Many investors choose to place a portion of their portfolios in foreign securities. This decision involves an analysis of various mutual funds, exchange-traded funds (ETF), or stock and bond offerings. However, investors often neglect an important first step in the process of international investing. When done properly, the decision to invest overseas begins with a determination of the riskiness of the investment climate in the country under consideration. Country risk refers to the economic, political and business risks that are unique to a specific country, and that might result in unexpected investment losses. This article will examine the concept of country risk and how it can be analyzed by investors. (For more, read Finding Fortune In Foreign-Stock ETFs.)
Economic and Political Risk
The following are two main sources of risk that need be considered when investing in a foreign country.
* Economic risk: This risk refers to a country's ability to pay back its debts. A country with stable finances and a stronger economy should provide more reliable investments than a country with weaker finances or an unsound economy. * Political risk: This risk refers to the political decisions made within a country that might result in an unanticipated loss to investors. While economic risk is often referred to as a country's abilityto pay back its debts, political risk is sometimes referred to as the willingness of a country to pay debts or maintain a hospitable climate for outside investment. Even if a country's economy is strong, if the political climate is unfriendly (or becomes unfriendly) to outside investors, the country may not be a good candidate for investment. Measuring Economic and Political Risk
Just as corporations in the U.S. receive credit ratings to determine their ability to repay their debt, so do countries. In fact, virtually every investable country in the world receives ratings from Moody's, Standard & Poor's (S&P), or the other large rating agencies. A country with a higher credit rating is considered a safer investment than a country with a lower credit rating. Examining the credit ratings of a country is an excellent way to begin the analysis of a potential investment.
Another important step in deciding on an investment is to examine a country's economic and financial fundamentals. Different analysts prefer different measures, but almost everyone looks at a country'sgross domestic product (GDP), inflation and Consumer Price Index (CPI) readings when considering an investment. Investors will also want to carefully evaluate the structure of the country's financial markets, the availability of attractive investment alternatives, and the recent performance of local stock and bond markets. (For more insight, see The Consumer Price Index: A Friend To Investors andThe Importance Of Inflation And GDP.)
Sources of Information on Country Risk
There are many excellent sources of information on the economic and political climate of foreign countries. Newspapers, such as the New York Times, the Wall Street Journal and the Financial Timesdedicate significant coverage to overseas events. There are also many excellent weekly magazines covering international economics and politics; the Economist is generally considered to be the standard bearer among weekly publications.
For those seeking more in-depth coverage of a particular country or region, two excellent sources of objective, comprehensive country information are the Economist Intelligence Unit and the Central Intelligence Agency (CIA) World Fact Book. Either of these resources provides an investor with a broad overview of the economic, political, demographic and social climate of a country. The Economist Intelligence Unit also provides ratings for most of the world's countries. These ratings can be used to supplement those issued by Moody's, S&P, and the other "traditional"...