The level of country-risk must be examined for any country before it can be selected as an attractive destination as the level of returns on offer are immaterial if the returns cannot be recouped from the country
Investors typically take 5 to 10 years of historical data as a basis for projections of the future. But in cases such as Russia’s invasion of Ukraine or Sri Lanka’s rapid economic deterioration, the past is not a metric that can be relied on for the future.
Although the global financial system is based on faith and investors seeking to maximize risk adjusted returns, the risk amplifies when it comes to investing abroad as you need to account for the myriad of risks that come with investing in an unfamiliar territory and economy, not just the ones focused on the individual characteristics of the asset. Mature fundamental analysis in cross country investment also considers how the stock is positioned relative to its industry peers with respect to trends affecting the industry or country.
The level of country-risk must be examined for any country before it can be selected as an attractive destination as the level of returns on offer are immaterial if the returns cannot be recouped from the country.
This form of investment ranges from investments in the stock market of different countries to the foreign direct investments which are often so crucial for developing countries. Therefore, developing countries like Bangladesh who are competing to attract international funds should focus on improving their risk profile. Bangladesh needs to do a lot better on these metrics before we can expect significant inflows of FDI that will move the needle on our development.
Sovereign rating agencies are often viewed as the authority on the riskiness of the countries that are invested in. They take cognisance of the macroeconomic performance, fundamental structure of the financial system, tax system, policies for investment promotion and protection among other things while determining a country’s risk rating. International investment community does look up to them for their investment decision making.
Investors want a consistent set of policies which will protect the rights of investors in the long run. They do not want to simply cash out immediately but focus on growing their investment. In such a situation, flexible laws that adapt quickly but are based on the same principles are very important.
Country risk can be defined by different institutions into many complex and interrelated factors, but it can largely be divided into four types of risks: economic, political, market and security. Each of them can be broken down and there is no universal agreement on exactly what constitutes each type of risk, however, a few are generally accepted as being part of each bracket.
1) Economic and financial risk: This largely concerns the sovereign risk, exchange rate environment and trade credit risk.
a) Sovereign risk: It concerns the inability/unwillingness of a borrowing government to repay loans that it has taken. Since governments cannot be forced to pay the risk that a government might default on, its obligations are significant and investors all over the world treat this as one of the highest risks. For example, Argentina defaulted on its debt obligations in 2001 and since then has been flagged as a very risky investment destination. Sovereign risk increases when the budget deficit of the country is high as it must pay a large portion of its revenue just to service debts.
b) Exchange rate environment: How much a country’s currency fluctuates has a direct impact on the returns that investors can expect. Whether it is multi-national companies repatriating money or individual investors taking back funds, they all prefer a stable exchange rate environment with few fluctuations. This is affected by unexpected changes in inflation and interest rates which are affected by central bank policies. Thus, the macroeconomic situation has a large impact. This means Bangladesh Bank’s managed exchange rate with the USD has been useful to these investors. If the foreign reserves of the country are high, then it can manage exchange rate movements by selling the foreign reserves. However, if the level goes down beyond a certain level, the country may not be able to support its trade obligations so this must be managed carefully.
c) Trade credit: If the trading partner cannot or is unwilling to pay their share of the business, then international investors will not invest in the country. This is more than just the business culture of the country as it goes beyond to include the legal framework, options for receiving payment and support from national authorities.
d) Convertibility/repatriation: If it is difficult for investors to repatriate money from an economy that does not represent an attractive investment destination. Often currencies are not widely traded in the international market and large withdrawals may cause major forex losses that sacrifice overall returns.
2) Political risk: This is the most popular risk in this list and the one most people consider when investing in a developing country. This largely encompasses the nature of the political system and the stability of the political regime.
a) Political stability: If a country undergoes strikes, political upheavals, and disruptions on a regular basis, it suffers from low political stability and therefore is a riskier destination than a country which has peaceful transitions of power and there are fewer disruptions to business. For example, Bangladesh’s relative political calm has improved the investment profile internationally.
b) Nature of political system: The norms in the political system, especially regarding the transfer of power, treatment of business interests, ideologies of the political parties and the quality of international relations built by the country, all have a bearing on the attractiveness of a country politically as an investment destination.
3) Market risk: This relates to the legal environment in which a firm does business, the intellectual property regime, ease of doing business, banking structure in the host country and dispute resolution options available.
a) Legal environment: How easy it is to receive legal support and structured dispute resolution mechanisms plays a major role in the ease of doing business in the country. Since companies prefer to settle matters outside of costly litigation in courts, this is something they care about greatly. This is an area which is sorely lacking in Bangladesh.
b) Ease of doing business: Support with setting up a business, obtaining permits, setting up a supply chain and obtaining financing will all determine whether a company finds the hassle worth it to set up in a country. The banking structure and the norms which govern international settlements will also be important as multi-national companies receive and repatriate funds on a regular basis so international and local banks with strong international settlement regimes will be very important. The structure of tax laws and how supportive it is to businesses will have a major effect as well.
c) Intellectual property laws: This is becoming an increasingly important aspect for developing countries and those with laws which protect IP interests are highly regarded.
4) Security: Investors must feel their investment destination is a secure place before they choose to invest. If they feel as if the country is not secure and they and their businesses are at risk of harm due to ideological, religious, or political reasons, then they will be unlikely to invest.
A more comprehensive list must be used to evaluate potential investment opportunities with guidelines on how to update the status of those assumptions. Bangladesh must excel in mitigating the risks outlined above and be very transparent about the risks investors face before we can hope to attract the levels of foreign direct investment we have targeted. Close government collaboration with global banks and professional firms with an international presence will go a long way to making Bangladesh an attractive investment destination. Of course, we need to do some hard work to refine our domestic set up too.
The writer is an economic analyst