that investors monitor, and form the first hurdle the country must pass in order to be put on the feasible list.

Within the realm of macroeconomic stability, but perhaps the second most important variable investors paid credence to after growth forecasts, is the country’s ability and method of financing its current account deficit. It is taken as a given that emerging markets have current account deficits. However, if the country is relying on what is considered as the more volatile and fickle portfolio flows to finance the deficit, rather than foreign direct investment (FDI), investors attach a much higher risk to the country. Again, in times of volatility or crisis, portfolio flows can be withdrawn rather rapidly while FDI is in the country for the longer haul.

The sovereign ratings set by the international rating agencies do factor into the models, but in our sample, rarely directly. While some investment mandates will restrict investments into countries with ratings below a certain level (typically below investment grade) the impact through the models is more indirect. The external ratings – or rather the relative ranking of countries – are instead used as an external reality check on the results of the proprietary models. Large divergence between the results of the macro part of the in-house model and the external ratings will result in a more thorough investigation as to why the differences occur, but by no means necessitate a change in the in-house rating. Having a country’s sovereign rating also helps in so far as the rating agencies provide readily available periodic coverage of the economic situation and collect macro-economic data, which can be fed into the models.

# **7.1.2 Political environment/stability**

The political environment of a country also plays a very important role in whether an investor deems that country investable. While it is difficult to describe one characteristic that adequately summarizes what is meant by political stability, in a broad sense investors look for transparency and predictability in how a country’s government changes through time. Whether a democracy or a totalitarian regime, if a country has an established process for political change, the direction of future policy and leadership becomes more understandable, and investors are much more comfortable with assessing probabilities of economic growth and the country’s intention to pay its debts. Where the macro factors are used to assess a country’s “ability to pay” its debt obligations, the analysis of the stability of the political environment traditionally is used to assess its “willingness to pay”. An obvious risk is related to a change in administration, where a new administration does not feel obligated to honor the commitments made by a previous administration that it feels lacks legitimacy.

# **7.1.3 Quality of local financial markets**

While the quality of local financial markets – apart from aspects related to the quality of the “plumbing,” which we cover in section 7.2 below – did not surface immediately as an important indicator of whether an investor would consider investing in a country, several aspects emerged throughout the discussions which made this feature quite prominent anyway. The main aspects 17