Academic journal article Revue Canadienne des Sciences de l'Administration

The Prediction of Country Risk Classification: The Case of the Export Development Corporation of Canada

Academic journal article Revue Canadienne des Sciences de l'Administration

The Prediction of Country Risk Classification: The Case of the Export Development Corporation of Canada

Article excerpt

The Export Development Corporation (EDC) is Canada's official export credit agency. Its purpose is to facilitate and promote export activities of Canadian companies. Like the Export-Import Bank in the United States, the Exports Credits Guarantee Department in the United Kingdom, and the Compagnie Francaise d'Assurance pour le Commerce Extrieur in France, EDC's financial services assist Canadian exporters in competing effectively in international markets by reducing the financial risks associated with export sales or by funding foreign buyers of Canadian exports. An economic discussion and a review of these export credit and insurance programs in some developed and developing countries can be found in Fitzgerald and Monson (1989) and Letovsky (1990). Two recent statistics bring to light EDC's major and increasing role in the risk management of Canadian exporters: EDC paid 401 claims in 1989, totalling $22.7 million, and while the volume of exports insured by EDC has jumped by almost 80 percent since 1985, the number of claims paid has increased 224 percent over the same period (EDC's Economic Summaries, March 1990, p. 2-1).

The purpose of this paper is to replicate EDC's country risk classifications on the basis of economic variables. The motivation for this type of study is two-fold. First, is the desire to provide insight on the determinants of EDC's country risk classifications. The modeling of EDC's risk classifications should be of interest to EDC itself, and the assessed countries (Ederington & Yawitz, 1987; Foster, 1986). It is important to EDC that there be consistency in the classification assigned to individual countries. The incorporation of a model into the classification process is one way of reducing inconsistencies across individual classifications. Moreover, classification models could provide relevant information to EDC on the implicit judgment process of its assessors. If, for example, we are unable to replicate satisfactorily EDC's classification process using available economic statistics, this could be interpreted as 'indirect evidence' that judgment and qualitative analyses enter into the determination of EDC's country risk classification. Another use of a classification model is to highlight to sovereign governments those variables that affect country risk classifications. Governments can then factor into their decision the likely consequences for their risk classification of alternative actions they are considering (for example, measures taken to encourage export growth). The second motivation for this study stems from a need to contrast short-term and medium-/long-term country risk assessments. As described below, EDC distinguishes, for risk assessment purposes, short-term (less than one year) services (export insurance and guarantee) and medium-/long-term (over one year) services (export financing). By replicating both country risk classifications, we shall provide evidence on possible differences in EDC's short-term and medium-/long-term judgment process.

In the following section, EDC's risk classification process is described. Then we discuss the determinants of country risk classification.

EDC's Country Risk Classification Process

The rationale for country risk classification at EDC does not stem from the aim of value maximization, as it would in a private corporation. Rather, it is the obligation towards its partners (exporting firms and importing countries) to price its services equitably. Furthermore, although the Canadian government may accept to forego any direct return on its investment in EDC, it may not agree to cover any deficit that EDC could suffer. This forces EDC to operate near its break-even point. Thus the task of country risk management inside EDC is divided into two major phases: risk assessment (which should be as accurate as available information allows) and risk pricing (which may be subsidized, to account for externalities). The Economics Division is in charge of the risk assessment task. …

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