One of the ways to measure country risk is by using the Country Risk Classification (CRC) system developed by the Organisation for Economic Co-operation and Development (OECD). The CRC system assigns a numerical score from 0 to 7 to each country, based on a range of political, economic and financial indicators. The lower the score, the lower the risk and the higher the creditworthiness of the country.
According to the CRC system, countries like Tonga have a high country risk score of 6, which means they face significant challenges in meeting their external debt obligations and accessing international capital markets. Other countries with a CRC score of 6 include Afghanistan, Cuba, Iraq, Somalia and Zimbabwe.
Export Credit Facilities
Export credit facilities are financial products that help exporters and importers conduct international trade transactions. They can take various forms, such as:
- Cash facilities: These are loans that provide working capital to exporters or importers to finance their trade activities.
- Contingent obligation facilities: These are guarantees or insurance that cover the risk of non-payment or non-performance by the exporter or importer.
Export credit facilities are usually provided by commercial banks or specialized export credit agencies (ECAs). ECAs are government-backed institutions that support their country’s exports by offering trade finance and other services to domestic exporters and foreign buyers.
Challenges for High-Risk Countries
Countries with high country risk face several challenges in accessing export credit facilities, such as:
- Higher interest rates: Lenders and insurers charge higher premiums to compensate for the higher risk of default or loss.
- Shorter repayment terms: Lenders and insurers limit the duration of their exposure to high-risk countries by requiring shorter repayment periods.
- Lower credit limits: Lenders and insurers impose lower credit ceilings on high-risk countries to limit their exposure and diversify their portfolio.
- Stricter eligibility criteria: Lenders and insurers require more stringent conditions for high-risk countries to qualify for export credit facilities, such as collateral, guarantees, sovereign guarantees or letters of credit.
Solutions for High-Risk Countries
Despite these challenges, countries like Tonga can still buy expensive machinery and other goods from abroad by using some of the following solutions:
- Multilateral development banks: These are international financial institutions that provide loans, grants and technical assistance to developing countries for various purposes, including trade facilitation. Some examples are the World Bank, the Asian Development Bank and the African Development Bank. These institutions can offer concessional financing terms, such as lower interest rates, longer repayment terms and higher credit limits, to high-risk countries.
- Bilateral development agencies: These are government agencies that provide development assistance and cooperation to other countries, often in the form of grants or loans. Some examples are USAID, DFID and JICA. These agencies can also offer concessional financing terms or grants to high-risk countries for specific projects or sectors, such as infrastructure, agriculture or health.
- Trade agreements: These are agreements between two or more countries that aim to facilitate trade by reducing tariffs, quotas and other barriers. Some examples are the Pacific Agreement on Closer Economic Relations (PACER) and the African Continental Free Trade Area (AfCFTA). These agreements can help high-risk countries access preferential market access, lower trade costs and regional integration.
- Supplier credit: This is a form of trade finance where the exporter provides credit to the importer by allowing deferred payment for the goods or services delivered. This can help high-risk countries buy expensive machinery without upfront payment or collateral. However, this also exposes the exporter to higher risk of non-payment or non-performance by the importer.
Examples
Here are some examples of how countries like Tonga have bought expensive machinery despite high country risk (source: https://www.gfdrr.org/):
- In 2019, Tonga bought two new fire trucks from Japan worth $1.4 million with a grant from JICA.
- In 2018, Tonga bought four new buses from China worth $800,000 with a loan from China Development Bank.
- In 2017, Tonga bought a new asphalt plant from India worth $1.2 million with a loan from EXIM Bank of India.
The Reliability of Rating Agencies
Rating agencies are firms that assess the creditworthiness of borrowers, such as governments, corporations and financial institutions. They assign ratings to debt instruments, such as bonds and loans, based on the probability of default or loss. Rating agencies play an important role in the global financial system, as they influence the cost and availability of credit for borrowers and the risk and return for lenders and investors.
However, rating agencies have also been criticized for their role in some of the major financial crises in recent history, such as the subprime mortgage crisis of 2007-2008 and the eurozone debt crisis of 2010-2012. In both cases, rating agencies were accused of being too optimistic in their ratings of complex and risky securities, such as mortgage-backed securities (MBS) and collateralized debt obligations (CDO), that were based on subprime or non-prime mortgages in the US or sovereign debt in Europe. These securities were given high ratings, such as AAA or Aaa, which implied they were very safe and reliable. However, when the housing market collapsed in the US and the fiscal situation deteriorated in some European countries, such as Greece, these securities suffered massive losses and downgrades, triggering a global financial crisis and a sovereign debt crisis.
Some of the reasons for the rating agencies’ failures include:
- Conflicts of interest: Rating agencies are paid by the issuers of the securities they rate, which creates an incentive for them to give favourable ratings to attract more business and avoid losing clients to competitors.
- Lack of transparency: Rating agencies do not disclose their methodologies, assumptions and data sources for their ratings, which makes it difficult for investors and regulators to scrutinize and challenge their judgments.
- Regulatory capture: Rating agencies are subject to regulation by national and international authorities, but they also have a significant influence on these authorities through lobbying and revolving doors. Rating agencies can use their power to resist reforms or shape regulations in their favour.
- Herding behaviour: Rating agencies tend to follow each other’s ratings, rather than independently assess the credit risk of borrowers and securities. This can lead to rating inflation or deflation, depending on the market sentiment and expectations.
Improving Rating Agencies
Rating agencies are essential actors in the global financial system, but they are also fallible and prone to errors and biases. Their ratings can have significant consequences for borrowers, lenders, investors and regulators, especially in times of financial stress and uncertainty. Therefore, rating agencies need to be more accountable, transparent and independent in their operations and decisions. They also need to be more vigilant and responsive to changing market conditions and risks. Moreover, users of ratings need to be more aware of the limitations and uncertainties of ratings and exercise their own due diligence and judgment when making financial decisions.
Conclusion
Country risk classification is a useful tool for measuring and comparing the creditworthiness of different countries. It can help lenders and insurers to price and manage their exposure to sovereign risk. It can also help borrowers and investors to access and diversify their sources of financing. However, country risk classification is not a static or objective measure. It can change over time and vary across different rating agencies and methodologies. Therefore, users of country risk classification need to be aware of the assumptions, limitations and uncertainties behind the ratings. They also need to complement the ratings with their own analysis and judgment of the political, economic and financial situation of each country. Moreover, countries with high country risk can still buy expensive machinery and other goods from abroad by using some of the solutions discussed in this article, such as multilateral development banks, bilateral development agencies, trade agreements and supplier credit.
