The expansion of ties in the economic space contributes to the emergence of risks that are inherent in this business in a foreign country. An investor who is interested in the optimal allocation of funds in an unfamiliar market may face an unstable political regime, corruption, defaults and other adverse events. All of these factors relate to country risks.
Definition
Country risk is the threat of financial loss in operations that, in one way or another, are associated with international activities. It is determined by the conditions of the country's development and the degree of their influence on customers and contractors. For example, the imposition of restrictions on operations with foreign currency may cause a delay in fulfilling obligations. Such a threat is especially characteristic for countries where the convertibility of national currency units has not historically been preserved.
Hierarchy
Country risk has two components: ability and willingness to pay. The first is associated with commercial losses, and with the second - the political regime in the country. Financial costs can be both at the state level (insolvency risk) and at the company level. The second one means that when pursuing an economic policy, the state can limit the transfer of capital. Political country risks provide for the likelihood of losses resulting from adverse external factors in the investment region.
Analysis Methods
To reduce financial losses, various methods of assessing the situation in the country were used. The analysis was carried out immediately before investing. If the risk is high, then either the project was postponed, or a “premium" was added to the cost. But the previously used methods for assessing country risks had one big drawback: they embellished the information received. Now the most popular method is Delphi. Its essence lies in the fact that, first, analysts develop a system of indicators, and then attract experts who determine the weight of each factor for a particular country. The disadvantage of this approach is the subjectivity of the estimates.
Modern methods
Country risk in the West is analyzed using a scoring technique. It consists in a quantitative comparison of the main characteristics of different countries and the derivation of the resulting integral indicator, which takes into account all the criteria and ranks states according to their investment attractiveness. The German BERI index is built on this technique. It is used to assess the investment climate of 45 countries based on 15 criteria with different specific gravities. Each indicator is assigned a score from 0 to 4. The more points, the higher the profit potential of the investor.
Fortune and Economist magazines analyze country risks in Eastern and Central Europe using a simplified methodology that focuses on the prospects for market reforms. The importance of the results is determined by the fact that the effective investment of capital directly depends on the intensity of transformations in countries.
Portfolio investors also use special credit ratings, on the basis of which the optimal object for investments is selected. Based on the method developed by Europe magazine, the reliability of the countries of the world is evaluated twice a year.
Factors
Creating a favorable investment climate is an important condition for the country's economic growth. Active capital inflows (for example, Russia) are hindered by such factors as:
- Lack of a stable legal framework.
- The growth of social tension due to the constant deterioration of the material situation of the population.
- Separatist sentiments that take place in some regions of Russia.
- Corruption in certain areas.
- Undeveloped infrastructure - primarily transport, communications, telecommunications, hotel services.
Types
Country and regional risks include threats such as:
1. Refusal to recognize a debt or its subsequent servicing.
2. Revision of repayment conditions: the lender will receive less money because the borrower has achieved a reduction in interest rates. If the contract refinancing the debt is initially compensated by penalties, then the consequences for the investor are the same as in the case of refusal to pay.
3. In the case of a revision of the debt repayment terms, two scenarios are possible:
- the amount of payments on the principal amount is reduced, part of the debt is written off;
- if the borrower seeks deferral of payments, then the rate will not change.
4. The suspension of payments for technical reasons is temporary. The creditor should not have doubts that the borrower will fulfill his obligations. The interest rate in this case remains the same.
5. Currency restrictions, when a country lacks a foreign currency, set limits on transfers of funds abroad. At the state level, this threat translates into a risk of denial of debt service.
Rating
The country risk premium is determined by the yield of government bonds of one country and debt obligations of another with a similar validity period. As for Russia, a strong decline was observed in 1998. Then the risk increased faster than the premium for it. That is, investors not only lacked reliable information, but also the markets were focused on the ratings of world agencies that missed changes in economic and political factors. The first crisis occurred a few days before the default in 1998 and immediately after it.
The level of country risk strongly affects banks whose activities are directly related to foreign economic relations. Such a threat is affected by several factors at once. All of them must be taken into account when analyzing the situation in a particular region.
Country risk of Russia
Moody's Investor Service agency downgraded the rating of the Russian Federation to the most speculative. While Standard & Poor's and Fitch evaluate a country for its willingness to pay debts, MIS takes into account the completeness of payments in the event of a default. Experts believe that the prohibitively negative assessment is due to political reasons. According to agency forecasts, the capital outflow this year will be $ 272 billion, GDP will decline by 8.5%, and inflation will accelerate to 15%. But the Ministry of Finance claims that Russia successfully survived the worst shock - a 50 percent drop in oil prices. Therefore, the country risk of the agency is greatly overstated. Accumulated international reserves, which are higher than public debt. There is also a current account surplus. The agency did not take these advantages into account. But the points were set based on the fact that Russia could receive new sanctions due to the unpredictable development of events in Ukraine.
Effects
Country risk assessment, on the one hand, is adequate. The external capital market is virtually closed for Russia. The downgrade affects the cost of borrowing for the country. This is almost painless. However, experts are worried that such a rating by a global agency will force investment funds to reset their investments in Russia. And even after stabilization of the situation, it is unlikely that these capitals will quickly return to the country. The second threat is that lenders will demand early repayment of Eurobonds. The rating decline was taken into account by the market in the form of a short-term and low jump in the dollar to the level of 64 rubles.
Banking sector also affected
The downgrade led to a deterioration in the investment attractiveness of Moscow, St. Petersburg and 13 regions. The sovereign assessment of the capital and the Leningrad region was at the Ba1 level. This is higher than that of Bashkortostan, Tatarstan, Samara, Nizhny Novgorod, Belgorod and other regions. The outlook for these regions remains negative. In addition, the country risk of Russia was reflected in credit institutions. Ratings of long-term deposits of Sberbank and VTB in rubles were reduced to “Baa3” and “Ba1”, and in foreign currency - to “Ba1” and “Ba2” with a forecast of negative changes. The same situation is observed in Alfa Bank, Gazprombank and Rosselkhozbank.
Conclusion
Country risk is formed on the basis of a large number of external and internal factors, on which the investment attractiveness of the state depends. Such threats are more characteristic of regions in which there are restrictions on currency convertibility. In such states, there is always a currency, transfer and risk of a complete refusal to repay the debt. Therefore, before investing, it is necessary to conduct a thorough analysis of external and internal factors. World rating agencies annually publish their assessments of the investment attractiveness of countries.