Page 208 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 12: Foreign Market Entry and Country Risk Management

economic capacity of a country to service its debt. Political instability has both direct effect and Notes
an indirect effect on the credit rating of a country.
Political instability has an indirect effect on debt servicing difficulties within a country and
reduces a country’s willingness to service debt. Indirectly, political instability generates adverse
consequences for economic growth, inflation, domestic supply, level of import dependency and
creates foreign exchange shortage from an imbalance between exports and imports. Burton and
Inoue (1985) have suggested that disruptive political events frequently precede debt rescheduling.
Also, the time-lag between political instability and ultimate loan default might be quite short in
countries with low foreign exchange reserves or low levels of GDP per capita.

The direct effect of political instability on debt service problems emerges in the form of
unwillingness rather than an inability to service the debt.
The political instability indicators which can be considered are:

1. The political protest, for example, protest demonstrations, political strikes, riots, political
assassination, etc.
2. Successful and unsuccessful irregular transfer, e.g., coup attempt, etc.

Checklist Approach

A number of relevant indicators that contribute to a firm’s assessment of country risk are chosen
and a weight is attached to each. All aspects of risk are summarised in a single country rating
that can be readily integrated into the decision making process. Factors having greater influence
on country risk are assigned greater weights.
The weighted checklist approach employs a combination of statistical and judgemental factors.
Statistical factors try and assess the performance of a country’s economy in the recent past in the
expectation that this will provide an insight into the future. These factors can be compiled
relatively easily. The analyst can choose from a wide range of statistical factors: rapid rise in
production costs, interest-service ratio, real GDP growth, debt/GDP, imports/reserves, foreign
exchange receipt, export/GDP ratio, import/GDP, etc.
The inclusion of judgemental factors gives some indication of a country’s future ability and
willingness to repay. They are essentially qualitative in nature requiring an in-depth knowledge
of the country concerned and cannot be very easily compiled. Factors in this category include
exchange rate management, political stability (i.e., possibility of war, riots, disorders), balance
of payments problems (i.e., fall in export earnings, deterioration of BOP), etc.
The weighting of the judgemental and statistical factors could then be done to arrive at a risk
ranking for countries. Those factors that presumably have a greater influence on country risk
could be assigned greater weights. However, the choice of the weights and the measurement of
the factors is highly subjective.
Hence the method though useful has its limitations.

Self Assessment

Fill in the blanks:
11. The higher the inflation rate, the lower the …………………… rating.
12. A very useful indicator of country risk analysis is the …………………… account balance.

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