Page 206 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 12: Foreign Market Entry and Country Risk Management

approaches. One approach regards default as arising out of an unintended deterioration in the Notes
borrowing country’s capacity to service its debt. The other approach views the probability of
default of external debt as an international decision made by the borrower based on an assessment
of the costs and benefits of rescheduling. Difficulties in debt servicing could be a result of
short-term liquidity problems or could be attributed to long-term insolvency problems.
For example, countries with a high export growth rate are more likely to be able to service their
debt and are expected to enjoy better creditworthiness rating since exports are the main source
of foreign exchange earnings for most countries – particularly developing economies. Thus,
lower export earnings are likely to increase the likelihood of short-term liquidity problems and
hence difficulties with debt servicing. Similarly, a decline in the growth of output could contribute
to long-term insolvency problem and lower the country’s credit rating.

The absolute size of a country’s debt has little significance unless it is analysed in relation to
other variables.
The debt service indicators include:

Debt/GDP (to rank countries according to external debt).
Debt/Foreign Exchange receipts (Important ratio – solvency).
Interest payments/Foreign exchange receipts (liquidity).

Debt-service ratio (relates debt service requirements to export incomes).
Short-term debt/Total exports.
Imports/GDP (sensitivity of domestic economy to external development).
Foreign public debt/GNP (relates external debt to country’s wealth).

Level of net disbursed external debt/GNP.
Net disbursed external debt/Export of goods and services.
Net interest payment/Exports of goods and services.
Current account balance on Gross Net Product (countries with large current account deficit
are usually less creditworthy).

Balance of Payments

The fundamental determinate of a country’s vulnerability is its balance of payment. The balance
of payments management is a function of, among other things, internal goals and changing
external circumstances.
A very useful indicator of country risk analysis is the current account balance. It summarises the
country’s total transactions with the rest of the world for goods and services (plus unilateral
transfers) and represents the difference between national income and expenditure. It also indicates
the rate at which a country is building foreign assets or accumulating foreign liabilities.

The balance of payments on current account is negatively related to the probability of default
since the current account deficit broadly equals the amount of new financing required. Countries
with large current account deficits are thus less creditworthy.
Another useful indicator of the balance of payment position of a country is the reserve to
imports ratio. Reserves provide a short-term safeguard against fluctuation in foreign receipts.
The larger the reserves are relative to imports, the more reserves are available to service debt
and the lower is the probability of default.

LOVELY PROFESSIONAL UNIVERSITY 201