Understanding Country Risk and How to Weigh It
Understanding Country Risk and How to Weigh It
What is Country Risk?
Country risk refers to the uncertainty associated with investing in a particular country, including political, economic, exchange-rate, or technological influences. Country risk is the risk that a foreign government will default on its financial commitments and increase transfer risk. It is also the degree to which political and economic unrest affect issuers’ securities in a specific country.
Key Takeaways:
– Country risk refers to the uncertainty of investing in a given country.
– It most often refers to the possibility of default on locally issued bonds.
– The United States is considered the benchmark for low country risk.
– Analysts use MSCI Indexes, OCED reports, or rating-agency reports to analyze country risk.
Understanding Country Risk:
Considering country risk is critical when investing in less-developed nations. Political instability and other factors can negatively impact investments in these countries, which can reduce the expected return on investment. While some risks can be mitigated, like exchange-rate risk through hedging, risks such as political instability often lack effective hedges. Therefore, analysts examine the country’s fundamentals, including politics, economics, and general health of society, when assessing sovereign debt. Foreign direct investment and long-term investments face the highest potential for country risk.
Weighing Country Risk:
The United States is commonly seen as the benchmark for low country risk. Investors interested in countries with high levels of civil conflict, like Argentina or Venezuela, should compare their country risk to that of the U.S. Professional analysts often use MSCI index data to measure the effect of country risk in a specific location.
Getting Help in Assessing Country Risk:
International organizations like the Organisation for Economic Co-Operation and Development (OECD) evaluate country risk, publishing updated lists of countries and associated risks for setting interest rates and payment terms. Credit rating agencies like Standard & Poor’s (S&P), Moody’s, and Fitch also provide sovereign ratings, analyzing institutional effectiveness, government, economic structure, growth prospects, external finances, and fiscal and monetary flexibility. Large investment-management firms rate country risk through indices like the BlackRock Sovereign Risk Index (BSRI), which tracks current risk levels and trends.
