The global financial system is based on confidence and investors seeking to maximize risk-adjusted returns.
And the kind of risks considered when making investments in the stock market or any sort of financial asset is focused on the individual characteristics of the asset class.
Mature fundamental analysis also considers how the stock is positioned relative to its industry peers with respect to trends affecting the industry or the country.
When making cross-border investments, the situation gets a lot more complex. The level of country-risk must be examined before it can be selected as an attractive investment destination as the level of returns on offer are immaterial if the country is unable or unwilling to repay the investment made into it. This may also include transfer or foreign exchange conversion risk.
This form of investment ranges from the investments made in the stock market in different countries or in different forms which are often crucial for economic development of a particular country.
Developing countries that are competing to attract international funds should focus on improving their risk profile. Bangladesh needs to do a lot better in these metrics before attracting significant inflows of FDI that will move the needle on our development.
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 these can be broken down and there is no universal agreement on exactly what constitutes each type of risk, but a few are generally accepted as being part of each bucket.
Economic and financial risk
This largely concerns the sovereign risk, exchange rate environment and trade credit risk.
Sovereign risk concerns the inability or unwillingness of a borrowing government to repay loans that they have taken. Since governments cannot be forced to pay, the risk that a government might default on its obligations is significant and investors across 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 revenues just to service debts.
Exchange rate environment is how much a country’s currency fluctuates has a direct impact on the returns that investors can expect.
Whether it is MNCs repatriating money or individual investors taking back funds, they all prefer a stable exchange rate environment. This is affected by unexpected changes in inflation and interest rates which are affected by the central bank’s 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 currency reserves. However, if the reserve level goes down beyond a certain level, the country may not be able to support its trade obligations so this must be managed carefully.
Then there is trade credit. If the trading partner cannot or will not pay their share of the business, then international investors will not invest in that country.
This is more than just the business culture of the country but goes beyond it to include the legal framework, options for receiving payment and support from national authorities.
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.
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 stability in recent times has improved the investment profile internationally.
Nature of political system: The norms in the political system especially regarding the autonomy of election authority, 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.
Market risk
This relates to the legal environment in which a firm does business, the intellectual property regime, ease of doing business, banking regulations in the host country, dispute resolution options available, etc.
Legal environment: How easy it is to receive legal support and receive 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 in which Bangladesh is lacking sorely.
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 support and the norms which govern international settlements will also be important as MNCs 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.
Intellectual property (IP) laws: This is becoming an increasingly important aspect for developing countries, and those with laws which protect IP interests are highly regarded.
Security
Investors must feel their investment destination is a secure place before they choose to commit to investment. 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.
There are a lot of other risks that can be mentioned in this context -- like current account deficit, budget deficit, political will, or commitment to reform, domestic strife and agitation, relationship with large neighbours, law and order, local currency depreciation, worker remittance flow, international fuel price, export order flow, bank failure, and others -- but
Bangladesh must excel in mitigating the risks outlined above before we can hope to attract the desired level of FDIs which we have targeted.
Close government collaboration with capable multinational banks operating in Bangladesh, along with professional firms with international presence, will go a long way to make our country an attractive investment destination.
Mamun Rashid is a partner at PwC Bangladesh, and has worked as macro and country risk auditor with two global banks.
