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Understanding Country Risk

This blog article summarizes a recent research article published in Politique Etrangère. Reference: Norbert Gaillard, “Le concept de risque pays”, Politique Etrangère, 80(2), Summer 2015.

It is difficult to determine exactly when the concept of “country risk” was forged. The expression was used as far back as 1967 by Frederick Dahl – then assistant director of the Division of Examinations at the Board of Governors of the US Federal Reserve System – in a research paper addressing the international operations of American banks (Dahl 1967). However, discerning readers could see that the risks identified by Dahl (i.e., the risks that lenders and investors encountered in a foreign country) had been analyzed in previous research. Thus, the notion of country risk is one that took some time to coalesce into its present status.

In the 1950s, a few academic papers focused on investment opportunities for American firms willing to investing abroad. These works identified potential targets and examined the investment climate in various foreign countries. The expropriation of US businesses in Cuba in 1960, which followed Fidel Castro’s successful coup, was understandably a traumatic experience for American investors – according to Root (1968), there were 187 seizures of American business property. Thereafter political risk became a widespread concern among business circles. This new challenge had two notable consequences. First, the US Export-Import Bank decided to expand its export credit insurance programs by offering a full guarantee against political risk (Marx 1963). Second, more researchers and practitioners began to study the impact of political disturbances on American business (Haner 1966, Root 1968).

It was not until 1975-1977 that the notion of country risk began to permeate the economic literature and media. What happened, exactly? Between 1970 and 1975, the external public debt of low- and middle-income countries soared by 140% while the share of that debt financed by Western banks climbed from 10% to 40%. This growing exposure to sovereign debt began to worry the US Office of the Comptroller of the Currency, which sought to ensure that long-term lending was supported by adequate long-term deposits (Stabler 1975). By 1977, country risk had become a buzzword among bankers and investors. In March of that year, Henry Wallich – a member of the Board of Governors of the Federal Reserve System – used the term in a statement before the Committee on Banking, Finance and Urban Affairs of the US House of Representatives (Wallich 1977). A few weeks later, in an interview given to the New York Times, Citibank vice-chairman G. A. Costanzo gave assurances that only a minor part of the loans granted to less developed countries (LDCs) involved any significant ‘country risk’. In its annual report released in June, the Bank for International Settlements (BIS 1977) explained that “country risks [did] add new dimensions to private banking in many ways”; this international institution added that it was “necessary to appraise a country’s overall economic and political development and to relate the data on the amount and the structure of its external indebtedness to a number of macro-economic figures, such as current and prospective foreign exchange earnings.” This definition echoes that provided by Cleveland and Brittain (1977), for whom country risk was a measure of a country’s creditworthiness that depended on “intangible factors such as the government’s political stability and its will and administrative ability to divert resources from current consumption and investment to meet its foreign obligations on schedule.” Here, “country risk” is clearly synonymous with “sovereign risk”. This restrictive approach, which was designed to assess the risk that a foreign government would be unable to pay its debts as they fell due, was subsequently adopted by a number of researchers (Eaton et al. 1986; Haque et al. 1996) and by the country credit rating classification launched by Institutional Investor magazine in September 1979.

The early 1980s witnessed the emergence of new players issuing country ratings: International Country Risk Guide (ICRG), Nord Sud Export, and Euromoney in 1980, 1981, and 1982 (respectively). Their ratings did not focus solely on sovereign risk but also addressed political, economic, financial, and business environment risks. Such thoroughgoing appraisals of country risk, which follow the approach of traditional analyses conducted by export credit agencies (ECAs) and Business Environment Risk Intelligence SA (BERI), are now standard among investors. Why?

First, credit rating agencies (e.g., Fitch, Moody’s, and Standard & Poor’s) have effectively been the providers of sovereign risk assessments since the late 1980s, mainly because financial regulatory rules have increasingly relied on their ratings (Gaillard 2011). This tendency convinced a growing number of researchers and practitioners to use the term “country risk” whenever the potential threat to business leaders exceeded the more specific risk of sovereign default. Second, the re-globalization of the 1980s and 1990s stimulated international trade and financial transactions. Outward foreign direct investment grew from $52 billion in 1980 to $2.272 trillion in 2007. These flows, which may generate high returns but can also lead to unexpected losses, have served as fodder for both ECAs and country risk raters. As bankers have enhanced their internal country rating methodologies (Allan et al. 1998; Marois and Syssau 2006), exporting firms and multinational corporations (MNCs) have made extensive use of country risk indicators. These have evolved since the 1980s. With regard to political risk, the likelihood of expropriation is now considered to be relatively low (Minor 1994) whereas governance issues have come under increasing scrutiny (Kaufmann et al. 1999). In the arena of economic risk, traditionally acceptable debt ratios have proved insufficient to prevent the liquidity or insolvency crises that erupted in Mexico, Asian countries, Argentina, and Greece in 1994, 1997, 2001, and 2010 (respectively). These developments explain why researchers and analysts now assess economic robustness primarily in terms of debt sustainability (Reinhart et al. 2003; Coface 2012). At the same time, the risk of capital flow reversals and self-fulfilling crises (Radelet and Sachs 1998) have convinced economists and country risk analysts to watch carefully for contagion effects.


This short overview has described the evolution of the concept of country risk. In fact, country risk includes any macroeconomic, microeconomic, financial, social, political, institutional, judiciary, environmental, technological, or sanitary risk that affects (or could affect) an MNC, an exporting firm, or a portfolio investor in a foreign country. Damages may materialize in several ways: financial losses; threat to the safety of the investing company’s employees, clients, or consumers; reputational damage; or loss of a market or supply source. As a result, country risk and sovereign risk are indisputably two different concepts.


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