The Economic Environment
Factors Affecting Economic Growth
Economic Factors
Non-Economic Factors
 Natural Resources
 Political Factors
 Capital Formation
 Social and
 Technological Progress
 Entrepreneurship
 Human Resources
Development
 Population Growth
 Social Overheads
Psychological Factors
 Education
 Desire for Material
Betterment
 https://wdi.worldbank.
org/table/3.14
2024 Global Multidimensional Poverty Index (MPI) report
Common Features Of Underdeveloped Countries
 Low per Capita Income
 Poor Level of Living
 High Rate of Growth of Population
 Highly Unequal Income Distribution
 Prevalence of Mass Poverty
 Low Levels of Productivity
 Low Rate of Capital Formation
 Technological Backwardness
 High Level of Unemployment
 Low Social Indicators of Development
Economic Cycle
Economic cycle
 Economic cycles are the recurrent boom-and-bust
phases that markets and economies typically exhibit.
Think of it like a wave:
 Expanding from a trough,
 Peaking at the crest,
 Descending (“contracting”) from the high point,
and
 Hitting bottom and recovering, where the wave
begins anew.
OECD report
OECD Report
 Enhancing the design and management of support
programmes
 Removing obstacles to effective resource utilisation
 Securing faster progress towards decarbonisation
 Making digitalisation a driver of productivity growth
 https://www.oecd-ilibrary.org/sites/9953de23en/1/3/3/23/index.html?itemId=/content/publicati
on/9953de23en&_csp_=4e52b6cafc2a11117e64315bdb0a41b0&ite
mIGO=oecd&itemContentType=book#sectiond1e3217-4ccc0aedb9
Balance of Payments
 The balance of payments is an accounting statement
that summarizes all the economic transactions
between residents of the home country and residents
of all other countries.
 It include transactions such as trade in goods and
services, transfer payments, loans, and short- and
long-term investments.
 Currency inflows are recorded as credits, and
outflows are recorded as debits. Credits show up with
a plus sign, and debits have a minus sign. There are
three principal balance-of-payments categories
Classification
 Currency inflows are
recorded as credits, and
 Currency outflows are
recorded as debits
 Visible items are physical
goods that are exported
and imported, while
 Invisible items are
services that are
exported and imported
 Current Account
 flow of goods and services,
income, and transfers
 Capital account
 net change in assets and
liabilities
 BOT= Ex-Im
 BOP= Tr-Tp
1. Current account, which records imports and exports
of goods, services, income, and current unilateral
transfers.
2. Capital account, which includes mainly debt
forgiveness and transfers of goods and financial
assets by migrants as they enter or leave a country.
3. Financial account, which shows public and private
investment and lending activities.
For most countries, only the current and financial
accounts are significant.
 The balance-of-payments statement is based on double-
entry bookkeeping; every economic transaction recorded
as a credit brings about an equal and offsetting debit
entry, and vice versa.
 According to accounting convention, a source of funds
(either a decrease in assets or an increase in liabilities) is
a credit, and a use of funds (either an increase in assets
or a decrease in liabilities or net worth) is a debit.
 Current-account balance+
 Capital-account balance+
Financial-account balance
 =Balance of payments=0

Current Account
 The balance on current account reflects the net flow of goods,
services, income, and unilateral transfers.
 It includes exports and imports of merchandise (trade balance),
service transactions (invisibles), and income transfers.
 The service account includes sales under military contracts,
tourism, financial charges (banking and insurance), and
transportation expenses (shipping and air travel).
 The income account was once part of the services account (as it
represents payments for the services of capital and foreign
employees), but it has become so large in recent years that it is now
shown separately.
 It includes investment income (interest and dividends) and
employee compensation.
 Unilateral transfers include pensions, remittances, and other
transfers overseas for which no specific services are rendered.
Capital Account
 The capital account records capital transfers that
offset transactions that are undertaken , without
exchange, in fixed assets or in their financing (such
as development aid).
 For example, migrants’ funds represent the shift of
the migrants’ net worth to or from the home country,
and are classified as capital transfers. This is a minor
account for most purposes.
Financial Account
 Financial-account
transactions affect a nation’s
wealth and net creditor position. These transactions
are classified as portfolio investment, direct
investment, other investment, or reserve assets.
 Portfolio investments are purchases of financial
assets with a maturity greater than one year ; shortterm investments involve securities with a maturity
of less than one year.
Balance-of-Payments Measures
 The basic balance focuses on transactions considered
to be fundamental to the economic health of a
currency. Thus, it includes the balance on current
account and long-term capital.
 The net liquidity balance measures the change in
private domestic borrowing or lending that is
required to keep payments in balance without
adjusting official reserves.
 The official reserve transactions balance measures
the adjustment required in official reserves to
achieve balance-of-payments equilibrium.
Terminologies
Country Risk Analysis
 Political risk
 Expropriation
 Political Stability
 frequency of changes of government,
 the level of violence in the country (e.g., violent deaths per 100,000
population),
 the number of armed insurrections,
 the extent of conflicts with other states,
 Economic Factors
 Subjective Factors
 Uncertain Property Rights
 Capital Flight
 Culture
Economic and Political Factors
 Fiscal Irresponsibility
 excessive government spending
 Monetary Instability
 Controlled Exchange Rate System
 little flexibility to respond to changing relative prices and
wealth positions
 Wasteful Government Spending
 subsidize consumption or is wasted on showcase projects
 Resource Base
 a stable political system that encourages hard work and risk
taking by allowing entrepreneurs to reap the rewards (and
bear the losses) from their activities,
 a flexible labour market that permits workers to be allocated to
those jobs in which they will be the most productive, and
 a free-market system that ensures that the prices people
respond to correctly signal the relative desirability of engaging
in different activities
Country Risk and Adjustment to External Shocks
 Domestic policies play a critical role
 Import-substitution development strategy
 Innovate in the international marketplace
 (East Asian tigers)
 Capitalism Vs Socialism
In a market economy—also known as capitalism—economic
decisions are made by individual decision makers based on prices of
goods, services, capital, labour, land, and other resources.
 In a command economy—often termed socialism—people at the top
decide what is to be produced, how it is to be produced, and where it
is to be produced, and then command others to follow the central
plan.

Key Indicators of Country Risk and Economic Health
 A large government deficit relative to GDP
 A high rate of money expansion, especially if it is
combined with a relatively fixed exchange rate
 Substantial government expenditures yielding low rates
of return
 Price controls, interest rate ceilings, trade restrictions,
rigid labour laws, and other government-imposed
barriers to the smooth adjustment of the economy to
changing relative prices
 High tax rates that destroy incentives to work, save, and
invest
 Vast state-owned firms run for the benefit of their
managers and workers
 A citizenry that demands, and a political system that
accepts, government responsibility for maintaining
and expanding the nation’s standard of living
through public sector spending and regulations (the
less stable the political system, the more important
this factor will likely be)
 Pervasive corruption that acts as a large tax on
legitimate business activity, holds back development,
discourages foreign investment, breeds distrust of
capitalism, and weakens the basic fabric of society
 The absence of basic institutions of government—a
well-functioning legal system, reliable regulation of
financial markets and institutions, and an honest
civil service
Positive indicators of a nation’s long-run economic health
include the following:
 A structure of incentives that rewards risk taking in
productive ventures
 A legal structure that stimulates the development of
free markets
 Minimal regulations and economic distortions
 Clear incentives to save and invest
 An open economy
 Stable macroeconomic policies
Country Risk Analysis In International Lending
 The Mathematics of Sovereign Debt Analysis
 the ratio of debt to GDP,
 The average interest rate on its debt,
 The primary budget balance(the budget deficit or surplus
before interest payments), and
 the growth rate of nominal GDP
 Country Risk and the Terms of Trade
 if terms of trade increase, a nation will be a better credit risk
 terms of trade improve, foreign goods become relatively less
expensive
 the speed with which a country adjusts to its new wealth
position
 The Government’s Cost/Benefit Calculus
 The cost of austerity is determined primarily by the nation’s
external debts relative to its wealth, as measured by its gross
domestic product.
 The cost of default is the likelihood of being cut off from
international credit.
 During trade shocks, when commodity prices fall, as inevitably
occurs, these countries are stuck with large debt burdens and
few resources to service their debts
Zimbabwe Descends into Chaos
 Zimbabwe, formerly known as Rhodesia, used to be an
industrial powerhouse in Africa, second only to South Africa
in the region. It has roads, factories, telephones, fertile
farmland, and some of the most educated people in Africa.
But the country is now undergoing an industrial revolution in
reverse. Its factories are grinding to a halt for want of power
and spare parts; its great mineral wealth is staying
underground; tourism has plummeted; and the shelves in its
shops are largely bare. These tribulations can be laid at the
door of President Robert Mugabe, leader of the party that
liberated Zimbabwe from white rule, and his policies. To
soothe disgruntled veterans of the war against white rule, he
gave 50,000 of them huge bales of cash that he borrowed or
printed (Zimbabwe already had a large budget deficit).
 To win over rural black voters, he offered them free land—not
idle state-owned land, but land belonging to white
commercial farmers (who tend to back the opposition party).
The peasants who settled on this land did not have the skills
or capital to properly farm it, so agricultural production
plummeted,
transforming
Zimbabwe
from
Africa’s
breadbasket into a basket case. Mugabe’s policies had their
predictable results. By voiding property rights, he killed
investment. By monetizing the large budget deficit (in 2000
Zimbabwe spent more than twice what it received in tax
revenues), he sparked inflation (running at an annual rate of
400% in July 2003). In a vain attempt to curb this inflation,
Mugabe imposed price controls on fuel and food, leading to
shortages.
 The government also started issuing treasury bills
yielding far less than the rate of inflation. Since no one
would buy them voluntarily, the regime forced
institutional investors to put 45% of their portfolios into
government paper. The high inflation forced the Zim
dollar to devalue in February 2003 from its previous
official exchange rate of Z$55/US$ to Z$824/US$.
Nonetheless, with a black market rate of Z$5500/US$,
the Zim dollar was still greatly overvalued at its new
official exchange rate. Only the government could get
U.S. dollars at the official rate, and only by forcing
exporters to surrender 40% of their hard-currency
earnings. Many previously honest businesspeople turned
to smuggling; others went bankrupt
 In response to these policies, the economy nosedived.
Although it is difficult to determine with precision just how
bad things had gotten because of poor-quality data,
economists estimate that between 1997 and 2002, income per
capita had fallen by at least 25% and possibly more than 50%.
By the end of 2008, 80% of the population was unemployed,
industrial output was at just 20% of capacity, inflation was
estimated at 6.5 quindecillion novemdecillion percent (65
followed by 107 zeros), and at least three million
Zimbabweans (out of a population of about 12.3 million) had
fled to South Africa and other neighbouring countries. The
regime was forced to print banknotes of ever-higher values to
keep up with surging inflation, culminating with the 100trillion-Zim dollar note (now a collector’s item on eBay) in
early 2009.
 The use of foreign currencies was legalized in
January 2009. In April 2009, with the economy
effectively dollarized (U.S.), Zimbabwe abandoned
its official currency.
Questions
1. What are key elements of country risk in Zimbabwe?
2. How has increased country risk affected Zimbabwe’s
economy and living standards?
3. By how much is the Zim dollar at its official rate
overvalued relative to its black market rate?
4. What caused the Zim dollar to be so overvalued? What
effect does an overvalued official rate have on businesses
and consumers in Zimbabwe?
5. According to theWall Street Journal(February 19, 2008,
A10), ‘‘Mr. Mugabe has blamed his country’s economic
crisis on Western saboteurs hoping to return the country
to white rule.’’ Comment on this statement