Where Did the Money Go? Country Risk and Entering Markets Abroad

Country risk only applies to big banks investing vast sums of money in a country, right?

No. It can affect even start-up businesses or non-profit organizations too.

Country risk is “the risk that, due to the country’s political/social situation, level of foreign reserves, international liabilities or government policy, the company will have difficulty obtaining the return on its investment into the country.”

We saw in the previous post that entering a country’s market requires the examination of the political context. The political situation feeds into country risk as well. Armed conflict or large scale protest can affect the availability of hard currency by decreasing the GDP.

In a different situation, a decrease in hard currency could also lead the government to protect its currency. For instance, Azerbaijan, a country that two years ago was awash with U.S. dollars from its flourishing oil industry is now struggling with money leaving the country. In January, the Azerbaijan parliament put a 20% tax on people sending 50,000 dollars or more per year. Aware that such regulations could affect foreign investment Azerbaijan’s Finance Minister was quick to reassure foreign investors that they were exempt from the regulations.

At the same time, to keep the manat from plummeting, the Azerbaijani government has withdrawn licenses from some private currency exchange booths around the country.

Furthermore, in 2015, Azerbaijan hosted the first European Games at a cost of roughly 1.2 billion dollars. Now it is looking to the IMF and Worldbank for 4 billion dollars’ worth of loans to address issues from the downturn in the oil industry.

How does this affect a business investing in Azerbaijan or any emerging market?

The less hard currency available in the country, the less chance the business will be able to receive a return on investment or the non-profit organization will be able to retrieve the money it has brought into the country.

Monitoring Country Risk

The company or organization is well advised to conduct a country risk analysis before going into the country. It’s impossible to predict everything, but that doesn’t mean we shouldn’t get a sense of the probable. Here are some of the tell-tale signs of country risk.

·         Gross Domestic Product—A falling GDP or a GDP that is too closely tied to one commodity or industry means that this country is at high risk if the price of the commodity takes a turn for the worse. This may make it difficult to find hard currency to repatriate.

·         Foreign Debt Level—A country with a high debt to GDP ratio may be too leveraged, and to pay the debt may need to take hard currency out of circulation. Look at what the trends in debt have been in recent years. Have the country’s loans been increasing? Are they relying too heavily on international loans?

·         Foreign Exchange Reserves—A good way to know whether or not hard currency is available in a country is to look at the amount of hard currencies (dollars, Euros, pounds sterling) held by the central bank. It’s also important to know how the national currency is managed. Has it been floated, i.e. does the market determine its exchange rate? Is it pegged to a hard currency or a basket of currencies? Or somewhere in between? In the case that the economy begins to heat up, the pegged currency could result in higher labor rates and thus inflation making the country less competitive in the global market. A decrease in GDP could then follow, meaning less hard currency which would affect the company’s ability to capitalize on investment.

A pegged currency in a downturn could be hard for the country’s government to maintain. It requires a large amount of the country’s reserves to prop up the national currency.

·          Current Account Balance—The current account balance is the ratio of a country’s savings to it expenditures. Often for comparative purposes it is represent as percentage of GDP. Investopedia notes that “A nation’s current account balance is influenced by numerous factors – its trade policies, exchange rate, competitiveness, forex reserves, inflation rate and others.” A negative current account balance can indicate poor overall health of the country’s economy which can be a warning sign for a company or organization beginning to do business in a country.

·         Investment Level—The Azerbaijan Finance Minister’s fear in the earlier example of the restrictions on cash flow in Azerbaijan was right on the money. He knew the parliament’s taxing money leaving the country could stop companies or individuals from investing there. The less investment in the country, particularly one suffering from a significant downturn in its most important industry, could lead to even greater economic woes. For the company or organization doing business in the country, the decline in Foreign Direct Investment would mean less hard currency in the country available for repatriation.

·         Fiscal Balance—An indicator of how well the country’s government can manage its own spending is its fiscal balance, which is the amount of taxes and assets sold, compared to its spending.  This is the indicator that political candidates in the United States are constantly bickering about. For a company or organization looking to invest in a country, fiscal balance is a way to understand whether or the government acts responsibly with its money, but also whether there is a chance in the future that hard currency will be needed for outstanding debts to foreign creditors.

Each of the above, can help your company or organization better understand the economy of the country you are seeking to enter, and it will give you an opportunity to understand the level of risk you are putting your company into with your investment, whether it be the conduct of activities or provision of services or a deeper investment by opening an office or buying into an already existing company. Conducting country risk analysis helps you keep your business safe.