Types of country risks might be applicable when operating
internatioally are as follows :
- Political risk : Political risk is the risk of
a country’s external relations has undergone significant changes.
For example, the war is occurred with other countries or the
occupation of territory. Sometimes the political risk is an
internal instability environment of the country, such as the coup
caused by the ideological differences, the unrest caused by
terrorist, the conflict of economic institutions, and the local
separatist struggle. All of these phenomenons will likely lead to
loss and cause the country risk.
- Sovereign risk : The sovereign risk is the
risk that the acts of sovereign government or government agencies
affect to the lenders. Sometimes, the sovereign government or
government agencies may refuse to carry out the debt refunding or
refuse to bear the surety responsibility. Consequently, that will
lead losses to the lending banks.
- Economic risk : Economic risk is the risk
caused by a country refuse to pay the external debt. The reasons of
the payment refusing may be variety such as the slow national
economic growth, the low investment willingness, the decreasing of
the exporting revenues, the balance of payment deteriorated, and
the shortage of foreign exchange.
- Transfer risk : Transfer risk is due to the
host government policies or regulations prohibiting or restricting
the transfer of funds, thus composes the threat to the lenders. In
the international business, as the foreign exchange control and
regulation of capital movements of the host country, banks’
deposits and income cannot be exported in the host country, and the
principle of loans cannot be recovered. For instance, in the Asian
currency crisis, the capital control of Malaysia was a political
solution to solve the exchange rate problem in their country. That
led the deposits and income of foreign countries in Malaysia
against high risks and may not be recovered.
- Exchange risk : Exchange risk means that the
potential loss from any negative unexpected changes of exchange
rate. The exchange risk generally caused by different factors such
as the international receipts and payments and currency reserves,
interest rate, inflation, and the political situation.
- Location or neighborhood risk : Meldrum (1999)
states this type of risk as “spillover effects caused by problems
in a region, in a country’s trading partner, or in countries with
similar perceived characteristics”. Several more sectors can also
cause the location or neighborhood risk such as geographic
position, international business partner and trading institution
and organizations.
Tools to evaluate such risks are as follows :
- Euromoney Country Risk Survey: This survey
covers 186 countries and gives a comprehensive picture of a
country's investment risk. The rating is given on a 100-point
scale, with a score of 100 representing virtually zero risk.
- Economist Intelligence Unit's Country Risk Service
Report: The EIU is the research arm of The
Economist and one of its best offerings is its Country Risk
Service Report. These ratings cover over 130 countries, with an
emphasis on "emerging and highly indebted" markets. The rating
analyzes factors similar to the ECR rating, such as economic and
political risk, and provides a rating on a 100-point scale;
however, unlike the ECR rating, higher scores mean higher sovereign
risk.
- Institutional Investor's Country Credit
Survey: This rating service is based on a survey of senior
economists and analysts at large international banks. The
uniqueness of this approach is appealing because it surveys people
from companies that are at the ground level, lending and providing
capital directly to these countries. In a sense, this adds a degree
of credibility to the ratings because major international banks
typically do a significant amount of due diligence before exposing
themselves to certain countries. Similar to the other approaches,
this rating is based on a scale of 0 to 100, with 100 being
virtually risk-free and zero being equivalent to certain
default.
Tools to mitigate risks are as follows :
- Consider the timing of your investments :
Investors should restrict capital transfers to a country to those
times when the foreign exchange rate is in equilibrium. The theory
of “Purchasing Power Parity” provides a guide to likely exchange
rate changes. Compare a country’s cumulative inflation over a
number of years with the cumulative inflation rate of its major
trade partners. If the difference in cumulative inflation rates
exceeds the percentage change in the foreign exchange rate, then
devaluation is a real possibility. For example, this calculation
would suggest that the Mexican peso is currently substantially
overvalued.
- Borrow domestically to do business domestically and
avoid foreign exchange rate exposure :Keep in mind that
this approach does expose the business to the possibility of
interest rate increases as a result of a central bank’s response to
foreign exchange rate devaluation. For a foreign-owned financial
institution, this approach also involves the possibility of a “run”
on deposits, as the depositors seek to withdraw funds in order to
transfer them abroad.
- Focus on the devaluation risk when choosing among
countries as investment sites : From this perspective,
Chile is currently a less risky region for investment than
Argentina or Mexico.
- Spread the purchase price over as long a time period as
possible : This allows domestic currency to be purchased
at a lower cost if devaluation occurs. Alternatively, gear the
purchase price to a weighted average of the exchange rate over
future years, with projected future payments adjusted in accordance
with the exchange rate.