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TowerAssociatescaseexample.pdf
Country Risk Analysis and
Managing Crises: Tower Associates
Team 2
Finance 490
Section 4
Professor McEnulty
November 29th, 2016
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TABLE OF CONTENTS
Introduction………………………………………………………………………..Page 2
Background of Countries…………………………………………………………..Page 2
Analyses of Past Crises…………………………………………………………….Page 3
Currency Crisis…………………………………………………………......Page 3
Financial Crisis……………………………………………………………..Page 8
Foreign Debt Crisis………………………………………………………...Page 12
Banking Crisis……………………………………………………………...Page 16
Analyses and Comparisons of Countries Depicted Through Graphs..…………….Page 21
Conclusion………………………………………………….……………………...Page 28
References……………………………………………………………………....….Page 29
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INTRODUCTION
Our firm, Tower Associates, is a large private equity firm looking to expand its business
into emerging markets overseas. We have narrowed down and identified four anonymous
countries that have optimal investment potential. Our company wishes to grow our business
quickly by expanding into a market that has more opportunities than traditional industrialized
nations. Moreover, our company wants to reduce risk and diversify our investment portfolio. To
provide the best option for business, we compared each country’s national accounts, balance of
payments, exchange rate and money supplies, interest and inflation rates, and government
finances data. The country’s names remained anonymous, which allowed us to give an unbiased
analysis, recommendation, and remain centered upon performance. This paper focuses on
currency, financial, foreign debt, and banking crisis to determine in which country would make
the best investment target.
BACKGROUND OF COUNTRY
Country A
This country A is advanced and large developing. This country faced economic
problems in 1980, but the situation has been improving and the government strongly support
economic growth. As regards on gross domestic products and other factors, economic growth is
becoming stronger. One of the concerns is high inflation rates, and domestic investment stays
weak. Furthermore, the currency floats freely.
Country B
This country has a volatile market that can experience vigorous changes, especially with
political leadership that can reshape the economy. However, it is highly industrialized, contains
vast resources, and has investment of private businesses which makes it an endearing
investment. With meticulous investment and strong leadership, it has the potential to prosper.
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Country C
Country C is a country in development. It is large and plentiful in natural resources, but
lacks the essential infrastructure to allow proper GDP growth.
Country D
Country D is a large developing country with abundant natural resources but insufficient
infrastructure to utilize them. It has an entrepreneurial market economy with a gap between
income distributions. The government has control of consumer prices, interest rates, and
exchange rates in order for the economy to continue at its fast growth path.
ANALYSIS OF PAST CRISIS
CURRENCY CRISIS
Currency crises occur when the exchange value of a currency is attacked and sharply
depreciated. Often, a government is forced to help that currency by raising interest rates or
expending large amounts of international reserves.
To determine which countries had past currency crises, we analyzed the exchange rates
and real effective exchange rates. Exchange rates are the values of currencies compared to the
US dollar. Real effective exchange rates (REERs) are a currency’s adjusted weight based on
inflation rates and other currencies. If the exchange rate and REER of a country are going in the
same direction, it means that the currency is getting stronger or weaker depending on the
direction the exchange rate and REER as going. However, if the exchange rate and REER are
going inversely, it means that the other currencies are getting stronger compared to the
country’s currency.
Our company also took a look at the countries’ consumer prices and domestic credit
growths. Consumer prices are used to determine inflation rates. If the consumer prices increase,
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inflation has increased. Domestic credit (growth) is the credit that the country or central banks
give to borrowers in their country. When domestic credit is at a higher percentage, there are
more investments in the country. Credit limits will raise for investors. Quasi money is a
country’s liquid assets that can be exchanged quickly for cash. Examples of quasi money would
be bonds, commonly traded foreign currencies, money markets, and saving accounts. Increases
in quasi money represents overall money growth. More money circulating the market can
benefit an economy’s growth.
Country A
Graph 1. Country A - Consumer Price and Exchange Rates
Based on the data, the exchange rate for Country A shows the decline between 2002 and
2006. This means that the imports of the country will be more expensive, but the exports will be
cheaper. Thus, domestic firms can increase their sales. From seeing the exchange rate, we can
assume that the government has a good policy to control its export and import. On the other
hand, there was no data available for the Real Effective Exchange rate which leaves us
uncertainty. In addition to this, the consumer price for its country is quite high and increasing,
so we could tell that inflation has also increased. However, there is no evidence for country A’s
currency crisis.
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Country B
Graph 2. Country B - Money + Quasi-money (growth)
Money+quasi-money are highly liquid assets that can be converted into cash. Based on
the graph 2 above, money+quasi-money in country B held a steady growth from 2002 to 2006,
but experienced a sharp decrease in 2007. This sudden drop indicates the country did not have
sufficient money stock/money supply in areas such as money funds, savings account, or time
deposits. This drop in money + quasi money shows that the country suffered from an economic
currency crisis.
Country C
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Graph 3. Country C - Exchange Rates of Country C
Our evidence claims that Country C’s economy is controlled by the government, and
headed towards being a market economy. Consumer prices, interest rates, and exchange rates
are carefully monitored in consideration for the population. The economy is experiencing
infrastructure growth. This government involvement can be healthy to the country’s economy,
but it is possible that this inclusion may cause blocks for foreign investors and international
trade. Graph 3 depicts that Country C’s currency exchange rate is slowly declining- meaning
that it is gradually weakening against the US dollar. With the rise of the real effective exchange
rate, we can assume that Country C is strengthening in comparison to other currencies around
the world.
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Graph 4. Country C - Domestic Credit and Money Growth
In Graph 4, we see that both domestic credit and money + quasi money declined in
2003, picked back up until 2004 where it took a dive, and rose in the year of 2005. These shifts
in credit and money growth prove that Country C has a past with currency crises. The country
struggles to steadily strengthen their currency.
Country D
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Graph 5. Country D - REER and Exchange Rate
Graph 6. Country D - Consumer Prices
Based on Graph 3 of the exchange rate and the real effective exchange rate (REER)
above, 2005 was the only year where both rates declined – meaning that the currency in country
D got weaker; and in 2006 and 2007 the rates where inverted meaning that the other currencies
got stronger compared to the country D’s currency. Furthermore, we used the consumer price to
analyze how the inflation rate changes. Based on Graph 6, the consumer prices are moderately
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increasing each year; consequently, we derived that country D’s inflation rate and exchange rate
are managed by the government to keep the economy growing rapidly. Due to these factors,
country D has not been under a currency crisis from 2002 to 2007.
FINANCIAL CRISIS
Financial crisis occurs when financial markets are abruptly disturbed- causing the
market to perform ineffectively. Economic activity is often immediately affected by this sort of
financial market disruption.
To determine which countries had past financial crises, we analyzed lending rates,
domestic credit, GDP, consumption, and government expenditures. When lending rates are high
investors will not want to borrow money, and investors who are already with loans will not be
able to pay the loans. As mentioned earlier, higher domestic credit means that there are more
investments in the country. GDP (Gross domestic product) measures the healthiness of a
country’s economy. In this sense, higher GDP levels are better.
Country A
Graph 7. Country A - Domestic Credit and Lending Rates
As seen in Graph 6, the domestic credit declined from 22.06% to 4.02% in 2007. This is
one of the concerns of country's finance situation. Moreover, lending rates are extremely high,
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and it is the highest compared to all four countries. This makes harder for people borrow money
and money does not flow into the country. A large percentage of domestic credit rate is
associated with a healthy strong economy, and a low lending rate helps with the flow of
investment in the country. Giving these points, it is reasonable to conclude that Country A is
suffering from a financial crisis.
Country B
Graph 8. Country B - Overall Balance and Current Account
Country B has the capacity to cover itself for a 13.5 months utilizing its imports covered
by international reserves, which is four times greater than the average 3 months. Overall balance
displays it can uphold private financial and economic transactions with the rest of the world
since the GDP percentage has been steady at an average of 10.55%, as shown in graph 7. In
addition, GDP dollar levels have been increasing along with reserves. However, the country’s
current account, an important indicator of the economy’s health, is approaching the 6% trigger
financial crisis threshold in 2007 with a 6.79%. Implicating that the net income from abroad,
balance of trade, and net current transfers are too low. Plus the government’s diminishing
involvement, represented by the balance in the government finance and lending rate. The
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country could potentially fall into a financial crisis in the upcoming years if foreign investment
and government is not engaged soon.
Country C
Graph 9. Country C GDP Analysis
As seen in Graph 9, country C’s GDP levels in consumption, investment, government,
exports and imports are fairly stable. There doesn’t seem to be any dramatic disruptions. The
revenues have increased within the past few years, and expenses have decreased. Interest rates
have been fairly steady, and domestic credit rates consistently grew. Country C doesn’t really
look promising for our establishment in the near future. The country does not show any extreme
positive changes in its finances- which proves that growth is perhaps too slow. In 2002 and
2004, consumption and import levels decreased as investments increased. The economy slowed,
and people held onto investments- perhaps by fear of economic failure. By the year 2005 until
2007, all these levels seemed to stop changing. The years 2002 and 2004 show us that the
country has experienced minor financial crises.
Country D
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Graph 10. Country D-Domestic Credit (growth)
Graph 11. Country D - Leading Rates
It is indisputable that the government controls the economy and foreign direct
investments in country D, because, as seen in Graph 9, the domestic credit increases and
decreases by enormous amounts, such as 10%, per year. Whenever the government wants
foreign companies to invest in country D, they increase the percentage of the domestic credit
rate; so there are more investments in the country. Moreover, based on Graph 10, country D’s
lending rates did not change much over the six years, they varied between 5.31% and 6.39%.
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Compared to countries A, B, and C, country D had the lowest lending rates. However, from
2006 to 2007 the lending rate increased and the domestic credit rate decreased; doing the
opposite of what a country would do to benefit the economy. Furthermore, consumer prices
increased and consumption in country D decreased from 37.4% to 35.9% in 2007. Based on the
country D’s rates, it is evident that it has fallen under a financial crisis in 2007.
FOREIGN DEBT CRISIS
Foreign debt crisis only takes place when a country cannot pay off its debt to foreign
countries. This type of debt can be both sovereign and private.
To determine which countries had evidence of past foreign debt crisis, we analyzed trade
balances, capital accounts, net profit investment, and domestic credit levels. Trade balances are
used to understand the strength of a country in regards to trading. They involve land (natural
resources, labor, and capital), infrastructure, and production capabilities. When trade balances
are at a positive percentage, that country has a surplus in purchasing goods and services.
Negative percentages indicate that country has a deficit and has to borrow money to purchase
goods and services. Capital accounts measure the overall economic status. They include foreign
direct investment (FDI), net portfolio investments, and other capital inflows. Capital accounts
indicate the overall economic status of a country. Current accounts keep track of exports and
imports of goods and services. When the percentage is positive, the economy in that country is
better because there is more money flowing into the country instead of out of the country. Net
profit investments are the financial assets that are held by foreign investors. Foreign investors
cannot be the direct owners of financial assets. Net profit investments are relatively liquid -
depending on the volatility of the market.
Country A
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Graph 12. Country A Capital Account, Trade Balance, and Net Portfolio
Investment
Net portfolio investment is increasing significantly, and it shows a good trend in GDP.
The country should consider a better prospect in FDI. The trade balance shows decline from
2005 - which could indicate the weakness of its economy compare to other countries.
Moreover, domestic credit also has declined dramatically from 22.06% to 4.02% in 2007. This
data is evidence of a foreign crisis because money is not flowing into the country. Another
concern is that this country’s average capital account rates are close to 0. The capital account
represents overall economy, so it is fair to assume that the country’s economic situation is not
the best. Based on the information, the country is facing a foreign debt crisis.
Country B
Graph 13. Country B Trade Balance, Capital Accounts, Domestic Credit (growth)
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Due to the country’s growing industrial economy and private business investment the
country has relatively low foreign debt based on graph 13. The trade balances decreased from
13% to 9% within 5 years, indicating low strength in trading as it decreases. Capital accounts
have not been greater than 0.15% from 2003 to 2007, depicting low inflow and outflow of
money flow. In addition, the domestic credit growth has decreased and become negative in 2007
at -3.75%, which has led us to believe it has not borrowed. Therefore, based on the data, the
country has not experienced a foreign debt crisis, but could potentially face a foreign debt crisis
in upcoming years due to their low domestic credit growth.
Country C
Graph 14. Country C Balance of Payments
As seen in Graph 12, trade balance has been decreasing since 2002. Net portfolio investment
began to rise in 2003, took a sudden drop in 2003, and has steadily decreased up until 2007.
These percentages indicate that foreign investment of country C is low. The rate of country C’s
current account slowly decreases since 2003, and the capital rate increases. Growth in the
capital account proves that the country is paying off foreign debts such as loans, investments,
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and commercial borrowings. They are not likely to have foreign debt crisis because they are
exporting more than importing, and seemingly paying off foreign debt.
Country D
Graph 15. Country D - Trade Balance
Graph 16. Country D - Capital Accounts
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In Country D, Trade Balance has increased from 2004 to 2007. It is evident it is a
developing country, and the fact that trade balance is increasing is a positive sign for
infrastructure, land, and labor. Country D possibly had a Foreign Debt crisis from 2004 to 2005
because capital accounts and net portfolio investment decreased, meaning that there was less
money and investments flowing into the country. Simultaneously, balance of the government
finances in percentage of GDP decreased as well. However, when there is an economic crisis,
the lending rates usually decrease because of less demand towards loans. In country D this did
not happen. Instead of the lending rates decreasing, they stayed the same at 5.58%, while the
domestic credit increased from 8.79% to 10.67%. Because the lending rate did not increase the
following year, the domestic credit increased (causing more investments to flow into country
D). Based on this analyzation, country D did fall into a foreign debt crisis in 2004. However, in
2007 it seems that country D was in good shape. Increases in trade Balance, capital accounts,
and lending rates determine that the country is in a healthy economic shape.
BANKING CRISIS
Banking crises are caused by banks’ suspension of internal convertibility of their
liabilities. This sort of crisis can lead to bank failures, and a government usually intervenes by
providing extensive assistance.
To determine which countries had past banking crises, we analyzed the balance of
government finances, lending rates, money+quasi money rates, and investments. The balance
of government finances is total revenue minus the expenses of a country’s government. When a
country has a negative balance, that countries expenses outweigh what they actually own.
Lending rates are basically a country’s interest rates. The higher the interest- the more that
consumers will cut back. When interest rates are low, an economy can flow with ease from the
inexpensive trading and buying rates. Interest rates can raise or lower from a variety of
instances such as inflation, economic growth, and so forth. As mentioned before, money + quasi
money growth means that a country’s economy has a higher number of liquid assets circulating
the market.
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Country A
Graph 17. Country A- Government Finances
Country A’ revenue was 45.48 % in 2007. This is the highest revenues rate out of all the
countries we analyzed. However, its expenditures are increasing (marked 52.82% in the same
year), and this led the country to have the negative balance of -7.34%. This data indicates that
the country is failing to meet the financial needs. Banking crisis occurs when the banks cannot
pay their internal debts so that government intervenes to provide an assistant. The country’s
leading rate is continuing to be the highest and investments rates are keep falling. This results in
having hard times for financial institutions to borrow money and negatively affecting country
A’s banking system. Moreover, this country has negative rates in its finance balance which
mean the country cannot cover the serving and cost of the loans. Since money market rates are
high and the government has a negative balance in its finances, there are possibilities for
country A to face a banking crisis.
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Country B
Graph 18. Country B- Lending Rate
Graph 19. Country B- Government Finances (% of GDP)
Country B has not experienced an abrupt bank crisis. Government involvement has been
slowly decreasing. One factor that can perceive this change is the annual lending rate because it
decreased from 15.71% in 2002 to 9.90% in 2007 (illustrated by graph 18). Lending rates
largely fluctuate based on the demand and supply of money in the economy, international
forces, and actions of the government. Based on the data, it is safe to say that the low
international involvement and government action could have decreased the bank liabilities and
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expenses. This could have made the country volatile to external or political forces. In addition,
government finance balance (shown on graph 19) increased from 1.65% to 8.44% in 2002 and
2006, and quickly dropped to 3% in 2007. This could mark a sudden change in interest and
inflation rates for the country in the upcoming years. This fact must be taken into account for
upcoming years to invest domestically and internationally.
Country C
Graph 20. Country C
The government of country C seems pretty involved in influencing consumer prices,
interest rates, and exchange rates in order to balance out the living standards of its population.
Slowly, the negative government finances are growing. This means that the country’s economic
infrastructure is expanding, and the economy is gaining momentum and GDP growth.
Eventually, the economy is expected to evolve into a market economy. The pricing of goods
and services will be taken over by citizens and businesses. This steady and independent flow of
money will help the banks to be strong and stable. The country probably has a low chance of
facing banking crisis. We can see from Graph 20 above that money and quasi money growth
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matches the 2002 and 2004 problematic scheme the country faced. Consumer spending went
down, and investments went up. We also found a trend in exchange rates falling. This indicates
that the overall economy is failing. Because the government finances and lending rate have
remained fairly stable, a past banking crisis doesn’t appear evident.
Country D
Graph 21. Country D- Balance of Government Finances
Some reasons that there could be a banking crisis is in country D are that the
government did not pay their obligations (causing a declination in value of government bonds
that are held by the bank), or there was a decrease in value of bank assets (collapse in real estate
prices or the banks have too many liabilities and cannot pay them). As a result, balance of
government finance and government national accounts in percentage of GDP decreased; during
2002 to 2004, and in between 2005 and 2006 the country seemed to be recuperating. Country
D’s balance of government finance from 2002 to 2005 stayed in the negative percentage.
However, investment was steadily increasing during that period, and lending rates were being
managed so that the percentage increased in a minimal and steady way. This means that there
was no banking crisis in country D because the investment and lending rates were increasing at
a steady rate. Unless the government did not pay their obligations and the country’s assets
decreased in value, it does not appear like Country D has been under a banking crisis.
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ANALYSIS OF COUNTRIES
Graph 22. Domestic Credit (growth)
Graph 23. Exchange Rate
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Graph 24. Consumer Prices
Graph 25. Gross Domestic Product
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Graph 26. Balance of Government Finances
Graph 27. Net Portfolio Investment
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Graph 28. Capital Accounts
Graph 29. Investment
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Graph 30. Money + Quasi-money (growth)
Graph 31. Leading Rates (Annual)
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Country A:
This country’s government has a good economic policy. Although GDP is a concern for
the country, it is showing a moving trend. Since the exchange rate is low, it is clear that growth
of GDP is affected by its export and control of its import. As seen in Graph 17, the government
finance revenue was 45.48% in 2007; which is the highest out of all the four countries. Thus, we
could assume the current international economic situation of this country is in a healthy stage.
However, expressed on the graph 1 of consumer prices, this country has high inflation; which
negatively affects its economy. For example, in Graph 12, this country’s lending rates are much
higher than all given countries; and, as seen in Graph 28, the average capital rates are very close
to 0. In addition to this, expenditures marked 52.82% resulting in a negative balance of -7.34%
on government finances; which is the lowest compared to other countries, as seen in graph 17.
From the given information, this country must be suffering from a financial crisis in 2007,
possibly a banking crisis, and it went through a foreign debt crisis in 2003. Therefore, we do not
think country A is the best country to invest.
Country B:
Country B offers vast opportunities to invest at the small private sector because it
provides the extensive resources and consumer involvement. This can be depicted in its
increasing GDP % consumption, GDP dollars, reserves, and consumer prices. It has the ability
to cover liabilities if needed for at least a year with its current economic status. However, due to
its low portfolio diversification, the country does not convince Tower Associates. Country B
does not prove that it has established a healthy economy in foreign investment, which can be
seen in decreasing lending rates, low capital account, and negative domestic credit. In addition,
we noticed the government’s decreasing involvement based on its sudden decrease in
government finance balance in 2007 (3%) compared to 2006 (8.44%). The current account
approaches the 6% threshold- assuming a possible financial crisis. Our equity firm would not
wish to invest in a country with such a volatile relationship with foreign and political impact
that has little room to develop its internal financial market.
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Country C:
Country C would be an interesting long term investment hedge to become involved in.
Although the country’s government is showing success in raising their GDP and exchange rate,
it is a work in progress. It seems as if a handful of investors have already come into the country,
and are starting business that may be promising in the distant future. Investment and domestic
credit growth in 2005 show that the economy is being backed by the right people. The past two
years have not shown either significant growth in areas like trade, nor the necessary decreases in
consumer prices and interest rates. If our company were to engage in business on the land of
country C, we might be able to gain first-mover benefits. Being the first of our trade to move
into country C, we could have the opportunity to learn the exact rules of the government, and
gain devoted customers that trust us as the first developers in their country. It may be an
expensive venture, but it could gain us long-term clients and a trusted brand name for our
company. In conclusion, a long term investment and strategy for future growth would be the
only worthwhile investment in Country C.
Country D:
Country D has a well-planned economic policy which provides more positive trends in
the international and domestic market. Since the government controls the economy’s exchange
and interest rates, they are able to have a steady economic growth. According to Graph 24,
compared to the other countries, Country D’s consumer prices are lower. This means that
inflation rates are stable and do not increase fast- a perfect example of how well the government
controls the economy. Furthermore, the GDP of country D is the highest compared to the other
countries (see Graph 25). The amount of production in the country is increasing, and the
citizens are spending more money because they are having higher income.
For balance of government finances, country D is the only one that seems to be
increasing (see Graph 26). Therefore, country D has more revenue than expenditures and is
more stable when it comes to money handling. As seen in Graph 28, country D does not have as
high of capital accounts rates as country C. Country D is still a developing country lacking the
infrastructure needed to use all the natural resources that it has.
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In comparison to the other countries, country D has the highest investment rate (see
Graph 29) and the lowest lending rates. This shows that the country’s government wants people
to invest in it. Overall, our company felt that Country D’s growing economy makes it the best
option to invest in. Because of its low money market rates, low interest rate, and low inflation
rates, Tower Associates should truly consider investing in Country D.
CONCLUSION
After analyzing each of our four countries, Tower Associates would have to decide what
kind of venture they are hoping to make. With a past history of banking and financial crises, the
country may be a risky choice for long-term investment. Country A and country B did not stand
out to our team as potential countries for business venture investment. Country A suffers from
financial crises and lack of capital accounts- making us believe that it would be unwise to invest
in. Country B offers a great investment in the private sector, and seems to have an industrialized
economy. It does not have much foreign investment, government involvement is decreasing,
and there is little room for entrepreneurship. Country B may therefore subtly fall into a crisis
and does not give Tower Associates a promising optimal portfolio. As mentioned previously,
country C could make a suitable long-term investment. With a history of minor financial crises,
and no foreign debt or banking crises; country C is a “safe” investment. If Tower Associates
wants to try slowly entering into the economy in hopes of gradually winning the people of
country C’s loyalty, the country provides the opportunity for distant future growth. However, if
Tower Associates is hoping for a more efficient growth in business, country D looks more
promising. Country D’s recent rapid growth in GDP and extreme lowering of interest rates
makes it a potential candidate for an expeditious and profitable venture.
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