Country Risk Analysis and Managing Crises- Tower Associates
Paper analysis of Mathis, Keat and O'Connell's case study "Country Risk Analysis & Managing Crises: Tow...
Perceptions of Country Risk and Their Influences on International Market Development as Evidenced by Tower Associates
In their case study, Country Risk Analysis and Managing Crises: Tower Associates, Mathis, Keat, and O’Connell (2007) analyze the decision-making process of Susan Brede, and executive at Tower Associates, as she explored her options for developing trade in selected foreign countries. In the case study, Mathis, Keat, and O’Connell provide the constructs of the situation that Brede faces, by providing the criteria she was to use in her decision-making, identifying the target countries considered – though they do veil them with only letter identification – and offering a historical review of country crises to ad color to the dilemma of which country market to select for new business. The criteria that Susan Brede used in her decision-making process include: •
Political and economic stability
Well-functioning legal and accounting systems
A favorable entrepreneurship environment
A supportive attitude toward foreign investment
Some form of developed internal financial market
as noted by Mathis, Keat, and O’Connell (2007, p. 1). The study goes on to put the criteria in the context of the historical significance of country risk, citing specific examples of the types of risk that it identifies. Mathis, Keat, and O’Connell (2007, p. 2) define these as: •
“Currency crisis occurs when a speculative attack on the exchange value of a currency results in a devaluation or sharp depreciation of the currency. A currency crisis often forces the government to defend the currency by expending large volumes of international reserves and/or by sharply raising interest rates.
Financial crisis is a severe disruption in financial markets that, by impairing a market’s ability to function effectively, may result in significant adverse effects on economic activity.
Foreign debt crisis occurs when a country cannot service its foreign debt, whether sovereign or private.
Banking crisis results when actual or potential bank runs or failures cause banks to suspend internal convertibility of their liabilities, compelling the government to intervene to prevent this extending large-scale assistance.”
The study authors go even further and assert “banking crises are significantly worse than currency crises because they last longer” (Mathis, Keat & O’Connell, 2007, p. 3). In addition, they theorize that the “more diversified economies tend to be less vulnerable to unexpected internally or externally originated events” (Mathis, Keat & O’Connell, 2007, p. 3). Another area of interest to the case study is the focus on indicators of a potential crisis and what they can tell risk managers. Mathis, Keat, and O’Connell discuss the idea of separating these indicators into two categories: short-term and long term (2007). Short-term indicators can include variations or changes in: •
Stock market prices
Real estate prices
Real interest rates
Real exchange rates
any combination of which can “foretell a foreign exchange or financial crisis within the next six to nine months” (Mathis, Keat & O’Connell, 2007, p. 4). Long-term indicators can include: •
The debt service ratio
Short-term debt as a percent of total debt
Variable rate debt as a percent of total debt
Total foreign debt as a percent of GDP
The merchandise trade balance or current account balance as a percent of GDP
Finally, the study constructionists reveal the characteristics of the four countries being considered by Susan Brede and Tower Associates. Mathis, Keat, and O’Connell (2007, pp. 4-5) define these target countries as follows: •
Country A is a large advanced, developing country that had its share of economic problems in the 1980s, but since then has been performing relatively well. Economic growth is strongly supported by the government in terms of spending as a percent of GDP and as measured by the deficit in the fiscal budget. Domestic private investment as a percent of GDP, on the other hand, is not strong. Although money supply growth has been modest, inflation remains high. The currency floats more or less freely.
Country B is a large industrial economy that has experienced volatile performance during the past decade. It has vast resources including energy resources to support continued transition to a more diversified competitive economy. Private business investment has been growing as a percent of GDP while the role played by the government has been declining. During the
upcoming year some significant changes are expected in the political leadership of the country, which could impact growth prospects. The country could have great potential depending on the outcome of this transition. •
Country C is a large developing country, well-endowed with natural resources but lacking sufficiently developed infrastructure to allow it to utilize them effectively in support of GDP growth. The economy is not yet a market economy, but is moving in that direction as the government has gradually liberalized its control. It continues to influence consumer prices, interest rates, and the exchange rate in order to prevent deterioration in living standards for most of the population. The economy continues to gain momentum as it expands its economic infrastructure.
Country D is large developing economy, well-endowed with natural resources but lacking the economic infrastructure needed to capitalize on its wealth efficiently. The economy is moving in the direction of a market economy and is very entrepreneurial with wide disparity in income distribution. Consumption represents only one-third of GDP. The government continues to cautiously manage consumer prices, interest rates, and the exchange rate to keep the economy on its rapid growth path.
Why is all of this important? Well, according to Galai and Weiner (2012), “today, companies operating internationally have opportunities to finance their capital investments and activities in diverse international markets” (p. 883). So, now that we have the background information and specific criteria, which Tower Associates is considering in its decision-making process, we can conduct a deeper analysis and ask more specific questions. For instance, let’s explore the country profiles to see if there
are any hidden characteristics that might inhibit market force indicators. Country A seems to be relying on government funding and encouragement to keep its GDP active, while Country B is about to encounter significant political leadership changes, and Country C is lacking infrastructure. The current domestic and international economic situations of each country are reasonably sound. If we dig deeper, however, we can discover how well each country is currently following appropriate economic policies. Country A, for instance, is following regulated domestic policies, but its inflation remains high, contradicting some international best practices. Country B’s government has allowed its regulatory role to decline and is now on the brink of major political change. This hints that Country B may not be following appropriate policies on both a domestic and international level. Country C seems to be taking the most sound approach to its economic policies, slowly building to a market economy while ensuring all aspects of its economic infrastructure are well-tended to. Finally, Country D is lacking infrastructure, and its government may be a bit too cautious in its monetary policy management. With Country A’s impediment of the government motivating much of its economic activity, it may be headed towards a banking crisis, given the need for government rescue. Country B, with its impending political shifts, may be headed for a full on financial crisis, due to the potential sever disruption the political changes may cause. Country C may be facing a currency crisis with its inability to capitalize on the worth of its natural resources. And, finally, Country D could land itself in a foreign debt crisis is its entrepreneurial spirit takes it too far in the wrong direction. However, “the flexibilities that characterize young entrepreneurial ventures more strongly increase their
propensity for intensive learning activities when these flexibilities can be used to respond to adverse circumstances” (DeClercq & Zhou, 2014, p. 52). So it may quickly pull itself out of the debt situation even if it were to occur. If I were to recommend that Tower Associates begin transaction with Country C, I would encourage a country risk crisis management strategy approach to the new trade. The country is developing, and doing so quite well. With a solid base of endowment, natural resources with room for regulation and capital growth in the ROI, things seem to be moving in the right direction, so a typical exchange hedge may not be ideal. It would appear that the greatest risk element is the country risk, and therefore, a strategy to curb that potential is wisest. “The expansion of business across country borders requires identification, assessment and analysis of the overall risk that economic agents would face in a targeted national economy” (Asiri, 2014, p. 52). Additionally, “banks can design their organizational structures to better cope with two primary sources of risk, namely, political risk and credit risk” (Dell’Ariccia & Marquez, 2010, p. 1090). Armed with this information, Tower Associates can fortify its plan for growth and trade in a selected country to properly arming itself against all forms of potential risk, including foreign exchange, sovereign, liquidity, market, credit risks, and ultimately, insolvency.
Asiri, B.K. (2014). An empirical analysis of country risk ratings. Journal of Business Studies Quarterly, (5)(4), pp. 52-67.
De Clercq, D. & Zhou, L. (2014). Entrepreneurial strategic posture and performance in foreign markets: The critical role of international learning effort. Journal of International Marketing, (22)(2), pp. 47-67.
Dell’Ariccia, G. & Marquez, R. (2010 June). Risk and the corporate structure of banks. The Journal of Finance, (65)(3), pp. 1075-1096.
Galai, D. & Wiener, Z. (2012 August). Credit risk spreads in local and foreign currencies. Journal of Money, Credit and Banking, (44)(5), pp. 883-901.
Mathis, F.J., Keat, P., & O’Connell, J. (2007 October 21). Country risk analysis and managing crises: Tower Associates. Thunderbird School of Global Management.