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Country Risk Analysis

1.

Definition

2.

Key indicators

3.

Economic development

4.

Solvency

1.

Definition

MNCs constantly assess business environments of countries they operate in, as well as the ones they are considering investing in.  Similarly, private and public investors are interested in determining which countries offer the best opportunities for sound investments.  

This is the area of country risk analysis --- assessing the potential risks and rewards associated with making investments and doing business in a country.  

MNCs are interested in the economic policies of these countries, because economic policies determine the business environment.  However, country risk assessment cannot be only economic in nature.  It is also important to consider the political factors that lead to economic policies.  This interaction of politics and economics is the subject area of political economy.

2.

Key Indicators

Expropriation (nationalization) is the most extreme form of political risk.  However, there are other levels and forms of political risk, including currency and trade controls, changes in tax or labor laws, regulatory restrictions, and requirements for additional local production.

Political risk can be assessed from a country-specific (macro or country risk analysis) and a firm-specific (micro or firm risk analysis) perspective.  A useful indicator of the degree of political risk is the seriousness of capital flight.  Capital flight refers to the export of savings by a nation’s citizens because of fears about the safety of their capital.

We now turn to some key indicators of the general level of risk in the country as a whole – termed country risk.  Some of the common characteristics of country risk are:

i)

a large government deficit relative to GDP

ii)

a high rate of money expansion, especially if it is combined with a relatively fixed exchange rate

iii)

substantial government expenditures yielding low rates of return

iv)

price controls, interest rate ceilings, trade restrictions, rigid labor laws, and other government-imposed barriers to the smooth adjustment of the economy to changing relative prices

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