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FRM Part II · FRM Exam Part II · Country Risk: Determinants, Measures, and Implications

A bank's country risk team assesses a commodity-exporting emerging market. The government has dollar debt equal to 40% of GDP, reserves covering 3 months of imports, and revenues heavily dependent on a single commodity whose price just fell sharply. Which action best reflects sound analysis of the sovereign's default risk?

The best approach is to assess how the commodity shock affects fiscal revenue, reserves and hard-currency debt service capacity together with the debt ratio. Default risk is forward-looking, so a static debt-to-GDP figure or a clean payment history can understate the deterioration.

  1. ARely solely on the current debt-to-GDP ratio since it is below 60%
  2. BFocus only on the political stability of the government and ignore economic variables
  3. CAssess the fiscal and external impact of the commodity shock, including revenue loss, reserve adequacy and hard-currency debt service capacity, alongside the debt ratioCorrect
  4. DAssume default risk is unchanged because the sovereign has not missed a payment

Explanation

Default risk depends on forward-looking capacity to pay: fiscal revenue concentration, reserves and hard-currency debt service all deteriorate after a commodity shock. A static debt ratio (A) can understate risk, and a history of payment (D) does not capture the new shock. Ignoring economic variables (B) omits core determinants.

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