Objective
The purpose of the Economist Intelligence Unit's Country Risk Model (CRM) is to provide complete internationally comparable and regularly updated country risk scores for 100 developing and highly indebted countries, and to generate credit ratings of the relative risks from a macroeconomic and financial standpoint.

Until now, the CRM was used solely by the Economist Intelligence Unit's team of country experts to generate the scores and ratings that underpin the Country Risk Service (CRS), a monthly publication available from the EIU store. The CRS tries to identify explicitly and, as far as possible, to quantify the risks that concern institutions lending money, financing trade or conducting other types of business that generate crossborder risk.

As an accompaniment to the CRS, the Economist Intelligence Unit also produces the Risk Ratings Review, a comparative summary of risk ratings for all 100 key emerging and highly indebted countries monitored by the Country Risk Service.

Frequency
In May 2000, to meet a growing demand from risk analysts and managers, the Economist Intelligence Unit increased the frequency of the CRS publication and its risk scores and ratings from once a quarter to every month.

Methodology
Our revised risk ratings methodology (introduced in January 1997) examines risk from two distinct perspectives: 1) broad categories of risk grouped in analytical categories of political, economic policy, economic structure and liquidity factors; and 2) risk exposure associated with investing in particular types of financial instruments, namely specific investment risk. This includes risk associated with taking on foreign-exchange exposure against the US dollar, foreign-currency loans to sovereigns and foreign-currency loans to banks. The CRM operates by asking the EIU's country expert to answer a series of quantitative and qualitative questions on recent and expected political and economic trends in the relevant country.

Letter scores range from "A" (the lowest risk) to "E" (the highest risk). Overall scores are awarded in one-point increments, and can range from 0 ("A" category) to a maximum of 100 points ("E" category) for the highest-risk countries.

Broad categories of risk
In terms of broad analytical categories of risk, a country's current and previous ratings, for example, may break down as follows.

These four types of general political and macroeconomic risk (political risk, economic policy risk, economic structure risk and liquidity risk) are assessed independently of their association with a particular investment vehicle. They are each given a letter grade. These factors are then used to compile an overall score and rating for the country. This overall country risk assessment can be used for making a general assessment of the risk of a crisis in the country's financial markets, where foreign investors may have exposure. It is also useful for investors wishing to get a snapshot of the generalised risk of investing in the country or for those investing in the country in an investment vehicle which is not expressly covered in the EIU's specific investment risk categories.

Political risk factors are the least quantifiable of all the factors in the risk ratings model. Political risk pertains to the risk of exposure stemming from the political environment. The factors in this category relate to the threat of war, social unrest, disorderly transfers of power, political violence, international disputes, regime changes, institutional ineffectiveness, but also include the quality of the bureaucracy, the transparency and fairness of the political system, and levels of corruption and crime in the country in question.

The economic policy factors that are assessed in the model relate to the quality and consistency of economic management. Open economies with low inflation and low fiscal deficits are rewarded in the model. Among the subcategories considered are monetary policy (inflation performance and interest rates), fiscal policy (magnitude of public-sector deficits and public debt/GDP), exchange-rate policy (type of exchange-rate regime), trade (barriers to an open trading system) and regulatory policies (capital controls and regulations/attitudes towards foreign investment).

Economic structure risk examines economic variables central to solvency. Among the subcategories of risk are growth and savings (growth performance, including volatility), the current account (deficit/GDP, magnitude and degree of sustainability) and debt structure (debt/exports, interest due/exports).

Liquidity risk examines the risk of potential imbalances between resources and obligations which could result in disruption of the financial markets. Among the factors considered are the direction of reserves, import cover, M2/reserves, the degree of a country's dependence on portfolio inflows and the size of its direct investment inflows.

Specific categories of risk
In terms of specific investment risk, a country's current and previous ratings, for example, may break down as follows.

A score and ratings are derived to assess the risk of a devaluation against the US dollar of 20% or more in real terms over the forecast period. Political, economic policy, economic structure and liquidity risk factors are taken into account in assessing the risk associated with this specific investment. Each is given a letter grade to evaluate its contribution to the overall score and rating as it pertains to foreign-currency exchange-rate risk.

A score and ratings are derived to assess the risk of a build-up in arrears of principal and/or interest on foreign-currency debt which are the direct obligation of the sovereign or guaranteed by the sovereign. Political, economic policy, economic structure and liquidity risk factors are taken into account in assessing the risk associated with this specific investment. Each is given a letter grade to evaluate its contribution to the overall score and rating as it pertains to sovereign debt risk.

A score and ratings are derived to assess the risk of a build-up in arrears of principal and/or interest on foreign-currency debt which are the obligation of the country's private banking institutions. In the case of banking sector risk, the model assesses whether there are likely to be payment problems within the banking sector, but not whether one particular bank is likely to experience payment problems. Political, economic policy, economic structure and liquidity risk factors are taken into account in assessing the risk associated with exposure to this sector. Each is given a letter grade to evaluate its contribution to the overall score and rating as it pertains to banking sector risk.

Ratings bands
The meaning of the ratings bands of "A" to "E" as they pertain to a country's overall risk rating are described below. The ratings bands of "A" to "E" as they pertain to political risk, economic policy risk, economic structure risk and liquidity risk are a convenient summary for translating the score obtained in the model into a letter category. For example, an "A" rating signifies the country is very strong in a particular category, and conversely an "E" underscores a severe weakness.

Contains countries which have no foreign-exchange constraints on their debt-service ability and no problems financing their trade activities. Their economic policies are deemed to be effective and correct regarding the conditions that they face (whether in a boom or a recession) and they have a working government (not always a multiparty democracy in the European mould) capable of effective policy implementation. These countries have no significant constraints on any international financial transactions.

Contains countries which also have no significant foreign-exchange constraint, but whose economic policies or political structure may be a cause for concern. B-rated countries have access to commercial capital markets. There are no major risks with respect to international financial transactions, but political risk and economic policy risk often need to be watched carefully.

Contains countries which have a record of periodic foreign-exchange crises and political problems. Many of these countries will have negotiated external debt-rescheduling agreements and could be in the process of successfully carrying out an economic reform programme. These economies will usually be in a state of flux with persistent, but controllable, internal and external imbalances. However, some will have access to commercial capital markets. With caution, this set of countries will often offer exciting opportunities for foreign investors.

Contains countries which are currently suffering from serious economic and political problems. Arrears, debt rescheduling and restricted access to official lending are common characteristics. Many have a narrow commodity-dependent export base, resulting in potentially large and frequent fluctuations in export earnings and lengthening remittance delays. Many of these economies will be heavily regulated in the initial phases of restructuring or will have failed to implement such reforms. Any investment or other international financial transactions should be very carefully considered and would best be postponed.

Contains countries which are likely to have a high and rising level of arrears. They will be characterised by severe fiscal imbalances and hyperinflation. Foreign exchange will be scarce, and their relations with multilateral lenders severely strained. Often they are in or on the verge of civil war or undergoing violent political change. Political risk is usually extremely high.