Country risk is a composite concept that relates not only to political risk but also to financial risk; it seems plausible that a lower country risk attract more foreign direct investment (FDI). On the one hand, political risk is the risk that the returns to investment may suffer as a result of low institutional quality and political instability, while financial risk refers to the inability of a country to repay its foreign liabilities. This paper investigates the effects on inward FDI of various components of political and financial risk and the relationship between inward FDI and not only the level of these risks but also their changes over time.
Based on the indices sourced from the International Country Risk Guide (ICRG) provided by the Political Risk Services (PRS) Group, there are 12 political components and 8 financial components that assess the impact of political and financial risks on inward FDI. The authors argue that GDP per capita does not appear to attract or deter FDI. Also, while countries with large initial levels of population attract greater FDI, a larger increase of population deters FDI. Further, greater amounts of FDI are attracted to countries with the larger decrease of current account deficit as a percentage of exports of goods and services.
The authors conclude that it is not the initial level of political risk that affects FDI inflows; it’s the change in its level only. On the contrary, financial risk is not associated with FDI inflow. In addition, a significant perceived reduction in political risk can help the country attract more FDI, even where the initial level of political risk is high. Moreover, the findings imply that in the case of developing countries, payment delays, contract expropriation, and corruption are negatively associated with FDI inflow, but significant improvement leads to increased FDI inflow, even if initial levels are high.