Country risk analysis is not a novel phenomenon in the finance literature, instead, it has a deep-rooted historical background. Owing to the fact that it facilitates multinational firms, seeking new opportunities abroad, to identify and assess the business environment in which they are to perform, the significance of the country risk analysis ought to be overtly comprehended. When it comes to the definition of country risk analysis, it is an assessment of the potential risks and rewards associated with making an investment in a country, which helps businesses to either eliminate or mitigate the possible obstacles with which they can confront while performing business activities. Suppose that you were in a position that you could make decisions about where to invest, so which factors would you take into consideration? In order to respond to the question asked above, let’s take a close look at factors that help measure country risk.
Political stability is the first factor that plays a fundamental role in identifying country risk, assisting to build both coherent and relentless path in which a government maintains its presence. Measures of political stability cover a number of factors, including the level of violence, the frequency of changes of government, armed conflicts, and so on. It is, therefore, an undeniable fact that ‘the greater stability a government experiences, the safer environment multinational firms perform’. That is to say, political stability is an indispensable element that foreign investors take into accounts to make a colossal amount of investments.
Economic Factor is another frequently employed indicator of political risk, including inflation rate, balance-of-payments deficits or surpluses, and the growth rate of per capita GDP. Since the better economy of a country has come to mean that the less likely political and social turmoil the country may face, the analysis of economic factors is quite important to ascertain investment decisions. However, it should not be forgotten that the current account deficit is not always an unfavorable situation which a country experiences. For instance, the United States is a country that has the biggest current account deficit, yet the quality of life is higher in the United States than in any other country saving some European countries such as Denmark, Switzerland, Finland, Germany, and so on. Hence, it is clear that more than one indicator should be harnessed while specifying the economic risk of a country.
Subjective Factors describe the general perception of the country’s attitude toward private enterprises. Because of the several external conflicts that arise among nations, a private firm may encounter with circumstances in which it is considered as ‘necessary evil’ to be eliminated. To illustrate, Turkey is a country that always a domestic political issue with Israel, and therefore, citizens living in Turkey are of the opinion that products stemming from Israel are evil and must be exterminated whenever a problem occurs between two nations.
There are also scores of factors determining the risk of a country, ranging from uncertain property rights to capital flights. Supposing that you were accountable for making investment decisions, would you invest in a country where inflation is high and domestic inflation hedging is difficult? In that case, virtually all investors might hedge by shifting their savings to another country that they think it is safer, which is called ‘capital flights’. In other words, by virtue of fear, savings are shifted overseas to protect them.
In conclusion, due to the competition which has been escalating notably with the onset of the globalization that triggers businesses to expand overseas, a company should be ready for the impediments which entail risk assessments to screen out the country in which the company is currently doing business or planning to do so. There are basically five indicators that help businesses to measure risks associated with the country, which are respectively political stability, economic factors, subjective factors, uncertain property rights, and capital flights.
Key Words: Country Risk, Assessment, Political Stability, Economic Factors, Subjective Factors, Property Rights, Capital Flights.
Foundations of Multinational Financial Management (Fourth Edition) published by Alan C. Shapiro.