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Expert Commentary

What the Euro Crisis Implies about Managing Country Risk

Having the right risk management tools at your disposal—whether it is knowledge or an insurance product—is essential to effectively managing cross-border risk. Yet, doing so involves much more than simply collecting data, which is relatively easy given the wealth of information at our disposal. Interpreting data is the real challenge, as is the ability to distinguish perception of risk from reality. A good risk analyst must be able to tell the difference.


Political Risk
August 2012

But, data can only tell you so much. Gut instinct is often as important as all the risk indicators one can identify—sometimes even more so. Including intuition and experience in the analytical process is extremely important; it is an integral part of analyzing cross-border risk. An overreliance on numbers and quantitative methodologies can lead to trouble, as they may prevent an analyst from thinking in sufficiently broad terms to adequately capture the true nature of risk. Ultimately, each risk must pass our own "smell" test, based on our own inherent experience, knowledge, and biases, because country risk analysis cannot be a purely objective undertaking.

Basic Guidelines

In considering which approach to country risk management may be best for your organization, bear in mind the following basic guidelines.

Politics Can Defy Logic

The political process is generally not logical, so applying logic to the creation of a country risk management tool does not make much sense.

Know Your Data Sources

Data may be obtained from any number of sources, but it is important to be able to trust the information sources being used. Where did the source you may select obtain its information? Too often, external information providers or consultants may not reveal where or how they received their information, which may raise questions about its validity and accuracy.

Question Official Statistics

Analysts tend to overrely on statistics generated by governments or multilateral organizations. While these are important sources of information to include in the analytical process, it should be remembered that governments often manipulate statistics for political purposes and that international organizations often rely on such information to produce their own analysis and projections.

Benefit from the Power of Observation

There is no better way to arrive at a conclusion about the nature of country risk than to see it for yourself. If you have the opportunity to visit the country and/or project site, it is often the best means of arriving at a conclusion about the nature of the risks associated with a given transaction. One's own experience and interpretive abilities add a great deal of legitimacy to the analytical process.

Qualitative Risk Assessment Can Ultimately Undo All Quantitative Approaches

An overreliance on quantitative measures can be dangerous. Adding texture to analyses by refusing to categorize them as either black or white, or good or bad, can be the single most effective addition to the analytical process. Human behavior (an unpredictable variable) can only be assessed through the incorporation of qualitative measurement.

Applying the Concept to the Euro Crisis

Country risk management is all about casting aside long-held assumptions and applying insight and foresight to imagine what a country and the world will look like in the future. Consider the question of the Euro Crisis. Logic tells us that continuing to throw good money down what appears to be a black hole may not make much sense, yet the Eurocrats continue to do just that. Rather than focusing on creating and implementing policies that will generate long-term growth, policymakers are stubbornly continuing down a path that has proven to be unsuccessful and will likely continue to be so.

If we look forward 3 to 5 years to imagine what Europe will look like if the same policies are pursued, what can we expect? More than likely, we can expect a prolonged crisis, with heightened unemployment, expanding budget deficits, greater uncertainty, and even less confidence about what comes next. Incorporating some of the concepts noted above, this implies a greater likelihood of social tension, economic hardship, and rising political risk. We don't need confirmation of continually declining gross domestic product figures and rising unemployment to tell us that the business climate may suffer for years to come. Common sense tells us that.

Putting the pieces of the puzzle together, it is not difficult to come to the conclusion that the business climate will continue to suffer in Europe for many years. This, in turn, has profound implications for countries that trade and invest in and with Europe. Many developing countries have paid a high price for the European imbroglio but have few resources or options with which to counter it. This implies a distressed trade and investment climate for much of the world for as a long as the Euro Crisis continues.

To manage risk in this environment, risk managers, strategic planners, and senior management in corporations throughout the world must not only think outside the box, they must refold the box into a pyramid, turn it upside down, and look at the world in a whole new way. Managing country risk in this kind of environment requires a range of skills that few companies have. So, companies that have muddled along in a unidimensional manner attempting to address risk are now forced adopt a multidimensional approach to managing cross-border risk. Some will make the transition successfully; others will not.

Conclusion

In our debt- and conflict-ridden world, with increasing forms of risk from unexpected places, country risk can only continue to rise in the near- and medium-term. The ability to look at the present and future with an open, creative, and foresightful mind is essential. If your company is not up to the task, there is a good chance future profitability will suffer. The best advice is to modify your corporate risk management policies now to anticipate and account for future challenges to growth and profitability.


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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