This paper addresses the challenge of how to express Country Risk. The authors focus on cross-border investment and review several approaches to Country Risk Assessment (CRA), which are placed in the context of the recent accession of many Eastern European countries to the European Union. However the issues and the principles would apply to the other areas of the widening global chess-board. As the creation of a single currency zone eliminates only one kind of Country Risk, the issue of measuring Country Risk in investment appraisals revives the debate as to whether Country Risk should be considered as specific risk and dealt with by adjusting the cash flows, or as a systematic risk and expressed in the additional premium to the discount rate, which is used in determining the cost of capital. The paper proceeds to apply and compare methods of incorporating risk factors into the cost of capital. A Polish example is used to test methods that can be used to estimate a country's equity risk premium. This is then followed by the issues involved in moving from the estimation of Country Risk to project risk, adopting the perspective of an individual company's exposure to risk. The calculations are once again speculatively applied to Poland, and show that different expected returns arise from different approaches. Within the great debate in the financial community as to how, where and when to include Country Risk factors in the project appraisal process, many s build from one point of consensus, namely, that the cost of capital (the discount rate) should reflect only non-diversifiable risk, whereas diversifiable risk is better handled in the cash flows. A key example using Discounted Cash Flow (DCF) for a green field project in Poland is subjected to two parallel analyses, one of which uses scenario analysis and the other a discount rate for Country Risk. Not only do the results significantly diverge, one of them appears contrary to any acceptable version of common sense. The authors therefore conclude that there is no established single correct approach to measuring Country Risk. This paper exhibited the need to interrogate assumptions; it did not purport to provide answers. For the subject of Country Risk, using the EU accession countries as fresh field for research, it is urgent that less ambiguous techniques for measuring risk be rapidly developed.
The
expansion of international trade and investment, and international company operations
in production, export-import and supply chain management, in the past 30 years
have stimulated interest in Country Risk. The political and economic dimensions
of ideological conflict surrounding multinational companies, intensified before
the collapse of the Soviet Union in the early 1990s, the demonstration of restrictive
and even threatening policies towards multinational companies on the part of newly
independent nations from the 1960s through the early 1980s, and the late 20th and early 21st centuries' renewal of radical opposition to globalization
and international capitalism, in turn excited the concern about the security of
foreign direct investment. Moreover, the world chess-board for foreign investment
is wider than it was in the 1980s, whilst some countries remained or became no-go
areas for most investment, the expansion of opportunities includeed countries
that have opened more to foreign direct investment and/or that have moved into
the focal range of investors, e.g., China, South Africa, Eastern and Central Europe,
India, to name the most obvious. In additionto this the September 11, 2001
terrorist attack, invasion of Iraq and many terrorist attacks have rejuvenated
concern with the adequacy of the tools by which risk in the field of cross-border
operations and investment can be identified and assessed—typically in uncertain
conditions. |
