Based solely on the predictions in Statement 2, over the next decade Country B’s sovereign credit risk will most likely:

A. increase.

B. decrease.

C. not change.

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Victor Klymchuk, the chief economist at ECONO Consulting (EC), is reviewing the long- term GDP growth of three countries over the recent decade. Klymchuk is interested in forecasting the long-term change in stock market value for each country. Exhibit C presents current country characteristics and historical information on selected economic variables for the three countries. EXHIBIT C Select Country Factors and Historical Economic Data, 2000-2010 Country Factors Growth in Hours Worked (%) 0.9 Country A High level of savings and investment Highly educated workforce Low tariffs on foreign imports Limited natural resources Country B Developed financial markets Moderate levels of disposable income Significant foreign direct and indirect investments Significant natural resources Country C Politically unstable Limited property rights Poor public education and health Significant natural resources Growth in Labor Growth in Growth in Productivity (%) TFP (%) GDP (%) 2.4 0.6 3.3 -0.3 1.6 0.8 1.3 33 1.8 0.8 -0.3 2.6 Klymchuk instructs an associate economist at EC to assist him in forecasting the change in stock market value for each country. Klymchuk reminds the associate: Statement 1: "Over short time horizons, percentage changes in GDP, the ratio of earnings to GDP, and the price-to-earnings ratio are important factors for describing the relationship between economic growth and stock prices. However, I am inter- ested in a long-term stock market forecast." A client is considering investing in the sovereign debt of Country A and Country B and asks Klymchuk his opinion of each country's credit risk. Klymchuk tells the client: Statement 2: "Over the next 10 years, I forecast higher potential GDP growth for Country A and lower potential GDP growth for Country B. The capital per worker is similar and very high for both countries, but per capita output is greater for Country A." The client tells Klymchuk that Country A will offer 50-year bonds and that he believes the bonds could be a good long-term investment given the higher potential GDP growth. Klymchuk responds to the client by saying: Statement 3: "After the next 10 years, I think the sustainable rate of economic growth for Country A will be affected by a growing share of its population over the age of 65, a declining percentage under age 16, and minimal immigration." The client is surprised to learn that Country C, a wealthy, oil-rich country with significant reserves, is experiencing sluggish economic growth and asks Klymchuk for an explanation. Klymchuk responds by stating: Statement 4: "While countries with access to natural resources are often wealthier, the relationship between resource abundance and economic growth is not clear. My analysis shows that the presence of a dominant natural resource (oil) in Country C is constraining growth. Interestingly, Country A has few natural resources, but is experiencing a strong rate of increase in per capita GDP growth." Klymchuk knows that growth in per capita income cannot be sustained by pure capital deepening. He asks the associate economist to determine how important capital deepening is as a source of economic growth for each country. Klymchuk instructs the associate to use the data provided in Exhibit C. Klymchuk and his associate debate the concept of convergence. The associate economist believes that developing countries, irrespective of their particular characteristics, will eventually equal developed countries in per capita output. Klymchuk responds: Statement 5: "Poor countries will converge to the income levels of the richest countries only if they make appropriate institutional changes."