Country Risk Assessment: Risk Assessment of the Developing Countries

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INTRODUCTION

International lending has become an integral part of the major U.S. Commercial banks. The recent surge in International lending and rescheduling has created both the opportunity for greater profit and exposed lenders to greater risk. The prime concern of the international bankers at this particular time, however, is the failure of the developing countries to repay their foreign debts on schedule. This failure was well publicized in August 1982, when billions of dollars in emergency credit was extended to Mexico. Since 1975, the number of countries in arrears on international repayments had risen from 15 to 68 by the end of 2003.

The developing countries are presently moving towards a trend of narrowing the account deficits; however, the problems of Argentina, Bolivia, Costa Rica, Mexico, Brazil, Poland, Romania, Sudan and Zaire are well-publicized. The adverse publicity given to the debt servicing problems of a few countries may have a negative impact on some credit worthy borrowers. It should be noted that developing countries are reducing their deficits in a period of economic difficulty, a fact often overlooked by the lenders. This narrowing is most significant for those developing countries that export manufactured goods.

The developing countries, on the whole, used borrowed funds productively. During the past 30 years, the middle income countries, which include the largest borrowers from private markets among the developing economies, performed far better than the mature industrial countries. The major borrowers, which include Argentina, Brazil, Mexico did not use external borrowed funds to substitute for domestic savings. Their gross domestic saving actually increased. External funds coming from abroad, therefore, contributed to the increased domestic investment; however all of these major borrowers experienced problems in repaying their loans on schedule due to a sharp rise in inflation in the non-oil developing countries, mostly attributable to the huge oil price increase between 2003 and 2005.

Presently, data relating to the credit worthiness of a country are commonly put into the form of ratios which are used as indicators of future debt servicing capabilities. This paper uses these debt indicators as used by the World Bank to discriminate between countries which are likely to default and countries which are likely not to default. Country risk is defined as the overall political and financial status in a country and the extent to which these conditions may affect the ability of a country to repay its debt. Debt indicators resemble the leading economic indicators used to forecast business cycles in that they contribute measurement without much underlying theory but, nonetheless are widely watched.

PURPOSE OF THIS STUDY

According to the World Bank the medium and long term indebtedness of the developing countries and territories amounted to more than 2 trillion dollars at the end of 2004. According to World Bank data the majority of this amount is indebtedness of public entities or is guaranteed for repayments by a public sector with government guarantees. A major part of the lending to developing countries is by U.S. Commercial banks whose claim on non-OPEC developing countries mounted to 8 percent for their total assets and 149 percent of their total shareholders capital. The potential threat to solvency from developing countries default is greater for the nine largest U.S. banks because their loans to the non-OPEC developing countries were 222 percent of their total capital, and their loans to Argentina, Brazil and Mexico were 113 percent of their capital. None of the banks which have been lending to the developing countries is closing its doors or reorganizing as a result of the defaults in those countries. But such upheavals are not idle fears and would surely materialize in the absence of enlightened self-interest on part of both borrowers and lenders. …