Country%20Risk%20Assessment%20Methodologies:%20the%20Qualitative,%20Structural%20Approach%20to%20Country%20Risk

1
Lecture VI

• Country Risk Assessment Methodologies the
  Qualitative, Structural Approach to Country Risk

2

• Risk management is not a program but an
  ongoing process that must be developed over time.
  Our models are constantly reviewed and improved.
  On the whole, they have proven their worth. But
  good risk management isn't just about
  mathematical models and systems it also
  requires an understanding of the market,
  intuition and the ability to weigh up what
  proportions of risk are healthy. In that respect,
  the abbreviation CS in my opinion doesn't just
  stand for Credit Suisse, but also for common
  sense, which plays a key role in risk
  management.
• Hans-Ulrich Doerig
• Chairman of the
• Board of Directors
• of Credit Suisse

3
The Qualitative Approach

• A robust qualitative approach leads to
  comprehensive country risk report that trackle
  the following six elements
• Social and welfare dimension of the development
  strategy
• Macroeconomic fundamentals
• External indebtedness evolution, structure and
  burden
• Domestic financial system situation
• Assessments of the governance and transparency
  issues
• Evaluation of the political stability.

4
Macroeconomic Structures of Growth

• Countrys main challenge capacity to preserve
  sustainable growth!
• Excessive growth (of spending, debt, money
  supply, GDP, investment, domestic credit) is NOT
  POSITIVE because it creates bubbles and costly
  imbalances!

5
Macroeconomic Structures of Growth (2)

• Growth is the product of
• Capital accumulation
• Physical (land and infrastructure)
• Human (education, incentives)
• Institutional
• Factor Productivity ? technology!
• (? Growth Theory? The Solow Model!)
• Globalisation (Trade and capital inflow)
• Good governance
• Solid macroeconomic environment.

6
Macroeconomic Structures of Growth (3)

• What is there behind the economic and financial
  crisis?
• Macroeconomic disequilibria
• High internal and external debt
• To adjust them ? expansionary monetary policy
  that causes
• Inflation
• Gov is unwilling to defend the fixed exchange
  rate!
• High real interest rates to defend the exchange
  rate parity in a context of speculative attack
  and falling reserve (Mexico, 1995 Russia, 1998)
• Underdevelopment of financial system large-scale
  financial capital inflows financial panic (Asian
  crisis, 1997-1998 Argentina, 2001-2002)
• Market expectations and international contagion
  (USA, 2008).

7
Macroeconomic Structures of Growth (4)

• Domestic Economy Assessment
• GDP evolution and composition sector analysis
• Informal economy, savings and investment ratios
• Trade structure, terms of trade, trade openness
  ratio, commodity prices.
• Which variables?

8
Macroeconomic Structures of Growth (5)

• Macroeconomic Policy Evaluation
• Prices (inflation) and exchange rate
• Government finance budget policy, privatisation,
  public sector borrowing requirement,
• Money and credit policy money supply growth,
  reserve money, claims on government and on
  private sector, real interest rate
• Legal and regulatory environment (customs,
  taxation, company law, flexibility of the labour
  market).
• Which variables?

9
Macroeconomic Structures of Growth (6)

• Balance of Payment Analysis
• Trade balance, resource gap and current account
  balance
• Capital accounts, international reserve assets
• Non-debt creating flows FDI, foreign transfer,
  remittances.
• Liquidity ratio current account/GDP
• Structure and composition of external capital
  sources
• Exceptional financing and IMF credit.
• Which variables?

10
The Qualitative Approach

• A robust qualitative approach leads to
  comprehensive country risk report that trackle
  the following six elements
• Social and welfare dimension of the development
  strategy
• Macroeconomic fundamentals
• External indebtedness evolution, structure and
  burden
• Domestic financial system situation
• Assessments of the governance and transparency
  issues
• Evaluation of the political stability.

11
External Indebtedness, Liquidity and Solvency
Analysis (1)

• External debt is a temporary phenomenon that
  supplements savings, bridges the
  resource-investment gap and speeds up the growth
  process towards the take-off stage of
  sustaining development.
• Problem Debt Repayment Risk of Default!
• If borrowing countries invest capital inflow in
  productive investments with higher return rates,
  without sizable adverse shocks, and compatible
  maturity ? they would generate the right income
  for timely debt repayment.

12
External Indebtedness, Liquidity and Solvency
Analysis (2)

• Risk of default increases for 3 reasons
• Debt is not invested but is used
• to finance current consumption
• to finance the black hole of the government
  budget deficit
• Is recycled in international banks.
• Debt composition, in term of maturity, currency
  or interest rates, is such that the borrowing
  country becomes highly vulnerable to external
  shocks
• debt overhang, i.e. the accumulated debt is
  larger than the countrys repayment capacity and
  expected debt servicing obligations will
  discourage domestic investors and exporters, as
  well as foreign creditors. Country becomes
  dependent from foreign loans.
• Moreover, weak macroeconomic situation would
  increase the risk of default, ceteris paribus!

13
External Indebtedness, Liquidity and Solvency
Analysis (3)

• Weak fundamentals large relative debt
• debt overhang and deterioration of
  creditworthiness!

14
External Indebtedness, Liquidity and Solvency
Analysis (4)

• Which indicators could be useful?
• Solvency VS Liquidity Indicators
• Solvency Indicators
• Illustrate the stock/stock relationship, linking
  the countrys debt obligations with the overall
  assets and its currency reserves.
• Debt/GDP
• Net external debt/exports
• Debt/exports
• Debt/official reserve assets
• Real weight of the debt NPV
• Debts structure
• Creditors, debtors, floating/fixed exchange rate,
  currency, maturity etc.)
• Short-term debt/liquidity reservecontingent
  credit lines
• Short term debt/outstanding debt.

15
External Indebtedness, Liquidity and Solvency
Analysis (5)

• Liquidity Indicators
• Debt flows VS debt stock
• Debt servicing ratio (debt payment/export)
• Interest payment/export
• Current account/GDP
• Reserves/imports
• Average maturity of external liabilities.

16
The Qualitative Approach

• A robust qualitative approach leads to
  comprehensive country risk report that trackle
  the following six elements
• Social and welfare dimension of the development
  strategy
• Macroeconomic fundamentals
• External indebtedness evolution, structure and
  burden
• Domestic financial system situation
• Assessments of the governance and transparency
  issues
• Evaluation of the political stability.

17
The Savings-Investment Gaps and Domestic
Financial Intermediation (1)

• Key role of a good and solid domestic financial
  system
• Channel between savings (from different sources)
  and productive investment
• Countrys sustainable economic growth.

18
The Savings-Investment Gaps and Domestic
Financial Intermediation (2)

• Efficiency factors in the Financial System
• Banking system and efficiency
• Level and structure of interest rates
• Financial liberalisation
• Stock market development and efficiency
  (capitalisation, value traded, listed companies,
  transparency)
• Non-bank credit and the role of securities
  markets in providing corporate funding
• Interbank market
• Development of financial instruments and
  financial innovation
• institutional development and structural
  reforms
• Legal restrictions on capital movements
• Role of national authorities for effective
  prudential supervision
• Legal, accounting, management and supervisory
  infrastructures.

19
References

• Bouchet, Clark and Groslambert (2003) Country
  Risk Assessment, Wiley finance (Chapter 4).
• Luo, Y. Political Risk and Country Risk in
  International Business. Concept and Measures, in
  Handbook of International Business, chapter 26.