Knowledge Services

When a firm is already operating in a country then whether its business is under the threat of expropriation by a foreign government in a shifting regulatory environment, or having difficulty converting or transferring currency, or facing attack by the political system, or in a difficult negotiation with a government, CRA can help it manage change by better understanding the environment in which it is operating and providing risk management tools to protect its business. CRA can also help position the operating country amongst its peers or in that particular region to give a bird’s eye view on the ever changing operating risks associated with it.

On the flipside, even when a firm is looking out to expand its reach, CRA can act as initial triggers and signals, by giving the credit worthiness of that particular country or region or a third party view of the risks.

In general for any kind of business, the riskiness to its operation can be broadly bucketed under these following 4 categories:

a)      Economic Risk

b)      Political Risk

c)       Business environment Risk and

d)      Currency Risk

Analysis of the above would require regional or country specific knowledge as well as expertise, along with access to detailed data. Determining the right variables under each category is also important as also fixing the appropriate weight. Principal component analysis (PCA) helps to convert a number of possibly correlated independent variables into a smaller number of uncorrelated variables.

Within the economic risks, the idea is to look at various key economic indicators like real GDP growth, inflation, fiscal balance (as well as public debt), external balance, unemployment etc and aggregate them suitably to arrive at comparative scores. Again for each indicator, a weighted average of the recent years is taken to avoid recency bias.

Analysis on the political risk should answer the following questions – Is there a functional democracy and an independent judiciary? How strong is the ruling party/coalition or may be how strong the opposition is? How frequent are elections in the country and how fast does key economic policies change with the change in rule? How independent are the government policies from foreign intervention? What is the state of law and order and where does the country rank in the corruption index? Foreign relations or stand in regional geopolitics? These questions often don’t yield any objective scores, which is why the regional/country specific domain of the analyst comes into play.

The business environment risk would typically cover the earlier analyzed economic and political score rating along with indicators like a) openness and competitiveness – these can be arrived at by looking at the country’s foreign investment policy, foreign trade policy, tax regime, labor policy, legal framework (viz. industrial laws etc), property rights; b) language and communications – acceptability as well as use of foreign languages is a key area of concern for firms when they wish to set up their operations there; c) physical and IT infrastructure – gauged by the extent and condition of road, air and port connectivity, telephone lines, internet penetration etc.; d) soundness of financial markets – health of the banking sector as well as the various asset classes; e) a detailed market research on the firm’s industry is equally important – information on large players already existing along with their market shares, information on the sectoral performance as well as government policies aiding or impeding the sectoral growth.

The currency risk, which can be part of the economic risk as well as the business environment risk, needs a separate classification just owing to its immense importance as this probably has the most immediate as well as severe impact on any operations. These can be gauged by looking at the type of foreign exchange regime that operates in the country as well as the independence of the monetary authority. Inflation rates, interest rate differential with other countries, level of foreign exchange reserves, level of portfolio flows and most importantly the volatility of the currency over its mean value are other significant contributors to this category.

Typically a firm would like to evaluate their strategies based on an average score of all the above, but given its nature of exposure or operations, it may want to choose or reweight the above for a more representative score.

Provision of such analysis is not new as we would have a lot of research organizations providing it, but what acts as the differentiating factor is the depth of regional and country specific domain, prior experience of doing it as well as access to the key data.

CRA thus on one hand helps reduce risk with access to all critical information impacting the market – market trends, competitor threat and economic factors, and on the other hand would help identify new growth areas by achieving a well rounded view of the market. Timely and accurate CRA is vital for undertaking more sound business decisions for boosting a stable and non-inflationary growth of a company and for coping with various risks under a dynamic and rapid integration of our economies.