
Macro economic indicators
6. COUNTRY RISK CHILE A+
Country Risk
6. COUNTRY RISK MEXICO BBB+
Strengths:
Has become a manufacturing power leveraging its membership in NAFTA
Good macroeconomic fundamentals.
The control maintained over the public deficit and the moderation of foreign debt
The banking sector is relatively healthy.
The working population is young and growing.
Weaknesses:
Excessive proportion of its exports that go to the United States
Public finances continue to be dependent on oil revenues.
Social
09 July 2009
inequality
and
poverty
and
from
30
business
environment
that
needs
Country Risk
Strengths:
Abundant
mining, extensive energy, agricultural and fishing resources, and an
exceptional cultural heritage.
Public finances have been managed with prudence.

Has maintained foreign exchange reserves at comfortable levels.
Weaknesses:
Lacking economic diversification.

Remains vulnerable to weather conditions
and fluctuations in world prices for raw
materials.
Ethnic cleavage between a modern society on coast and a subsistence one inland.
09 July 2009
31
6. COUNTRY RISK PERU BBB-
Country Risk
6. COUNTRY RISK PERU EMBI+

Perus country risk drops 13 basic points to 3.74
Lima, Apr. 13 (ANDINA).- Following the regional trend, Perus country risk dropped on Thursday (April 9) 13 basic points from 3.87 to 3.74 percentage
points, according to the EMBI + Peru estimated by JP Morgan investment bank.
It is worth noting that on June 12, 2007, Peru registered a historic country risk decrease when it fell 95 basic points.
The EMBI + Peru is measured in terms of the difference in the average performance of Peruvian sovereign bonds against the performance of U.S.
Treasury bonds.
Thus it is estimated the political risk and the possibility that a country can break with their payment obligations to international creditors.
In other words, the country risk is the index called Emerging Markets Bond Index Plus (EMBI +), which measures the degree of "danger" that involves a
country for foreign investment.
The main consequences of a high level of country risk are a decline in foreign investment and lower economic growth which could lead to unemployment
and low wages for people.
09 July 2009
32
Country Risk
Strengths:
Endowed
with extensive and varied natural resources and its economy has been
diversifying.
Manufactured products represent a growing proportion of production and exports.

Policy continuity on the pursuit of macroeconomic stability seems assured.
Brazil's domestic market potential and competitive labor costs
Weaknesses:
To
achieve sustainable growth, structural reforms will be necessary,
notably in
education, social security, the employment market, taxation, and the regulatory
09 July 2009
framework
33
6. COUNTRY RISK BRAZIL BBB-
Country Risk
6. COUNTRY RISK COLOMBIA BB+
Strengths:
Extensive natural resources (agricultural, mining).

The country has diversified its exports under the ATPDEA.
The government has pursued policy of consolidating public sector finances.
The military aid received from the United States will likely be redirected
development programs.
Weaknesses:
The security situation remains a problem.

The poverty afflicting half the population.
Fiscal reforms remain necessary.
09 July 2009
34
to civil
Country Risk
6. COUNTRY RISK VENEZUELA BB-
Strengths:
Large oil, gas, and mining resources.

Oil revenues = means to extend its regional political influence.
The United States remains the main export market.
Weaknesses:
The economy is overly dependent on a hydrocarbon sector that represents 95 per cent
of exports, over half of fiscal revenues, and nearly one-third of GDP.
Opaque management of the oil revenues.

A lack of investment has limited oil production capacity.
09 July 2009
35
Country Risk
2008
2009 est.
GDP 2008:
7.0%
-2.0%
Inflation
25.0%
16.0%
Public sector balance (%GDP)
1.6%
-0.8%
Strengths:
Benefited from the strong world demand and high prices for raw materials.
The undervalued local currency has benefited domestic production and
export
competitiveness.
The country's education level and human development indicators

The work force is skilled and adaptable.
Weaknesses:
The economy continues to be partially dependent on raw materials

Despite the restructuring of its bond debt foreign debt is still high.
Improvement in public finances will depend on implementation of tight fiscal policy.
09 July 2009
36
6. COUNTRY RISK ARGENTINA B-
Rating:
Country Risk
6. COUNTRY RISK LATIN AMERICA CAPITAL FLIGHTS
Between
1974
occurred
and
capital
1982,
flight
of
in
15
Argentina
to
27
billion
for
27
billion
dollars out of 32.6 billions borrowed.
For
Venezuela,
with
the
incomes
capital
flight
were
estimated
between
12
and 27 billion dollars.
For
Mexico,
between
the
1979
incomes
were
1984,
with
and
for
79
billion
capital
flight
estimated between 26 and 54 billion dollars.
As
of
end
of
Latin
America
Latin
Americans
1988,
debt
held
prior
crisis,
243
to
it
the
end
is
billion
estimated
of
assets abroad.
09 July 2009
of
37
dollars
the
that
in
Country Risk
6. COUNTRY RISK VENEZUELA POLITICAL RISK
In
1973,
in
oil
President
prices,
Carlos
declared
Perez
due
that
they
to
the
raise
did
not
need
foreign investors.
In
1980,
President
investors
not
Luis
Herrera,
back
successful
confidence
to
and
invited
but
companies
return
or
did
if
was
not
it
have
the
would
last.
controls
and
Declarations against foreign investing.
President
declared
Caldera
in
against
1994,
stopped
private
This
brought
to devaluation of the 87% of the Bolivar and high inflation.
09 July 2009
sectors.
38
Country Risk
6. COUNTRY RISK VENEZUELA POLITICAL RISK
Hugo
Chavez
in
Bolivarian
turned
issue
1992
arrived
Revolution
against
of
him,
49
to
the
to
attack
unions
revolutionary
power
the
poverty,
and
decrees
with
in
promise
and
of
businesses
media
and
followed
by
the
2001
that
brought
to
him
and
his
the total control of the country.
President
Chavez
thoughts
does
which
lead
not
to
believe
socialism
in
property
have
brought
rights,
to
more
poverty
and misery.
From
1998
to
2004,
the
nations
decreased in 47% despite the rise in oil prices.
By April 2005, Venezuelan Bolivar had declined it value by 73%.
09 July 2009
39
per
capita
income
has
Country Risk
7. CONCLUSIONS
No consensus what exactly is country risk and how to measure it.
Both
international
banks
and
nonbank
MNCs
analyze
economical
factors
country risk but from different perspectives
There
are
social,
cultural,
political
and
that affect the general level of risk in a a country
Country
(for
risks
a
could
be
whole
diversifiable
country
or
and
for
non
diversifiable
an
industry,
firm or specific project).
The country risk affects the companies Cost of Capital
The
improvement
of
Latin
have been related to their free market policies trend

09 July 2009
40
American
countries
performance
Country Risk
7. REFERENCES
Kirt
C.
Butler,
Multinational
Western College Publishing
http://www.investopedia.com
Alan C. Shapiro , Multinational Financial Management,
2010
http://www2.standardandpoors.com
http://www.latin-focus.com
http://www.trading-safely.com
09 July 2009
41
Finance,
3e,
2004,
South-

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International Finance

Global MBA Centrum | Tulane University

July 9th, 2009

Global MBA Centrum | Tulane University

AGENDA OUR PROGRAM

Country Risk: Definition / Political vs. Financial Risks

Global MBA Centrum | Tulane University

1. COUNTRY RISK THE BASICS

investing in a foreign country.

sovereign, transfer risk

unanimity what is and how to measure it

to discourage much foreign investment.

consideration whenever investing abroad

Global MBA Centrum | Tulane University

1. COUNTRY RISK DEFINITION

the MNCs cash flows.

offer the best prospects for investments

economic and political policies

MNCs invest- vs. banks debts-

Global MBA Centrum | Tulane University

1. COUNTRY RISK A POLITICAL OR ECONOMIC RISK?

Monetary & fiscal policies

Global MBA Centrum | Tulane University

2. COUNTRY RISK APROACHES

Global MBA Centrum | Tulane University

2. COUNTRY RISK ECONOMICAL & POLITICAL FACTORS

or worse from than an average.

Global MBA Centrum | Tulane University

2. COUNTRY RISK ECONOMICAL & POLITICAL FACTORS

Global MBA Centrum | Tulane University

2. COUNTRY RISK ECONOMICAL & POLITICAL FACTORS

service foreign debt:

Global MBA Centrum | Tulane University

2. COUNTRY RISK ECONOMICAL & POLITICAL FACTORS

market do not afford mistakes

Global MBA Centrum | Tulane University

2. COUNTRY RISK ECONOMICAL & POLITICAL FACTORS

substitution with export reduction

Global MBA Centrum | Tulane University

2. COUNTRY RISK - INTERNATIONAL BUSINESS

be constrained by the new policy (ies)-

Expropriation nationalization- risk

Protectionism restrictions for foreign-

Loss of intellectual property rights

Global MBA Centrum | Tulane University

2. COUNTRY RISK - INTERNATIONAL BUSINESS

events in a countrys financial, economic, or business life

Interest rate risk

Unexpected changes in the current

Unexpected changes in the balance

Global MBA Centrum | Tulane University

3. KEY INDICATORS OF COUNTRY RISK

Relative size of government debt

low rates of return

Number of state-owned enterprises

Political and fiscal responsibility

Amount and extent of corruption

Lack of basic institutions of government

Global MBA Centrum | Tulane University

3. KEY INDICATORS OF ECONOMIC WEALTH

Clear incentives to save

Stable macroeconomic policies

Global MBA Centrum | Tulane University

4. COUNTRY RISK RELATION TO COST OF CAPITAL