Country risk analysis in emerging markets India

Abstract

The Beta Country Risk Model was used to estimate the country risk of India based on several macroeconomic indicators. Ordinary least squares regression was run on the white noise (unexpected component) of these variables to explain the variation in country risk. The most significant of these variables are FDI inflows, short-term interest rates, unemployment rate and foreign currency exchange rate. Due to collinearity between some of these variables, two separate models were used for the estimation, one based in FDI inflows, exchange rate and unemployment rate, and the other based on FDI inflows and short term interest rates. The two models gave similar results. In addition, a qualitative variable – political risk index was also included in the model for the ten years from 1996 to 2008 when the data was available, but saw that it was causing multicollinearity – that is, political risk is already being incorporated into variables like FDI inflows and unemployment rate. It can be seen that the variation in country risk of India is highly correlated with the movements in the market, some specific to the Indian economy and some common with the rest of the world, as has been explained in the section on inferences. Country risk index is a highly variable and subjective index and as expected, not all of the variation can be explained using statistical methods. A lot of qualitative analysis and expertise goes into its determination. Thus, these models are not very significant – similar to other models already existing in literature. While qualitative inferences can be drawn and certain predictions made based on the index obtained from this analysis, it should only be one of the indicators used for country risk analysis and cannot be completely relied upon. This indicator is, nonetheless, an important starting point for understanding the determinants of risk in the Indian economy, gaining greater insights into the dynamics of the Indian market and for making broad forecasts about country risk in the near future.