How to Assess Country Risk for International Trade

How to Assess Country Risk for International Trade

Is your business ready for overseas expansion but not sure how to choose your next market? Do you have a few markets in mind but want to ensure you’re choosing the right ones? When you’re planning to expand abroad, it is crucial to your success to be strategic, not reactive.

Expanding into international trade is one of the best ways to grow a business. Not only does international trade provide access to new markets but it also helps businesses to diversify their portfolios.

However, doing business with trade partners operating in other countries also brings a new set of risks. Different countries have different legal systems, tax requirements, business cultures, and political environments that can all impact the viability and profitability of international business. In many ways, choosing the right countries in which to do business is just as important as choosing the right trade partners. That is why it is so important to conduct a country risk assessment.

A country risk assessment can help a business identify and evaluate country-specific risks. In doing so, businesses can determine how much those risks might impact their business and what steps they can take to manage or mitigate those risks.

The importance of this type of country risk analysis cannot be overstated. Without it, businesses could face unexpected and potentially devastating changes to the business environment without warning. Learn more about how to evaluate country risk by checking out Euler Hermes' resources.

Analyzing Country Risk

Country-specific risks cover a wide spectrum. Specific risks include fluctuations in currency exchange rates, economic or political instability, the potential for trade sanctions or embargo and anything else occurring in the country that could negatively impact the business environment or trade and cash flows in and out of that country.

By quantifying these risks and their potential impact on the business should they become reality, businesses can adjust forecasts and expectations, while also looking for ways to mitigate or protect against some of the more substantial or unpredictable risks to the business. 

Analyzing country risk requires both qualitative and quantitative analysis. A qualitative risk analysis relies on a subjective analysis of a country’s situation. This can include news and business intelligence from the target country. In some cases, this extends to rumors that can be confirmed or which are seen as having a realistic chance of being true. In other situations, this insight must be developed on the ground in the target country but it can also be gleaned from reputable sources of business and political news and insight.

A quantitative risk analysis relies on market data and statistics to identify and measure the amount of risk involved in doing business with partners in the target country. This includes the use of macroeconomic indicators, such as the country’s GDP, debt levels, sovereign ratings and independent ratings in tools like the MSCI Index.

Use Public and Government Resources to Analyze Risk

Governments and public resources can be a great support both at home and abroad. Your local government may help you expand abroad, and the foreign government can also help you to expand into the country. Most countries have departments or organisations dedicated to this. To find the right organisation try contacting the trade departments or organisations of your home country and the potential countries. You may find that they have programmes to help you expand, they can also help put you in contact with the right people.

 



Types of Risk in International Business

There are hundreds of factors to consider in international business. Those factors can be organized into three broad categories—economic, political and social. Because there are so many relevant factors within these three categories, it is important to focus only on those that are the most important based on the country and type of business involved. Only then can businesses conduct a meaningful analysis of country-level business risks.

What follows is a discussion of some of the most meaningful factors for most businesses when conducting a country risk analysis.

Economic Risk in International Trade

No matter where it is hoping to invest, any business must carefully evaluate the economic risk of investing in a specific country. No country is immune to economic risk. For example, the United Kingdom has historically been one of world’s most stable countries. However, it has still faced significant economic consequences, including significant currency fluctuations, as a result of its proposed exit from the European Union and the ongoing uncertainty that situation has created.

Businesses can analyze economic data by country using the following key economic indicators. These indicators provide a snapshot of a country’s economic performance and future prospects that can help paint a fuller picture when evaluating country risk.

  • The stability and solvency of banks
  • The short-, medium- and long-term outlook for country’s GDP and GNP
  • Unemployment rate
  • Overall government finances
  • Monetary policy and currency stability

Political Risk

Political risk is present in every country, from the most and to the least developed. It is only the level of risk that differs.

Political risk is measured by the stability of all levels of government, the presence or absence of corruption, and the regulatory environment, among other factors. A war or coup are obvious examples of political risks. However, changes to government policies and priorities following a democratic election or leadership change can also increase or decrease a country’s level political risk. For example, a shift from less to more regulation, greater state ownership of certain industries, or more government involvement in the economy also represent political risk.

Businesses can evaluate several factors when analyzing a country’s political risk as part of its overall country risk, including:

  • Government stability
  • Information access and transparency
  • Terrorism, violence and crime
  • Regulatory and policy environment
  • Workforce freedom and mobility

Structural Assessment

The structural factors within a specific country also merit close inspection. Structural factors include any fixed elements within the country that can impact economic performance, including:

  • Demographics
  • Physical infrastructure
  • Social infrastructure
  • Labor force

Is the country’s infrastructure able to support efficient transportation, telecommunications technology and necessary banking and financial services? Are the country’s current and future demographic trends and health and educational systems likely to support a strong labor force? For example, a business working with operations or partners in a country with an aging population that has not invested enough in its education and health care systems is may have trouble finding an adequate workforce with the skills the business needs to succeed.

Debt Management

Debt management is a core factor in any country risk analysis. Debt management deals with how well a country is managing its debt load and whether it is growing, static or declining. High levels of government debt can lead to inflation and currency destabilization, both of which are likely to have a real and significant impact on any company doing business in and with that country.

Some specific debt management indicators include:

  • Total debt stocks to GNP
  • Debt service to exports
  • Current account balance to GNP

Country Risk Ratings

Country risk ratings can be excellent tools for evaluating a country risk level. By evaluating the factors discussed here, it is possible to provide a rating score or letter grade indicating an overall country risk level. This process is similar evaluating and grading risks when awarding a credit rating score. This might include a letter grade, such as A through F, or a numerical score from 0 to 100, for example.

Importance of Mitigating Risk

Given the dynamic nature of the economy in the world at large and in specific countries, evaluating country risk prior to making any investments or conducting business in that country is now a critical part of basic business due diligence.

This is not an easy process. Many developing countries, in particular, are dynamic and often changing for the better or for the worse. However, by relying on trusted sources of analysis and information, it is possible for businesses to get a strong perspective of the potential risks these countries represent.

The one thing businesses should not do is ignore country risk factors. Without a clear view and knowledge of country risk factors, businesses will lack the insight necessary to manage and mitigate those risks. As a result, they will be even more vulnerable to any potential disruption and problems that occur.

However, businesses do not have to deal with these risks on their own. An intelligent risk management strategy relies on insurance policies to assume risks that the business cannot or does not want to manage on its own. For example, because so many of these country risk factors can impact the creditworthiness of current and potential business partners, credit insurance can be an important component of an international business risk management strategy. Credit insurance not only can provide a country risk analysis for international businesses, it can also provide protection against credit risk in international trade.

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