6 - Country Risk Analysis

Question 1

Example of country risk: Property Rights in China

Answer 1

• McDonald’s opened a 700 seat restaurant in Beijing in 1992 with a 20-year lease from local government
• Two years later, McDonald’s evicted by government in favour of commercial, residential and office complex to be built

Question 2

What are the four main types of political risks and their common denominator?

Answer 2

1. Expropriation/nationalisation
2. Currency or trade control
3. Changes in tax or labour laws
4. Regulatory restrictions
   Common den: government intervention into the workings of an economy affects the value of the firm

Question 3

Expropriation/Nationalisation

Answer 3

• Refers to the taking of foreign property by the government, with or without compensation
• Most extreme form of political risk
• E.g. Irani government’s nationalisation of the country’s oil industry, formally controlled by BP

Question 4

Measuring Political Risk

Answer 4

• Factors considered by the country risk measurement models:
  1. Political stability
  2. Economic and political factors
  3. Subjective factors

Question 5

Political Stability

Answer 5

• Great stability = safer environment to invest
• Measured by: frequency of changes of governments; level of violence; incidence of civil war; incidence of conflict with other states

Question 6

Economic and political factors: Fiscal Irresponsibility

Answer 6

• Excessive government spending (excessive revenue collected)
• Measured by gov deficit
• Investors will avoid countries with budget deficit as the gov will not sit still (continually try to fix the budget through expropriation, taxes, printing money etc)

Question 7

Economic and political factors: Monetary Instability

Answer 7

• MS in excess of real output growth causes inflation
• Unpredictable monetary growth leads to a volatile price level
• Rapid expansion in the MS indicates gov deficit
• Example: Mugabe printed money for independence veterans lead to 400% inflation; expropriation of land; destroying property rights; affecting investment

Question 8

Economic and political factors: Controlled exchange rate system

Answer 8

• Economic problems from fiscal and monetary irresponsibility are compounded by a fixed exchange rate as it doesn’t allow the market forces to adjust to policy changes brought about in other areas
• Can lead to overvalued currency, taxing export/subsidising imports, investors expect future devaluation so capital flight

Question 9

Economic and political factors: Wasteful government spending

Answer 9

-Unproductive use of resources (generally politically motivated)

Question 10

Economic and political factors: Resource base

Answer 10

• A country rich in natural, human and financial resources is a better risk
• Experience of Sub-Saharan countries, however, is a warning on the risks of the recourse curse

Question 11

Economic and political factors: Adjustment to external shocks

Answer 11

• The economic policy of a country determines how effectively it deals with external shocks
• E.g. East Asian countries (market-oriented) vs Latin American countries (statist policies) in the late 1980s

Question 12

Economic and political factors: Market- versus statist policies

Answer 12

• Difference between capitalism and socialism
• Economic freedom vs distortion of incentives
• Capitalism emphasises: personal choice, voluntary exchange of goods and services, freedom to enter and compete in markets, security of private property

Question 13

Economic and political factors: Market- versus statist policies REFORM

Answer 13

• Large budget deficit - fiscal restraint
• Expansion of MS - monetary discipline
• Nationalisation - Privatisation
• High taxes - Tax reduction
• Controlled currency - end currency control
• Price and interest rate control - price/interest rate controlled by market
• Government dominated economy - reduce size and scope of gov

Question 14

Market oriented reform: East Europe vs China/India

Answer 14

• Post soviet collapse, it was predicted that E European countries would do better than China and India by opening up their economies (reform)
• However, the contrary was true as these countries (among other things) were not ready to survive in a competitive environment

Question 15

Subjective factors

Answer 15

• A country’s subjective attitude toward private enterprise
• E.g. in May 2000 Hong Kong downgraded to 6th best place to invest from 1st place (merger with China)
• Capital flight: export of savings by a nation’s citizens because of fears about the safety of their capital (good indicator of political risk)
• Factors that promote capital flight: unstable political situation, government regulations, controls and tax policies etc