1

WORKING PAPER NO: 326

Country Risk Analysis in Emerging Markets: The Indian
Example
BY
Sankarshan Basu
Associate Professor
Finance & Control
Indian Institute of Management Bangalore
Bannerghatta Road, Bangalore 5600 76
Ph. 080-26993078
sankarshanbiimb.ernet.in
D. Deepthi
Student, IIMB
&
Jyothsni Reddy
Student, IIMB
Year oI Publication 2011
2
CCUN1k kISk ANALIS IN LMLkGING
MAkkL1S: 1HL INDIAN LkAMLL
Abstract:
1he 8eta Country k|sk Mode|, as oescrlbeo by Lrb, Parvey ano vlskanLa (1996) ano useo by
Anoraoe ano 1eles (2004) for 8razll, ls useo Lo esLlmaLe Lhe counLry rlsk of lnola baseo on
several macroeconomlc lnolcaLors. Crolnary leasL squares regresslon ls run on Lhe whlLe nolse
(unexpecLeo componenL) of Lhese varlables Lo explaln Lhe varlaLlon ln counLry rlsk Lo loenLlfy
Lhe mosL relevanL of Lhese varlables. 1he sLuoy shows LhaL Lhe varlaLlon ln counLry rlsk of lnola
ls hlghly correlaLeo wlLh changes ln lul flows, lnLeresL raLes (moneLary pollcy), exchange raLes
ano Lhe unemploymenL raLe. 1he effecL of pollLlcal rlsk on overall counLry rlsk ls also sLuoleo.
key words: counLry rlsk, counLry beLa mooel, rlsk mooellng
3
1. Introduct|on
CloballzaLlon ano lncreaslng flnanclal unlflcaLlon has leo Lo a raplo growLh of lnLernaLlonal
lenolng, forelgn olrecL ano lnsLlLuLlonal lnvesLmenL. WlLh Lhls, economles across Lhe globe are
lncreaslngly becomlng lnLeroepenoenL ano oevelopmenLs ln one parL of Lhe worlo affecL
reLurns ln anoLher. Clven Lhls, counLry rlsk analysls provloes lnslghLs lnLo LhaL parL of Lhe rlsk of
an lnvesLmenL speclflc Lo a cerLaln counLry. Country k|sk", ln general refers Lo Lhe rlsk
assoclaLeo wlLh Lhose facLors LhaL oeLermlne or affecL Lhe ablllLy ano wllllngness of a soverelgn
sLaLe or borrower from a parLlcular counLry Lo fulflll Lhelr obllgaLlons Lowaros one or more
forelgn lenoers ano / or lnvesLors, Lhls ls Lhe approach ano Lhe oeflnlLlon useo by 8aLes ano
Salnl (1984) as well as by Abassl ano 1affler (1982). 1hls shall also be Lhe oeflnlLlon useo ln Lhls
paper. 1he analysls of counLry rlsk conslsLs of Lhe assessmenL of Lhe pollLlcal, economlc ano
flnanclal facLors of a borrowlng counLry or lul
1
hosL. 1hese facLors glve an lnolcaLlon of Lhe
sLablllLy ano proflLablllLy ln an economy. As Parvey ano vlskanLa (1996) polnL ouL, non -
olverslflable sysLemlc rlsk" arlses ouL of Lhe facLors over whlch borrowers have llLLle conLrol,
ano counLry rlsk may also represenL such non-olverslflable sysLemaLlc rlsk".
Lmerglng MarkeLs counLry rlsk analysls provloes a challenge for researchers, accorolng Lo Luler
Permes
2
, slnce calculaLlon of sLaLlsLlcal properLles of Lhe varlous parameLers baseo on hlsLorlcal
reLurns coulo be mlsleaolng. ln aoolLlon, rellable oaLa ls noL avallable for several perloos,
especlally far back lnLo Lhe pasL. Such oaLa mlghL noL even be relevanL as, by Lhelr very naLure,
Lhe pasL ln emerglng economles rarely reflecLs Lhe presenL ano Lo a lesser exLenL, Lhe fuLure.
1he Country 8eta Approach ls a quanLlLaLlve meLhoo of counLry rlsk analysls ln whlch Lhe
olfference beLween Lhe reLurns of a counLry's equlLy markeL ano Lhe worlo equlLy markeL ls
aLLrlbuLeo Lo Lhe counLry rlsk. 1hls olfference lnolcaLes Lhe reLurns ln a counLry speclflc Lo lL ano
olfferenL from Lhe resL of Lhe worlo. 1hls mooel has flrsL been oescrlbeo ln Lhe semlnal paper by
Lrb, Parvey ano vlskanLa (1996b). 1hls mooel has been applleo Lo AusLralla by Cangeml, 8rooks
ano laff (2000) Lo examlne Lhe effecLs of forelgn oebL on counLry rlsk, Lo LaLln Amerlca by
verma ano Syoermlr (2006) Lo sLuoy Lhe economlc oeLermlnanLs of a Llme-varylng counLry beLa
ano Lo 8razll by Anoraoe ano 1eles (2004) Lo sLuoy Lhe effecL of lnLeresL raLes. 8uL such an
analysls has noL been prevlously oone for lnola. lnola provloeo an lnLeresLlng case for counLry
rlsk ano sLuoylng Lhose facLors affecLlng counLry rlsk ln an emerglng economy, Lhrough Lhe
llberallzaLlon phase ln Lhe early 1990s.
1hls sLuoy examlnes Lhe relaLlonshlp beLween counLry rlsk ano macroeconomlc varlables ano
loenLlfles Lhose varlables LhaL affecL counLry rlsk Lhe mosL, uslng Crolnary LeasL Squares (CLS)
regresslon on Lhe whlLe nolse of Lhe varlables. ln aoolLlon, Lhe lmpacL of pollLlcal rlsk ls also
sLuoleo. lL can been seen LhaL lul lnflows, lnLeresL raLes (moneLary pollcy), exchange raLes ano
Lhe unemploymenL raLe lmpacL counLry rlsk Lhe mosL. SecLlon 2 glves a brlef hlsLory of Lhe
1
lorelgn olrecL lnvesLmenL ls LhaL lnvesLmenL, whlch ls maoe Lo serve Lhe buslness lnLeresLs of Lhe lnvesLor ln
a company, whlch ls ln a olfferenL naLlon olsLlncL from Lhe lnvesLor's counLry of orlgln.
2
Luler Permes ls a lrench creolL lnsurance company. 1he arLlcle can be accesses aL
hLLp://www.eulerhermes.com/en/press/press_20090112_00100060.hLml
4
sLuoles oone ln Lhls flelo. SecLlon 3 oescrlbes Lhe counLry beLa mooel, Lhe meLhooology useo Lo
whlLe Lhe Llme serles of Lhe varlables ano Lhe flnal regresslon. SecLlon 4 glves an analysls of Lhe
resulLs obLalneo uslng Lhls mooel. CerLaln llmlLaLlons ano fuLure scope for Lhls sLuoy are
presenLeo ln secLlon S.
2. L|terature kev|ew
CounLry rlsk analysls has been oeflneo ano sLuoleo ln several olfferenL ways slnce Lhe laLLer parL
of Lhe prevlous cenLury. 8lbelro (2006) caLegorlzeo some sLanoaro economlc varlables LhaL
ofLen coulo be founo ln mosL of Lhe olverse approaches aoopLeo by flnanclal lnsLlLuLlons ano
raLlng agencles (such as Coloman Sachs, Merrlll Lynch, S& ano llLch 8aLlngs) lnLo Lxterna|
sector (exporLs, lmporLs, oebL servlces, olrecL lnvesLmenLs, loans, repaymenL of loans, exLernal
oebL ano flow of forelgn reserves), Interna| sector (lnLeresL raLe, publlc oebL ano lLs servlce,
level of lnvesLmenLs, buogeL equlllbrlum, lnLernal savlngs, consumpLlon, Cu/Cn, lnflaLlon
raLe, money supply, eLc) ano Cther var|ab|es (populaLlon, llfe expecLancy, raLe of
unemploymenL, level of llLeracy, eLc). 1elxelra, kloLzle ano ness (2008), loenLlfleo Lhe
oeLermlnanL facLors of Lhe counLry rlsk for selecLeo emerglng markeLs. 1hree mooels were useo
Lo esLlmaLe counLry rlsk - ln Lhe flrsL mooel Lhe relaLlon beLween counLry rlsk ano funoamenLal
economlc varlables was LesLeo, ln Lhe secono mooel Lhe exLernal componenL was be aooeo Lo
Lhe group of explanaLory varlables, ano Lhe Lhlro mooel LesLeo Lhe relaLlon beLween speclflc
counLry rlsk ano Lhe economlc funoamenLals. 1he resulLs founo for emerglng markeLs lnolcaLeo
LhaL four oomesLlc facLors are conslsLenL oeLermlnanLs of counLry rlsk ano speclflc counLry rlsk
- growLh raLe, exLernal oebL, publlc oebL ano lnLernaLlonal reserves.
varlous meLhoos useo for counLry rlsk appralsal may be caLegorlzeo lnLo one of four Lypes -
lully CuallLaLlve MeLhoo, SLrucLureo CuallLaLlve MeLhoo, CheckllsL MeLhoo ano CLher
CuanLlLaLlve MeLhoos. 1he popular quanLlLaLlve meLhoos useo for counLry rlsk analysls are
llsLeo by naLh (2008). ArLlflclal neural neLworks are exLenslvely useo for counLry rlsk analysls.
?lm ano MlLchell (2004) lnvesLlgaLeo Lhe posslblllLy of ouLperformance of LraolLlonal sLaLlsLlcal
mooels by Lwo arLlflclal neural neLworks, mulLllayer percepLron ano hybrlo neLworks, for
preolcLlng counLry rlsk raLlng. 1he resulLs ln sample lnolcaLe LhaL Lhe hybrlo Ann - Ann-LoglL-
loglL - proouceo Lhe besL resulLs. 1hls supporLs Lhe concluslon LhaL for researchers,
pollcymakers ano oLhers lnLeresLeo ln early warnlng sysLems, hybrlo neLworks woulo be useful.
AnoLher novel mooel useo for counLry rlsk analysls ls Lhe counLry beLa mooel oescrlbeo by Lrb,
Parvey ano vlskanLa (1996). 1hls mooel was applleo Lo esLlmaLe Lhe counLry rlsk of 8razll from
1991 Lo 2002, by Anoraoe ano 1eles (2004). 1he four varlables useo for Lhe mooel are forelgn
reserves, worlo oll prlces, nomlnal lnLeresL raLe ano publlc oebL. 1hree olfferenL speclflcaLlons
of Lhe mooel were analyzeo - one lncluolng all Lhe 4 varlables, one wlLhouL publlc oebL ano one
wlLhouL lnLeresL raLe. 1he followlng observaLlons were maoe - one, Lhe effecLs of forex
reserves ls very small slnce Lhe aoopLlon of Lhe floaLlng exchange raLe reglme, ano Lwo,
unanLlclpaLeo lncrease ln lnLeresL raLes reouces counLry rlsk.
1hls paper uses Lhe same mooel, as has been useo by Lrb, Parvey ano vlskanLa (1996) ano
Anoraoe ano 1eles (2004) for esLlmaLlng 8razlllan counLry rlsk, for analyzlng lnola's counLry rlsk.
S
3. 1he Mode|
Country 8eta Mode| of Lrb, Parvey ano vlskanLa (1996) ls oescrlbeo below. As sLaLeo earller,
Lhls ls Lhe mooel useo ln Lhe sLuoy of 8razlllan counLry rlsk ano ls also useo Lo esLlmaLe lnola's
counLry rlsk. 1he oaLa perloo for Lhe sLuoy ln Lhe lnolan conLexL ls beLween 1984 ano 2008.
3.1. 1he Country 8eta Mode|
Lrb, Parvey ano vlskanLa (1996) have shown LhaL Lhe olfference beLween Lhe reLurns of a
counLry's equlLy markeL ano Lhe worlo equlLy markeL may be aLLrlbuLeo Lo Lhe counLry rlsk. 1hls
relaLlon may be expresseo as follows:
8
LqulLy_CounLry
= o + 8
LqulLy_Worlo
+ e
L
(1)
ls Lhe baslc measure of counLry rlsk, slnce lL lnolcaLes Lhe reLurns ln a counLry speclflc Lo lL ano
olfferenL from Lhe resL of Lhe worlo. As lncreases, counLry rlsk oecreases, LhaL ls, Lhe reLurns
ln Lhe counLry are affecLeo only by facLors common Lo Lhe resL of Lhe worlo, whlch ls essenLlally
a non-olverslflable rlsk for a parLlcular counLry.
CounLry rlsk woulo be a varlable affecLeo by cerLaln macroeconomlc varlables speclflc Lo Lhe
counLry. 1hus, beLa ls mooeleo as a llnear comblnaLlon of Lhose varlables:
= b
0
+ b.k (2)
where k represenLs a vecLor of macroeconomlc lnolcaLors.
1hls was applleo Lo Lhe lnolan conLexL ano Lhe followlng mooel was useo Lo esLlmaLe counLry
rlsk:
8
lnola
= o + 8
Worlo
+ e
L
(3)
where 8
lnola
ls Lhe reLurn on Lhe lnolan equlLy markeL ano 8
Worlo
ls Lhe reLurn on Lhe worlo
equlLy markeL. ls an lnolcaLor of lnola's counLry rlsk. As lncreases, counLry rlsk oecreases.
1he varlables LhaL go lnLo Lhe vecLor of macroeconomlc lnolcaLors, k, are oescrlbeo ln SecLlon
3.2. LquaLlon (2) ls subsLlLuLeo ln (3) ano sub[ecL Lo CLS regresslon analysls Lo oeLermlne Lhose
varlables LhaL affecL , ano Lhus, Lhe counLry rlsk.
8aseo on Lhe fflcleot Motket nypotbesls (lama (196S)), only unexplalneo shocks ln Lhe
explanaLory varlables affecL counLry rlsk, slnce markeL expecLaLlons geL lncorporaLeo lnLo 8
lnola
ano 8
Worlo
. 1hus, an AuLo-8egresslve lnLegraLeo Movlng Average (A8lMA) mooel ls run on each
of Lhe varlables Lo fllLer ouL Lhe expecLeo componenLs.
3.2. Data
1he regresslon was run on Lwo olfferenL mooels baseo on slgnlflcance of explanaLory varlables.
Annual macroeconomlc oaLa for Lhe varlables was collecLeo from Lhe otomooltot lotetootloool
6
oaLabase
3
. 1he varlables useo are Lhe followlng, formlng Lhe lnlLlal macroeconomlc lnolcaLor
vecLor, k, useo ln equaLlon (2):
Cu
Cu oeflaLor
ubllc oebL
CurrenL AccounL 8alance
lnLeresL raLes
lorex reserves
Lxchange 8aLe (agalnsL Lhe uSu)
lul lnflows
unemploymenL
ollLlcal 8lsk lnoex (8l)
lnLeresL raLes ano exchange raLes glve an lnolcaLlon of Lhe moneLary pollcy ln lnola, whlle publlc
oebL ano currenL accounL balance reflecL Lhe flscal pollcy of Lhe economy. lul lnflows lnolcaLe
how forelgn economles percelve Lhe lnolan economy. uaLa on Lhe macroeconomlc lnolcaLors 1
Lhrough 9 were collecLeo from 1980 Lo 2009. 1he oaLa for 8l (10) was avallable for a few years
from 1996 Lo 2008 (1ab|e 1), provloeo by Lhe cooomlst lotelllqeoce uolt. lLs lnoex of ollLlcal
SLablllLy ano Absence of vlolence"
4
was useo as a proxy for counLry rlsk. 1hls lnolcaLes how
non-buslness pollLlcal evenLs such as wars, reglme changes ano LerrorlsL aLLacks affecL
proflLablllLy of buslnesses.
1able 1: ollLlcal 8lsk lnoex
ear o||t|ca|
k|sk Index
1996 0.80
1998 0.7S
2000 0.6S
2002 0.3S
2003 0.30
2004 0.3S
200S 0.S0
2006 0.S0
2007 0.SS
2008 0.60
1he annual reLurn on Lhe 8SL SLNSLk |ndex was useo for 8
lnola
ano Lhe reLurn on Lhe NSL
|ndex was useo as a proxy for 8
Worlo
.
Lach of Lhe economlc varlables was sub[ecL Lo Lhe A8lMA smooLhlng uslng Lhe 8ox-Ienk|ns
MeLhooology, as oescrlbeo by 8ox ano !enklns (1970), wherever appllcable.
3
hLLp://www.euromonlLor.com/
4
hLLp://lnfo.worlobank.org/governance/wgl/pof/c104.pof
7
All regresslons were run uslng Lhe SSS 16.0 sLaLlsLlcal sofLware.
3.3. Wh|t|ng the 1|me Ser|es (AkIMA)
A Lhorough observaLlon ano graphlng of oaLa showeo LhaL a loL of Lhese varlables were non-
sLaLlonary, l.e., Lhey are loteqtoteJ. As shown by Anoraoe ano 1eles (2004), unoer Lhe
assumpLlon of Lhe fflcleot Motket hypoLhesls, only unanLlclpaLeo shocks of Lhe varlables are
expecLeo Lo affecL reLurns. Slmply puL, Lhls means LhaL Lhere woulo be a neeo Lo make Lhe oaLa
sLochasLlc or sLaLlonary ln Lhls case. 1he oeLermlnlsLlc Lreno ln Lhese varlables neeos Lo be
ellmlnaLeo. 1haL belng Lhe case, Lhe economeLrlc mooel shoulo consloer only Lhe non
anLlclpaLeo componenLs of Lhe relaLeo serles. 1herefore, Lo whlLe Lhe serles 8ox-!enklns (8-!)
proceoure was applleo ano a unlvarlaLe A8lMA process for each macroeconomlc serles was
obLalneo.
1he chlef Lools ln loenLlflcaLlon are Lhe auLocorrelaLlon funcLlon (ACl), Lhe parLlal
auLocorrelaLlon funcLlon (ACl), ano Lhe resulLlng correlograms, whlch are Lhe ploLs of ACls
ano ACls agalnsL Lhe lag lengLh - Lhe approach useo ls Lhe one oescrlbeo ln Cu[raLl (2007). 1he
'l' parL of A8lMA can be seL by olrecLly chooslng from Lhe SSS Lool for auLocorrelaLlon.
loenLlflcaLlon of A8MA ls oone baseo on Lhe followlng Lable whlch Lalks of paLLern recognlLlon.
1able 2: 1heoreLlcal paLLerns of ACl ano ACl
1ype of mode| 1yp|ca| pattern of ACI 1yp|ca| pattern of ACI
A8(p) uecays exponenLlally or wlLh oampeo
slne wave paLLern or boLh
SlgnlflcanL splkes Lhrough lags q
MA(q) SlgnlflcanL splkes Lhrough lags q uecllnes exponenLlally
A8MA(p, q) LxponenLlal oecay LxponenLlal oecay
1he ACl ano ACl funcLlons for each of Lhe Llme serles oaLa were calculaLeo ano analyzeo Lo
maLch wlLh one of Lhe Lyplcal paLLerns from 1ab|e 2. AfLer a LenLaLlve 8ox-!enklns mooel has
been flLLeo, lL ls sub[ecLeo Lo varlous olagnosLlc checks (baseo on ACl ano ACl) as formulaLeo
by 8ox ano lerce (1970) & 8ox ano !enklns (1970) Lo LesL lLs aoequacy as a sLochasLlc
represenLaLlon of Lhe process unoer sLuoy. lf Lhe mooel ls founo Lo be lnaoequaLe, analysls of
Lhe mooel reslouals suggesLs ways Lo moolfy Lhe mooel sLrucLure Lo obLaln a new LenLaLlve
mooel whlch wlll llkely oo an lmproveo [ob of represenLlng Lhe process. MulLlple comblnaLlons
of (p, q) were Lrleo Lo loenLlfy Lhe A8lMA process unoerlylng Lhe serles. 1he followlng Lable
(1ab|e 3) glves Lhe flnal A8lMA mooel useo for each of Lhe macroeconomlc varlables.
8
1able 3: A8lMA Mooels for Lhe Macroeconomlc Serles
Macroeconom|c Var|ab|e AkIMA (p,d,q)
Cu (1,1,0)
Cu ueflaLor (1,1,0)
ubllc uebL (1,0,0) on square of flrsL olfference
lorex 8eserves (3,1,0)
Lxchange 8aLe (1,1,0)
unemploymenL (1,1,0)
lul lnflows (2,1,0)
CurrenL AccounL 8alance llrsL ulfference - no correlaLlon
ShorL 1erm lnLeresL 8aLe no correlaLlon
1he serles obLalneo afLer fllLerlng Lhe oeLermlnlsLlc componenLs correspono Lo 'whlLe nolse'
l.e., Lhe sLochasLlc componenLs or unanLlclpaLeo shocks ln Lhe markeLs. 1hls way, our analysls
woulo lnvolve only sLaLlonary oaLa ano hence avolo 'spurlous regresslon'. 1he olfference
beLween Lhe acLual Llme serles ano Lhe serles whlLeo uslng A8lMA ls glven ln Lxh|b|t 1.
1he 8eLa for Lhe counLry rlsk esLlmaLlon lnvolves Lhe followlng macroeconomlc explanaLory
varlables. 1he Lable below glves Lhe A8lMA resulLs of Lhese esLlmaLors. 1he flnal values useo ln
Lhe 8eLa esLlmaLlon are obLalneo by ao[usLlng Lhe oaLa polnLs accorolng Lo Lhe A8lMA resulLs.
3.4. kegress|on kesu|ts
uslng Lhe A8lMA-smooLheo Llme serles from above, olfferenL regresslons were run Lo flno Lhe
mooel LhaL flLs Lhe oaLa besL. 1he followlng Lwo mooels were founo Lo glve Lhe hlghesL 8
2
(ao[usLeo) as well as reasonable slgnlflcance of Lhe varlables. 1he resulLs from Lhe Lwo
regresslons are summarlzeo below.
1able 4: Mooel 1
Var|ab|es Coeff|c|ent p-va|ue (t test) Mode| k-square D-W test p-va|ue (I test)
Lxchange 8aLe -0.400 23.1 0.164 1.807 18.7
unemploymenL -0.774 18.9
lul lnflows -4.S4L-6 8.8
ConsLanL 0.274 12.1
9
1able S: Mooel 2
Var|ab|es Coeff|c|ent p-va|ue (t test) Mode| k-square D-W test p-va|ue (I test)
S1 lnLeresL 8aLe 0.07 18.3 0.0S4 2.093 20.9
lul lnflows -S.79L-6 1S.6
-2.S
-2
-1.S
-1
-0.S
0
0.S
1
1.S
2
2.S
3
1
9
8
4
1
9
8
S
1
9
8
6
1
9
8
7
1
9
8
8
1
9
8
9
1
9
9
0
1
9
9
1
1
9
9
2
1
9
9
3
1
9
9
4
1
9
9
S
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
S
2
0
0
6
2
0
0
7
2
0
0
8
I|gure 1: Country 8eta - Mode| I
8eLa
-1.S0L+00
-1.00L+00
-S.00L-01
0.00L+00
S.00L-01
1.00L+00
1.S0L+00
2.00L+00
2.S0L+00
3.00L+00
3.S0L+00
1
9
8
4
1
9
8
S
1
9
8
6
1
9
8
7
1
9
8
8
1
9
8
9
1
9
9
0
1
9
9
1
1
9
9
2
1
9
9
3
1
9
9
4
1
9
9
S
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
S
2
0
0
6
2
0
0
7
2
0
0
8
I|gure 2: Country 8eta - Mode| II
8eLa
10
lL can be seen LhaL Lhe Lwo mooels glve slmllar resulLs, especlally afLer 2002. 1hus, lL can be salo
LhaL Lhe mooels reasonably esLlmaLe counLry rlsk ln Lhe perloo from 1984 Lo 2008, Lo Lhe exLenL
posslble ln a maLhemaLlcal mooel.
3.4.1. Add|ng o||t|ca| k|sk
Slnce Lhe pollLlcal rlsk oaLa was avallable for only 10 years beLween 1996 ano 2009, lL was noL
lncluoeo ln Lhe maln regresslons. AnoLher regresslon was run on Lhe sample for Lhe Len years
when Lhe pollLlcal rlsk oaLa was avallable Lo see how much Lhls lnoex affecLs counLry rlsk. 1he
resulLs are summarlzeo below.
Aoolng Lhe pollLlcal rlsk lnoex Lo Mooel 1 leaos Lo hlgh mulLlcolllnearlLy, lnolcaLeo by hlgh 8
2
,
low slgnlflcance of Lhe varlables ano hlgh varlance-lnflaLlon facLors. 1hus, lL can be lnferreo LhaL
Lhe explanaLory varlables (Lxchange raLe, unemploymenL raLe ano lul lnflows) oeLermlne
pollLlcal rlsk Lo a large exLenL. lL ls Lhus noL necessary Lo lncluoe pollLlcal rlsk ln Lhls mooel.
upon aoolng pollLlcal rlsk lnoex Lo Mooel 2, Lhe varlance lnflaLlon coefflclenL of S1 lnLeresL raLe
becomes hlgh, lnolcaLlon sLrong correlaLlon wlLh pollLlcal rlsk. 1he slgnlflcance of Lhe mooel
remalns Lhe same ano Lhus, lncluolng pollLlcal rlsk ooes noL aoo lncremenLal value Lo Lhe
esLlmaLlon. 1hls ls probably because Lhe pollLlcal rlsk ls alreaoy reflecLeo ln oLher facLors llke
lnLeresL raLes ano lul lnflows.
1hese resulLs coulo be oue Lo Lhe small sample slze, lncreaslng Lhe sample slze mlghL glve
beLLer resulLs.
-3
-2
-1
0
1
2
3
4
1
9
8
4
1
9
8
S
1
9
8
6
1
9
8
7
1
9
8
8
1
9
8
9
1
9
9
0
1
9
9
1
1
9
9
2
1
9
9
3
1
9
9
4
1
9
9
S
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
S
2
0
0
6
2
0
0
7
2
0
0
8
I|gure 3: Country 8eta - Mode| I vs. Mode| II
8eLa - Mooel l
8eLa - Mooel ll
11
1able 6: Mooel 2 wlLh ollLlcal rlsk lnoex
Var|ab|es Coeff|c|ent p-va|ue (t test) Mode| k
2
D-W test p-va|ue (I test) VII
S1 lnL 8aLe -0.072 36.4 0.2S9 1.700 20.8 8.742
lul lnflows -6.43SL-6 7.4 1.067
8l 1.694 S0.0 8.603
4. Interpretat|on of the kesu|ts
1hls secLlon oeals wlLh explanaLlon of slgnlflcance of cerLaln macroeconomlc varlables. 1he
mosL slgnlflcanL varlables are lul lnflows, Lxchange raLe, unemploymenL raLe ano ShorL-Lerm
lnLeresL raLes.
4.1. Lxp|a|n|ng Var|at|on |n 8eta
ln Lhe mooel, hlgher lmplles lower counLry rlsk. 1he level of ooes noL have as much
slgnlflcance as Lhe change ln Lhe level, slnce we are Lrylng Lo esLlmaLe how macroeconomlc
lnolcaLors leao Lo a cbooqe ln .
lrom I|gure 3, lL can be seen LhaL Lhe varlaLlon ln counLry rlsk lncreases slgnlflcanLly, especlally
ln Mooel 2, afLer 1991 - Lhe resulL of llberallzaLlon ln lnola.
1he years 1998 Lo 2001 saw lncreaslng , or a reoucLlon ln counLry rlsk ourlng Lhe ooL-com
bubble. lollowlng Lhls perloo unLll 2003, Lhere was an lncrease ln counLry rlsk when Lhe bubble
bursL. 1hls ls expecLeo ln a counLry llke lnola wlLh Lhe l1 lnousLry accounLlng for a S.9 of lLs
Cu as of 2009, employlng over 2.3 mllllon people.
osL Lhe l1 bubble, lnola was back on Lrack ano counLry rlsk oecreaseo unLll arouno 2007, ano
agaln lncreaseo ourlng Lhe sub-prlme crlsls.
4.2. ke|evance of the Var|ab|es Chosen by the Mode|
4.2.1. IDI Inf|ows
lnflows are a clear lnolcaLlon of Lhe confloence forelgn counLrles place ln Lhe performance of
our economy. lL can be seen LhaL as our economy has progresseo, Lhe lul ano lll percenLages ln
our sLock markeLs have conslsLenLly rlsen. 1hey help Lrack Lhe lnLernal pollcles ano regulaLlons.
A low rlsk economy ls bouno Lo aLLracL hlgher caplLal lnflows. We see a very sLrong negaLlve
correlaLlon beLween rlsk ano lnflows.
4.2.2. Lxchange kate
ln lnola, exchange raLes are slgnlflcanLly governeo by Lraoe acLlvlLles. 1he rlghL prlce of currency
ln oemano-supply Lerms ls essenLlal ln [uoglng Lhe sLablllLy ano growLh of any counLry. 1he
exchange raLe ls lnfluenceo sLrongly by Lhe behavlor ano oeclslons of economlc agenLs ano
lnLeracLs wlLh mosL of Lhe macroeconomlc parameLer changes. lL ls a represenLaLlon of a
counLry's lncome olsLrlbuLlon, ouLpuL, prlce levels ano Lraoe Lerms. Lven Lhe sllghL change ln
Lhe raLe can be lnLerpreLeo as olfference ln reLurns beLween alLernaLlve cholces of lnvesLmenLs.
12
lL ls also a represenLaLlon of opLlmal resource allocaLlon ln Lhe economy Lo maxlmlze proflLs ln
Lhe economy.
lnola has aoopLeo a flexlble exchange raLe reglme ln oroer Lo unoerplay exLernal lmbalances
arlslng ouL of hlgh volaLlllLy of caplLal flows ano lLs requesLs for lmmeolaLe macroeconomlc
ao[usLmenLs. 1hls ls why CovernmenLs promoLe arLlflclal raLes Lo make necessary ao[usLmenLs.
1hls woulo also lmpacL many oLher macroeconomlc varlables.
4.2.3. Unemp|oyment
Plgher Lhe unemploymenL, lower ls Lhe wage raLe, whlch lmplles LhaL Lhere ls a large pool of
unemployeo workers avallable ln Lhe counLry. Labor rlsk, l.e., olfflculLy ln flnolng quallfleo
workforce aL reasonable wage raLes, plays a crlLlcal role ln a counLry's growLh. 1he labor rlsk ls
lower when unemploymenL ls hlgher. Powever, Lhls ls more effecLual Lhan causal. 1he Cu
growLh whlch resulLs ln lowerlng unemploymenL raLe coulo have been accounLeo ln oLher
facLors llke lul lnflows ano exchange raLe.
4.2.4. Short 1erm Interest kate
lnLeresL raLe ls generally oeLermlneo by Lhe markeL buL Lhe CovernmenL ofLen conLrols lL Lo
resLore economlc balance ln Lhe counLry by means of moneLary pollcy. CovernmenL
lnLervenLlons arlse ouL of neeo Lo resLore sLablllLy ln Lhe economy. 1herefore, Lhey can provloe
a proxy for unexpecLeo shocks experlenceo by Lhe economy.
S. Iuture Scope
Cne of Lhe blggesL challenges ln Lhe analysls was Lhe lack of sufflclenL oaLa for an CLS
regresslon. 1he mooel can be preolcLeo wlLh greaLer accuracy lf monLhly oaLa can be obLalneo
for macroeconomlc parameLers. Cur analysls was resLrlcLeo Lo 30 oaLa polnLs (1978-2008). 1he
numbers of explanaLory varlables belng more Lhan 10 orasLlcally reouces Lhe oegrees of
freeoom. ln aoolLlon, Lhe n?SL composlLe reLurn was useo as a proxy for worlo reLurn 8
Worlo
.
8eLLer resulLs may be obLalneo uslng an lnoex LhaL ls an aggregaLe of several sLock exchanges
from olfferenL parLs of Lhe worlo. uue Lo Lhe oynamlc naLure of Lhe varlables ano Lhe
oeLermlnanLs of counLry rlsk Lhemselves, lL mlghL make more sense Lo use coefflclenLs LhaL vary
Lhrough Llme (Llme-varylng beLa uslng kalman lllLer). CuallLaLlve parameLers llke Lhe pollLlcal
rlsk lnoex may be calculaLeo for Lhe enLlre Llme serles ano lncluoeo ln Lhe regresslon Lo accounL
for non-quanLlflable elemenLs causlng change ln counLry rlsk. A regresslon may be run on a
panel of slmllar economles, raLher Lhan on a slngle counLry Lo cancel ouL common
quanLlLaLlvely unexplalneo facLors ln Lhe regresslon.
13
6. keferences
Abassl, 8. ano 8. !. 1affler (1982), CounLry 8lsk: A Mooel of Lconomlc erformance 8elaLeo Lo oebL Servlclng
CapaclLy." ClLy unlverslLy 8uslness School (Lonoon), Worklng aper no. 36.
Anoraoe, !. ano 1eles, v. k (2004), An Lmplrlcal Mooel of Lhe 8razlllan CounLry 8lsk - An LxLenslon of Lhe
8eLa CounLry 8lsk Mooel", unlversloaoe oe 8rasllla
8ox, C.L.., ano u.A. lerce(1970), "ulsLrlbuLlon of 8esloual AuLocorrelaLlons ln AuLoregresslve-lnLegraLeo
Movlng Average 1lme Serles Mooels," !ournal of Lhe Amerlcan SLaLlsLlcal AssoclaLlon, vol. 6S, no. 332, p.
1S09-1S26.
8ox, C.L.. Ano C.M. !enklns (1970), 1lme serles analysls: lorecasLlng ano conLrol", San lranclsco: Poloen-
uay.
C. 8., Parvey, C. 8., ano vlskanLa, 1. L. (1996b). LxpecLeo reLurns ano volaLlllLy ln 13S counLrles", !ournal of
orLfollo ManagemenL Sprlng: 46-S8
uamooar n. Cu[araLl, SangeeLha, 8aslc LconomeLrlcs, lourLh eolLlon, 2007, p. 864
L. l. lama (196S), 1he 8ehavlor of SLock-MarkeL rlces," !ournal of 8uslness.
Lrb, C., Parvey, C., vlskanLa, 1. (1996a), oloLlcal rlsk, economlc rlsk ano flnanclal rlsk", llnanclal Analysls
!ournal S2:28-46
!oaqulm Anoraoe, vlaolmlr kuhl 1eles (2004), An Lmperlcal mooel of Lhe 8razlllan CounLry 8lsk- An
exLenslon of Lhe 8eLa counLry rlsk mooel", unversloaoe oe 8rasllla, p.S
M. A.M. Cangeml, 8.u. 8rooks ano 8.W. laff (2000), Mooellng AusLralla's counLry rlsk: A counLry beLa
approach", !ournal of Lconomlcs ano 8uslness S2, pp. 2S9-276
Mlcheal okorney (1987), An lnLrooucLlon Lo LconomeLrlcs, 8asll 8lackwell, new ?ork, p.343.
naLh, P. k. (2008),"CounLry 8lsk Analysls: A Survey of Lhe CuanLlLaLlve MeLhoos", SPSu Lconomlcs & lnLl.
8uslness Worklng aper no. SPSu_LCC_W08-04
8. verma ano C. Soyoemlr (2006), Mooellng counLry rlsk ln LaLln Amerlca: A counLry beLa approach", Clobal
llnance !ournal 17, pp. 192-213
8lbelro, 8enaLo u (2001), CounLry 8lsk Analysls", CWu- l8l- MlnL8vA rogram, aL
www.gwu.eou/~lbl/mlnerva/sprlng2001/renaLo.rlbelro.pof
Salnl, C. k. ano 8aLes, . S. (1984), A Survey of Lhe CuanLlLaLlve Approaches Lo CounLry 8lsk Analysls",
!ournal of 8anklng ano llnance, pp 341-3S6
1elxelra, M. l., kloLzle, M. C. ano ness, W. L. (2008), ueLermlnanL lacLors of Lmerglng MarkeLs 8lsk: A SLuoy
of Speclflc CounLry 8lsk." aper presenLeo aL Lhe annual meeLlng of Lhe 8ALAS Annual Conference,
unlversloao oe los Anoes School of ManagemenL, 8ogoLa, u.C., Colombla
?lm, !ullan ano MlLchell, PeaLher (2004), Comparlson of counLry rlsk mooels: hybrlo neural neLworks, loglL
mooels, olscrlmlnanL analysls ano clusLer Lechnlques." LxperL SysLems wlLh AppllcaLlons, pp 137-148
14
Lxh|b|t 1
nomlnal Cu [A8lMA (1,1,0)]
Cu oeflaLor [A8lMA (1,1,0)]
CurrenL AccounL 8alance [l(1)]
-10,000,000.00
-
10,000,000.00
20,000,000.00
30,000,000.00
40,000,000.00
S0,000,000.00
60,000,000.00
1983198S1987198919911993199S1997199920012003200S2007
Cu
Cu (A8lMA)
-S0
0
S0
100
1S0
200
2S0
1983 198S 1987 1989 1991 1993 199S 1997 1999 2001 2003 200S 2007
Cu oefl
Cu oefl (A8lMA)
-3S000
-30000
-2S000
-20000
-1S000
-10000
-S000
0
S000
10000
1S000
1
9
8
3
1
9
8
4
1
9
8
S
1
9
8
6
1
9
8
7
1
9
8
8
1
9
8
9
1
9
9
0
1
9
9
1
1
9
9
2
1
9
9
3
1
9
9
4
1
9
9
S
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
S
2
0
0
6
2
0
0
7
2
0
0
8
CA8
CA8 (A8lMA)
1S
ubllc uebL [A8lMA (1,1,0)]
Lxchange 8aLe [A8lMA (1,1,0)]
unemploymenL [A8lMA (1,1,0)]
-S000000
0
S000000
10000000
1S000000
20000000
2S000000
30000000
3S000000
40000000
4S000000
ubllc oebL
ubllc oebL (A8lMA)
-10
0
10
20
30
40
S0
60
Lxchange 8aLe
Lxchange 8aLe (A8lMA)
-2
0
2
4
6
8
10
12
unemploymenL
unemploymenL (A8lMA)
16
lul lnflows [A8lMA (2,1,0)]
lorex reserves [A8lMA (3,1,0)]
-1000000
-S00000
0
S00000
1000000
1S00000
2000000
lul lnflows
lul lnflows (A8lMA)
-S0000
0
S0000
100000
1S0000
200000
2S0000
300000
1983 198S 1987 1989 1991 1993 199S 1997 1999 2001 2003 200S 2007
lorex res
lorex res (A8lMA)