What is Sovereign Risk?

Sovereign Risk Definition. Sovereign Risk refers to that subset of Country Risk that specifically relates to the government in a foreign country or one of its agencies refusing to comply with the terms of an agreement by defaulting on its obligations or imposing regulations that prevent importers from settling their currency obligations. Country Risk refers to the probability that changes in the business environment in another country where you are doing business may adversely impact your operations or payment for imports resulting in a financial loss. Country Risk also includes Sovereign Risk. Causes of Country Risk include political, macroeconomic mismanagement, war or labor unrest resulting in work stoppages. Political changes may come about due to a change in leadership, control by a ruling party, or war. New economic policies may be instituted resulting in expropriation of assets, nationalization of private companies, currency controls, inability to expatriate profits, higher taxes or tariffs, and a host of minor impacts. On a macroeconomic level, countries may pursue unsound monetary policy resulting in inflation, recession, higher interest rates, and shortages in hard currency reserves. The recent debt problems in Europe highlighted sovereign risk issues in Greece and other member states of the Eurozone when loan defaults were a real concern for banks holding the respective loan paper.