Country Risk

Country risk is a term for the risks involved when someone invests in a particular country. 

Country risk varies from one country to the next, and can include political risk, exchange-rate risk, economic risk, and transfer risk. In particular, country risk denotes the risk that a foreign government will default on its bonds or other financial commitments. In a broader sense, country risk is the degree to which political and economic unrest affect the securities of issuers doing business in a particular country.

Country risk is critical to consider when investing outside of the United States. Because factors such as political instability can cause great turmoil in financial markets, country risk can reduce the expected return on investment (ROI) of securities. Investors may protect against some country risks, like exchange-rate risk, by hedging; but other risks, like political instability, do not have an effective hedge. Thus, when analysts look at sovereign debt, they will examine the business fundamentals—what is happening in politics, economics, general health of the society, and so forth—of the country that is issuing the debt. Foreign direct investment—those not made through a regulated market or exchange—and longer-term investments face the greatest potential for country risk.

Most people think of the United States as the benchmark for low country risk, as do most other most nations themselves. So if an investor is attracted to investments in countries with high levels of civil conflict, like Argentina or Venezuela for instance, he would be wise to compare their country risk to that of the U.S. or Canada.

Some international organizations evaluate the country risk on behalf of their member nations. For example, the Organisation for Economic Co-Operation and Development (OECD), as part of its arrangement regarding officially supported export credits, publishes an updated list of countries and their associated risks for the purpose of setting interest rates and payment terms. In addition, the major credit rating agencies—Standard & Poor's (S&P), Moody's, and Fitch—all have their own lists of sovereign ratings, which also analyze fundamentals such as effectiveness of institutions and government, economic structure, growth prospects, external finances, and fiscal and monetary flexibility. Large investment-management firms also rate country risk in their specific business lines. BlackRock Inc., for example, publishes the BlackRock Sovereign Risk Index (BSRI), a quarterly sovereign risk index that tracks current risk levels and trends for various countries and regions.