Risk Country

What is country risk

country risk is a financial indicator that measures the possibility of default of an emerging nation (on process of development). This value estimates whether a country will be able to meet its internal (public spending) and external (international credits, Treasury bills, bonds) obligations.

When a nation has a high country risk, local and foreign investors lose confidence in it and stop investing. This has a great impact on the economy of the debtor country, by limiting its ability to generate income.

The possibility of default of a country is measured with the risk premium. The risk premium is the difference between the interest rate on the debt of a country with a higher probability of default and that of a more stable country. The interest rate will always be higher in countries with higher country risk. That is why, to calculate the risk premium, countries with stable economies, such as the United States in America and Germany in Europe, are taken as a reference.

Country risk is measured according to three indices created by the financial company JP. Morgan Chase, whose measurements are used as a reference throughout the world:

  • EMBI (Emerged Market Bond Index).
  • EMBI+ (Emerged Market Bond Index Plus)
  • EMBIGlobal

The three indices measure the same thing (the probability of default), but each of them groups together a set of different countries.

The term country risk is relatively recent. It was only in the 1970s that the economist Arnold Harberguer raised the need to measure the possibility that a debtor country would default on its commitments to its creditors, which in the economic field is known as falling into default.

Types of country risk

The possibility that a country cannot meet its economic commitments can be of three types:

  • sovereign risk: it is the possibility that individuals, legal entities or the public administration of a country cannot pay their debts. For example, if the state electricity company of a country asks for an international credit to improve its infrastructure, its possibility of default is called sovereign risk.
  • Transfer risk: it is the impossibility of honoring a debt due to lack of access to foreign currency, for example, due to exchange controls.
  • generic risk: debt risk associated with the behavior of the business sector of a country. If the business sector of a given country faces difficulties in paying its debts due to an exchange control or a general decrease in its productive capacity, the possibility that it will pay its debts decreases, therefore, its risk increases.
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Factors influencing country risk

Country risk can be affected by three types of variables. Typically, in countries with the highest probability of debt default, there is more than one factor involved.

  • Economic factors: such as the stability of the local currency, whether or not there is access to foreign exchange, inflation levels, the increase or decrease in GDP, per capita income, autonomy of the Central Bank, price controls, etc.
  • political factors: stability of government institutions, levels of governance, whether there is alternation of power, whether political plurality exists and is respected, size of the bureaucratic apparatus, whether or not there is legal security, etc.
  • Social factors: existence or not of citizen participation, social movements, freedom of expression, etc.

Who rates country risk and how is it measured?

Country risk is measured by investment firms and media specialized in economic analysis. Each one of them uses its own methodologies, considering the factors previously seen.

The indices most currently used to measure country risk are the EMBI (Emerged Market Bond Index), created by the investment bank JP Morgan Chase.

EMBIs measure the difference between the interest rate on bonds issued by an emerging country and the interest on bonds issued by the United States or Germany. These countries are taken as a reference as they are considered risk-free in the American and European continents, respectively.

The difference between the two rates is called swap either spread and is expressed in basis points (bp). to major spreadhigher country risk.

The EMBI indices consider a series of quantitative and qualitative factors to determine how feasible it is for that country to honor its debts. They are a kind of qualification that is given to a country based on its ability to pay.

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EMBI (Emerged Market Bond Index Plus)

It is an index created in 1994 and is calculated daily based on Brady bonds. These bonds are financial instruments that allow emerging nations to restructure their debts for up to a maximum of 30 years, which gives them greater payment flexibility.

EMBI+

This index was created in 1995 and is much broader than the traditional EMBI, since it considers other investment variables such as loans and Eurobonds, in addition to Brady bonds.

The countries whose risk is measured with this index are:

  • Ukraine
  • Bulgaria
  • Russia
  • Poland
  • Morocco
  • Nigeria
  • Malaysia
  • Philippines
  • Panama
  • Peru
  • Ecuador
  • Argentina
  • Brazil
  • Colombia
  • Mexico
  • Venezuela
  • South Africa
  • Turkey.

EMBIGlobal

This index was created in 1999, and includes countries that were not previously considered emerging. To select the countries that will integrate the index, their income per capita and their history of debt restructuring are taken into account.

Currently, this index is made up of:

  • Bulgaria
  • Croatia
  • Hungary
  • Argentina
  • Brazil
  • Chili
  • China
  • Colombia
  • Ivory Coast
  • Egypt
  • Dominican Republic
  • Ecuador
  • The Savior
  • Lebanon
  • Poland
  • Morocco
  • Nigeria
  • Pakistan
  • South Africa
  • Uruguay
  • Venezuela
  • Thailand
  • Tunisia
  • Turkey
  • Ukraine
  • Russia
  • Malaysia
  • Mexico
  • Panama
  • Peru
  • Philippines

Country risk in Latin America

Most Latin American countries are considered emerging or developing. And many of them have a long history of indebtedness and economic crises that have led them, at different historical moments, to have a very high country risk.

For example, between 2019 and 2020, Argentina ranked second in the Latin American country risk ranking, due to its inability to pay a debt contracted with the International Monetary Fund. The first place was occupied by Venezuela, due to its complex economic, political and social situation.

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In contrast, countries such as Peru and Chile have the lowest country risk in the region and are therefore considered more reliable and attractive to local and foreign investors.

This is an example of a country risk ranking from January to September 2019 that includes some Latin American countries from the EMBI+ index:

Country risk, example of ranking with Latin American countries

Why does the country risk increase?

When a country is experiencing serious economic, political or social problems, its risk of default increases. For example, countries with high inflation, exchange controls or social unrest generate mistrust in the international market.

In this type of situation, analysts and investors assume that the country is going through a crisis that may have an impact on its economy and, therefore, on its ability to pay the debts it has contracted, so its “reputation” as a debtor decreases. In other words, the greater the mistrust, the greater the country risk.

It can be said then that the country risk not only measures the probability of default, but is also a measure of the confidence that a nation generates to do business. Therefore, it is also a measure of the level of risk that investors are willing to take in that country.

How does the country risk affect the common citizen?

Country risk is an indicator that can have a direct influence on personal finances. A country with a low risk of default is very attractive for domestic and foreign investment, and this has a direct impact on the income that the nation can receive.

A higher income, greater expansion of the productive apparatus, more employment and opportunities for economic growth if the resources are well managed.

On the other hand, a country with a high risk is not very reliable for investment, since no individual, company or organization will want to invest their money if there are no guarantees of return. And if the country does not generate income due to lack of investment, it may suffer an economic collapse.

See also Inflation