Project sponsors face many uncertainties before deciding to invest their time and resources in new projects. Uncertainties such as government taxation, sales quotas, limited access to new technologies, political and economic instability, subsidies avail­able, and local currency fluctuation are among the many variables that need to be assessed. Assessing these factors becomes even more critical when considering invest­ments in developing countries, where the impact of external factors may threaten the continuity of the business and influence the viability and success of the project.

Under different perspectives and not necessarily at equivalent proportions, lenders and borrowers share the risks involved in a financial transaction from the lender’s disbursement up to the liquidation by the borrower or guarantor. At unexpected local or international financial crises during the lifetime of a loan, additional risks are added to the basket of existing risks being shared by those institutions. The likelihood of any factor to occur that might negatively affect the borrower’s capacity to repay its loan is taken into account and “priced” into the total premium charged by the lender. These factors are commonly combined into the so-called Country Risk, also called sovereign and political risk.

Figure 13.1 shows a breakdown of risks, as adopted by financial institutions. The country risk includes every potential constraint for local currency convertibility to hard currency equivalents, cash transferability, asset expropriation, confiscation or nationalization of goods, governmental caps on exports (i. e. increase in local market supply), and a sudden increase in taxation on trade or cash payments abroad. Those risks are beyond the borrower’s responsibility, but they largely affect their

Credit base (all companies related to the borrower)

Legal framework, financial structure, guarantees Sector, company (or project) competitive strength

Confiscation, expropriation, nationalization (CEN)

Cash convertibility and transferability

Others such as banking moratorium, war, revolution, etc.

capacity to produce and sell the goods being used to repay loans or they restrict the cash transfer to the lender’s account.

Due to the risks involved, financial institutions set up criteria for loans in countries where those risks are more likely to happen. These criteria are normally defined in terms of a maximum cash amount available for loans. Since the risk is directly linked to the duration of the loan, more restrictive limitations are imposed on long-term transactions, unless the country risks can be mitigated. The most common way to mitigate Country Risk is by the acquisition of Country Risk Insurance for long-term deals from insurers, development banks or export credit agencies.

A Country Risk Insurance typically covers expropriation acts (confiscation, nationalization, requisition and sequestration), restrictions for currency convert­ibility and transfer, political violence, civil commotion, civil war, rebellion, riot, sabotage, strike, war and terrorism. Even if one or some risks are irrelevant for a specific country they are offered as part of a package, which are typically not customized. The insurance premium is directly related to the features of the transaction and the risk perception in that specific country. However, during economic turmoil, the premium of the insurance increases sharply and its availability is drastically reduced.

Therefore, a bank’s internal requirement for country risk coverage can sometimes become a deal-breaker for any of the involved parties, either due to a tenor limitation for the banks (i. e. the availability of long-term funding may disappear) or due to the price limitation for the borrowers or project sponsors. Invariably, the cost for such insurance is always passed on to borrowers, thus increasing the total cost of the loan.