San José State University
Department of Economics

applet-magic.com
Thayer Watkins
Silicon Valley
USA

The concept of a country risk premium refers to an increment in interest rates that would have to be paid for loans and investment projects in a particular country compared to some standard. One way of establishing the country risk premium for a country is to compare the interest rate that the market establishes for a standard security in the country, say central government debt, to the comparable security in the benchmark country, say the United States. For the securities to be comparable they must have the same maturity and involve payment in the same currency, say U.S. dollars. The reason the payments must be the same is that otherwise the differential in the interest rates would reflect the differential rates of inflation in the two countries instead of solely the market-perceived risk of nonpayment. The interest rate that is relevant is the market-determined yeild to maturity rather than the coupon interest rate. The coupon interest rate is valid only if the issuers are careful to set the coupon rate so that it is equal to the yield to maturity of the security.

For example, suppose the U.S. government has a currently issued five year bond that has a yield to maturity of 6 percent and the government of Poland borrows dollars by selling a five year bond that pays in dollars and the yield to maturity of that bond is 8 percent. The country risk premium for Poland would be 2 percent or, as such premiums are often expressed, 200 basis points. The two percent is the correct value providing the yields to maturity are expressed as instantaneous rates. If they are expressed as effective annual rates then the correct computation of the risk premium ρ is as follows:

#### 1+ρ = (1+0.08)/(1+0.06) = 1.01887 and thus ρ = 0.01887

The above procedure is easily implemented if a country's government borrows through securities denominated in dollars. This is common among the various emerging market economies but rare in the developed economies.

In the table below are estimates of the country risk premiums compiled by Allan Huang of San Jose State University based upon information from Moody's bond ratings.

 Estimates of Country Risk Premiums Country Long-Term Rating Typical Interest Rate Country Risk Premium United States Aaa 6.10% 0.00% Andorra Aa2 6.75% 0.65% Argentina Ba3 10.10% 4.00% Australia Aa2 6.75% 0.65% Austria Aaa 6.10% 0.00% Bahamas A3 7.05% 0.95% Bahrain Ba1 8.60% 2.50% Barbados Ba1 8.60% 2.50% Belgium Aaa 6.10% 0.00% Belize Ba2 9.10% 3.00% Bermuda Aa1 6.70% 0.60% Bolivia B1 10.60% 4.50% Brazil B2 11.60% 5.50% Bulgaria B2 11.60% 5.50% Canada Aa2 6.75% 0.65% Cayman Islands Aa3 6.80% 0.70% Chile Baa1 7.30% 1.20% China A3 7.05% 0.95% Colombia Baa3 7.55% 1.45% Costa Rica Ba1 8.60% 2.50% Croatia Baa3 7.55% 1.45% Cyprus A2 7.00% 0.90% Czech Republic Baa1 7.30% 1.20% Denmark Aa1 6.70% 0.60% Dominican Republic B1 10.60% 4.50% Ecuador B3 12.60% 6.50% Egypt Ba1 8.60% 2.50% El Salvador Baa3 7.55% 1.45% Estonia Baa1 7.30% 1.20% Finland Aaa 6.10% 0.00% France Aaa 6.10% 0.00% Germany Aaa 6.10% 0.00% Gibraltar Aaa 6.10% 0.00% Greece Baa1 7.30% 1.20% Guatemala Ba2 9.10% 3.00% Guernsey Aaa 6.10% 0.00% Honduras B2 11.60% 5.50% Hong Kong A3 7.05% 0.95% Hungary Baa2 7.40% 1.30% Iceland Aa3 6.80% 0.70% India Ba2 9.10% 3.00% Indonesia B3 12.60% 6.50% Ireland Aaa 6.10% 0.00% Isle of Man Aaa 6.10% 0.00% Israel A3 7.05% 0.95% Italy Aaa 6.10% 0.00% Jamaica Ba3 10.10% 4.00% Japan Aa1 6.70% 0.60% Jersey Aaa 6.10% 0.00% Jordan Ba3 10.10% 4.00% Kazakhstan Ba3 10.10% 4.00% Korea Baa3 7.55% 1.45% Kuwait Baa1 7.30% 1.20% Latvia Baa2 7.40% 1.30% Lebanon B1 10.60% 4.50% Liechtenstein Aaa 6.10% 0.00% Lithuania Ba1 8.60% 2.50% Luxembourg Aaa 6.10% 0.00% Macau Baa1 7.30% 1.20% Malaysia Baa3 7.55% 1.45% Malta A3 7.05% 0.95% Mauritius Baa2 7.40% 1.30% Mexico Ba2 9.10% 3.00% Moldova B2 11.60% 5.50% Monaco Aaa 6.10% 0.00% Morocco Ba1 8.60% 2.50% Netherlands Aaa 6.10% 0.00% New Zealand Aa2 6.75% 0.65% Nicaragua B2 11.60% 5.50% Norway Aaa 6.10% 0.00% Oman Baa2 7.40% 1.30% Pakistan Caa1 13.60% 7.50% Panama Baa1 7.30% 1.20% Papua New Guinea B1 10.60% 4.50% Paraguay B2 11.60% 5.50% Peru Ba3 10.10% 4.00% Philippines Ba1 8.60% 2.50% Poland Baa3 7.55% 1.45% Portugal Aaa 6.10% 0.00% Qatar Baa2 7.40% 1.30% Romania B3 12.60% 6.50% Russia B3 12.60% 6.50% San Marino Aa3 6.80% 0.70% Sark Aaa 6.10% 0.00% Saudi Arabia Baa3 7.55% 1.45% Singapore Aa1 6.70% 0.60% Slovakia Ba1 8.60% 2.50% Slovenia A3 7.05% 0.95% South Africa Baa3 7.55% 1.45% Spain Aaa 6.10% 0.00% Sweden Aa2 6.75% 0.65% Switzerland Aaa 6.10% 0.00% Taiwan Aa3 6.80% 0.70% Thailand Ba1 8.60% 2.50% Trinidad & Tobago Ba1 8.60% 2.50% Tunisia Baa3 7.55% 1.45% Turkey B1 10.60% 4.50% Turkmenistan B2 11.60% 5.50% Ukraine B3 12.60% 6.50% United Arab Emirates A2 7.00% 0.90% United Kingdom Aaa 6.10% 0.00% Uruguay Baa3 7.55% 1.45% Venezuela B2 11.60% 5.50% Vietnam B1 10.60% 4.50%

The correspondences between the bond ratings and the above risk premiums are given in the table below.

Risk Premiums by Rating Class (in Basis Points)
Rating Country Risk Premium for Corporate Bonds Country Risk Premium for Government Bonds
Aaa 0 0
Aa1 60 75
Aa2 65 85
Aa3 70 90
A1 80 100
A2 90 125
A3 85 135
Baa1 120 150
Baa2 130 175
Baa3 145 200
Ba1 250 325
Ba2 300 400
Ba3 400 525
B1 450 600
B2 550 750
B3 650 850
Caa 750 900
Based upon information from Moody's and Bondonline.com