By Boczko, Anthony
Financial Management (UK)
Everyone's talking about globalisation its ethical pros and cons and the potential of vast emerging markets in, say, China. But overseas investment is not only a huge opportunity; it's also an enormous risk. To assess and manage this, you first have to understand the volatility of the global marketplace. This puts pressure on local cultures and identities; on established political boundaries and social constituencies; and on traditional market arrangements.
It is also important to consider what globalisation really means. Some people see it as a predominantly social trend--a westernisation of the world involving the extension of western rationalism to create a standardised culture. This depend', on the global media and consumer demand for a western identity. Other people see globalisation as predominantly political--a shift in state sovereignty and an attempt to reshape the geography of international power relations between core nation states and peripheral economies. And others see it as an economic trend, fuelled by the deregulation of international commodity markets, the increased mobility of investment capital and the expansion of multinational businesses.
The connections between the economics of international trade and the social and political pressures of cultural expansion and geographical sovereignty combine to create country risk.
Understanding the risk
Given its complexity, it's not surprising that country risk is defined using a wide range of political, economic and socio-cultural criteria. Broadly, it is the exposure that a company faces as a consequence of a change in a national government's policy and the effect this change could have on the value of an investment, a project or cash receipts.
Country risk often arises when a government seeks to expropriate assets and/or profits, impose discriminatory pricing intervention policies, enforce restrictive foreign exchange currency controls or impose discriminatory tax laws. It can also occur if a government attempts to impose social or work-related regulations that favour domestic companies, limit the movement of assets or restrict access to local resources. Any one of these actions can damage a company's short-term ability to generate profits. In the long term, they can dramatically limit its ability to repatriate or reinvest profits.
Unfortunately, recognising and assessing your firm's exposure to this risk is complicated. It is relatively easy to spot increasing social unrest, economic volatility and an unstable political infrastructure, but much harder to quantify the resulting risks.
Assessing the risk
There are a number of sophisticated rating models that attempt to provide a structured framework to assess potential country risk. The models vary widely, but most rely on two distinct, but interrelated, levels of analysis: a macro assessment of overall country risk and a micro assessment of industry-segment or company-specific risk.
Macro risk assessment generally involves evaluating a range of social, economic and political characteristics. Although the quantification of these is subjective, the assessment framework tends to equate country risk with economic volatility, social unrest and political instability.
The results of most rating methods, while interesting, are too often inconsistent and inconclusive. This reinforces the belief of many social scientists that measuring qualitative social, economic and political characteristics using a rigid formula is of limited use.
Micro risk assessment involves evaluating a range of country characteristics as they relate to the company or its industry. The aim is to determine the sensitivity of the company or industry to particular macroenvironmental factors. Although such models vary from a simple Pest or Swot analysis to a sophisticated qualitative rating model, the underlying assumption remains the same: the greater the company or sector profile, and the greater the socio-economic volatility, the higher the possibility of government intervention. …