Buyer's Risk

An international manager needs to avoid the main pitfalls of country risk assessment by looking for information in a variety of places, conducting relevant analysis, and changing opinions if necessary. A company must set acceptable risk objectives based on its reward goals and risk tolerance. The key to reducing risk is a thorough assessment of the country and customers. Maintaining a systematic approach for each customer and country in this analysis will assure that each evaluation is consistent, relevant, and objective.

The goal of this material is to introduce you to the concepts of commercial, economic and political risks found in a buyer’s country, including understanding these risks and their effect on timely payment and financing international transactions.

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Ensuring Timely Payment

One approach to country risk assessment is to use “CAMEL” to analyze:

Capital Adequacy = financial status based on a country's balance of payments
Asset Quality = economic and financial strength based on a country's combined natural, human, and general economic resources
Management Quality = a government's fiscal, monetary, credit policies and politics and how well these are implemented
Earnings Potential = internal and external variables that affect how well a country is achieving its capabilities
Liquidity = a nation's foreign exchange cash flow prospects

To ensure timely payment, an international manager needs to determine what the risk really is. These determining factors come in various forms:

non-payment
late payment
currency devaluation
import restrictions
bank problems
government issues
debt chains
tariff changes
shipping difficulties
pilferage

When measuring risk to determine how prompt payments can result, an international manager should attempt to put real values on the potential loss. These will have to include the absolute cost in cash terms and the cost in relation to the anticipated profit/loss.
The company's risk tolerance (established by the credit management policy) will have to be taken into consideration as well the company's specific objectives in a given country, since the goal of "maximum market penetration," for instance, will point to different defensive measures than an objective that reads "maximum cash flow."

A check of the possible options for mitigating risk will reveal a number of possibilities, which need to be evaluated for anticipated benefits and costs.
Alternatives could be:

agreement to open account terms
insistence on draft terms
unconfirmed L/C
confirmed L/C
insurance
arranging payment from an account the importer has abroad
forfeiting/Factoring
cash in advance
refusal to ship

Because of the different way in which international markets now finance themselves and the implications such have for a risk to a seller, the following questions should be asked in the normal assessment of variables that determine country risk:

Does the country have a fixed exchange rate and free movement of international capital?
Is the exchange rate overvalued or widely deemed to be?
Has a country with similar characteristics recently experienced a currency crisis?
Is there a large budget deficit and much government debt outstanding, especially short-term, needing constant rollovers at rising interest rates?
Is there loose monetary policy and high inflation?
Is the domestic economy in, or at risk of, recession?
Is there a large current-account balance-of-payments deficit?
Is there an asset-price boom, especially a credit-driven one, occurring?
Is there a large volume of bad debt in the banking sector, coupled with a poor system of bank supervision?
Has there been a lot of unhedged foreign currency borrowing?
Are accounting standards poor, with few disclosures requirements, ambiguous bankruptcy proceedings, etc.?
Is there socio-political uncertainty?

Facilitating External Financing

To understand the risks of external financing, the following questions need to be asked:

What is external financing?
How can it be viewed and understood?
How does CAMEL play a role in external financing as it has been described above?
What are the issues and factors that need to be considered when determining external financing?

The answers can be grouped by both commercial and political risk categories as discussed below.

Commercial Credit Risk

Nature of the business
Financial strength of the buyer
Nature of the relationship with the buyer--new buyer or a frequent customer, dealer/distributor, or a subsidiary/affiliate
Buyer’s record of meeting local and international payment obligations
Ownership of buyer, private or public sector
Potential loss if shipment is not accepted:
value of the shipment (marginal pricing concept--cash invested in the goods, high or low profit at the margin)
types of goods , perishable or specially manufactured where total loss might result if shipment were refused
likelihood of shipment being refused-- a change in market conditions for commodity shipments may induce buyer to refuse shipment).

Sources of information to help companies identify commercial credit risk are:
credit reports from independent agencies, banks, etc.
customer-supplied financial data
industry intelligence

Political Risks

Political conditions in buyer’s country
Stability of the local, state and federal governments
Possibility of import license cancellation, or other unexpected actions that would result in the non-acceptance of the shipment
Possibility of coup, civil disturbance, etc.
Possibility of change in foreign exchange regulations that could delay or disrupt payment

Economic Risks

Economic conditions in buyer’s country including expected and recent changes
Economic trends-- inflationary, recessionary, etc.
Currency exchange control regulations
Currency flow regulations
Country’s balance of payments
Sources of information to help companies identify political and economic risks are government and private agency intelligence reports including the following:
Chase World Guide for Exporters
Chase Econometrics Country Reports
International Monetary Fund Data
World Bank Data
CIA World Fact Book
US Department of Commerce – Country Commercial Guides
US State Department – Country Reports