BRIEF GUIDE

TO THE

RATINGS SYSTEM

THE RATING SYSTEM

The ICRG Risk Rating System assigns a numerical value (risk points) to a predetermined range of risk components, according to a preset weighted scale, for each country covered by the system. Each scale is designed to award the highest value to the lowest risk and the lowest value to the highest risk. All countries are assessed on the same basis to allow for comparability.

The risk components are grouped into three Risk Categories Political, Economic, and Financial. Each Risk Category is made up of a number of Risk Components. The sum of the Risk Points assigned to each Risk Component within each Risk Category determines the overall risk rating for that Risk Category.

The total Risk Points for each Risk Category are further combined, according to a formula, to produce a Composite Risk Rating for the country in question. In every case, the higher the number of Risk Points awarded, the lower the perceived risk, while the lower the number of Risk Points awarded, the higher the perceived risk.

The risk ratings are produced as a current situation (the current month) assessment, and as one-year and five-year forecasts.

THE POLITICAL RISK RATING

The aim of the political risk rating is to provide a means of assessing the political stability of the countries covered by ICRG on a comparable basis. This is done by assigning risk points to a pre-set group of factors, termed political risk components. The minimum number of points that can be assigned to each component is zero, while the maximum number of points depends on the fixed weight that component is given in the overall political risk assessment. In every case the lower the risk point total, the higher the risk, and the higher the risk point total the lower the risk.

To ensure consistency, both between countries and over time, points are assigned by ICRG editors on the basis of a series of pre-set questions for each risk component.

THE POLITICAL RISK COMPONENTS Table 3B

The following risk components, weights, and sequence are used to produce the political risk rating:

Government Stability 12 Points

This is an assessment both of the governments ability to carry out its declared program(s), and its ability to stay in office. The risk rating assigned is the sum of three subcomponents, each with a maximum score of four points and a minimum score of 0 points. A score of 4 points equates to Very Low Risk and a score of 0 points to Very High Risk.

The subcomponents are:

Government Unity

Legislative Strength

Popular Support

Socioeconomic conditions 12 Points

This is an assessment of the socioeconomic pressures at work in society that could constrain government action or fuel social dissatisfaction. The risk rating assigned is the sum of three subcomponents, each with a maximum score of four points and a minimum score of 0 points. A score of 4 points equates to Very Low Risk and a score of 0 points to Very High Risk.

The subcomponents are:

Unemployment

Consumer Confidence

Poverty

Investment Profile 12 Points

This is an assessment of factors affecting the risk to investment that are not covered by other political, economic and financial risk components. The risk rating assigned is the sum of three subcomponents, each with a maximum score of four points and a minimum score of 0 points. A score of 4 points equates to Very Low Risk and a score of 0 points to Very High Risk.

The subcomponents are:

Contract Viability/Expropriation

Profits Repatriation

Payment Delays

Internal Conflict 12 Points

This is an assessment of political violence in the country and its actual or potential impact on governance. The highest rating is given to those countries where there is no armed opposition to the government and the government does not indulge in arbitrary violence, direct or indirect, against its own people. The lowest rating is given to a country embroiled in an on-going civil war.

The risk rating assigned is the sum of three subcomponents, each with a maximum score of four points and a minimum score of 0 points. A score of 4 points equates to Very Low Risk and a score of 0 points to Very High Risk.

The subcomponents are:

• Civil War
• Terrorism/Political Violence
• Civil Disorder

External Conflict 12 Points

The external conflict measure is an assessment both of the risk to the incumbent government from foreign action, ranging from non-violent external pressure (diplomatic pressures, withholding of aid, trade restrictions, territorial disputes, sanctions, etc) to violent external pressure (cross-border conflicts to all-out war).

External conflicts can adversely affect foreign business in many ways, ranging from restrictions on operations, to trade and investment sanctions, to distortions in the allocation of economic resources, to violent change in the structure of society.

The risk rating assigned is the sum of three subcomponents, each with a maximum score of four points and a minimum score of 0 points. A score of 4 points equates to Very Low Risk and a score of 0 points to Very High Risk.

The subcomponents are:

War

Cross-Border Conflict

Foreign Pressures

Corruption 6 Points

This is an assessment of corruption within the political system. Such corruption is a threat to foreign investment for several reasons: it distorts the economic and financial environment, it reduces the efficiency of government and business by enabling people to assume positions of power through patronage rather than ability, and, last but not least, introduces an inherent instability into the political process.

The most common form of corruption met directly by business is financial corruption in the form of demands for special payments and bribes connected with import and export licenses, exchange controls, tax assessments, police protection, or loans. Such corruption can make it difficult to conduct business effectively, and in some cases my force the withdrawal or withholding of an investment.

Although our measure takes such corruption into account, it is more concerned with actual or potential corruption in the form of excessive patronage, nepotism, job reservations, 'favor-for-favors', secret party funding, and suspiciously close ties between politics and business. In our view these insidious sorts of corruption are potentially of much greater risk to foreign business in that they can lead to popular discontent, unrealistic and inefficient controls on the state economy, and encourage the development of the black market.

The greatest risk in such corruption is that at some time it will become so overweening, or some major scandal will be suddenly revealed, as to provoke a popular backlash, resulting in a fall or overthrow of the government, a major reorganizing or restructuring of the country's political institutions, or, at worst, a breakdown in law and order, rendering the country ungovernable.

Military in Politics 6 Points

The military is not elected by anyone. Therefore, its involvement in politics, even at a peripheral level, is a diminution of democratic accountability. However, it also has other significant implications.

The military might, for example, become involved in government because of an actual or created internal or external threat. Such a situation would imply the distortion of government policy in order to meet this threat, for example by increasing the defense budget at the expense of other budget allocations.

In some countries, the threat of military take-over can force an elected government to change policy or cause its replacement by another government more amenable to the militarys wishes. A military takeover or threat of a takeover may also represent a high risk if it is an indication that the government is unable to function effectively and that the country therefore has an uneasy environment for foreign businesses.

A full-scale military regime poses the greatest risk. In the short term a military regime may provide a new stability and thus reduce business risks. However, in the longer term the risk will almost certainly rise, partly because the system of governance will be become corrupt and partly because the continuation of such a government is likely to create an armed opposition.

In some cases, military participation in government may be a symptom rather than a cause of underlying difficulties. Overall, lower risk ratings indicate a greater degree of military participation in politics and a higher level of political risk.

Religious Tensions 6 Points

Religious tensions may stem from the domination of society and/or governance by a single religious group that seeks to replace civil law by religious law and to exclude other religions from the political and/or social process; the desire of a single religious group to dominate governance; the suppression off religious freedom; the desire of a religious group to express its own identity, separate from the country as a whole.

The risk involved in these situations range from inexperienced people imposing inappropriate policies through civil dissent to civil war.

Law and Order 6 Points

Law and Order are assessed separately, with each sub-component comprising zero to three points. The Law sub-component is an assessment of the strength and impartiality of the legal system, while the Order sub-component is an assessment of popular observance of the law. Thus, a country can enjoy a high rating 3 in terms of its judicial system, but a low rating - 1 if it suffers from a very high crime rate of if the law is routinely ignored without effective sanction (for example, widespread illegal strikes).

Ethnic Tensions 6 Points

This component is an assessment of the degree of tension within a country attributable to racial, nationality, or language divisions. Lower ratings are given to countries where racial and nationality tensions are high because opposing groups are intolerant and unwilling to compromise. Higher ratings are given to countries where tensions are minimal, even though such differences may still exist.

Democratic Accountability 6 Points

This is a measure of how responsive government is to its people, on the basis that the less responsive it is, the more likely it is that the government will fall, peacefully in a democratic society, but possibly violently in a non-democratic one.

The points in this component are awarded on the basis of the type of governance enjoyed by the country in question. For this purpose, we have defined the following types of governance:

Alternating Democracy

The essential features of an alternating democracy are:

A government/executive that has not served more than two successive terms.

Free and fair elections for the legislature and executive as determined by constitution or statute;

The active presence of more than one political party and a viable opposition;

Evidence of checks and balances among the three elements of government: executive, legislative and judicial;

Evidence of an independent judiciary;

Evidence of the protection of personal liberties through constitutional or other legal guarantees.

Dominated Democracy

The essential features of a dominated democracy are:

A government/executive that has served more than two successive terms.

Free and fair elections for the legislature and executive as determined by constitution or statute;

The active presence of more than one political party

Evidence of checks and balances between the executive, legislature, and judiciary;

Evidence of an independent judiciary;

Evidence of the protection of personal liberties.

De-facto One-Party State

The essential features of a de-facto one-party state are:

A government/executive that has served more than two successive terms, or where the political/electoral system is designed or distorted to ensure the domination of governance by a particular government/executive.

Holding of regular elections as determined by constitution or statute

Evidence of restrictions on the activity of non-government political parties (disproportionate media access between the governing and non-governing parties, harassment of the leaders and/or supporters of non-government political parties, the creation impediments and obstacles affecting only the non-government political parties, electoral fraud, etc).

De jure One-Party state

The identifying feature of a one-party state is:

A constitutional requirement that there be only one governing party.

Lack of any legally recognized political opposition.

Autarchy

The identifying feature of an autarchy is:

Leadership of the state by a group or single person, without being subject to any franchise, either through military might or inherited right.

In an autarchy, the leadership might indulge in some quasi-democratic processes. In its most developed form this allows competing political parties and regular elections, through popular franchise, to an assembly with restricted legislative powers (approaching the category of a de jure or de facto one party state). However, the defining feature is whether the leadership, i.e. the head of government, is subject to election in which political opponents are allowed to stand.

In general, the highest number of risk points (lowest risk) are assigned to Alternating Democracies, while the lowest number of risk points (highest risk) are assigned to autarchies.

Bureaucracy Quality 4 Points

The institutional strength and quality of the bureaucracy is another shock absorber that tends to minimize revisions of policy when governments change. Therefore, high points are given to countries where the bureaucracy has the strength and expertise to govern without drastic changes in policy or interruptions in government services. In these low-risk countries, the bureaucracy tends to be somewhat autonomous from political pressure and to have an established mechanism for recruitment and training. Countries that lack the cushioning effect of a strong bureaucracy receive low points because a change in government tends to be traumatic in terms of policy formulation and day-to-day administrative functions.

ASSESSING POLITICAL RISK

In general terms if the points awarded are less than 50% of the total, that component can be considered as very high risk. If the points are in the 50-60% range as high risk, in the 60%-70% range as moderate risk, in the 70-80% range as low risk and in the 80-100% range as very low risk. However, this is only a general guideline as a better rating in other components can compensate for a poor risk rating in one component.

Overall, a political risk rating of 0.0% to 49.9% indicates a Very High Risk; 50.0% to 59.9% High Risk; 60.0% to 69.9% Moderate Risk; 70.0% to 79.9% Low Risk; and 80.0% or more Very Low Risk. Once again, however, a poor political risk rating can be compensated for by a better financial and/or economic risk rating.

THE ECONOMIC RISK RATING

The overall aim of the Economic Risk Rating is to provide a means of assessing a countrys current economic strengths and weaknesses. In general terms where its strengths outweigh its weaknesses it will present a low economic risk and where its weaknesses outweigh its strengths it will present a high economic risk.

These strengths and weaknesses are assessed by assigning risk points to a pre-set group of factors, termed economic risk components. The minimum number of points that can be assigned to each component is zero, while the maximum number of points depends on the fixed weight that component is given in the overall economic risk assessment. In every case the lower the risk point total, the higher the risk, and the higher the risk point total the lower the risk.

To ensure comparability between countries the components are based on accepted ratios between measured data within the national economic/financial structure. It is the ratios that are compared, not the data themselves. The points assigned to each component (ratio) are taken from a fixed scale.

ASSESSING ECONOMIC RISK

As noted above, points are awarded to each risk component on a scale from zero up to a pre-set maximum. In general terms if the points awarded are less than 50% of the total, that component can be considered as very high risk. If the points are in the 50-60% range as high risk, in the 60%-70% range as moderate risk, in the 70-80% range as low risk, and in the 80-100% range as very low risk. However, this is only a general guideline as a better rating in other components can compensate for a poor risk rating in one component.

Overall, an economic risk rating of 0.0% to 24.5% indicates a Very High Risk; 25.0% to 29.9% High Risk; 30.0% to 34.9% Moderate Risk; 35.0% to 39.9% Low Risk; and 40.0% or more Very Low Risk. Once again, however, a poor economic risk rating can be compensated for by a better political and/or financial risk rating.

THE ECONOMIC RISK COMPONENTS TABLE 5B

GDP Per Head Table 7

The estimated GDP per head for a given year, converted into US dollars at the average exchange rate for that year, is expressed as a percentage of the average of the estimated total GDP of all the countries covered by ICRG. The risk points are then assigned according to the following scale:

Real GDP Growth Table 8

The annual change in the estimated GDP, at constant 1990 prices, of a given country is expressed as a percentage increase or decrease. The risk points are then assigned according to the following scale:

Annual Inflation Rate Table 9

The estimated annual inflation rate (the unweighted average of the Consumer Price Index) is calculated as a percentage change. The risk points are then assigned according to the following scale:

Budget Balance as a Percentage of GDP Table 10

The estimated general government budget balance (excluding grants) for a given year in the national currency is expressed as a percentage of the estimated GDP for that year in the national currency. The risk points are then assigned according to the following scale:

Current Account as a Percentage of GDP Table 11

The estimated balance on the current account of the balance of payments for a given year, converted into US dollars at the average exchange rate for that year, is expressed as a percentage of the estimated GDP of the country concerned, converted into US dollars at the average rate of exchange for the period covered. The risk points are then assigned according to the following scale:

THE FINANCIAL RISK RATING

The overall aim of the Financial Risk Rating is to provide a means of assessing a countrys ability to pay its way. In essence, this requires a system of measuring a countrys ability to finance its official, commercial, and trade debt obligations.

This is done by assigning risk points to a pre-set group of factors, termed financial risk components. The minimum number of points that can be assigned to each component is zero, while the maximum number of points depends on the fixed weight that component is given in the overall financial risk assessment. In every case the lower the risk point total, the higher the risk, and the higher the risk point total the lower the risk.

To ensure comparability between countries the components are based on accepted ratios between measured data within the national economic/financial structure. It is the ratios that are compared, not the data themselves. The risk points assigned to each component (ratio) are taken from a fixed scale.

ASSESSING FINANCIAL RISK

As noted above, points are awarded to each risk component on a scale from zero up to a pre-set maximum. In general terms if the points awarded are less than 50% of the total, that component can be considered as very high risk. If the points are in the 50-60% range as high risk, in the 60%-70% range as moderate risk, in the 70-80% range as low risk and in the 80-100% range as very low risk. However, this is only a general guideline as a better rating in other components can compensate for a poor risk rating in one component.

Overall, a financial risk rating of 0.0% to 24.5% indicated a Very High Risk; 25.0% to 29.9% High Risk; 30.0% to 34.9% Moderate Risk; 35.0% to 39.9% Low Risk; and 40.0% or more Very Low Risk. Once again, however, a poor financial risk rating can be compensated for by a better political and/or economic risk rating.

THE FINANCIAL RISK COMPONENTS TABLE 4B

Foreign Debt as a Percentage of GDP Table 12

The estimated gross foreign debt in a given year, converted into US dollars at the average exchange rate for that year, is expressed as a percentage of the gross domestic product converted into US dollars at the average exchange rate for that year. The risk points are then assigned according to the following scale:

Foreign Debt Service as a Percentage of Exports of Goods and Services Table 13

The estimated foreign debt service, for a given year, converted into US dollars at the average exchange rate for that year, is expressed as a percentage of the sum of the estimated total exports of goods and services for that year, converted into US dollars at the average exchange rate for that year.

The risk points are then assigned according to the following scale:

Current Account as a Percentage of Exports of Goods and Services Table 14

The balance of the current account of the balance of payments for a given year, converted into US dollars at the average exchange rate for that year, is expressed as a percentage of the sum of the estimated total exports of goods and services for that year, converted into US dollars at the average exchange rate for that year.

The risk points are then assigned according to the following scale:

Net International Liquidity as Months of Import Cover Table 15

The total estimated official reserves for a given year, converted into US dollars at the average exchange rate for that year, including official holdings of gold, converted into US dollars at the free market price for the period, but excluding the use of IMF credits and the foreign liabilities of the monetary authorities, is divided by the average monthly merchandise import cost, converted into US dollars at the average exchange rate for the period.

This provides a comparative liquidity risk ratio that indicates how many months of imports can be financed with reserves.   The risk points are then assigned according to the following scale:

Exchange Rate Stability Table 16

The appreciation or depreciation of a currency against the US dollar (against the German mark in the case of the USA) over a calendar year or the most recent 12-month period is calculated as a percentage change.

The risk points are then assigned according to the following scale:

THE COMPOSITE RISK RATING TABLE 2B

The method of calculating the Composite Political, Financial, and Economic Risk Rating remains unchanged. The political risk rating contributes 50% of the composite rating, while the financial and economic risk ratings each contribute 25%.

The following formula is used to calculate the aggregate political, financial and economic risk:

CPFER (country X) = 0.5 (PR + FR + ER)

where

CPFER = Composite political, financial and economic risk ratings

PR = Total political risk indicators

FR = Total financial risk indicators

ER = Total economic risk indicators

The highest overall rating (theoretically 100) indicates the lowest risk, and the lowest rating (theoretically zero) indicates the highest risk.

As a general guide to grouping countries on the basis of comparable risk, the individual risk of individual countries can be estimated using the following fairly broad categories of Composite Risk.

ONE-YEAR AND FIVE-YEAR FORECASTS

The one- and five-year risk forecasts are produced using the same methodology that is used for the current risk forecasts.

Three forecasts are produced for each time period a Worst Case Forecast (WC Forecast), a Most Probable Forecast (MP Forecast) and a Best Case Forecast (BC Forecast).

The WC Forecast is produced by extrapolating the worst-case trend for each risk component in each risk category to produce a WC Forecast for Political, Economic, and Financial Risk.

The MP Forecast is produced by extrapolating the most probable trend for each risk component in each risk category to produce a MP Forecast for Political, Economic, and Financial Risk.

The BC Forecast is produced by extrapolating the best-case trend for each risk component in each risk category to produce a BC Forecast for Political, Economic, and Financial Risk.

The results of these assessments are shown in the following tables.

Table 3C: One- and Five-year forecasts of political risk (WC, MP and BC Forecasts).

Table 4C: One- and five-year forecasts of financial risk (WC, MP and BC Forecasts).

Table 5C: One- and five-year forecasts of economic risk (WC, MP and BC Forecasts).

These risk assessments are combined, in accordance with the formula, to produce a composite risk rating (CRR) for each of the three forecasts in both time periods. These Composite Risk Forecasts are presented in Table 2C. The one- and five-year MP Forecasts are also presented in Table 2B.

The Risk Forecasts

The WC and BC Forecasts do not represent the possible extremes of risk, but a reasonably possible outcome.

However, negative and positive trends can be identified and a reasonable supposition made as to their outcome, presuming action is not taken to avert such an outcome. Such trends could be an accelerating build-up of debt, political fragmentation, worsening ethnic or religious tensions, in adequate arrangements for government takeover in the case of the death or assassination of a leader, and so on. In approaching the forecasting exercise we make a judgment as to the reasonableness of the trend or event identified and the ability of the government to counteract such trends. This is the basis on which the WC and BC forecasts are determined.

Thus, it is possible for a country to produce a worse performance than our WC forecast or a better performance than our BC forecast, but we do not see such an outcome as likely.

The MP Forecasts is not a mean or median measure between the WCF and BCF, but a trend established by assuming that a government is aware of the negative trends we have established to produce the WCF and takes action to avoid them or mitigate their affects.

Analyzing the Forecasts

The forecasts lend themselves to a variety of analyses. We think the following are probably the most useful Risk Stability, Downside Risk, and Upside Risk.

Risk Stability

A country can appear to present a solid basis for investment on the basis of an acceptable level of risk in terms of its current CRR and its forecast MP Forecast CRR. However, these numbers give no indication of how stable that assessed situation is i.e. to what degree that risk assessment might vary.

We have made an attempt to measure this stability or instability by introducing the concept of Risk Stability.

In our forecasting system the Risk Stability of an individual country is the difference between the WCF and the BCF and represents the volatility or stability of risk for that country. The greater the difference, the greater the volatility or the less the stability.

Downside Risk

This is a measure of the degree to which a Risk Category could reasonably be expected to deteriorate if the negative trends noted in the risk components are not compensated for, and is expressed as the difference between the MP forecast and the WC Forecast. The greater the difference, the greater the downside risk.

Upside Risk

This is a measure of the positive potential of the country that could be realized if the positive trends identified in the risk components are fully exploited in conjunction with a generally favorable environment. It is expressed as the difference between the MP Forecast and the BC Forecast. The greater the difference, the greater the downside risk.

ONE-YEAR AND FIVE-YEAR FORECASTS

The one- and five-year risk forecasts are produced using the same methodology that is used for the current risk forecasts.

Two forecasts are produced for each time period a Worst Case Forecast (WC Forecast) and a Best Case Forecast (BC Forecast).

The WC Forecast is produced by extrapolating the worst-case trend for each risk component in each risk category to produce a WC Forecast for Political, Economic, and Financial Risk.

The BC Forecast is produced by extrapolating the best-case trend for each risk component in each risk category to produce a BC Forecast for Political, Economic, and Financial Risk.

The results of these assessments are shown in the following tables.

Table 3C: One- and Five-year forecasts of political risk (WC and BC Forecasts).

Table 4C: One- and five-year forecasts of financial risk (WC and BC Forecasts).

Table 5C: One- and five-year forecasts of economic risk (WC and BC Forecasts).

These risk assessments are combined, in accordance with the formula, to produce a composite risk rating (CRR) for each of the forecasts in both time periods. These Composite Risk Forecasts are presented in Table2C and Table 2B.

The Risk Forecasts

The WC and BC Forecasts do not represent the possible extremes of risk, but a reasonably possible outcome.

However, negative and positive trends can be identified and a reasonable supposition made as to their outcome, presuming action is not taken to avert such an outcome. Such trends could be an accelerating build-up of debt, political fragmentation, worsening ethnic or religious tensions, in adequate arrangements for government takeover in the case of the death or assassination of a leader, and so on. In approaching the forecasting exercise we make a judgment as to the reasonableness of the trend or event identified and the ability of the government to counteract such trends. This is the basis on which the WC and BC forecasts are determined.

Thus, it is possible for a country to produce a worse performance than our WC forecast or a better performance than our BC forecast, but we do not see such an outcome as likely.

Risk Stability

The Risk Stability of an individual country is the difference between the WCF and the BCF and represents the volatility or stability of risk for that country. The greater the difference, the greater the volatility or the less the stability.

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