Is Country Risk Really Rising?
July 2010
It has become fashionable for political and
economic pundits to declare in unison that the world is today a dangerous place,
and that the risks associated with conducting cross-border business are rising.
But is it? Is cross-border risk really more dangerous to today than it was in,
say, 1989 or 2001?
by Daniel
Wagner
Country Risk Solutions
Today's risk-averse business climate is not the result of a single event—the
titanic collapse of the former Soviet Union or 9/11—both of which significantly
altered the long-term global trade and investment landscape. Rather, what got
us here is a combination of greed, inadequate regulation of the banking industry,
improper regulatory enforcement, inexplicable comfort with obscene amounts of
debt on an institutional and individual level, and short memories. The world
is now adapting to an evolutionary change in the international banking and credit
systems that should result in an improved cross-border trade and investment
environment in the long term.
In 1989 and 2001, the world was neither globalized nor interconnected to
the extent that it is today, and trade and investment landscapes were more easily
defined and categorized. Trade and investment decisions then were based on less
information and less sophisticated means of managing risk. Today, cross-border
traders and investors benefit from a more level playing field with respect to
access to information, more open markets, and a more competitive landscape.
More countries want to attract foreign direct investment (FDI), enhance international
trade, and be members of the global "club" than ever before. To do so, they
must maintain a competitive footing and constantly reinforce their comparative
attractiveness as trade and investment destinations. That makes the global trade
and investment climate less risky than in recent history.
As will be demonstrated below, foreign investment has notably increased from
its 2009 lows—especially among emerging markets—and protectionism remained largely
muted throughout the Great Recession. As a result, country risk in general is
not rising, but has remained stable throughout the crisis.
FDI in Recovery Mode
Statistics compiled by the World Bank1 show that
net FDI flows contracted by approximately 40 percent in 2009, representing the
sharpest decline in 20 years, but this was much less than the net decline in
private bank lending, which plummeted 134 percent last year. FDI began to improve
in the second quarter of 2009 among both developed and developing countries.
As noted below, FDI into developed countries fell further than into developing
countries from 2008 through 2009, but proportionately, developing countries
made up more ground after the first quarter (Q1) of 2009 than did developed
countries. If the collective view of foreign investors was that country risk
was rising during the period, the FDI statistics would not have demonstrated
such strength following the peak of the crisis among either developed or developing
countries.
Click to see
Figure 1: Global Net FDI Flows: 2008–2009.
FDI flows are expected to rise up to 30 percent this year, with the lion's
share of investment going to developing countries. Private capital flows to
developing countries are expected to rise to their late 1990s/early 2000s levels,
but are not likely to reach their 2007 levels in coming years. Capital should
remain more expensive and less available than before the crisis, meaning traders,
investors, and lenders will remain more selective about which transactions they
choose to support. Risk aversion should remain elevated for some time and country
risk management should take on renewed importance.
Trade Protectionism Largely Absent
According to the WTO and World Bank,2 unlike
during the Great Depression, overt acts of trade protectionism were largely
absent from the global trade arena during the crisis, but the number of restrictive
trade actions taken on the part of governments exceeded those of liberalized
trade actions by 10 to 1. This is not surprising, as countries naturally seek
to protect domestic industries in times of crisis. As noted in Figure 2 below,
the top five countries restricting trade transactions were (in order) India,
Argentina, China, the United States, and India.
Click to see
Figure 2: Trade Measures Taken by the G20.
In spite of this, global trade volumes rose by 21 percent year-on-year in
January 2010, both in terms of volume and value. Interestingly, during the period
October 2008 to February 2010, the number of antidumping investigations initiated
by G20 governments fell by 21 percent. Given the number of restrictive actions
taken by governments during the period, new antidumping investigations should
have risen considerably, but did not. So, does this point to rising country
risk? Again, the answer appears to be no. Having avoided tit-for-tat protectionist
measures among the world's major economies, and having seen an impressive rebound
in trade during the height of the crisis, country risk has remained stable in
my view.
A Transformed Cross-Border Landscape
The International Monetary Fund (IMF) has estimated that developing economies
will grow by more than 6 percent this year, with China and India expected to
each reach 9 or 10 percent growth. For China, such impressive growth has been
consistently high for more than a decade. What is true is that emerging economies
are the locomotive of global growth. In the absence of such strength, global
growth would be fractional this year, with the United States likely to reach
only 2.5 percent growth and Europe perhaps 1 percent.
As a result of the derailing of the global economy since 2007, a dramatic
transformation is occurring—perhaps more dramatic than at any time in modern
economic history. According to the IMF and Goldman Sachs, the United States
expanded its productive capacity by some $4.3 trillion between 2000 and 2009.
In second place was China, at $3.5 billion, followed by Germany. But in the
second decade of the 21st century, China is expected to add more than $7 trillion
to global growth, while the United States is expected to produce less than half
that amount. Only the United States, the United Kingdom, and Japan will remain
among the top 10 contributors to global output in this decade; newly industrialized
and emerging countries will round out the other top 10.
An Evolving Perception of Risk
What all this means is that our perceptions of risk must change. Simple categorization
of countries into "good" or "bad," "rich" or "poor," and "risky" or "not risky"
no longer captures the scope of risk companies face when investing in today's
evolving mosaic of investment climates. Greece is clearly perceived as riskier
than India today, but that was not the case just a year ago. Rather than saying
the world is a riskier place, it is more accurate to say that, depending on
where a company invests and in what sector, a developed country can easily be
riskier than a developing country. For example, the country that has been the
boldest in taxing mining company profits is not a corrupt, poor, developing
country, but Australia. And as a result of the Australian government's recent
actions, other mineral-rich countries in the developed and developing world
are likely to follow suit.
Gone are the days when the West calls the shots and the rest of the world
snaps to attention. Gone also is the time when so many of the good ideas, best
risk management practices, and acceptable standards of behavior are automatically
derived from the developed world. Countries such as Brazil, China, and India
are showing dramatic progress in establishing improved governance, business
practices, and advances in technological prowess. If the global economy is akin
to a business cycle, then the developed countries are mature markets in the
process of gradual decline, while the most dynamic economies of the emerging
world have yet to hit their prime.
Country risk management is a function of where one invests, in what sectors,
and in what manner. In that regard, country risk is indeed rising, but largely
in the developed world, where the price being paid and the ongoing risk of contagion
from some of the mistakes that were made over the past decade will linger for
several more years. Country risk is, if anything, falling in many parts of the
emerging world, where opportunity abounds, governments continue to liberalize
foreign investment regimes, and trade and investment volumes continue to outpace
that of the developed world.
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