Country risk premium

The country risk premium refers to the difference between the higher interest rates that less stable and riskier countries must pay to attract investors, and the interest rates of an investor's home country.

By investing in less stable and poorly-rated countries you can expect a higher return, but you also have to accept a higher level of risk. For example El Salvador is a much more probable candidate for insolvency than Germany.

Investing in Bolivia is considered riskier than investing in the USA. Have you ever wondered how this "riskiness" can be calculated? The answer is particularly important to investors in junior mining stocks who could be particularly affected by geographical (and legal) risk. For instance, if a certain company's mines are suddenly nationalized then the stock price will plummet.

Country risk in the above example is based on different economic concepts and policies introduced throughout the years as well as some external factors. The situation is so complex that the difference seems to be unexplainable at first sight. However, thanks to the country risk premium, we are able to measure, define and compare such differences with a decent accuracy. As a result, we are better able to estimate risk associated with investing in junior stocks with operations in various countries.

The country risk premium is the difference between the imposed market interest rates for the government of a given country (often called the benchmark country) and comparable rates for other countries. Usually this term refers to a positive divergence between these rates.

The benchmark country is a country with a stable, well-respected and developed business environment. These countries are often referred to as “low risk” or “developed.” Thanks to these conditions, the cost of capital and consequently, the expected returns on low-risk investment projects, remain at a stable but relatively unimpressive level. This term is commonly used in reference to government bonds. The USA is an example of a benchmark country. In other countries with a less attractive business environment investors may be more reluctant to make loans or invest in the market. That is why the government has to offer relatively higher interest rates compared to those of the benchmark country. Investors are more willing to accept the risk if the risk premium is higher.

To sum up, the country risk premium may be defined as an investor’s premium for accepting a higher level of overall risk in the business environment. The relative risk levels in various countries may be easily compared using bond- or sovereign ratings issued by the rating agencies (Moody’s, S&P, Fitch). The lower the rating, the higher the risk. Investors have to be aware of the fact that the relationship between country risk and country risk premium may be flawed. The optimum level of acceptable risk has to be estimated according to other economic factors and principles.

A wise investor will always think about the possible costs and profits of each investment, especially when considering investing in riskier countries. In some cases it may pay off, while in others it can be a total flop. Proper diversification is an important caveat. By smart diversification one can minimize the "sum of risks" or even make the particular countries' risks cancel each other out. To do this you need proper tools and data. We demonstrate how this can be done below.

Before we continue, please note that one of the ways to limit the risk in one's portfolio is through diversification - adding assets that are less / not correlated (or negatively correlated) with the rest of one's portfolio. Gold and the rest of the precious metals sector, might be particularly useful in this case, and if you'd like to learn more about this topic, we invite you to sign up for our gold mailing list. It's free and if you don't like it, you can easily unsubscribe. Sign up using this link today.

Moving back to the core topic of this page, the common way of measuring the country risk premium is by taking the difference between the country's average bond yield and the default-free government's bond yield (a bond whose issuer is highly unlikely to default – for example US T-bonds). Please look at the table below, based on the work of Professor Aswath Damodaran of the Stern School of Business at NYU (original version available here). The table shows the level of country risk premium by country (as of 2011), as well as the long term rating issued by the rating agencies. US T-bonds were used as default-free bonds:

Country

Long-Term Rating

Country Risk Premium

Albania

B1

6.00%

Angola

B1

6.00%

Argentina

B3

9.00%

Armenia

Ba2

4.13%

Australia

Aaa

0.00%

Austria

Aaa

0.00%

Azerbaijan

Ba1

3.60%

Bahamas

A3

1.73%

Bahrain

A3

1.73%

Bangladesh

Ba3

4.88%

Barbados

Baa2

2.63%

Belarus

B1

6.00%

Belgium

Aa1

0.38%

Belize

B3

9.00%

Bermuda

Aa2

0.75%

Bolivia

B1

6.00%

Bosnia and Herzegovina

B2

7.50%

Botswana

A2

1.50%

Brazil

Baa3

3.00%

Bulgaria

Baa3

3.00%

Cambodia

B2

7.50%

Canada

Aaa

0.00%

Cayman Islands

Aa3

1.05%

Chile

Aa3

1.05%

China

Aa3

1.05%

Colombia

Baa3

3.00%

Costa Rica

Baa3

3.00%

Croatia

Baa3

3.00%

Cuba

Caa1

10.50%

Cyprus

Aa3

1.05%

Czech Republic

A1

1.28%

Denmark

Aaa

0.00%

Dominican Republic

B1

6.00%

Ecuador

Caa3

15.00%

Egypt

Ba1

3.60%

El Salvador

WR

15.00%

Estonia

A1

1.28%

Fiji Islands

B1

6.00%

Finland

Aaa

0.00%

France

Aaa

0.00%

Georgia

Ba3

4.88%

Germany

Aaa

0.00%

Greece

Ba1

3.60%

Guatemala

Ba1

3.60%

Honduras

B2

7.50%

Hong Kong

Aa1

0.38%

Hungary

Baa3

3.00%

Iceland

Baa3

3.00%

India

Ba1

3.60%

Indonesia

Ba2

4.13%

Ireland

Baa1

2.25%

Isle of Man

Aaa

0.00%

Israel

A1

1.28%

Italy

Aa2

0.75%

Jamaica

B3

9.00%

Japan

Aa2

0.75%

Jordan

Baa3

3.00%

Kazakhstan

Baa2

2.63%

Korea

A1

1.28%

Kuwait

Aa2

0.75%

Latvia

Baa3

3.00%

Lebanon

B1

6.00%

Lithuania

Baa1

2.25%

Luxembourg

Aaa

0.00%

Macao

Aa3

1.05%

Malaysia

A3

1.73%

Malta

A1

1.28%

Mauritius

Baa2

2.63%

Mexico

Baa1

2.25%

Moldova

B3

9.00%

Mongolia

B1

6.00%

Montenegro

Ba3

4.88%

Morocco

Ba1

3.60%

Netherlands

Aaa

0.00%

New Zealand

Aaa

0.00%

Nicaragua

B3

9.00%

Norway

Aaa

0.00%

Oman

A1

1.28%

Pakistan

B3

9.00%

Panama

Baa3

3.00%

Papua New Guinea

B1

6.00%

Paraguay

B1

6.00%

Peru

Baa3

3.00%

Philippines

Ba3

4.88%

Poland

A2

1.50%

Portugal

A1

1.28%

Qatar

Aa2

0.75%

Romania

Baa3

3.00%

Russia

Baa1

2.25%

Saudi Arabia

Aa3

1.05%

Singapore

Aaa

0.00%

Slovakia

A1

1.28%

Slovenia

Aa2

0.75%

South Africa

A3

1.73%

Spain

Aa1

0.38%

Sri Lanka

B1

6.00%

St. Vincent & the Grenadines

B1

6.00%

Suriname

Ba3

4.88%

Sweden

Aaa

0.00%

Switzerland

Aaa

0.00%

Taiwan

Aa3

1.05%

Thailand

Baa1

2.25%

Trinidad and Tobago

Baa1

2.25%

Tunisia

Baa2

2.63%

Turkey

Ba2

4.13%

Ukraine

B2

7.50%

United Arab Emirates

Aa2

0.75%

United Kingdom

Aaa

0.00%

United States of America

Aaa

0.00%

Uruguay

Ba1

3.60%

Venezuela

B1

6.00%

Vietnam

B1

6.00%