Transcript - Episode 7: Helping companies conquer country risk


Laura Gatz: A warm welcome to another episode of our Economics in Business podcast series.  My name is Laura Gatz and I’m your host for this series.

We are living currently in an era of geopolitical transformation and unprecedented global interconnectivity.  The financial crisis, Brexit, political shifts, so many factors in the news currently seem to point towards a conclusion that our world is becoming more and more uncertain and risky.  I think 'uncertain' may have even been the word of 2017.

Today, I am joined by economist Rob Vaughan, who joins me to talk about the insights financial markets have to offer about country risk. Rob, welcome, and thanks for joining us today.

Rob Vaughan: Great to be here.

Laura: Rob, what is country risk, and why is it important?

Rob: Laura, we view country risk as the additional premia that investors demand to invest in a country outside their home market, and I think it’s important for two reasons really. One is, to manage their existing asset base effectively; and the second reason is when they are looking to grow and expand their portfolio beyond their home market, how can they appropriately price and get a good price for the investments that they are considering. We help our clients with both of those areas.

Laura: You’ve been working in this area for a while now.  What exactly is your work about, can you tell us little bit about that?

Rob: Yes, we support clients in this area for our country risk service.  So, we’ve developed the service actually over 10 years ago, and throughout that period, we’ve consistently measured country risk using our country risk model, and essentially what we’ve done there is to plot a relationship between sovereign bond yields and the risk and credit fundamentals of those countries, and that allows us to have a predictive relationship. So for 187 economies around the world, we can help to estimate what the country risk premia is for those economies.

Laura: What types of countries are you looking at for your model?

Rob: We are looking at a range of developed market and emerging market countries, and investors are increasingly interested in developed market countries, not just emerging markets, because we are seeing a lot of differentiation even within economies that three or four years ago looked quite similar. I think that plays to your point around actually there being lots of different risks, which have emerged in the investment landscape over the last few years.

Laura: Wow, so have you seen any particular trends that are common and global across all of these different countries you are looking at?

Rob: Yes, I think, the differentiation is definitely one.  I think, overall actually, we've seen a decline in country risk levels, which actually might be quite surprising to some of your listeners.  As you say, risks are being played out in the newspaper headlines every day, from North Korea to the US presidential election, to Brexit, and political crises around the world, but what we’ve actually seen, in five out of the six quarters, country risk has declined over the last eighteen months. So, that’s been a really quite marked shift over the last 18 months.

Laura: That does sound counter intuitive given all those news headlines that you’ve mentioned just now.  What’s going on here?

Rob: Yes, I think, a really important factor is the base effect here.  So, a big driver of country risk levels is that dynamics are playing out in global capital markets and the real benchmark for that is the US; and in the US, we are seeing inflation expectations increase, and we are seeing growth increase, and that’s actually driving increases in short-term interest rates.  That is also feeding through into the debt markets.  So, long-term interest rates have increased.  So, spreads wouldn’t actually decline as a result of that, but very interestingly what we are seeing is that’s not necessarily drawing investment back into the US.  Actually what we are seeing is that global investors are really sticking with emerging markets.

Some of your listeners may remember the 'taper tantrum' from a few years ago, and the emergence of 'the fragile five'.  So, when there was US tapering, lots of investors, were kind of panicking and withdrawing their money from emerging markets and pulling that back into the US, exposing some of the cash flow problems in those economies.  But, really investors so far are sticking with emerging markets, and that’s a reflection of risk appetite really holding up, and investors wanting that additional yield they can get from those foreign investments.

I think the third factor that’s really driving this is a normalisation in some of the biggest bond markets around the globe.  So, your listeners again will remember the peripheral Eurozone crisis from five or six years ago, when Italian and Spanish bonds spiked at 7% yield.

What we’ve seen really gradually over that period is economic conditions improve, and investors return to those bond markets and supporting better prices for those bonds. So, what we are seeing is a decline in country risk in the Eurozone and that’s fed through into the broader global trends.

Laura: Given that there has been so much that’s been going on, are there any big risers and fallers in country risk?

Rob: Yes, in the Eurozone, we’ve seen Cyprus, we’ve seen Italy, Greece, Portugal, as really big fallers in our model, so we are seeing country risk levels reduce in those economies.On the flip side, you could probably guess the economies where we are seeing some of the biggest increases.  So, unfortunately some of the war-torn countries in Africa, like Somalia and Sudan, North Korea for example, they have the highest country risk levels in our model and they have also increased over the past 18 months.

Laura: So far, we’ve mainly been focussing on the short-term trends, but given that you’ve actually had this model for quite a long time now, are there any long-term trends that are worth mentioning?

Rob: Yes, I think, picking up on that theme of differentiation that you mentioned earlier.  So, I think, really what we are seeing is investors become much more nuanced in how they price country risks. I think a really good example of this is Brazil and Argentina.  Now, three years ago, Brazil was one of the safest South American economies.  Argentina had a country risk level around four times that of Brazil, and what we’ve seen over that period is really a divergence in the risk fundamentals of those economies.

So, you’ve seen Argentina - you've had a new reformist president come in and enact a lot of economic reforms and negotiate with some of the sovereign debt holdout investors and really get the economy back on track.  What you’ve seen in Brazil is a political crisis, and also a lot of economic problems, particularly the large amount of debts, which consumers and the government held, and that’s really been unwound over the last few years.

Now, our country risk model plays that out.  So, what we are seeing are very similar risk levels in those economies now, and that’s a reflection on, investors understanding those risk dynamics and pricing those risks proportionately. Also, driven by a lot of reforms in the banking sector, for example, where every global bank now has to have a country risk department.

I think we've seen some big improvements in this space over the past 18 months, so it's really important investors keep on top of country risk, because it’s an area which is changing on a daily basis.

Laura: It definitely sounds like you need to be having very, very up-to-date knowledge on this topic. Do you have any examples of how you’ve used your knowledge and insight into country risk with some of your clients?

Rob: Yes, absolutely. This has a really big impact on clients' balance sheets.  For example, we’ve seen that just a 2% change in country risk could swing an investment valuation by around 500 million dollars.  So, we’ve helped clients to effectively price their country risk exposures, and traditionally that’s been to look at some of their foreign investments and help the clients work out what a fair valuation would be for those investments, and sometimes that’s to test the valuations on their balance sheets, and other times that’s really to work out whether they might need to write down their investment, and whether risk conditions have changed to an extent where they might actually have to reduce the valuations on their balance sheets.

It can also be used to help investors and organisations look at their global portfolio, and help understand where the best risk-adjusted returns are, and help to re-numerate those areas of their business which are doing best when you account for the increases in risk, which might be evident across the global portfolio.

I think possibly, the one interesting example I would pull out was working for an investor, who had recently invested in the Maldives economy. This was a large infrastructure asset, which actually the government recently expropriated.  So, really we were using country risk as part of a suite of tools to help understand to what a fair level of compensation might be to that investor to reflect those return and risk dynamics over the period, which they would have held the asset.

Laura, I can say unfortunately that it did not involve a client visit, but we really look forward to, you know, interest in the application of the country risk and support our clients in different ways in the future.

Laura: It’s a shame it didn’t work out this time, maybe better luck next time Rob.

Well, thank you so much Rob.  You’ve shared some really interesting examples today about different countries and the different long-term and short-term trends in country risk and may I just say, it’s really good to have some insight that is up-to-date in these uncertain times on such a topical issue. Thanks very much for joining us here today.

Rob: Thanks for having me Laura

Laura: It’s been a pleasure. To our listeners, if you would like to find out more about our country risk modelling, please head to, and don’t forget to subscribe in order to keep up with our latest episodes. Thank you for listening!

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Barret Kupelian

UK Chief Economist, PwC United Kingdom

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