The equity risk premium rate for any given country is calculated by subtracting the treasury bill rate from the lending rate. It works as an incentive, helping countries to attract investors who are willing to take on a somewhat higher risk of equity investing. In general, risk premiums are inversely proportional to the price point for risky assets. When risk premiums go up, risky asset prices go down, and vice versa. For investors, asset allocation choices and market timing decisions are essentially based on predicting the future direction of risk premiums in various asset markets.
A number of factors are considered while deciding the equity risk premium rate for individual countries. The first is the economic risk: when a country's economy is in flux, equity risk will increase. The same goes for politics: if fiscal or government policy are unstable, equity risk increases. Volatility in GDP also leads to higher equity risk. Infrastructure and communication can also influence a country's equity risk premiums: if companies do not provide accurate or adequate information to investors, equity risk premiums will increase. Finally, warfare and environmental catastrophes can have devastating effects on a country's economy. In countries where catastrophe happens often or has happened recently, equity risk will often rise.
The following are the ten countries that currently have the world's highest risk premium rates. Although these countries have a variety of challenges and diverse economic histories, they all share one characteristic: an economy in flux. Risk premiums rarely remain stable. For shrewd investors, early and accurate prediction of future improvements in a developing country's economy could lead to a significant return on investments.
Madagascar tops the list, with a staggering 51% risk premium rate on loans in 2015. This figure is due in large part to its struggling economy, with various political factors causing instability in industry, services, and tourism. Governmental corruption has hindered efforts to strengthen and improve the market economy. Infrastructure is underdeveloped: roads, railroads, and seaports are all poorly inadequate. More than seventy percent of the population live in poverty, earning less than $50 a year. Madagascar's economy is primarily based on agriculture, and the country is susceptible to flooding, droughts, and other natural disasters.
Although Brazil is one of the world's top agricultural producers and exporters, corruption and mismanagement have long been a stumbling block to economic stability. Its history has been characterized by extremes: excessive borrowing, overspending and relying too heavily on the highly volatile oil market has brought about several devastating recessions. Petrobras, Brazil's publicly-owned energy company, has recently been embroiled in a corruption scandal that caused a GDP loss of more than $30 billion.
Sierra Leone (16.7%)
Sierra Leone is one of the poorest countries in the world. Its government is heavily dependent on foreign aid, and most citizens rely on subsistence agriculture. Civil war devastated the country for more than twenty years. Corruption at all levels of government remains a significant problem. However, recent efforts to reform and improve the diamond industry (an important source of revenue for the country, accounting for more than 60% of total exports) has significantly improved Sierra Leone's future economic potential.
Civil war, genocide and ongoing tension and unrest continue to influence Rwanda's developing economy. Despite significant increases in tourism and exports of coffee and tea, the poverty level remains high. More than 80% of Rwandans rely on subsistence agriculture, occasionally supplemented by cash crops. The government exercises control over prices through power and agriculture subsidies, and corruption and graft hinder economic growth and reform.
Widespread government corruption and weak law enforcement have been long-standing challenges for Guyana. Organized crime, drugs and human trafficking are rampant, and violent crimes are a major problem. Legal restrictions on new investment and the lack of accessible long-term financing hinder economic development and job growth. The banking system is archaic and inefficient, and the financial regulatory framework is in dire need of reform.
The Kyrgyz Republic has yet to free itself from the Soviet regime, with remnants of the former Communist system still in effect across the country. Widespread poverty, weak law enforcement, political unrest and violence, as well as organized crime, corruption, and terrorism, have kept the country from peacefully transitioning to a free market economy. External debt is extremely high, and both the public and private sectors are heavily dependent on foreign aid.
Although Jamaica is an upper-middle income country, it has long been plagued by low growth, high public debt and a series of natural disasters that include frequent hurricane activity. Since the 1990s, real per capita GDP has only increased by an average of 1% annually, far behind the growth of most developing countries.
Belize's economy is highly dependent on exports and imports. Due to its location in the hurricane belt, infrastructure and crops are regularly damaged by natural disasters such as hurricanes, tropical storms, and flooding. The country has yet to develop a plan for long-term economic growth; however, an increase in tourism and the discovery of oil in 2005 may have set Belize on a path towards significant economic gains.
Solomon Islands (10%)
The Solomon Islands consist of half a million people scattered across 90 inhabited islands in a remote area of the South Pacific. It is the poorest Pacific country in terms of GNI per capita. Natural resources and economic options are limited, and major markets are prohibitively far away. Climate change and natural disasters also have continued to affect growth and economic stability.
Shattered by a civil war spanning from 1975 to 2002, Angola's economic progress has been slowly improving. Many reforms are still needed, including diversifying its exports (presently, Angola relies heavily on the oil industry), improving infrastructure, and addressing widespread poverty.