Economics: Country Risks and FDI
A country risk analysis identifies imbalances that increases the risks of a shortcoming in the expected
return of a cross-border investment.
Introduction
Business transactions across international borders carry additional risks which were not present in
domestic transactions. (Domestic = in own country) These additional risks are called country risks,
including risks arising from economic structures, policies, socio-political institutions, geography and
currencies. With a country risk analysis (further on: CRA) you can identify the risks and attempt to
decrease the expected return of a cross-border investment.
Risk implies an analyst can identify a well-defined event drawn from a large sample of observations.
This contain enough observations to develop a statistical function amenable to probability analysis. If
there is a lack on requirements, it is not a risk but it moves forward to a uncertainty. For example: a
car accident is a risk, a meltdown is a uncertainty because there are no large samples of observations
of meltdowns.
Uncertainty makes CRA more similar to a soft art than a hard science. The soft nature can result in
widely varying views of the risk level of a country.
Theory vs. practice
Growing imbalances in economic, social or political factors increase the risks of a shortfall. Mapping
all the factors at the appropriate level of influence creates an overall assessment of investment risks.
Country risk categories and measurements
Country risks are separated in six main categories. Many of these categories overlap each other. The
main categories are:
i. Economic risk
ii. Transfer risk
iii. Exchange rate risk
iv. Location or neighbourhood risk
v. Sovereign risk
vi. Political risk
Economic risk
This is a significant change in the economic structure or growth rate that produces a major range in
the expected return of an investment. Risks arises in fundamental economic policy goals such as,
fiscal, international etc. or a significant change in a country’s comparative advantage. Economic risks
often overlaps with political risks.
Economic risk measures: analyst examine traditional measures of fiscal and monetary policy. They
invest growth theory factors for longer term investments.
- Fiscal policy: size and detail of government expenditures, tax policy, governments debt
situation.
- Monetary policy and financial maturity: economic growth.
A country risk analysis identifies imbalances that increases the risks of a shortcoming in the expected
return of a cross-border investment.
Introduction
Business transactions across international borders carry additional risks which were not present in
domestic transactions. (Domestic = in own country) These additional risks are called country risks,
including risks arising from economic structures, policies, socio-political institutions, geography and
currencies. With a country risk analysis (further on: CRA) you can identify the risks and attempt to
decrease the expected return of a cross-border investment.
Risk implies an analyst can identify a well-defined event drawn from a large sample of observations.
This contain enough observations to develop a statistical function amenable to probability analysis. If
there is a lack on requirements, it is not a risk but it moves forward to a uncertainty. For example: a
car accident is a risk, a meltdown is a uncertainty because there are no large samples of observations
of meltdowns.
Uncertainty makes CRA more similar to a soft art than a hard science. The soft nature can result in
widely varying views of the risk level of a country.
Theory vs. practice
Growing imbalances in economic, social or political factors increase the risks of a shortfall. Mapping
all the factors at the appropriate level of influence creates an overall assessment of investment risks.
Country risk categories and measurements
Country risks are separated in six main categories. Many of these categories overlap each other. The
main categories are:
i. Economic risk
ii. Transfer risk
iii. Exchange rate risk
iv. Location or neighbourhood risk
v. Sovereign risk
vi. Political risk
Economic risk
This is a significant change in the economic structure or growth rate that produces a major range in
the expected return of an investment. Risks arises in fundamental economic policy goals such as,
fiscal, international etc. or a significant change in a country’s comparative advantage. Economic risks
often overlaps with political risks.
Economic risk measures: analyst examine traditional measures of fiscal and monetary policy. They
invest growth theory factors for longer term investments.
- Fiscal policy: size and detail of government expenditures, tax policy, governments debt
situation.
- Monetary policy and financial maturity: economic growth.
