Economic Country Risks Emanating from Austria’s International Exposure Austria’s special role as one of the leading investors in Eastern and Southeastern European Matthias Fuchs1 growth markets increasingly raises questions on the risk capacity of Austria’s foreign portfolio. Using selected macroeconomic indicators, this article assesses the economic country risk attached to Austria’s external assets. A scoring model facilitates the calculation of individual country risks, which are linked to detailed regional data from the external statistics of the Oesterreichische Nationalbank (OeNB), thus enabling us to draw conclusions on the regional and functional risk structure of Austrian international investment. This reveals that, in capital- weighted terms, the developed and leading financial markets of Europe and the U.S.A. have a far stronger influence on total risk than that of the 12 EU entrants since 2004 (EU-12) or the Eastern and Southeastern European countries. Despite its intensive investment in Eastern Europe, Austria’s international risk largely stems from securities holdings in developed industri- alized countries. The EU-12 account for no more than a fifth of capital-weighted risk, while the region of Eastern and Southeastern Europe represents just a tenth of total exposure. Nevertheless, some growth markets, such as Hungary, Poland, the Czech Republic or Russia, already have more impact on Austria’s total risk than some Western European markets. The projection up to 2009 suggests a leveling off in the total risk presented by Austria’s external assets. A generally stable development in the EU-27 is somewhat offset by a more unfavorable risk environment in some European growth markets and in the U.S.A. JEL classification: F36, G11, G15, G32 Keywords: country risk, financial integration, portfolio choice, international investment position Given the upsurge in international finan- Notably for major banks, internal rat- cial investment over the past two de- ing models have become far more im- cades, country risk analyses have be- portant in recent years, mainly reflect- come an indispensable component of ing the implementation of the new comprehensive risk management. They Basel Capital Accord (Basel II), because can be regarded as an important supple- the now mandatory rating of the bor- ment to individual credit quality assess- rower with the help of internal models ments of potential borrowers. Interna- offers greater flexibility than the stan- tional investors rely heavily on country dardized approach, and hence competi- risk analyses when planning their re- tive advantages.2 gional investment strategy. Banks em- However, the credit ratings by es- ploy them as an aid in structuring their tablished commercial agencies – partic- foreign exposure, setting credit terms, ularly Standard & Poor’s, Moody’s and and defining regional country lending Fitch – have been playing a crucial sig- limits. Financial investors either base naling role in the international financial their investment decisions on internal markets for a long time and they have rating models or fall back on the ser- been influencing the refinancing condi- vices of commercial rating agencies. tions for both public and private bor- Refereed by: Gerhard Fink, 1 [email protected]. The author thanks Eva-Maria Nesvadba, Michael Pfeiffer and Patricia Walter for their valuable suggestions and Dieter Kreuz for research assistance. Vienna University 2 Moreover, notably banks active in the European markets, which are dominated by small and medium enterprises, of Economics have no choice other than to apply internal ratings since external ratings focus mainly on large corporations and Business (Daldrup, 2006). Administration MONETARY POLICY & THE ECONOMY Q3/08 41 Economic Country Risks Emanating from Austria’s International Exposure rowers considerably. Although rating type of financial instrument is involved. agencies have come in for criticism in The object of analysis is thus the gen- the wake of the recent subprime crisis – eral economic environment as the key for which they were deemed partly re- determinant for the repayment capac- sponsible – the persistent increase in ity and willingness of foreign debtors.3 the information asymmetries between It goes without saying that analyses borrowers and lenders consequent on from this macroeconomic perspective globalization will continue to form a do not compete in any way with indi- key commercial justification for these vidual risk assessments of borrowers, institutions in the future. Independent but rather form a supplement to them. ratings will remain highly important Section 1 explains the model and as an instrument for reducing uncer- the risk factors, while section 2 eluci- tainties in lender/borrower relations dates the model results. Conclusions (Büschgen and Everling, 2007). are presented in section 3. In contrast to the issuer ratings as- signed by the large agencies, this study 1 Theoretical Explanations does not relate the term country risk to 1.1 Scoring Methods in Country Risk the sovereign power, but to a country’s Analysis overall macroeconomic situation. It Scoring models are among the most pop- seeks to assess the economic risks of ular tools in the field of country risk those countries and regions that bear analysis (Krämer-Eis, 1998; Lichtlen, relevance as targets for Austrian finan- 1997). They are based on selected cri- cial investment, looking especially at teria that appear suitable for systemati- the Eastern and Southeastern European cally explaining an economy’s risk situ- growth regions. The analysis is con- ation. These factors are weighted and fined exclusively to economic risks. compressed to a synthetic risk measure, Political, legal or institutional aspects the rating. Like other rating proce- of country risks, which are also mean- dures, e.g. discriminant analysis or re- ingful in the context of a comprehen- gression models, scoring methods must sive country risk analysis, have been de- meet some basic requirements as sum- liberately left out of consideration. marized in table 1. The key assumption of this study is a significant connection between the Table 1 macroeconomic situation of the bor- Requirements for Rating Systems rower’s country of residence and the Target measure PD (Probability of Default) can be probability of default on the corre- depicted sponding financial claim. Crisis symp- Completeness of all information relevant to credit toms in the real economy, such as re- assessment Objectivity cessions or rapid currency deprecia- Acceptance by the user tions, hence generally reduce the Consistency with recognized theories and methods likelihood of repayment, no matter Source: OeNB (2004). which economic sector is liable or what 3 Repayment willingness is lacking if borrowers no longer meet their repayment obligations although they would be financially able to do so. Since such conduct would seriously impair their reputation in the capital markets, rational borrowers would only choose this strategy if the cost of losing their reputation is outweighed by that of the repayment. Related to the payment conduct of sovereign states, such a situation is only conceivable in actual crisis scenarios. Repayment capacity and repayment willingness are therefore generally closely related (Blüml and Neus, 2002). 42 MONETARY POLICY & THE ECONOMY Q3/08 Economic Country Risks Emanating from Austria’s International Exposure A key advantage of the scoring economy and three in the external sec- method is the high degree of transpar- tor, weighted as shown in table 2. These ency that allows us to readily recon- established factors for assessing the struct the scores and draw intertempo- macroeconomic situation in a given ral comparisons. Scoring models have economy are found in many methods of hence become widely popular. They are country risk analysis. This selection is applied in pure form or in combination underpinned by empirical studies which with other rating procedures in numer- demonstrate a high correlation between ous country risk analyses – including some indicators4 and the credit rating those by the Economist Intelligence by both Standard & Poor’s and Moody’s Unit (EIU) of Euromoney or by BERI (Will, 2001). (Business Environment Risk Intelli- The factors listed in table 2 are ap- gence) in the form of the Forelend In- praised within a set interval and are en- dex (Maltritz, 2006). tered in the model in accordance with Scoring methods are not undis- their specific fixed weighting. This re- puted, however. The subjective selec- sults in a risk coefficient that permits tion and weighting of the influencing comparisons across different countries factors are particularly subject to criti- or regions. cism. In reality, even when every effort = + is made to ensure objectivity within the KD IE ( kDI ,) FkDI + + (1) scoring method, subjective influences PI (EkPI ,)FkPI SI(,LD) cannot be totally ruled out. However, K = Austria’s total external financial since other methods of analysis un- assets avoidably rely on assumptions too, the DI = Direct investment assets, criticism of a lack of neutrality should EkDI = Direct investment equity, be seen in perspective. Even economet- FkDI = Corporate loans ric methods are affected by the subjec- PI = Portfolio investment, tive specifications of the model design. EkPI = Stocks and mutual fund shares, 1.2 Selection and Weighting of FkPI = Debt securities Risk Factors SI = Other investment, The scoring applied in this study com- L = Credit claims,