Country Risk Matter and Foreign Direct Investment

The study covers the risks that the FDI carries and the impacts of investment in the target country. There are two major risk elements, of course, the financial risk and the political risk. The study has shown that with a decreased political risk, FDIs increase, but not the same happens when the financial risk is lowered. Investors are more concerned with the political stability of the developing country, transparency of their policies, and enforcement of regulation in the target country. What also stimulates capital flows are facilitated and cost-efficient administrative procedures, and more and more developing countries start to focus on simpler administrative processes.

Developing countries need to make sure that proper institutions and coordinators are in place which will foster the trust between the country and the investor.

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Financial risk refers to the potential failure of the country to repay the investment. FDIs are more complex and cannot be returned to the investor easily if the economy should worsen. Therefore, countries which have an extensive foreign debt carry higher financial risk and are subsequently less attractive locations to set up a business.

Empirical studies have shown that the FDI flows are more common in countries which have a lower risk of nationalizing businesses and where governments are more transparent. Instability and political unrest is what drives investors away, and not the law or close military-government cooperation. Still, many studies vary displaying mixed results.

Specifying Empirical Data

Mostly developing countries were examined over the course of the past several years, and it was found that the FDI was negative for most of them at some point. Even if an increased GDP indicates a healthier economy and even if investors prefer such an economic environment, it also has its downsides. For example, a higher GDP means increased consumer demands, which derive from higher income and wages. This means that investors will also have to stay true to the trend and pay higher salaries where the standard of living has risen.

Data Issues

ICRG data are highly valued in the international community, so investors mostly rely on ICRG reports as part of their investment plan. The IRCG derives its data from assessments of the country’s capabilities and performance when it comes to servicing their debts.

Empirical results

Many studies have shown that FDIs will look into the past of the country and performance of other FDIs and their profit returns. It is more likely that a new FDI will model their investment on their predecessors and mimic what they did. Results have also proven that financial risk comes second to political risk which is a more decisive factor when selecting the host country.