Emerging market country risk: adjusting emerging market country risk by the cash flows

[Question]

1. One argument is that companies respond differently to the risk in their country. For example, exporters would benefit from a weaker local currency but importers would be hurt by a depreciating currency. Adjusting the discount rate by the same amount for all companies within a country would misstate the influence of country risk on each company.
2. Additionally, country risk is one-sided and asymmetric in that the country risk to foreign investors is much greater than that to local investors. So if a single discount rate were used to discount cash flows, then the valuations would be inaccurate for either the foreign investors or the local investors.

Are both statements 1 and 2 correct?

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[Answer]
No, only Statement 1 is correct.

It is correct that emerging market valuations should be adjusted for country risk by adjusting the cash flows and not the discount rate.

1. The argument that companies within an emerging market will be affected differently by country risk is correct.

2. It may be true that country risk for foreign investors is greater than that for local investors. However, it is incorrect in the justification because it incorrectly describes the one-sided nature of country risk in this context. Country risk is asymmetric because many emerging market companies have risk profiles that are one-sided (down only). It is best to adjust for this in the cash flows rather than to adjust the discount rate.