country risk - latin america

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GROUP 4 PRESENTATIONInternational Finance

Global MBA II Centrum | Tulane University

July 9th, 2009Country Risk N 09 July 2009

Global MBA Centrum | Tulane University

Country Risk1AGENDA OUR PROGRAM

Country Risk: Definition / Political vs. Financial Risks Economic and Political Factors Key Indicators Relationship with the Cost of Capital From International Banking Point of View Survey of Country Risk for LatAm Countries Summary and Conclusions

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Country Risk21. COUNTRY RISK THE BASICS

A collection of risks associated with investing in a foreign country. Political, exchange rate, economic, sovereign, transfer risk MNCs, political scientists, economist: no unanimity what is and how to measure it Country risk varies among countries: some countries have high enough risk to discourage much foreign investment. Can reduce the expected return on an investment and must be taken into consideration whenever investing abroad

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Country Risk31. COUNTRY RISK DEFINITIONThe assessment of the potential risks and rewards associated with making investments and doing business in a countryRepresents the potentially adverse impact of a countrys environment on the MNCs cash flows.What the public and private investors measure to determinate which countries offer the best prospects for investmentsMust be assessed comprehending its economic and political policies MNCs invest- vs. banks debts-

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Country Risk4 Political considerations lead to countries to pursue economic policies -so country risk analysis cannot be exclusively economic- Political economy: interaction between politics and economics. It is done in a continuous basis and affects: Monetary & fiscal policies Property Currency & trade controlsLabor lawsRegulatory restrictionsRequirements for more production

1. COUNTRY RISK A POLITICAL OR ECONOMIC RISK?

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Country Risk52. COUNTRY Risk APROACHES

From a country specific: macro indicators - country risk analysis affect all firms in a host country non diversifiable From a firm specific: micro indicators individual firm specific to an industry, firm or project in a country: diversifiable

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Country Risk6 Primary focus: How well is the country doing economically?. No country offers a perfect business environment. Countries are better or worse from than an average. Fiscal Irresponsibility: high government deficits (as % GDP), insatiable appetite for money: expropriations, raising taxes or printing money (monetizing the deficit)

2. COUNTRY RISK ECONOMICAL & POLITICAL FACTORS

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Country Risk7 Monetary Instability: Lead to high and volatile inflation: large government deficits that central bank monetizes Controlled Exchange Rate System: Fixing the exchange rate: taxing exports & subsidizing imports. lead, capital flights, no reinvesting, negative terms of trade


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Country Risk8 Wasteful Government Spending: Capital from abroad is used for subsidize consumption or wasted in showcase projects: exchange controls, higher taxes & others. Promote capital flights.unproductive spending & inability to service foreign debt:


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Country Risk9 Resource Base: natural, human & financial. Quality of human resources highly skilled & productive workers- and how they are put in their most efficient use (political stability: investing, flexible labor market: well allocated & free market: wages). Free market do not afford mistakes


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Country Risk10Country Risk and Adjustment to External Shocks: What are the impacts of external shocks: how well a nation responds is not the same, Asia vs LatAm; imitation& innovation vs import substitution with export reduction Market Oriented vs. Statist Policies: market economy vs command economy. Economic freedom. It is not enough to identify factors: it is needed to identify of nations susceptibility to theses shocks: focus on the financial policies and development strategies


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Country Risk112. COUNTRY Risk - international business

Political risk:The risk that a sovereign host government will unexpectedly change the rules of the game under which businesses operate -a business foreign investment would be constrained by the new policy (ies)- Expropriation nationalization- risk Disruptions in operations Protectionism restrictions for foreign- Blocked funds Loss of intellectual property rights Currency/trade controls

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Country Risk122. COUNTRY Risk - international business

Financial risk: Refers more generally to unexpected events in a countrys financial, economic, or business life Currency risk Interest rate risk Inflation risk Unexpected changes in the current account balance Unexpected changes in the balanceof trade

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Country Risk133. KEY INDICATORS OF COUNTRY RISK

Relative size of government debt Money expansion High government expenditures with low rates of return Government-imposed barriers to market forces Tax rates Number of state-owned enterprises Political and fiscal responsibility Amount and extent of corruption Lack of basic institutions of government

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Country Risk143. KEY INDICATORS OF ECONOMIC WEALTH

Structural incentivesLegal structureClear incentives to saveOpen economyStable macroeconomic policies

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Country Risk154. COUNTRY Risk RELATION TO COST OF CAPITAL

Cost of capital: The cost of capital determines how a company can raise money (through a stock issue, borrowing, or a mix of the two). This is the rate of return that a firm would receive if it invested in a different vehicle with similar risk (investopedia)

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Country Risk16

wd = debt portion of value of corporation tC = coporate tax rate cD = cost of debt (rate) we = equity portion of value of corporation cY = cost of internal equity (rate) 4. COUNTRY Risk RELATION TO COST OF CAPITAL

Cost of capital: The weighted average cost of capital (WACC) is the rate (expressed as a percentage, like interest) that a company is expected to pay to debtholders (cost of debt) and shareholders (cost of equity) to finance its assets

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Country Risk174. COUNTRY Risk RELATION TO COST OF CAPITALCost of debt: The interest rate a company is paying on all of its debt, such as loans and bonds. The cost of debt is computed by taking the rate on a risk free bond (RF) whose duration matches the term structure of the corporate debt, then adding a default premium. This default premium will rise as the amount of debt increases (since the risk rises as the amount of debt rises).

(Rf + credit risk rate)(1-T)

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Country Risk184. COUNTRY Risk RELATION TO COST OF CAPITALCost of Equity: The return that stockholders require for a company.

Investors need to be compensated in two ways: time value of money and risk. The time value of money is represented by the risk-free (rf) rate and compensates for placing money over time. The other part represents risk and calculates the amount of compensation the investor needs for taking on additional risk . This is calculated by taking a risk measure (beta) that compares the returns of the asset to the market over a period of time and to the market premium

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Country Risk194. COUNTRY Risk RELATION TO COST OF CAPITAL Evidence of country risk and investors required returns An increase (decrease) in country risk tends to be followed by a stock market fall (rise) Countries with high country risk have more volatile returns higher betas (systematic risks)

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Country Risk204. COUNTRY Risk RELATION TO COST OF CAPITAL

The country risk affects the companies Cost of Capital:

If the country is high risk, the banks will ask a higher interest rate before lending money

If the country is high risk, the shareholders will ask for a higher interest rate to invest their money

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Country Risk21 Explores the ability for borrowers to repay their debts to foreign lenders in a timely manner. Countries which have defaulted on their international debts have a high grade of corruption, bureaucracy and uncompetitive industries. Many of these countries show large budget deficits, leading to high rates inflation.

5. COUNTRY Risk from International Banking view

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Country Risk225. COUNTRY Risk from International Banking view

Country Risk and Terms of trade: If terms of trade increase, a nation will be a better credit risk and foreign goods will become less expensive. The standard of living will improve and consumers and businesses will become more dependent on imports. This is considered a political risk. The Governments Cost/ Benefit Calculus: The cost of austerity is determined by the countries external debts relative to its wealth. Lower is the ratio, lower is the amount of consumption to be sacrificed to meets a nations foreign debts.

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Country Risk236. COUNTRY Risk ASSESERSStandard and Poors Moodys Investor Services Fitch Bank of America Business Environment Risk Intelligence Control Risks Information Services Dun and Bradstreet Economist Intelligence Unit Euromoney Org for Econ Co-operation and Development

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Country RiskFiscal and Economic Key Indicators Real GDP (Gross Domestic Product) Growth rate per capita Public sector balance a % of the GDPNational budgeting performancePublic sector debtCPI (Consumer Price Index) = InflationAbility to service the foreign debtSolvency

Social, Politic and Regulatory Key Indicators Corruption Doing Business Competitiveness (the GCI - Global Competitiveness Index measure 100 indicators, from labor law to those referred to the governability of the countries). Income equality (GINI = poverty index). Human Development (measure 30 social economics indicators, from technology to literacy).

6. COUNTRY Risk Standard & Poors Methodology

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Country Risk AAA: The obligor's capacity to meet its financial commitment on the obligation is extremely strong. AA: The obligor's capacity to meet its financial commitment on the obligation is very strong. A: Is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions. The obligor's capacity to meet its financial commitment on the obligation is still strong. BBB: Adverse economic conditions are more likely to lead to a weakened capacity of the obligor to meet its financial commitment. BB, B, CCC, CC, and C: Obligations rated 'BB', 'B', 'CCC', 'CC', and 'C' are regarded as having significant speculative characteristics.

6. COUNTRY Risk S&P Rating Definitions (Sovereign Bonds)

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Country Risk BB:Major ongoing uncertainties or exposure to adverse business, financial, or economic conditions which could lead to the obligor's inadequate capacity to meet its financial commitment. B: Adverse business, financial, or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitment on the obligation. CCC: In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitment on the obligation. CC: Is currently highly vulnerable to nonpayment. C: Highly vulnerable to nonpayment. The 'C' rating may be assigned to subordinated debt, preferred stock or other obligations on which cash payments have been suspended. D: Is in payment default.

6. COUNTRY Risk S&P Rating Definitions (Sovereign Bonds)

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Country Risk6. COUNTRY Risk S&P Latin America, January 2009

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Country Risk6. COUNTRY Risk CHILE A+

Macro economic indicatorsStrengths: Copper producer, abundant mining, agricultural, and forestry resources.Benefited from economic expansion for the past twenty years.Free trade agreementsPolitical stability, quality institutions and infrastructure, solid financial system.

Weaknesses:Too dependent on copper exports (half total sales abroad). Energy needs: The country remains dependent on foreign sources.The income gap still among the world's highest due especially to disparities in the education system has been a source of social tensions.

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Country Risk6. COUNTRY Risk MEXICO BBB+

Macro economic indicatorsStrengths: Has become a manufacturing power leveraging its membership in NAFTAGood macroeconomic fundamentals.The control maintained over the public deficit and the moderation of foreign debt The banking sector is relatively healthy.The working population is young and growing.

Weaknesses:Excessive proportion of its exports that go to the United States Public finances continue to be dependent on oil revenues.Social inequality and poverty and from a business environment that needs improvement. .

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Country Risk6. COUNTRY Risk PERU BBB-

Macro economic indicatorsStrengths: Abundant mining, extensive energy, agricultural and fishing resources, and an exceptional cultural heritage.Public finances have been managed with prudence. Has maintained foreign exchange reserves at comfortable levels.

Weaknesses:Lacking economic diversification.Remains vulnerable to weather conditions and fluctuations in world prices for raw materials.Ethnic cleavage between a modern society on coast and a subsistence one inland.Infrastructure developmentPoverty afflicting over half the population = political and social instability

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Country Risk6. COUNTRY Risk PERU EMBI+Perus country risk drops 13 basic points to 3.74Lima, Apr. 13 (ANDINA).- Following the regional trend, Perus country risk dropped on Thursday (April 9) 13 basic points from 3.87 to 3.74 percentage points, according to the EMBI + Peru estimated by JP Morgan investment bank. It is worth noting that on June 12, 2007, Peru registered a historic country risk decrease when it fell 95 basic points. The EMBI + Peru is measured in terms of the difference in the average performance of Peruvian sovereign bonds against the performance of U.S. Treasury bonds. Thus it is estimated the political risk and the possibility that a country can break with their payment obligations to international creditors. In other words, the country risk is the index called Emerging Markets Bond Index Plus (EMBI +), which measures the degree of "danger" that involves a country for foreign investment. The main consequences of a high level of country risk are a decline in foreign investment and lower economic growth which could lead to unemployment and low wages for people.

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Country Risk326. COUNTRY Risk BRAZIL BBB-

Macro economic indicatorsStrengths: Endowed with extensive and varied natural resources and its economy has been diversifying. Manufactured products represent a growing proportion of production and exports.Policy continuity on the pursuit of macroeconomic stability seems assured.Brazil's domestic market potential and competitive labor costs

Weaknesses:To achieve sustainable growth, structural reforms will be necessary, notably in education, social security, the employment market, taxation, and the regulatory framework Deficient energy, rail, road, port and airport infrastructure Remains exposed to fluctuations in world prices for certain commodities. Public debt remains high.

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Country Risk6. COUNTRY Risk COLOMBIA BB+

Macro economic indicatorsStrengths: Extensive natural resources (agricultural, mining).The country has diversified its exports under the ATPDEA. The government has pursued policy of consolidating public sector finances.The military aid received from the United States will likely be redirected to civil development programs.

Weaknesses:The security situation remains a problem.The poverty afflicting half the population. Fiscal reforms remain necessary.Exposure to sovereign risk continues to undermine the banking sector.

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Country Risk6. COUNTRY Risk VENEZUELA BB-

Macro economic indicatorsStrengths: Large oil, gas, and mining resources.Oil revenues = means to extend its regional political influence.The United States remains the main export market.

Weaknesses:The economy is overly dependent on a hydrocarbon sector that represents 95 per cent of exports, over half of fiscal revenues, and nearly one-third of GDP. Opaque management of the oil revenues. A lack of investment has limited oil production capacity. State interventionism and extensive corruption have undermined confidence.

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Country Risk6. COUNTRY Risk ARGENTINA B-

Macro economic indicatorsStrengths: Benefited from the strong world demand and high prices for raw materials.The undervalued local currency has benefited domestic production and export competitiveness.The country's education level and human development indicators The work force is skilled and adaptable.

Weaknesses:The economy continues to be partially dependent on raw materials Despite the restructuring of its bond debt foreign debt is still high.Improvement in public finances will depend on implementation of tight fiscal policy. Good performance by the economy will require an improved business environment and a steadier legal framework. Substantial inequality and social tensions have persisted.

Rating: 20082009 est.GDP 2008:7.0%-2.0%Inflation25.0%16.0%Public sector balance (%GDP)1.6%-0.8%

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Country RiskBetween 1974 and 1982, in Argentina occurred a capital flight of 15 to 27 billion dollars out of 32.6 billions borrowed. For Venezuela, the incomes were for 27 billion with a capital flight estimated between 12 and 27 billion dollars. For Mexico, the incomes were for 79 billion between 1979 and 1984, with a capital flight estimated between 26 and 54 billion dollars. As of end of 1988, prior to the end of the Latin America debt crisis, it is estimated that Latin Americans held 243 billion of dollars in assets abroad.

6. COUNTRY Risk LATIN AMERICA Capital FlightS

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Country Risk37In 1973, President Carlos Perez due to the raise in oil prices, declared that they did not need foreign investors. In 1980, President Luis Herrera, invited investors back but was not successful and companies did not have the confidence to return or if it would last. Declarations against foreign investing. President Caldera in 1994, stopped controls and declared against private sectors. This brought to devaluation of the 87% of the Bolivar and high inflation.

6. COUNTRY Risk Venezuela Political Risk

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Country Risk386. COUNTRY Risk Venezuela Political Risk

Hugo Chavez in 1992 arrived to power with the promise of Bolivarian Revolution to attack poverty, and businesses turned against him, the unions and media and followed by the issue of 49 revolutionary decrees in 2001 that brought to him the total control of the country. President Chavez does not believe in property rights, and his thoughts which lead to socialism have brought to more poverty and misery. From 1998 to 2004, the nations per capita income has decreased in 47% despite the rise in oil prices. By April 2005, Venezuelan Bolivar had declined it value by 73%.

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Country Risk397. CONCLUSIONS

No consensus what exactly is country risk and how to measure it. Both international banks and nonbank MNCs analyze country risk but from different perspectives There are social, cultural, political and economical factors that affect the general level of risk in a a country Country risks could be diversifiable and non diversifiable (for a whole country or for an industry, firm or specific project). The country risk affects the companies Cost of Capital The improvement of Latin American countries performance have been related to their free market policies trend

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Country Risk407. REFERENCES

Kirt C. Butler, Multinational Finance, 3e, 2004, South- Western College Publishing http://www.investopedia.com Alan C. Shapiro , Multinational Financial Management, 2010 http://www2.standardandpoors.com http://www.latin-focus.com http://www.trading-safely.com

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Country Risk41

country risk - latin america

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