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In Today’s Rapidly Changing Environment, Country Risk Must Constantly Be Monitored

Published on Monday, July 01, 2002

A variety of factors impact country risk, as well as potential market revenue. And since these factors often increase or decrease without notice, it is essential to study the trends.

Factors To Consider

Before committing resources for the purpose of expanding overseas through trade or investment, a number of factors must be analyzed. They include country GDP growth, demographic shifts, political leadership, level of economic and political stability, currency vulnerability, investment flows, existing and projected trade agreements, competing market strengths, projected trade disputes, rule of law, and much more.

Measuring the change in each factor and identifying its impact may require the insight of a risk consultant. However, in lieu of this, the use of common sense and assistance from your banker is essential.

Variables Beyond Any Control

Country risk is affected by a number of variables, including political, economic and social factors. Generally, political risks are assessed in terms of country stability, and are sometimes measured by the level of confidence in a government. Economic risks are reflected by levels of national growth, inflation, unemployment, balance of trade, and taxes. Social risks usually involve social unrest and violence.

But numerous other factors must be considered as well. These include commercial risk, which is mainly viewed in terms of the credit strength of the buyer and the credibility of his or her bank, operational risks, which involve the documentation and customs process, and a host of other nontraditional risks that don’t neatly fit into simple categories. For example, if your customer is located in a country that becomes a member of a powerful trade bloc, he/she may decide to source your product from member countries that are subject to fewer trade barriers.

“Hot Money” Issues

Developing countries, no doubt, tend to pose higher levels of risk than developed countries. For example, a developing country change in leadership is often a time of instability. And the fear that a new government may impose a different economic policy than the previous administration — as in Brazil today — often puts fear in the minds of investors.

Since portfolio investment is driven by market forces and seeks the greatest returns, its flows often surge, then dip, partly based on perceptions of future growth and stability. As a result, it has created havoc on some developing countries’ economies and political structures.

Also known as “hot money,” portfolio investment tends to be short-term investment and is very sensitive to economic or political volatility. Its flows can add an element of risk where none previously existed. In turn, this can put downward pressure on a nation’s currency, creating political instability and social unrest. The Mexican peso, Asian and Russian crises of the 1990s highlight the volatility of hot money.

Mexico, Brazil and Argentina

On December 20, 1994, an attempted currency adjustment by the Mexican government accelerated out of control. Within two days, pressures mounted and currency reserves used to prop up the peso quickly dwindled. As a result, the peso was allowed to float freely. Shortly thereafter, it nose-dived. Like falling dominoes, what began as a short-term liquidity crisis turned into a full panic. Fallout quickly spread to Brazil and Argentina. Today, Brazil’s and Argentina’s economies are again undergoing a severe challenge.

With these and other events, traders and investors have received what some refer to as a “wake-up call,” reminding them that political and economic instability in developing countries can largely affect your customer’s ability to pay for goods shipped. Consequently, companies need to be aware of economic and political trends in target markets in order to protect themselves. In our fast-changing and increasingly competitive global business environment, it is necessary to outperform the competition. But, you must accurately assess all country risks, and plan accordingly.

The Rise and Fall of the U.S. Dollar: How Does It Impact Your Business?

Published on Monday, July 01, 2002

From February through July 2002, the value of the U.S. dollar decreased 9.4% against major currencies. However, by August it had climbed 1.8%, likely indicating a temporary pause in its downward trend.

The overall decline is welcomed by U.S. exporters, whose products have become less expensive and more competitive abroad. But where will the dollar go from here? Is its level of volatility a concern? And how will it impact your business?

A Historical Perspective

Since March 1973, when the Federal Reserve’s Nominal Major Currencies Dollar Index was set at 100, the value of the U.S. dollar reached its highest level in March 1985, at 140.35. Its lowest point came about 10 years later in April 1995, when it fell to 77.68.

Last February, the index reached 108.82, its highest value since April 1986, compared to major currencies. However, it dropped to 98.57 by July, but then increased slightly in August to 100.31, according to the U.S. Federal Reserve. Although the dollar’s value has dropped considerably, it is still well above its mid-1990s level.

What’s Driving the Dollar’s Value?

During the 1990s, foreign investment flowed into the United States at an unprecedented pace. The longest U.S. peacetime expansion on record, strong productivity gains and a stock market with exceptional returns attracted capital from all corners of the globe. Additionally, after the Asian crisis and uncertainty over the value of the euro, investment looking for a safe haven poured into the U.S. These factors largely contributed to the rise in the dollar’s value.

But for quite some time, economists predicted the U.S. dollar was due for a correction. The U.S. current account deficit (which is the largest of any nation), less investment from abroad, a volatile American stock market, and a decline in U.S. confidence have contributed to the dollar’s overall decline. And these and other factors likely will continue to put downward pressure on the dollar. How low and how fast it will fall is impossible to predict.

The Impact of the Highs and Lows

The change in value of any currency has a substantial impact on trade and investment trends. For example, because the value of the U.S. dollar rose 40% from April 1995 through February 2002, the cost of a
$1 million American machine was increased by $400,000. Not surprisingly, this resulted in lost export deals.

To compensate for the stronger dollar, many U.S. producers attempted to increase productivity in order to remain internationally competitive. Many were successful, and U.S. productivity outpaced most other countries. However, those manufacturers who did not increase productivity or resort to lowering prices watched their products lose marketshare abroad, as well as in the United States due to rising imports.

On the other hand, the rise in the dollar enabled U.S. companies purchasing foreign assets to obtain more for their money. But, U.S. firms already invested in foreign production facilities generated smaller profits when converting their foreign currency revenues into dollars.

A weak or declining dollar has the opposite effect. As the value of the dollar decreases from its recent high in February 2002, the cost of U.S. exports, in terms of the importers’ currency, are becoming more attractive, allowing foreign importers to obtain more for their money. The result: U.S. exports as a whole are likely to rise.

A Billion Yen Doesn’t Buy What It Used To

In 1995, one U.S. dollar could buy 93.96 yen, according the Federal Reserve. However, by May 2002, one dollar was worth 126.38 yen, reflecting an increase in the dollar’s value or a decrease in the yen’s value, depending on your perspective. By July 2002, one dollar was, on average, equal to 117.90 yen, reversing the previous trend.

To a large degree, Japan depends on exports to generate economic growth. A weakening yen means more Japanese exports, but a strengthening yen makes Japanese products more expensive and less attractive abroad. And, as the yen increases in value compared to the dollar, Japan’s Asian competitors gain an export price advantage. As a result, the strengthening yen has been a major concern for Japanese policy planners. To compensate for the declining dollar, on several occasions the Japanese government has intervened in world currency markets in an attempt to prop the dollar up and to push the yen down.

The Euro Reaches Parity with the Dollar

Over the past several years, investors repeatedly expected the single European currency, the euro, to gain against the dollar. But, the euro entered each new year with high expectations that never materialized.

However, following a smooth transition to euro notes and coins at the beginning of 2002, markets reacted positively. Months later, some analysts predicted the euro eventually would challenge the dollar for world dominance. On July 16, 2002, and continuing through July 23, the euro average daily rate hit the $1 mark for the first time in several years.

The Next Step

Currency volatility can be very damaging, as demonstrated by the Asian crisis that began in 1997. With the front page news of plunging currencies — beginning with the Thai baht and quickly affecting the Malaysian ringgit, the Indonesian rupiah, and the Korean won — it is easy now to understand the risks generated by currency fluctuations. Not only did the domino effect put pressure on traditionally strong currencies, but it also resulted in banking and financial crises, as well as economic recessions in several countries.

Exporters, importers and investors need to be aware of the impact currency shifts can have on their business, and work closely with their banker to eliminate the risks.

Selecting Export Markets Requires a Balanced Criteria and Sound Research

Published on Monday, July 01, 2002

Exports are increasingly becoming more important to the success of both our economy and individual companies. And, if you’re responsible for any international activity, chances are your company’s success at exporting will impact your job performance and value in your organization.

Consequently, identifying, assessing and choosing the right foreign markets to pursue can result in your company exceeding its profit expectations. However, selecting the wrong markets can result in great expense and frustration. To make your job easier, consider the following factors.

Study Economic Indicators

Rank the potential countries’ markets by the dollar value of your product they import from the United States. (Data needed is available from the U.S. Department of Commerce). Then rank each market by its total demand (domestic production plus world imports) for the previous three years. This will determine each country’s market size, its rate of growth, U.S. market share, and whether that is increasing or decreasing.

If total demand for your type of product is increasing, look at the country’s rate of growth and per capita income. If indicators are positive, it’s likely that your product demand will continue to rise. However, if these indicators are stagnant or down, it’s likely that the growth in demand for your product will slow and may not provide the market potential you’re looking for.

Can You Be Competitive?

Identify each selected market’s trade barriers (tariffs, standards, regulations, quotas, labeling requirements, etc.). If excessive, these barriers may make your product too expensive and limit your exports. If manageable, investigate whether any vested interests can bar your product from the market.

Importantly, know your competitors’ products, prices, distribution methods, commitments to after-sale service, and target customers. If intense competition exists, look to smaller markets which may be unattractive for multinationals, but big enough for you.

Consider Currency Strengths and Risks

Importers from countries with soft currencies or insufficient reserves may find it difficult to pay you. Understand the risks, buy insurance or choose other markets. Should you accept the importer’s currency, guard against wide fluctuations. And keep abreast of political risks.

Should a military coup take place, a succeeding government may reverse policy; should social turmoil envelop a nation, the disruption of activities could put you out of business. New governments have been known to reverse policy with regard to a whole range of investment and trade issues. Additionally, follow the political relationship between the United States and your target countries. Warmer political relations may allow U.S. businesses greater access to the foreign marketplace. Cooler relations obviously can have the opposite effect.

Determine Infrastructure Needs

If your product requires a skilled support staff (human infrastructure) make sure it’s available in your target markets. If not, you may be forced to provide costly support from your home office.

The lack of physical infrastructure may also curtail exports. For example, the inability to quickly deliver perishables due to inoperable roads or inaccessibility to refrigerated storage can be a deterrent. The shipping costs of heavy merchandise to distant locations may also prove too expensive. In this case, you may wish to consider licensing your technology.

Understand the Culture and Adapt

Sensitivity to foreign cultures is not only polite, it’s good business. Become familiar with your customers’ cultures and study their tastes. If your products and designs don’t suit them, make changes or consider going elsewhere.

Products not adapted to suit cultural preferences may not be accepted. For example, Mexican women prefer bright, splashy prints on swimsuits that may not sell well in the U.S.

Furthermore, behavior considered friendly in one country may be considered offensive in another. And be aware that many foreigners believe that to be polite means having to agree with you, not always considering the ramifications of doing so.

Investigate Intellectual Property Protection and Environmental Laws

Many countries claim to enforce intellectual property laws, but have a poor track record. If you sell software, investigate how piracy is handled. If protection isn’t a priority, you may want to avoid this market.

Environmental standards greatly differ from country to country. Certain machinery may not meet stringent foreign environmental pollution standards, which could prevent product importation.

On the other hand, some developing countries may not provide adequate facilities to treat or store toxic by-products generated by a manufacturing process, which could create a serious health risk and legal problems.

Understand the Legal System

In some countries, the accused is presumed guilty until proven innocent, and judges may unfairly favor domestic sales agents terminated over poor performance or consumers who are injured by the inappropriate use of a product.

One of the most pressing issues in doing business abroad is the lack of civil, commercial and criminal codes. And confusing and burdensome bureaucratic requirements can tie up valuable time. That’s why you must carefully assess each country’s laws and practices and determine if you wish to expose your company to them.

How Many Markets Should I Pursue?

Depending on your company’s level of resources, objectives and product competitiveness, the number of foreign markets to target simultaneously and the selection process used to determine what markets to pursue will differ considerably.

If your company is new to international trade and your staff and level of resources allocated to pursuing exports are limited, it may be wise to focus on fewer foreign markets (i.e., one to three). This will prevent spreading your resources too thin.

Determine the Criteria Right for You

Based on your product or service, export market considerations will differ. Understanding these differences will help you to pursue the markets with the highest returns and the least risk.

Foreign Direct Investment Flows To Increase and Become Integral Part of Corporate Expansion Plans

Published on Saturday, June 01, 2002

Facilitated by large scale cross-border mergers and acquisitions, global foreign direct investment (FDI) has been on the rise since the 1970s. And since the early 1990s, the value of global FDI flows has rapidly increased.

The Logic Behind FDI Flows

In today’s fast changing business environment, with its technical advances, global market possibilities, and greater consumer sophistication, companies are increasingly competing internationally through FDI. Designed to gain access to lucrative markets, technology and talent, this strategy is a driving force behind globalization, and is likely to become a more integral part of corporate expansion plans.

FDI tends to be long-term investment in foreign companies or subsidiaries, and results in controlling stakes or shares. It is affected by interrelated complex economic, political and social factors and generally cannot be withdrawn quickly.

Mergers and Acquisitions Are Preferred

Mergers and acquisitions, which offer advantages over greenfield FDI as a mode of foreign entry, present corporations with the fastest means to achieve market dominance or strong positions in new markets. They allow firms to realize synergies by pooling resources and skills, promote greater efficiencies, spread risk, and quickly obtain tangible and intangible assets in various countries.

Additionally, mergers and acquisitions enable firms with complementary capabilities to share both the costs associated with innovation and access to new technologies, all that lead to a higher level of global competitiveness.

These deepening relationships, which often involve global production facilities and complex supply management chains throughout the world, have been further facilitated by the relaxation and removal of FDI restrictions in a growing number of countries. Furthermore, trade liberalization, regional integration efforts, and the proliferation in new methods of financing have contributed to the success of mergers and acquisitions.

The 16 largest acquisitions recorded in the first eight months of 2001 involved four U.K., three German, two American, and two Australian companies, plus one French, one Swiss, one Bermuda, one Japanese, and one Italian company.

Portfolio Investment Is More Volatile

Portfolio investment, which tends to be short-term investment, is very sensitive to economic or political volatility, is driven by market forces, and seeks the greatest returns. Consequently, its flows often surge, then dip, based on perceptions, rational or not. The Mexican peso, Asian and Russian crises of the 1990s highlight the volatility of “hot money” or portfolio investment.

September 11 Has Little Impact on FDI

Surveys conducted by the United Nations in late 2001 reveal that few companies expect to change their FDI plans in light of the September 11th terrorist attacks in the United States.

These findings are consistent with A.T. Kearney survey results that indicate two-thirds of corporate executives from the world’s 1,000 largest firms said they still intend to invest abroad at almost the same level as previously planned.

The FDI/Globalization False Start

Between 1870 and 1913, approximately half of all British investment flowed outside the country, making Britain the biggest exporter of capital by far. But then, the tragic events caused by the two world wars interrupted the world’s first period of globalization. It did not resume until after 1974, when several wealthy countries removed controls on capital movement and gave up fixed exchange rates.

Over the last decade, capital flows have increased significantly, but are nowhere close to the percentage experienced by the British 89 years ago.

The U.S. Is the Greatest FDI Beneficiary

According to the OECD, from 1990 through 1999, the United States — the greatest beneficiary of the explosion in international investment among OECD countries — received almost three times more cumulative direct investment inflows than the U.K, the number two recipient. In third place was France, followed by the Netherlands, Sweden, Belgium/Luxembourg, Germany, Canada, Spain, Mexico, Australia, Italy, and Switzerland.

During this period, the United States led by a large margin in direct investment cumulative outflows. Following were the U.K., Germany, France, the Netherlands, Japan, Canada, Switzerland, Belgium/Luxembourg, Sweden, Spain, Italy, and Finland. According to the U.S. Federal Reserve, during the 1980s, 12% of total capital flows went to Asia. Over the course of the 1990s, this share jumped to 43% of total flows.

Global FDI Flows in 2001 Dipped

FDI flows to both developing and developed countries declined in 2001. In fact, flows to developed countries declined by nearly half, from over $1 trillion in 2000 to $500 billion in 2001. The number of cross-border mergers and acquisitions also dipped, from 7,900 deals in 2000 to fewer than 6,000 deals in 2001.

The considerable drop in FDI flows to the United States was partly due to the general economic slowdown and a drop in foreign acquisitions of U.S. firms. While investment shrunk in Japan in 2001, Japanese investment grew abroad. Investment flows to Asia by Japanese firms partly involved the relocation of Japanese production facilities abroad.

FDI flows to China gained greater momentum in 2001, part of a trend that is likely to continue well into the future. According to the United Nations, China beat out the United States as South Korea’s largest FDI destination in 2001, and Taiwan eliminated its $50 million ceiling on investments in mainland China. This is sure to result in more Taiwanese investment in China, although Taiwan continues to ban investment by its semiconductor industry.

Flows to Latin America and the Caribbean dwindled in 2001 as a result of a drop in mergers and acquisitions. Spain, which has become a major investor in Latin America, decreased flows to the region significantly. While flows to Brazil and Argentina dipped, flows to Mexico increased.

Although the overall 2001 FDI drop is unlikely to be recouped in 2002, FDI is anticipated to rise as world economic growth picks up. This assumes other important factors will remain the same, such as the quality of infrastructure, the availability of technology and skills in host countries, the United Nations says.

The Top Projected FDI Destinations

According to the United Nations Conference on Trade and Development, the United States is forecast to be the most favored FDI destination by transnational corporations among all developed countries through 2005.

During this period, Germany, the U.K. and France are projected to be the most favored FDI destinations in Western Europe, Brazil in Latin America, Poland in Eastern Europe, South Africa in Africa, and China in Asia. Investment in China in the first four months of 2002 was estimated to be 20% higher than the same period last year. This is attributed in part by China’s December 2001 accession to the World Trade Organization.

Industries Attracting Most FDI

According to United Nations data, industries targeted by cross-border mergers and acquisitions differ by country and region. For example, the most targeted industries in the European Union by foreign companies are chemicals, food, beverages and tobacco. The most targeted industries in the United States are electrical, electronic equipment and chemicals.

In Latin America and the Caribbean, merger and acquisition activity tends to focus on public utilities, finance, petroleum products, transport, storage, and communications. In Asia, the primary targeted sector is finance; in Central and Eastern Europe, it is finance, beverages and tobacco.

Cautious Investing Pays Off

Expanding globally through FDI can significantly increase foreign marketshare and profits, and by pooling resources, it can increase your level of competitiveness. As a result, the number of mergers and acquisitions are likely to rapidly increase. But, because the risks can be very steep, they need to be identified and studied in great depth.