Country risk is an all-encompassing term used to describe the risk that companies face when investing/operating in a country. Focusing on areas from political instability to natural disasters, the scope of the topic can be somewhat overwhelming. Treasury Today speaks to an expert in this field to offer treasurers advice on how to manage this threat.
We live and operate in an unstable world. One which is continually shifting under pressures from competing political, economic and social forces. On some occasions the pressure becomes too much, and change erupts.
The recent trouble in Ukraine is a well-publicised example. And there have been equally significant crises stemming from every corner of the world over the past 12 months. These range from natural disasters and civil unrest in Asia, continuing political violence and instability in the Middle East, and flooding across Europe, to mass protests in Brazil and Venezuela.
Leading Western powers have also faced disruption in their ranks, with the UK answering continued calls for Scottish independence and the closure of the federal government in the United States. All of these events have played out against a backdrop of continued global economic instability.
As the nature of business becomes increasingly international, treasurers should have country risk firmly on their radar.
Broadly speaking, country risk refers to the different political, economic, social and environmental risks which can result in a loss on an investment in a country, or a loss of earnings from operations in that country. This however encompasses a huge number of factors which need to be considered. Here, Professor Alyson Warhurst, CEO of global risk analytics company Maplecroft breaks down country risk into manageable areas for corporate treasurers to consider:
There are three main areas of country risk which treasures should assess, says Warhurst.
– there are a number of factors which are included under this banner, such as regime stability, macroeconomic risk and short-term political risks such as political violence and terrorism. Remittance and expropriation risks also fall under this heading, both of which are particularly salient to a treasury department.
Legal and regulatory risk
– it is important that a corporate treasurer is aware of the regulations surrounding the business environment in any given country of operation – and the costs these can have to the business. In particular, the strength of rule of law is fundamental to assessing the potential success of any investment. Furthermore, it is helpful to be aware of the effectiveness and independence of the judiciary in the country, should legal issues arise.
– This is often the most important factor, yet is also the most overlooked when it comes to country risk analysis, says Warhurst. Societal risk focuses on the condition of the population in a country and how they are treated by the government. This is particularly relevant in emerging markets, where there is often inequitable distribution of wealth, widespread corruption and a lack of respect for human rights. In turn, this can create civil unrest as we have seen recently in Ukraine and Egypt. This can ultimately lead to disruption of business activities and supply chains, or governments attempting to pacify unrest through policies such as resource nationalism.
In addition, the following three areas play an important part in building a complete image of the risk landscape in a particular country:
Climate and environmental risk
– this contains factors such as climate change vulnerability, land use, and water and food security, all of which are vital to a company’s long term operations.
– this area analyses the health issues in a country and how these can affect business operations; the level of education; and the degree to which the transport and communications infrastructure can support investment.
– many countries in the world face geophysical natural hazards such earthquakes and volcanic eruptions, while others witness severe flooding, drought and typhoons – it is vital that a company fully assesses the potential impact of these on their operations (more on how to do this below).
“It is important that treasury professionals understand that it is not just political and financial risks which they should consider, but also societal and environmental risks, especially in fragile economies,” notes Warhurst. “Only then can a rich picture of the risk in a country be built.”
Quantifying the risk
The next step for treasurers who wish to assess country risk is to quantify the risk posed to business operations. But by its very nature, the assessment of country risk is primarily qualitative. This can make it difficult to fully evaluate the impact it can have on treasury operations.
One way to help quantify the risk is to apply a numerical value to the overall risk profile of a country, using a sliding scale. Maplecroft, for example, utilises both quantitative and qualitative data to index over 200 different risks on a scale of zero to ten to analyse the degree of risk a country has, with zero representing the most extreme level of risk, while ten is low risk. For Warhurst, using this method and “applying figures to the risks using indices enables treasurers to objectively assess the risks and their potential impact.”
Quantitative country information which can help treasurers to determine the level of risk is also widely available. Data such as investor confidence, debt to GDP, and the MSCI index provide insight into the condition of a country and can be used to supplement qualitative data. In addition, sovereign ratings are another tool which treasurers have at their disposal. While there is no silver bullet, quantitative information such as this can be used to enhance a treasurer’s picture of country risk. Simply following the news can also be an effective way to supplement this risk picture.
Making informed decisions
But country risk is not all about the numbers, opines Warhurst. “Firstly the focus should not just be on where a country is ranked within an index,” she says, “it is about where it has come from and where it is going. Plotting a country’s risk trajectory is where true value lies. Treasurers often have to take a long term view and they certainly should when thinking about country risk.”
Thailand and Myanmar are cited as examples; the former is regarded as a growth economy and currently offers many incentives for investment. However, conditions are changing; Thailand is witnessing a deterioration of civil and political rights. Myanmar, on the other hand, is improving its legal and regulatory structure, investing in infrastructure, tackling corruption and opening up to foreign investment. The reforms are also widely supported by the US and UK governments. “Although Myanmar undoubtedly faces significant challenges, it is currently on a positive upward trajectory,” says Warhurst.
“Secondly, social risks are increasingly important,” advises Warhurst “these are the ones which can cause the most disruption when they take hold through civil unrest and conflict, as seen in Syria.” She also believes that analysing society is an effective indicator of the stability of the businesses environment. For her it is about understanding the social fabric and tensions in the country. “Treasury should be going beyond the financial to include the political and going beyond the political to include the societal.”
“It is an exciting time for treasury departments,” Warhurst concludes, “they now have the ability to evaluate risk readily and understand what is happening around the world – and then use various techniques to transform this information into working decisions.”