Country risk September 2009: A world in flux


Jacqueline Cutler
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With the international economy more volatile than ever, global investors are paying more attention to country risk analysis. Risk looms both where you most and least expect it. In Euromoney’s latest rankings, the US has fallen out of the top 10. Jacqueline Cutler reports.

For historical country risk data please visit the Euromoney Country risk website
Country risk September 2009: Methodology

IN THE INCREASINGLY interdependent global economy, country risk is spreading and transferring among nations at unprecedented rates. The size and speed of international financial integration and global capital mobility impose greater economic and political risks on all countries involved. Particularly over the past 18 months, we have learnt that no country is immune to the financial, macroeconomic or geopolitical shocks of other regions. Since Euromoney’s last country risk survey in March, nations have soared and slipped in the rankings more than ever before. The velocity of change is astounding: in the past, a country would move 10 places in 10 years; now, we are seeing nations jump as many as 30 slots in six months.

Gabriel Stein, director and chief international economist at Lombard Street Research, says: "The pace of change is due to globalization. As countries become more and more integrated, a lot of differences are arbitraged out. Even small political or economic differences may mean large changes in the rankings."

With more volatility in global capital markets today, country risk analysis is gaining importance in the eyes of international investors as they search the world for investment opportunities that are both profitable and safe.

Big changes

Although industrialized countries have remained politically stable over the past six months, Euromoney’s country risk ratings have fluctuated a great deal because of turmoil in the global banking industry, as well as skyrocketing public debt. Not surprisingly, the US has fallen sharply, down six places. So has southeast Asia’s financial hub, Singapore (down eight). Iceland also continues to struggle.

Economically risky countries in eastern Europe and the Balkans have all predictably slipped in the rankings, including the former Yugoslav Republic of Macedonia (down 26), Estonia (down 15), Bosnia (down 13), Hungary (down 10), Ukraine (down six) and Russia (down seven). In the Middle East, Iran has slipped significantly (down 11) as it continues to struggle with the political backlash from its controversial presidential elections in June. In addition, politically unstable nations in Africa, such as Sierra Leone (down 22), Lesotho (down 18) and Congo (down 10), have also seen steep revisions downward.

In terms of safe havens for investment, the usual destinations of Luxembourg, Switzerland and the Nordic region continue to reign supreme. Noteworthy risers include Qatar, up 19 places to number 10, surpassing the US and most of western Europe, with a stellar economic performance this year; Libya (up 30), which received its first investment-grade credit rating at the end of March; and Lebanon (up 22), which achieved greater political stability with its elections in June. Sweden (up three) has climbed into the top-five safest countries and Australia (up five) into the top 10. Both continue to maintain relatively healthy public sector finances and balanced economies in spite of the financial crisis.

The US slump

For the first time, the US has fallen out of the top-10 safest countries for investment. Uncertainty surrounding the political and economic environment, as well as budget and unemployment issues, has significantly increased its country risk over the past year. The US ranking has dropped six places since March, in the light of growing concerns about government intervention and support in the banking sector, massive budget spending and mounting public debt.

Nonetheless, most economists believe that the drop in the ratings is short-term. Cautious hopes for an economic recovery will help boost the US’s relative place once again.

"Despite the US’s recent loss of economic buying power, its political and military might will continue to make it powerful," says Stein at Lombard Street. "People and countries want to remain connected to the US. It is only a matter of time before we begin to see markets stabilize and people reinvest [in the US]. When that happens, several sectors of the US economy are likely to recover."

Looking towards the future, as Tarp loans are repaid and US governmental financial guarantees are withdrawn, further fiscal consolidation on the part of the US government and others will be necessary. Many observers expect the US government to raise taxes across the board to counter the substantially worsening public financial burden.

Some economic experts have even suggested that the Obama administration might introduce a national value added tax akin to the consumption tax systems in the EU. Representing a break from the current state-level sales tax system, federal VAT would penalize spending and promote saving at the national level, resulting in huge revenues for the US government without the same visibility as raising federal income taxes for everyone. Although this proposed flat VAT structure would be regressive in the sense that it would hit the poor the worst, the federal government could correct this imbalance by exempting certain goods such as food, children’s clothing and books, as in the UK.

Singapore’s fall from grace

Just six months ago, Singapore was nearly in the top-10 safest countries for investment. This September, however, the picture is very different: Singapore has slipped eight places in Euromoney’s latest country risk rankings. Its rapid fall reflects its increased exposure to country risk, a direct result of capital market globalization.

Singapore was particularly hard hit by the international banking crisis as one of the big financial centres of southeast Asia; it is host to several international companies and is heavily reliant on capital flows through the region. Birgit Niessner, country risk analyst at Erste Bank, says: "Singapore was so exposed and open to trade and foreign investment that as soon as international trade suffered, the country suffered."

According to AKE’s Global Intake political risk profile: "Singapore will continue to preserve a regulatory framework that encourages foreign investment, while carefully maintaining flexibility, since it is Singapore’s reputation as a hub for international trade and business that keeps the city-state’s economy afloat."

No other country in the region can challenge Singapore for its attractiveness to foreign investors, given its excellent infrastructure, safe environment, active free-trade stance and general ease of doing business. Erste’s Niessner maintains: "Since there are no serious internal problems that need to be cleaned up, Singapore should recover in line with the global economy."

Escalating risk in Iceland

Having suffered the collapse of all three of the country’s big banks, Iceland continues to struggle with its substantial economic crisis. Relative to the size of its economy, Iceland’s banking collapse has been very dramatic; thus, both short-term and long-term risk effects for the country are likely.

The national currency has declined sharply in value, foreign-currency transactions have been virtually suspended, and the market capitalization of the Icelandic stock exchange has dropped by more than 90% in the past year. Despite multilateral aid from the IMF, global economists expect even further recession, fuelled by exposure to foreign debt, double-digit interest rates, increasing inflation and soaring unemployment.

The election of a new Green-Left-led coalition government in April will not necessarily guarantee future political stability; the government will remain particularly vulnerable, given the public pressure to resolve the financial crisis. Although an economic policy stalemate in parliament remains a possibility, unpopular reform programmes or the perceived failure of new initiatives to counter the crisis could spark anti-government sentiment and civil unrest.

Although the global economy might be poised to begin recovery by the end of this year, Iceland still has many internal issues to resolve before it can take part.

Eastern Europe cracks under pressure

Many countries in eastern Europe and the Balkans have been particularly wounded by the financial crisis, given their underlying political, economic and banking distress. In times of economic slowdown, country risks are exacerbated in fundamentally weaker regions – a fact that has caused several countries in eastern Europe to slip as many as 26 spots in the rankings.

Nadina Bernecker, head of risk consultancy and intelligence at AKE Group, explains: "Pervasive corruption and a lack of functioning transparent institutions [in eastern European countries] made it inevitably difficult for many nations to weather the storm of the financial crisis."

Highly dependent on foreign-currency-denominated lending, many eastern European countries have been particularly susceptible to increased currency risks and demand slowdowns. Nations and corporations in this region have faced especially severe credit, liquidity and fiscal problems as they are often takers and receivers of what is happening in the broader banking sector. Eastern European central banks have had a hard time cutting rates dramatically and have had little room to manoeuvre because of increased borrowing costs associated with currency effects.

On the bright side, the EU and the IMF have intervened with financial support through programmes such as the EU balance of payments support facility, making sovereign defaults in this region highly unlikely. These structural funds facilitate the construction of uniform-quality infrastructure across Europe, effectively sending capital from the west to the east.

Gabriel Stein, Lombard Street Research

"The pace of change is due to globalization. As countries become more and more integrated, a lot of differences are arbitraged out"

Gabriel Stein, Lombard Street Research

Stein of Lombard Street Research says: "Of all the ex-Soviet republics, Estonia, Latvia and Lithuania are politically the safest. Corruption is not very present and, as members of the EU, they do not face much risk of becoming soft dictatorships. Their Nordic brethren will not let them go down the drain; if Denmark, Sweden, Norway and Finland allowed Estonia, Latvia, Lithuania to collapse, it would be a stain that they could not live with."

Although there is little danger of total sovereign meltdown in the region, Jon Levy, Europe and Eurasia analyst at Eurasia Group, warns: "Private sector defaults in eastern Europe still loom, with trillions of euros in tiny loans all over the place. The situation is not dissimilar to the sub-prime crisis in the US, and the region continues to be a wait-and-see environment. Eastern European countries must adopt and adapt to lower growth rates; they can no longer sustain the breakneck consumption growth that was fuelled by excessive bank lending."

Shining star of the Middle East

Hugely cash-rich and politically stable for the foreseeable future, Qatar has jumped 19 places, finding its way into the top 10 of Euromoney’s country risk rankings. Armed with vast natural gas reserves, a relatively resilient and regulated financial sector, and few liabilities to fund, Qatar has been able to ride out the financial crisis better than most states in the Middle East. Qatar remains a neutral diplomatic force, as well as one of the most politically contented countries in the region.

After starting to pump its gas reserves in 2004, Qatar continues to reap the benefits. Its strong cash position generated thus far from gas is only a fraction of what the country will have in the next two to three years, as its investments in gas fields come on tap in 2011 and 2012.

Rochdi Younsi, director of Middle East and Africa research at Eurasia Group, explains: "Qatar had the necessary sources of liquidity to inject funds [into local businesses] and was much more careful in infrastructure development programmes than its regional counterparts. Learning from the failures of Dubai, the Qatar Financial Centre has guaranteed that the most sophisticated transparency standards will be applied to prevent the Qatari economy from moving too fast."

AKE’s Bernecker says: "Qatar’s financing is diversified in the sense that it receives both western and regional investments, which are unlikely to dissipate simultaneously." Given its access to international bank finance and capital markets, Qatar has enough liquidity to ensure financial stability over the next few years.

African exception

Recently emerging from years of international isolation, oil-rich Libya received its first investment-grade credit rating at the end of March. As a result, the country has soared 30 spots in the rankings.

Reflective of its improving relationship with the west, Libya’s recent upgrade should create confidence among international investors, attracting foreign investment and helping to reintegrate the country into the global economic and financial community.

With substantial public assets and negligible debt, relatively low financial contingent liabilities and solid medium-term growth prospects for its energy sector, Libya’s country risk has substantially decreased over the past six months. International oil companies have demonstrated great interest in Libya, enticed by low production costs and the fact that some 75% of the country remains unexplored for hydrocarbon reserves.

In addition, Libya’s political and economic policies are becoming more moderate and transparent relative to those of its regional peers: Libya now discloses its external financial assets, including those of its sovereign wealth fund.

AKE Group’s Bernecker believes that, as for other developing nations in Africa, "the direct impact of the financial crisis on Africa has not been as devastating as was forecast, but Africa has not been spared or untouched".

Many developing African countries lack mature financial institutions, and thus were not as vulnerable to the international banking crisis.

Nevertheless, most of these nations are highly dependent on donor money from abroad and remain political priorities for the west, particularly in the fight against terrorism. Since the industrialized world barely has enough money to keep its own economies strong and growing, underdeveloped African nations are expected to suffer over the next three to five years from the scaling back and delay of donor money.

Prospects for global recovery

When investing abroad, there are both internal and external factors that might affect a nation’s country risk. Often, investors see internal economic and political problems as signs of more long-term trouble, as in the cases of Iceland, eastern Europe and Iran. On the other hand, problems caused by external influences, in countries such as Singapore, might abate more rapidly because of globalization and the fast pace of cross-border risk transfer.

Jon Levy, Eurasia Group

"Governments that spend money on projects that support employment and demand in line with their overall broad objectives, such as clean energy, will recover relatively quickly"

Jon Levy, Eurasia Group

As the force of the global recession begins to recede, many economic experts believe that real improvement, when it comes, is likely to be uneven around the world. Countries with greater internal challenges will have a more difficult time regaining strength. Despite the globalized spread of risk, certain industries and regions will be quicker to recover than others.

Asia and commodity-based countries have done relatively well recently, given increased optimism that global consumption will resume and that the oil price has rebounded from its March lows. Levy of Eurasia Group says: "The renewable and sustainable energy sectors will recover strongly, with manufacturing and industrial production following shortly thereafter. Countries heavily dependent on construction and real estate will take a much longer time to pick up again."

He continues: "Governments that spend money on projects that support employment and demand in line with their overall broad objectives, such as clean energy, will recover relatively quickly."

However, Stein at Lombard Street Research cautions: "As we begin to see economic turnaround in the US slowly spreading to other parts of the world, the recovery could be quite anaemic, potentially even leaving us with a second downturn shortly thereafter." 

World Bank/IMF special focus: Global economic outlook and financial stability

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