Page 214 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 12: Foreign Market Entry and Country Risk Management

Political Factor C 4 20% .8 Notes
Political Factor D 3 10% .3
Political Factor E 2 50% 1.0
Political Risk Rating 100% 2.4
Social Risk Factor
Social Factor A 1 50% .5
Social Factor B 2 50% 1.0
Social Risk Rating 100% 1.5
Column 1 Column 2 Column 3 Column 4 = (2) *
(3)
Category Rating as Weights assigned to Weighted Ratings
determined above each Risk Category
Economic Risk 1.3 30% .39
Political Risk 2.4 60% 1.44
Social Risk 1.5 10% .15
Overall Risk Rating 100% 1.98

The economic risk rating for the given example is 1.3, Political risk rating 2.4 and Social risk
rating 1.5. This signifies that the economic and social condition of the country is better than its
political condition. Once the three risk ratings have been determined, the overall country risk
rating can be calculated, as shown in the lower part of Table 12.3. Political risk (weight 60%) is
perceived to be a much more important factor than economic risk (weight 30%) and social risk
(weight 10%) in the given example. The overall country risk rating as calculated in the lower
portion of Table 12.3 is 1.98 (based on a scale of 1–5). In absolute terms, the rating appears to be
satisfactory but the final answer depends upon the acceptable level of risk as related to the
proposed project as also the risk tolerance of the country in question.
Thus, after developing an overall country risk rating, the first step is to determine whether the
rating suggests that the risk is tolerable. If the country risk is too high (e.g., the country is often
engaged in war), the proposed project need not receive further consideration. If the risk rating
of country is tolerable, then the firm needs to further analyse the feasibility of projects.

Notes To determine whether the project is feasible, capital budgeting technique from the
perspective of an MNC can be used.

Thus, country risk analysis is a difficult task and recent events in several countries have dramatised
the importance of country risk analysis. Country risk analysis requires a comprehensive and
coordinated approach and also demands constant monitoring of key variables and reliable
assessment of the policies of the government. Correct, systematic and up-to-date information is
essential for the analyst to increase his understanding and manage country risk in the best
possible manner. Yet, many times it may be difficult to anticipate country crisis in advance until
it is too late. In some countries crisis occur randomly and without prior warning.
Practitioners of country risk face a daunting task in their selection of variables and evaluation
systems in assessing a country’s performance. With this approach, a number of key economic
variables could serve as indicators of future liquidity and solvency problems. For example,
higher the ratio of debt to GDP, greater is the threat of a sudden liquidity crisis and lower is the
country’s rating. Similarly, lower export earnings are likely to increase the likelihood of
short-term liquidity problem and hence problems with debt servicing. The balance of payments
on current account is another important variable in assessing country risk. If the balance of
payments on the current account is positive, the creditworthiness of the country under analysis

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