Country Risk vs. Company Risk

In the same way as a company has a set of accounts, so in effect, does each country. 

Every country has a balance-sheet which includes it´s assets and liabilities.                A simplified version lets us examine the current “crisis” and assess some of the risk. 

A State’s profit & loss ‘Balance-Sheet’ Account

Raising Money vs. State Expenditure

Taxation                                                                          Education budget

Bonds (capital raising from the markets)          Health budget

Sale of Assets (e.g. state owned buildings)       Defence budget

Interest on past loans or bonds                             Bail outs and rescues

We can easily see that if a country has to bail out a bank this can be a drain on the Government´s finances and make the situation worse.  There is a direct relationship between bank bail outs/rescues and a State’s financial health. (This creates a sovereign debt)

To improve its finances a Government can cut expenditure.  Examples include pay cuts for public servants and reduced spending, reducing the pensions of public paid employees.

Whilst most countries are raising tax, many are also raising capital by borrowing more/ issuing bonds.  In some cases, such as Ireland, this capital raising is simply to repay other loans and bonds that have reached their maturity and the country is obliged to repay at the prescribed time.  It is the ability or potential inability of a country to repay the loan which is the most important factor in a sovereign financial crisis.

A company has an increase in it expenditure if the cost of its raw materials rises. These raw materials include the cost of employing the workforce, purchased and other items.

Many companies which rely heavily on Government contracts are currently very nervous about the degree of austerity measures but many companies have found their income has held up relatively well.  Production lines for many companies are holding up as the demand for their products continues to surge in the Far East and other developing nations.

How should we apply the above scenarios to the financial sector?

When deposit money into our own bank accounts we expect that money is still “ours”.  The account is in fact just a simple method of recording how much we have invested and are owed by that bank.  What has actually happened is to agree that the bank can use the money for any purpose it sees fits in return for a service, for example the payment of interest.  Thus if a bank then lends it to a person or government that defaults the bank needs money in its reserves to cover the shortfall when it in turn needs to repay the account holder. When the defaults get so big that there is no money left in the reserve, account holders will not get their money back. In this event, for many banks, there is a fall back onto a compensation scheme. These schemes were put in place when Government credit ratings were good and they also had reserves. 

A Government with sovereign debt problems may raise taxation, issue bonds and even print money as we have seen in the past and is happening now.

This is a way of simplifying the current world sovereign debt crisis and the impact it has on us all. When making investment decisions we should consider:

Governments can be brought down by having to bail out or rescue banks

Governments cannot bring down a company unless that company relies upon government contracts for most of its income

When you pay money into the bank, you are giving the bank authority to use the money as they wish.