International Business 4a

7/27/2019 International Business 4a

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Country Risk Analysis

Balance of Payments


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The dictionary defines risk as exposure toperil

From an investor point of view risk is

exposure to a loss Country risk is exposure to a loss in cross-

border lending/ investment, caused by eventsin a particular country

Generally these events are, to a great extent,under the control of the Govt. of that country


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All cross border lending/ investment in a country whether to theGovt., a bank, a private enterprise or an individual is exposed tocountry risk

Country risk is thus a broader concept as compared to Sovereignrisk- which is the risk of lending to the Govt. of a sovereign nation

Only events that are, to some extent, under the control of the Govt.can lead to the materialisation of country risk Natural calamities, in unforeseeable, cannot be considered as

country risk But if past experience shows the recurrence of such events then

these must be considered for the analysis of country risk

There are three components of country risk they are: Political component Socio-cultural component Economic component Each of these has a domestic aspect and an international aspect


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A Domestic1 The political system Its basic strength Its resiliency-capacity for change without disruptive

conflict2 The group in power Philosophy Policies Govt. officials Ability and number of qualified officials Willingness and capacity to make tough decisions Strength & capability to implement plans


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3 Opposition groups

Strength

Likelihood of system-disrupting conflict arising

from within the country Philosophy of strong opposition groups

4 The Govt. system

Efficiency

Red tape

Flexibility

Responsiveness


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We must consider possible effects socio-cultural variables such as:

1 Domestic Social groups Homogeneity of population Ethnic Religious Linguistic Class Extent of cohesiveness or divisiveness

A. General psychology of the peopleB. Work ethicC. UnemploymentD. Political activism of populationE. Extent of social unrest strikes, riots, insurgency

2 International Cross border ties Cross border antagonism Historical issues in the region


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Domestic Economic growth, investment trends Cyclicality of economy, economic diversification Inflation monetary policy, fiscal policy, budget deficit

Strength of local financial markets, proportion of localinvestment

International Balance of payments International trade- importance of trade to economy,

diversity of exports, elasticity of export demand,elasticity of import demand: capital equipment,necessities, degree of self reliance on food, luxuries,international trade ties, proximity to major markets,extent of trade controls


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International capital

Currency- strength, stability, quality ofexchange markets, depth of exchange markets,

extent of control over exchange markets Debt. total, short-term as share of total, debt.

Service

International financial resources- internationalreserves, international borrowing capacity,history of debt. Repayment, credit rating,autonomous capital inflows


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Generally country risks are quite difficult toanalyse

Most organisations will look for various types ofhistorical data

To approach through govt. commercialarrangements is also a safer route

Also it is common for companies to take thepremium for risk approach

This is a form of self insurance that the firmimplements by requiring a higher rate of return incountries considered exceptionally risky


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Before investing: One way to hedge risks is to minimise the firms equity

investment in the country Local borrowing not only limits the company investment that is

subject to risks, it has the important benefit of creating allies, local

lenders who have a vested interest in the success of the firm This also helps reduce the firms exposure to forex risks, sincelocal profits will go to service the borrowing

Minimising equity stake can also be achieved through local equityparticipation-forming a joint venture with local share holders

Participation of local share holders will also help build links with

the local markets and also provide the benefits of localmanagement advice and knowledge In some countries this is a pre-requisite to doing business Equity risk can be eliminated altogether through a management

contract that compensates the firm for management servicesprovided


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International integration: if the company established in a foreigncountry is dependent on raw-materials, technical skills,machinery, management or other inputs from abroad then localpressures will think before jeopardising these inflows

This can also be achieved through control of external markets

Also the use of international trade marks and brand names whichcan be registered in a wide numbed of countries External hedging: insurance is available for covering certain types

of risks associated with loss of assets Does not cover opportunity costs/ losses Host govt. guarantees cover things like tax concessions, provisions

for compensation, and some other contingencies These serve as an additional protective measure but change in

govts. Can repudiate such agreements


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Some other ways mitigate risks after investingare:

Prompt response to host govt. requests

Contribution to national goals

Contribution to national welfare

Developing a national image

Increased technical contribution


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Investment codes: An increasing number of international organisations are

attempting to promulgate international codes providingguarantees between multinational companies and host govts.

United nations and IMF are involved in enabling such agreements

which will ensure compensation if there is a default Multilateral investment guarantee agency, a member of the worldbank group is trying to put together processes in place for

Guaranteeing investment made by foreign investors againstpolitical risks

And producing promotional and advisory services to assist

member countries to creating an alternative climate for privateforeign direct investment


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The balance of payments can be defined as thestatistical record of a countrys internationaltransactions, over a certain period of timepresented in the form of double entry book

keeping It is worth looking at because: It provides detailed information concerning the

demand and supply of a countrys currency A countrys BOP data may signal its potential as a

business partner for the rest of the world The BOP data can be used to evaluate the

performance of the country in terms of itsinternational competitiveness


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A countrys international transaction can begrouped into the following three types:

1. The current account

2. The capital account3. The official reserve account


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The current account includes the export andimports of goods and services

The structure of the account

Merchandise Invisibles (a+b+c)

a) Service travel, transportation, insurance, govt.

not classified elsewhere and miscellaneousb) Transfers- official, private

c) Investment incomes


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Merchandise trade covers all transactionsrelating movable goods, where the ownershipchanges from resident to non-

resident(export)and from non-resident toresident(import)

Exports valued at FOB (international freightand insurance are treated distinctly from the

value of goods)

Imports valued at CIF


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Invisibles account include services like transportation andinsurance, income payments and receipts for factor services andunilateral transfers

Credits include services rendered by residents to non-residents,income earned by residents from their ownership of foreignfinancial assets(interest, dividends), income earned from the useby non-residents, of non-financial assets such as patents andcopyrights owned by residents and the offsets entries to the cashand in-kind gifts recd. By residents and non-residents.

Debits consists of the same items with the roles reversed ofresidents and non-residents

Transfers include foreign aid, repatriations, official and private

grants and gifts- these are usually uni-directional

The current account balance, especially the trade balance, tends to besensitive to exchange rate changes


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Capital account includes all purchases and sale of assets such asstocks, bonds, bank accounts, real estate and business

The structure of capital account:1. Foreign investments In India direct & portfolio

Abroad2 LoansA External assistance - By India and To IndiaB Commercial borrowings - By India and To IndiaC Short term - To India

3 Banking capital Commercial banks assets, liabilities and non-resident deposits Others4 Rupee debt services5 Other capital


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The first sub-group relates to foreign equity investments inIndia either in the form of direct investments or portfolioinvestments by institutional investors

The next group of loans include concessional loans recd. Bythe Govt. or public sector bodies, long and medium term

borrowings from commercial capital markets in the form ofloans, bond issues and short term credits such as traderelated credits

The third group separates out the changes in foreign assetsand liabilities of the banking sector

Non-resident deposits with Indian banks are shownseparately

The reserve assets consists of RBI holdings of gold andforeign exchange ( in the form of balance with foreigncentral banks and investments in foreign Govt. securitiesand Govt. holdings of SDRs


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1 Trade balance

Refers to merchandise trade account

2 Balance on goods and services

This is the balance exports and imports of goods andservices

3 Current account balance

This is the net balance on the entire current account

4 Balance on current account and long-term capital

This is also called basic balance This indicates long-term trends in BOP

Essentially short-term flows can be volatile but long-term capital flows indicate the strength of the economy


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Classification1. BOP on current account2. BOP on capital account BOP current account includes Trade relating to imports and exports

Invisible items such as shipping, banking, insurance, travel etc. Unilateral transfers such as donations The current account shows whether India has a favourable balance

or deficit balance of payments in any given year The BOP in capital account shows the implications of current

transactions for the countrys international financial position For instance, the surplus and the deficit of the current account is

reflected in the capital account, through change, in the foreignexchange reserves of India, which is an index of the currentstrength or weakness of Indias payment position


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Capital account is divided into three parts1 Private capital further divided into long-term and short-term

capital Anything more than one year is long-term and less than one year

is short-term

Private capital includes foreign investment(direct and portfolio)and long-term loans, foreign currency loans and estimated portionof the unclassified receipts allocated to the capital account

2 Banking capital covers movements in the external financial assetsand liabilities of commercial and co-operative banks authorised todeal in forex

3 Official capital, The RBIs holdings in terms of forex and Specialdrawing rights held by the Govt. categorised into loans,amortisations and miscellaneous receipts and payments

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International Business 4a

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