Country Risk and Sovereign Risk Analysis

We classify factors that determine country risk into four groupings: the political climate, the economic environment, the financial condition, and the social institution. The political climate factor refers to the stability, maturity and functioning of the political system; the representativeness and collectiveness of government; the scale of domestic conflict—racial relations, civil war or insurgence; and the conditions of international relations—sanctions imposed due to political reasons, border dispute or military conflict with neighbouring countries. The economic environment is concerned with economic development stages—GDP per capita and growth in GDP; economic stability—inflation, unemployment and provision of social security; infrastructure—the communications system, skills of the labor force, the competitiveness of the industry, the maturity of the service sector and the efficiency of government departments and agencies; taxation—consistency in and levels of tax charges, and tax incentives for foreign investment and for certain industries; macroeconomic management—formation, implementation and effectiveness of monetary policy and fiscal policy; and international economic relations—international trade, balance of payments, foreign exchange rate arrangements and foreign reserves. The financial condition is related to the stability of the financial system, the functioning of the capital market, the operation of the foreign exchange market, and the maturity of the corporate sector. Finally, the social institution reveals the legal, regulative, cultural and institutional aspects of a country that may have effects on the financial interests and performance of an MNC in the country. It covers the legal system—independence, transparency and enforcement of the legal system, crime and security in the society; regulations and legislations—consistency, fairness and effectiveness; work organisation and corporate governance—compatibility, harmony and functioning; the influence of interest groups—professional bodies, trade unions and employers organisations; the ability of handling natural disasters and emergency rescues; and social attitude towards work, social life, wealth distribution, foreign investment, and national interests. Table 18.1 lists and summarises these factors of influence for country risk analysis.