News Release

Risk indexes do not predict the economic future of country

The various crises between 1994 and 2002 presented factors not reflected in the indexes, according to Ms Nerea San Martín in her thesis at the University of the Basque Country

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The economic collapse of Mexico in 1994, with its worldwide repercussions, was indicative that something was changing. Globalisation of the markets was giving rise to crises that were different from previous ones: they were occurring in emerging countries which were apparently stable, and giving rise to a contagion effect between states. Ms Nerea San Martín studied the characteristics presented by countries which suffered a crisis between 1994 and 2002, for the months before these economies actually fell into such crises, and compared these variables with those of the most commonly used country risk indexes (Euromoney and ICRG), showing that, in some cases, they do not coincide. Thus, she concluded, these ratings do not predict the vulnerabilities that might give rise to a crisis. Her thesis, defended at the University of the Basque Country (UPV/EHU), is entitled External monetary and financial crises and country risk indexes: an analysis of predictive capacity in the 1994-2002 period.

Ms San Martín underlined that the country risk and crises should be studied as two closely linked things. Her starting point was the analysis of the most relevant external crises that happened between 1994 and 2002, in order to look for similarities amongst them.

Short-term risk investment

The countries suffering a crisis over this period were those with an exchange system tied to the United States dollar and mainly run along the lines of free market liberalisation. Their economic growth depended a great deal on external investments; investments that moreover were short term and based on high-profitability but high-risk projects. Lack of supervision, high inflation and high current account deficit (except in South Korea, Brazil and Turkey), as well as problems of liquidity with respect to external reserves, were the other hallmarks of these countries' economies.

Also, the not very open privatisation of public enterprises, a high public deficit, the inability of the government to collect taxes and the extent of the public sector debt may also have had influence in the crises, especially in Mexico, Brazil, Russia and Argentina. As regards the Asian countries, it is remarkable that they showed apparently healthy public accounts just before the crisis. Likewise, the high external debt of the private sector, the dependence on exports and the excessively high speculative investment on the stock markets and real estate on that continent, with the concomitant formation of bubbles.

Ms San Martín defined a series of variables that reflect some of the above-mentioned factors, and thus may act as a pattern for anticipating episodes of external monetary and financial crises.

Key variables missing

Next the researcher compared these variables with those of the Euromoney and ICRG country risk indexes, and concluded that these show certain deficiencies. For example, in neither of the two indexes is the internal and external situation of the banking sector or trends in the stock market analysed. Likewise, Euromoney omits variables such as the public budget balance, external liquidity or the rate of inflation, while the ICRG does not take trends in interest rates or confidence of the international markets in the country into account.

Given all this, the thesis concludes that, due to these deficiencies, neither of the two indexes reflects the economic-financial vulnerabilities of a country in an anticipatory manner, and thus is incapable of predicting an episode of crisis in the medium term. In any case, the Euromoney seems to be somewhat more reliable than the ICRG. Despite the ICRG having more key variables, with Euromoney it is finance rate ones (factors related to debt) and those about market expectations (political risk, etc.) that are of greater importance - precisely the variables that have greater capacity to differentiate between countries at risk and those free of risk.

Taking uncertainty on board

The failure in predicting the current crises behoves establishing new methods for correctly measuring risk countries. Ms San Martín starts from the basis of having to take uncertainty as a characteristic itself of economic-financial globalisation, and not allowing events to be seen as something easily predictable. She stresses that the new methods should identify the most important sources of risk, should regulate to control trends in less sustainable economic phenomena and should take into account that countries are now subject to the contagion effect.

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About the author

Ms Nerea San Martín Albizuri (Bilbao, 1981) is a graduate in Business Administration and Management, with a diploma in Advanced Studies and a PhD in Finances. She undertook her thesis under the direction of Mr Arturo Rodríguez Castellanos, Dean of the Economics and Business Sciences Faculty at the UPV/EHU (Bilbao). She presented it at the Department of Finance Economics II of the same faculty. Ms San Martín is currently researcher and lecturer under contract at this department.


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