Country Risk Analysis

South-Western/Thomson Learning © 2006 Slides by Yee-Tien (Ted) Fu

 What all we will cover :
 To identify the common factors used by
MNCs to measure a country’s political risk
and financial risk;
 To explain the techniques used to measure
country risk; and
 To explain how MNCs use the assessment of
country risk when making financial decisions.
 Case study on McDonalds in France.
 What is Country Risk Analysis

• Country risk represents the potentially

adverse impact of a country’s environment
on an MNC’s cash flows.
Why Country Risk Analysis Is Important
• Country risk analysis can be used:
¤ to monitor countries where the MNC is
currently doing business;
¤ as a screening device to avoid conducting
business in countries with excessive risk;
and
¤ to revise its investment or financing
decisions in light of recent events.
 Financial Risk Factors
• Indicators of economic growth
¤ The current and potential state of a
country’s economy is important since a
recession can severely reduce demand.
¤ A country’s economic growth is dependent
on several financial factors - interest rates,
exchange rates, inflation, etc.
 FINANCIAL RISK FACTORS
Contd…
• Financial distress in a country can
encourage a government to implement
policies that could limit the MNC’s market
penetration there
• Additional host government restrictions
may be enforced after an MNC establishes
a foreign subsidiary
 Political Risk Factors
• Attitude of consumers in the host country
¤ Some consumers are very loyal to locally
manufactured products.
• Actions of host government
¤ The host government may impose special
requirements or taxes, restrict fund
transfers, and subsidize local firms. MNCs
can also be hurt by a lack of restrictions,
such as failure to enforce copyright laws.
 Political Risk Factors
• Blockage of fund transfers
¤ If fund transfers are blocked, subsidiaries
will have to undertake projects that may
not be optimal for the MNC.
• Currency inconvertibility
¤ The MNC parent may need to exchange
earnings for goods if the foreign currency
cannot be changed into other currencies.
 Political Risk Factors
• War
¤ Internal and external battles, or even the
threat of war, can have devastating effects.
• Bureaucracy
¤ Bureaucracy can complicate businesses.
• Corruption
¤ Corruption can increase the cost of
conducting business or reduce revenue.
 SUBJECTIVE FACTORS

• Country’s attitude towards private enterprise

• Risk of currency devaluation
• Risk of government`s income reduction
• External flows dependence
• Productivity restrictions
• Social pressures
• Attitude of consumers in the host
Types of Country Risk Assessment
• A macroassessment of country risk is an
overall risk assessment of a country
without considering the MNC’s business.
• A microassessment of country risk is the
risk assessment of a country with respect
to the MNC’s type of business.
• The overall assessment thus consists of
macropolitical risk, macrofinancial risk,
micropolitical risk, and microfinancial risk.
Types of Country Risk Assessment
• Note that there is clearly a degree of
subjectivity in:
¤ identifying the relevant political and
financial factors,
¤ determining the relative importance of each
factor, and
¤ predicting the values of factors that cannot
be measured objectively.
 Techniques of
Assessing Country Risk
• The checklist approach involves rating
and weighting all the macro and micro
political and financial factors to derive an
overall assessment of country risk.
• The Delphi technique involves collecting
various independent opinions and then
averaging and measuring the dispersion
of those opinions.
 Techniques of
Assessing Country Risk
• Quantitative analysis techniques like
regression analysis can be applied to
historical data to assess the sensitivity of
the business to various risk factors.
• Inspection visits involve traveling to a
country and meeting with government
officials, firm executives, and consumers
to clarify uncertainties.
 Techniques of
Assessing Country Risk
• Often, firms use a variety of techniques for
making country risk assessments.
• For example, they may use the checklist
approach to develop an overall country
risk rating, and some of the other
techniques to assign ratings to the
factors.
 Measuring Country Risk
The checklist approach involves:
 Assigning values and weights to political and
financial risk factors,
 Multiplying the factor values with their
weights, and summing up to give the political
and financial risk ratings,
 Assigning weights to the risk ratings, and
 Multiplying the ratings with their weights, and
summing up to give the country risk rating.
 Measuring Country Risk
• The procedures for quantifying country
risk will vary with the assessor, the
country being assessed, as well as the
type of operations being planned.
• Firms use country risk ratings when
screening potential projects, and when
monitoring existing projects.
 Comparing Risk Ratings
Among Countries
• One approach to comparing political and
financial ratings among countries is the
foreign investment risk matrix (FIRM ).
• The matrix displays financial (or economic)
and political risk by intervals ranging from
“poor” to “good.”
• Each country can be positioned on the
matrix based on its political and financial
ratings.
 Incorporating Country Risk in
Capital Budgeting
• If the risk rating of a country is acceptable,
the projects related to that country
deserve further consideration.
• Country risk can be incorporated into the
capital budgeting analysis of a proposed
project either by adjusting the discount
rate or by adjusting the estimated cash
flows.
 Incorporating Country Risk in
Capital Budgeting
• Adjustment of the discount rate
¤ The higher the perceived risk, the higher the
discount rate that should be applied to the
project’s cash flows.
• Adjustment of the estimated cash flows
¤ By estimating how the cash flows could be
affected by each form of risk, the MNC can
determine the probability distribution of the
net present value of the project.
 Applications of
Country Risk Analysis
• As a result of the crisis that culminated in
the Gulf War in 1991, many MNCs
reassessed their exposure to country risk
and revised their operations accordingly.
• The 1997–98 Asian crisis caused MNCs to
realize that they had underestimated the
potential financial problems that could
occur in the high-growth Asian countries.
 Applications of
Country Risk Analysis
• Following the September 11, 2001 attack
on the United States, some MNCs reduced
their exposure to country risk by
downsizing or discontinuing their
business in countries where U.S. firms
may be subject to more terrorist attacks.
 Reducing Exposure
to Host Government Takeovers
• The potential benefits of DFI can be offset
by country risk, the most severe of which
is a host government takeover.
• To reduce the chance of a takeover by the
host government, firms often:
 Use a short-term horizon
¤ This technique concentrates on recovering
cash flow quickly.
 Reducing Exposure
to Host Government Takeovers
 Rely on unique supplies or technology
¤ In this way, the host government will not be
able to take over and operate the
subsidiary successfully.
 Hire local labor
¤ The local employees can apply pressure
on their government if they are affected by
the takeover.
 Reducing Exposure
to Host Government Takeovers
 Borrow local funds
¤ The local banks can apply pressure on their
government if they are affected by the
takeover.
 Purchase insurance
¤ Investment guarantee programs offered by
the home country, host country, or an
international agency insure to some extent
various forms of country risk.
 Reducing Exposure
to Host Government Takeovers
 Use project finance
¤ Project finance deals are heavily financed
with credit, thus limiting the MNC’s
exposure. The loans are secured by the
project’s future revenues and are
“nonrecourse.” A bank may guarantee the
payments to the MNC.
 McDonalds in France
• According to some analysts, McDonald's entry into
the French market was seen as an invasion of
American culture in a country known for its rich
heritage of cuisine. "It has been tough for us to
become integrated in the French market. The focus
we had at the beginning was to open more stores and
to get suppliers, and we were attacked because we
had this image of globalization,"6 said Eric Gravier,
vice-president of McDonald's France, in 2008.
 Contd…

• The first McDonald's restaurant in France

was opened in 1972 at Créteil, near Paris
by Raymond Dayan (Dayan), who had
acquired exclusive franchise rights from
the company. As there was low demand
for American fast food chains in France,
McDonald's granted a master franchise to
Dayan to open 166 stores in the country
for a reduced fee.
 Contd

• When McDonald's entered Paris, its policy

was not to adapt to foreign cultures, but
rather to change the cultures to fit
McDonald's. However, it soon learned that
in order to succeed in France, it had to
follow the ways of the French and tailor its
menu to local tastes
 Contd

• Though McDonald's was able to establish

its presence in France, some French
consumers were of the view that the
Golden Arches were a symbol of
globalization and a threat to the refined
palates of the French.
 Contd

• Initially in France, McDonald's outlets

were similar to their American
counterparts and the menu items mostly
similar. However, over the years,
McDonald's promoted itself in accordance
with the tastes of the French customers.
 Contd

• However, McDonald's popularly known as

McDo in France, attracted French diners
and boosted its sales by responding to the
preferences of the locals, tailoring its
menu to suit local tastes, remodeling its
restaurants, and adding new menu items.
THANK YOU