COUNTRY RISK IN INTERNATIONAL BUSINESSES
Mario G.R. Pagliacci 1
Introduction
Historical documents give the lie to the common opinion that internationalisation is a modern
phenomenon; in fact in any historical period people continuously moved to better their physical and
spiritual welfare.
In comparison to past periods, it is possible to observe more intensity and diffusion of international
activities nowadays, thanks to the increasing optimization of the space/time ratio (longer distances
in minor time) and the development of transports and logistics.
Nevertheless, international economic activities are charged by: (i) generic business risks 2; (ii)
specific international risks 3.
The second category of risks represents the consequence of several differences among countries in
the world 4: geographic and climate differences; cultural differences; political and institutional
differences.
Geographic and climate differences get direct impact on the various range of natural catastrophic
risks, and indirect impact on the human behaviour (with effects on operative risks and counterpart
risks), as well as on the needs of people and enterprises (with effects on markets risks). All these
phenomena take influence on competitive structure and distribution cannels.
Cultural differences have a strong influence on nature and characteristics of governmental and legal
regimes, and on economic and financial systems; they originate the competitive behavior of
enterprises as well as the decisions and actions of workers and consumers.
Political and institutional differences play a decisive role in consolidation of economic systems, in
structuring demand and offer in the market, in putting more or minor barriers in free movement of
people, goods and capitals.
All these differences generate the complexity of the systemic risks and the contamination among the
other categories of risks.
Following table shows the main relationships linking phenomena and risks 5.
1 Faculty of Economics, Seat of Terni – Università degli Studi di Perugia (Italy).
2 That is: operative risks, counterpart risks, credit risks, market risks. All these risks have a different strength and
impact in international context, owing to the minor knowledge of foreign markets and partners.
3 Two typical international risks are: risk of exchange (in the category of market risks) and country risk (in the category
of systemic risks).
4 See: M.G.R. Pagliacci, Rischi finanziari nelle operazioni commerciali, FrancoAngeli, Milano, 2010.
5 This table was published first time in: M.G.R. Pagliacci-L.Biancifiori, Asymmetric factors in country-risk evaluation,
Acts of Jubilee International D.Tsenov Academy of Economics, Svishtov (Bulgaria), 2006.
CULTURE, STYLE OF LIFE, BEHAVIOR
GOALS
STYLE ET VALUE IN ECONOMICS
METHODOLOGIES IN
GOVERNANCE/CONTROL
BASIC ECONOMIC CULTURE
STYLE OF
MANAGERS
CULTURE IN
JOB
FEELING AMONG PARTNERS AND OTHER ACTORS
AVAILABILITY OF SOCIO-ECONOMIC INFORMATION
ABOUT THE COUNTRY
COUNTERPART-RISK
POLITICAL/SOCIAL/ECONOMIC SITUATION
FINANCIAL SITUATION OF
COUNTRY AND ENTERPRISES
CURRENCY-RISK
EFFICIENCY OF FINANCIAL OPERATORS
AND BANKS
SITUATION OF LEGISLATION
STRUCTURAL REFORMS
POLITICAL STABILITY
COUNTRY-RISK
This paper has the target to put in evidence the difficult identification of nature and characteristics
of systemic risks in international context. The uncertain and improbable assessment and evaluation
of country risk is an additional barrier against the internationalization of enterprises and the activity
of financial and insurance agencies, specialized in offering risk management tools.
1. Identification of systemic risks
Systemic risks are generated by a large range of different events; the only common factor can be
found in the fact that they are not generated by decisions of single persons or enterprises, rather by
the context where the economic activities develop.
Typical systemic risks are:

Catastrophic risks, caused by adverse events, which origin can be natural one or under the
human responsibility;

Political and Social risks, determined by decisions of institutional authorities, or social
groups, or religious movements, etc.;

Technological risks, generated by strong or unexpected innovations in technologies models
of life and/or work, with high impact on the whole community;

Economic risks, connected with significant critical conditions in the structure and/or
conjuncture of inters sectors of economy and finance;

Legal risks, depending to laws, rules and so on regulating a territorial or sectorial area.
Even if different terms and definitions are used in different countries and agents in identifying area
of systemic risks (political risk, country risk, counterparty risk), nevertheless it is possible to put in
evidence a common characteristic: this concept is generally used in case of countries with weak
economic fundamentals and fragile institutional structures.
On the contrary, a lot of proves attest that systemic risks are not a prerogative of emerging
countries. The events of international terrorism (i.e. in New York, London, Madrid) as well as the
ecologic disaster (i.e. hiding of radioactive waste in Italy and other european countries), as well as
the financial crises in Greece and Hungary, demonstrate that industrialized countries are also
exposed to systemic risks.
In addition it is important to underline that the origin of systemic risks can be external - caused by
host countries - or domestic, when the causes are found in relevant diversities or conflicts existing
among the territories of the same country.
In all cases, systemic risks have always an international impact and became global risks, because
world is more and more integrated.
2. Focus on country risk
Rather than some difference exists among systemic risk, political risk and country risk, these
expressions are frequently used in promiscuous manner.
Indeed these concepts can be treated like a particular type of fractal, because any component of risk
is comprehensive of the whole risk 6. In this direction is the opinion of Raoul Ascari, who writes:
“political risk is an omnibus term and as such cannot be precisely framed and analyzed” 7.
According to this vision, I will maintain in this paper the original terms adopted by different
Authors; nevertheless I wish to underline that in my opinion the expression “country risk” is more
complete and suitable in international context.
An important definition of “Political risks” is offered by MIGA-Multilateral Investment Guarantee
Agency: “Probability of disruption of operations of MNEs (Multi-National Enterprises) by political
forces or events when they occur in host countries, home countries, or as a result from changes in
the international environment. In host countries, political risk is largely determined by uncertainty
over the actions of governments and political institutions, but also minority groups, such as
separatist movements. In home countries, political risk may stem from political actions directly
aimed at investments destinations, such as sanctions, or from policies that restrict outward
investment” 8.
This definition is clearly partial, because it considers Multi-National Enterprises only and their
investments; it neglects other enterprises (i.e. small and medium enterprises, banks, etc.) that can be
engaged in different businesses (i.e. manufacturing or financial activities). In addition, MIGA
considers events caused by host countries only: currency convertibility and transfer; expropriation;
political violence; breach of contract by host government; non-honoring of sovereign financial
obligations.
Another definition is given by Meldrum: “When business transactions occur across international
borders, they carry additional risks not present in domestic transactions. These additional risks,
called country risks, typically include risks arising from a variety of national differences in
economic structures, policies, socio-political institutions, geography, and currencies” 9.
6 According to the mathematician and economist Benoit Mandelbrot, fractal is a particular form composed by different
parts, and each one is like the whole (1986).
7 R. Ascari, Political risk insurance: an industry in search of a business?, Working Paper n.12, SACE, Rome, March
2010, page 3.
8 See: www.pri-center.com
9 D.H. Meldrum, Country risk and foreign direct investment, in “Business Economics”, July, 34, 2000.
In my opinion, this definition - utilizing the concept of “country risk” - is more complete in
comparison to MIGA’s definition, because it take in account “a variety of national differences”, that
are able to generate a variety of risks.
Meldrum attests it is possible to classify risks in six categories, taking in account that “many of
these categories overlap each other, given the interrelationship of the domestic economy with the
political system and with the international community”:
I. Economic Risk;
II. Transfer Risk;
III. Exchange Rate Risk;
IV. Location or Neighborhood Risk;
V. Sovereign Risk;
VI. Political Risk.
I) Economic risk : this risk can be the consequence of internal measures (i.e. size and
composition of government expenditures, tax policy, government's debt situation, monetary
policy and financial maturity) or external events (i.e. bad relationships towards other
countries). Economic risk becomes systemic in case of crisis, when several negative events,
generate a strong ruin, evidenced by unbalancing of fundamentals. Owing to globalization,
internal causes of crisis have international impact also (becoming external causes).
II) Transfer risk : it regards any institutional foreign decision restricting capital flows (i.e
difficulty to repatriate profits, dividends, capital), owing to potential imbalances that could
lead a country. Generally these measures concern strong limits to currency convertibility,
with the purpose to put any barriers to free movement of capitals.
III) Exchange Risk : this risk is rightly classified in the area of systemic risks when it concerns
unexpected change in currency regime (i.e. a change from a fixed to a floating exchange
rate), because it takes origin by institutional decision. On the contrary, I do not agree to
Meldrum, when he considers in this category an unexpected adverse movement in the
exchange rate; this case is not in the area of systemic risks, rather in market risks area,
because floating of exchanging rate is a effects of demand and offer of currencies.
IV) Location or Neighborhood Risk : it includes spillover effects caused by problems in a
region and/or in border countries with similar characteristics, where it is really high the
probability of contagion. In addition, this risk concerns all countries taking part of over
national institutions (i.e. European Union, NATO, etc.); in fact these countries are involved
and influenced by the events happening in alliance area.
V) Sovereign Risk : it is a particular kind of credit risk, when the government of a country
refuses or is enable to respect its financial obligations towards public or private lenders. This
risk is usually examined in international context; nevertheless is not unusual to observe
some grave cases of credit risk in domestic relationships with public entities.
VI) Political Risk : it concerns the risk of a change in political institutions, in government
control, social fabric, or other noneconomic factors. This category can be considered an
omnibus category, concerning a lot internal and external events (see the fractal vision):
legal, social, religious, ethnic events and so on.
It is possible to observe that MIGA’s and Meldrum’s definitions utilize different terms (Political
risks and Country risks), but they show several similarities. Nevertheless they neglect the risks
caused by catastrophic events. Someone might observe that they are not in political/institutional
frame; on the contrary, some recent events demonstrate that a lot of catastrophes are caused directly
(i.e. leak of oil in Gulf of Mexico) or indirectly (i.e. pandemic phenomena) by insufficient controls
or wrong decisions of institutional authorities.
3. Is it possible to measure these risks?
Ascari writes: “Ideally we can think of risks as being positioned along a straight line: at one
extreme we can have pure actuarial risks; in the middle financial risks distributed on large
portfolios; and the other extremely lumpy, political risks. The first group of risks meets the criteria
of the ‘Law of large numbers’…The second one can approximate a normal distribution but with
unknown (fat) tails. The third one cannot be expressed statistically at all” 10.
Actually, multiple causes influence political risks (institutional, legal, financial ones, and so on),
and they are linked each other, so creating complicate phenomena of contamination.
As consequence, political risks change dramatically their nature over time and/or in different
contexts and geographic areas, as Ascari demonstrates in following table11.
10 R. Ascari, op.cit., page 8.
11 R. Ascari, op.cit., page 8.
1970s
1980s
1990s
2000s
XXX
XXX
X
X
X
X
XX
XX
n.r.
n.r.
XX
X
XXX
XXX
X
XX
XXX
XXX
X
X
XXX
XXX
X
XX
n.r.
n.r.
X
XX
Confiscation,
expropriation,
nationalization
Creeping
expropriation
Break
of
contract
Political
violence
Transfer
and
convertibility
Non-honoring
of financial
obligations
Trade-related
Financing
Legenda: X = the lowest intensity of the event; XXX = the highest intensity; n.r. = not relevant
Owing to political risks change continuously, estimating historical performance is difficult while
predicting future evolution is almost impossible. Nevertheless enterprises have to decide if and
where make businesses and specialized organizations have to decide if and how to insure political
risks.
This is the reason that scholars and experts are engaged in assessing and measuring systemic risks
in international context. It is a complicate job, because no comprehensive country risk theory exists.
4. Methodologies for analysing and measuring country risk 12
Authors and country-risk services engaged in this job generally use an eclectic mix of economic and
socio-political indicators based on their experience and judgment. Anyway, it is possible to
evidence some historical trends:
 1960-70’s literature adopted prevailing qualitative methods, having the purpose to analyse
political risks;
 starting to ’80 quantitative approach prevailed, for investigating on possible country default
or financial crisis;
 nowadays econometric models are preferred, considered more available for anticipatory
analysis.
Following Authors marked the stages of this itinerary.

Dragoslav Avramovic
The origin of country risk analysis is signed by the Chief of the Central Bank of Yugoslavia,
Avramovic. He studied the problems of emerging countries after the war and concluded that they
were caused by the high frequency of the due dates in international loans. The unique solution was
in utilizing monetary reserve of Central Bank and accessing to drawing measures at International
Monetary Fund.
Avramovic analysis founded on two financial indicators:
 Monetary reserve adequacy: monetary reserve in comparison to current import flow;
 Debt-service ratio : annual debt service in comparison to current export flow.
Avramovic concluded that in long period of time, the capacity of a country in serving foreign debts
is related to: saving rate, output rate of internal investments, cost of foreign debt.

Nicholas Sargen
At the beginning of ’80 the sort of international credits was a big problem for lender banks.
Sargen gave two different conceptual approaches to the problem of rescheduling: the first one
connected to the influence of exogenous causes (i.e. floating of international prices); the second
linked to the monetary dynamics. He studied several indicators and thanks to the discriminant
analysis he selected the most significant ones in order to classify different countries according to the
major or minor probability of insolvency.
12 See: M.G.R. Pagliacci, op.cit.

Robert Aliber
Aliber’s paper was published in the same period of Sargen one.
Robert Aliber takes in account two fundamental matters about the foreign debt of emerging
countries:
 First one - similarly to Avramovic e Sargen - consists in financial indicator about debts;
 Second matter is new one, and concerns some output and growth indicators, able to compare the
performances of emerging and industrialized countries.
According Aliber’s conclusion, if the growth rate of a country is higher than the prevalent rate of
industrialized countries, it is convenient for financial entities to allocate capitals in that country,
under the condition that interest rate is able to cover additional risks.
Completely different is the approach preferred by financial operators, always looking for easy and
synthetic indicators in their job. They frequently measure country risk on using the level of spread
quoted in interest rate in comparison to an official referring rate. For instance, in spring 2010 public
bonds of Greece recognize 12% of interest, in comparison to other european countries, quoting less
than 2-3%: this spread is a clear sign of the high risk in Greece.
Nevertheless the critical question is that spread is not influenced by the country risk’s perception
only, because some other financial entities play (i.e. level and volatility of interest rate, liquidity of
financial system, and so on).
Scholars and operators are searching the optimal methodology yet, but this target is really far.
At the moment it is possible to classify at least four categories of methodologies:

Qualitative systems;

Structured qualitative systems;

Quantitative systems based on check list;

Other quantitative systems.
Any system offers some opportunities and is useful for specific analysis. Generally speaking,
qualitative systems are better for political and environmental investigations, in order to understand
how to move in the context of a foreign country; quantitative systems are frequently adopted in
order to compare the opportunities offered by different countries.
 Qualitative Systems
These systems do not utilize any model and format, so that the personal experiences of analyst
determinate high level of subjectivity. In addition, the evaluations are influenced by the nature and
quality of information.
The absence of quantitative measures makes impossible to compare different countries and to
generate the ranking of risks. As consequence, these systems are useful in order to have an intensive
knowledge about a country, without any purpose of comparison to others.
 Structured qualitative systems
Subjectivity of analyst is influent, but it is balanced by standardized models, formats and sources of
information.
The level of partial standardization and the use of some quantitative information make possible a
kind of comparison among different countries.
The analysis is generally conducted on three areas:

Domestic policy and economy;

Foreign relationships;

Situation of foreign debts.
 Quantitative systems based on check list
Using check-list is really useful in order to identify specific factors that are considered able to
influence the country risk.
Each political, social, economic factor is expressed by one or several quantitative indicators. After
having measured each indicator according a common scale, it is possible to make a total sum in
order to have a final score, able to give a measure of country risk.
Check-list systems make possible to produce: systematic, comparable, intensive, objective analysis.
 Other quantitative systems
This category concerns a lot of econometric models, all characterized by high standardization with
the purpose to minimize the subjectivity of analyst.
These models are generally focused on the attempt of forecasting future financial crisis of countries
and their default in honoring their international debts.
The strong formality in these systems is not a guarantee of good evaluation, because the algorithms
and mathematics relationships never represent the reality of a country.
***
Whatever methodology may be chosen, strategic and competitive intelligence are fundamental in
order to collect and select the necessary information about countries under evaluation.
Authors that are specialist in the discipline of intelligence 13 recommend to operate according to six
fundamental conditions:
1) Orientation towards future;
2) Accuracy on information and data;
3) Efficiency of cost in comparison to the objective;
4) Objectivity of analysis;
5) Functionality of decisional process;
6) Actuality of conclusions.
5. Industry of country risk insurance
International competition of States is founded on the capacity of national enterprises to penetrate
foreign markets. Considering that this activity is particularly risky, modern States promoted special
insurance agencies (Export Credit Agencies) uncharged to guaranty national enterprises against
political risks and commercial risks.
In past periods these Agencies cumulated high losses and negative cash flow, and the Governments
preferred to adopt a confidential approach, so by-passing the scientific investigation of scholars and
academic literature. Nevertheless, in last decade most of them were engaged in changing their
strategy, their policy, their juridical status, according to criteria of efficiency and profitability.
There are four important events that contributed in this direction:
1) the growing importance of emerging markets;
2) the changing nature of emerging economies;
3) the increasing sophistication of capital markets;
4) the increasing integration of manufacturing.
Nowadays, the most important Export Credit Agencies are engaged in an important process of
transformation, with the purpose to became global players in the field of international insurance and
guaranty 14.
13 See:C.S. Fleisher-B.E. Bensoussan, Strategic and Competitive Analysis: Methods and Techniques for analyzing
Business Competition, Prentice Hall, Upper Saddle River, New Jersey, 2003.
14 Over 50 countries in the world participate to the International Union of Credit and Investment Insurers (Union of
Berne), whose purpose is in regulating the activity of export credit insurance. They signed in February 1976 an
important agreement (Consensus) with the objective of reducing the competitiveness among States in supporting
international businesses. European Union introduced Consensus in its own legislation (Decision 93/112/CEE), so
making obligatory the respect of this agreement.
This is the target of Italian Export Credit Agency also.
***
Italy is provided with a basket of laws supporting internationalization of businesses; the most
important law is well known as “Legge Ossola” (n.227/77) by the name of the competent Minister.
The original text was approved in 1977 and continuously renewed until now.
The finalities of this law are in:
 granting special financial tools in favour of domestic enterprises operating in international
context, according to the terms of Consensus;
 offering to domestic enterprises the possibility of insuring against political, catastrophic,
commercial and exchange risks.
Law 227/77 created the public export credit agency named SACE. From its origin to nowadays
SACE enlarged its competences, on offering as export insurance products, as integrated solutions of
credit management (i.e. factoring, cautions, guaranties and so on).
6. Synthetic scenery
Specialized literature utilizes different terms for indicating systemic risks in international context:
someone uses the expression “country risk” - more adapt in order to underline territorial context
where risks occurs; someone prefers the expression “political risks” - in order to underline the
nature of risks.
Actually, it is really difficult to delimitate this area of risks, owing to the complicate inter-relations
between the different components, so changeable over the time and in different territories of the
world. As consequence, no statistical regularities are available and the experts consider these risks
“uninsurable” according the principles of insurance industry.
Export Credit Agencies are considered political tools of international policy and their particular role
justified in the past the absence of the traditional economical criteria of profitability.
Recent phenomena of globalization in economic and financial markets and the increasing role of
private sector in economy, gave a new vision to export credit insurance and offered the chance to
transform the traditional role of “insurance of last resort” in the new role of “global financial
player” uncharged to help enterprises to growth in international context.