Country risk refers to the uncertainty associated with investing in a particular country, and more specifically the degree to which that uncertainty could lead to losses for investors. This uncertainty can come from any number of factors including political, economic, exchange-rate, or technological influences. This is the risk that a foreign government will default on its bonds or other financial commitments. Country risk also refers to the broader notion of the degree to which political and economic unrest affects the securities of issuers doing business in a particular country.
The risk of foreign exchange rate movements has become a significant part of a bank’s business and economy. The economy has the risk that a government may simply lack the economic capacity to repay its loans. Recently, numerous countries have been going through fiscal deficits and rapid money-supply growth. Consequently, inflation rates have become high in these countries, and devaluation crises appear time and again. A devaluation of one currency automatically creates pressure for devaluation in other countries’ exchange rates.
Risk is a matter because the political and economic crisis produces volatility. In turn, investors need higher returns as compensation for this calculated risk. As you can imagine, Canada would have much less country risk than Nigeria, but in exchange for this peace of mind, Canadian bonds will yield less than the Nigerian bonds. As a result, the presence and degree of country risk make it more expensive for many emerging economies or struggling countries to borrow money.
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