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 OConnell (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
OConnell 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 OConnell (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 OConnell (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

markets 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 & OConnell, 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 & OConnell,
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 OConnell 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 & OConnell, 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 OConnell
(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, lets 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 Bs 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 As 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 (DellAriccia & 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.

REFERENCES

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.

DellAriccia, 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., & OConnell, J. (2007 October 21). Country risk analysis and
managing crises: Tower Associates. Thunderbird School of Global Management.