LECTURE-1

UNIT-1

INTERNATIONAL TRADE: Export & Import of goods & services.

INTERNATIONAL MARKETING: The multinational companies which were producing the products in their home countries & marketing them in various foreign countries.

INTERNATIONAL BUSINESS:

DEFINITION1: International business is the study of transactions taking place across national borders for the purpose of satisfying the needs of individuals & organizations.

These economic transactions consist of trade, as in the case of exporting or importing & direct investment of funds in overseas operations.

The study of international business is heavily focused on activities of large MNEs, which are headquartered in one country but have operations in other countries; but small scale enterprises are also included.

DEFINITION 2:

International business means carrying business activities beyond national boundaries.

It normally includes the transactions of economic resources such as goods, capital, services (comprising technology, skilled labor, transportation etc.) and international production.

Production may either involve production of physical goods or provision of services like banking, finance, insurance, construction, trading and so on.

Thus, international business includes not only international trade of goods & services but also foreign investment especially foreign direct investment.

SCOPE:

International business relates to transactions involving more than one country.

Scope of international business is very vast. Scope exists to exchange goods

Services (accounting, legal services, healthcare, management consultancy, banking, insurance, transportation, tourism)

Transfer of knowledge( technology, innovation, intellectual property rights),

Other resources( materials, capital , people) ,

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Skills (managerial skills),

Information, People.

IMPORTANCE:

Study of International business has become important because

It comprises a large & growing portion of world’s total business

All companies are affected by global events & competition, whether large or small since most sell output to & secure raw materials & supplies from foreign countries.

WHY COMPANIES ENGAGE IN INTERNATIONAL BUSINESS:

TO EXPAND SALES- e.g. Toyota in Japan expanded sales in US

TO ACQUIRE RESOURCES

TO MINIMIZE RISK

TO COUNTER COMPETITORS

TO AVOID TARIFF & IMPORT QUOTAS

RECENT TRENDS

The past couple of decades have witnessed significant growth in international business.

DURING 1990- the amount of FDI outflow stood at US $245 billion, over two-thirds of which were accounted for by only 5 countries , namely , United States of America, United Kingdom, Japan, Germany, and France.

There were 170,000 foreign affiliates of over 37,000 parent companies. The worldwide sales of these affiliates were approximately US $5.5trillion, which were greater that the world export of goods and non-factor services.

FDI outflow grew from US $245 billion in 1990 to US$1,150 billion in 2000.

However, during 2000, there were ups and downs in the size of the flow.

In 2005, it was US $779 billion which increased to US $1,858 billion during 2008.

The annual growth rate ascended from 15.7% during 1991-1995 to 35.7% during 1996-2000 but was negative by 5.1% during 2001-2005.

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In 2006-2007, the outflow increased by around 50% but again in 2008, due to international financial crisis, the growth rate in FDI outflow was negative by 13.5%

M&A formed a large part of the FDI outflow. In 1990s, the FDI through cross-border M&As had amounted to US$151 billion which rose to US$1,144 billion in 2000 but fell to US$716 billion in 2005.

During 2008, it was of the order of US$1,205 billion. If one looks at the annual growth rate, it rose from 23.3% in 1991-95 to 51.5% in 1996-2000 but fell to 2.2% during 2001-2005.

In 2006 & 2007, the cross border M&As grew by 20% & 46%, respectively, but in 2008, it was negative at 35%.

Along with rapid internationalization of firms, world trade, both intra firm and inter-firm trade grew manifold. The reduction of tariff and non-tariff barriers under the aegis of GATT and now under the WTO umbrella too gave a fillip to international trade.

During two and a half decades beginning from 1980, the value of world trade increased almost fivefold-from US $6,327 billion in 2000 and to US $10.2 trillion in 2005. The world trade in 2008 was as high as $15.8 trillion.

MNCs have a big role in the increasing volume of trade. However, in recent decades, the small and medium sized multinationals do account for sizeable world trade.

There has not been any noticeable change in the share of the developed market economies in the world trade. Their share continued to remain at 64%. Thus, international business has witnessed a phenomenal growth in the recent past.

INTERNATIONAL BUSINESS Vs DOMESTIC BUSINESS

The basic tasks & functions of international business are almost the same as domestic business; but the environment becomes complex. The differences are pronounced primarily in the areas of currency, interest rates, inflation, taxation systems, government regulations, language, cultural & economic barriers. When a company operates internationally, foreign conditions are added to domestic ones making external environment more diverse n complex.

i. IMMOBILITY OF FACTORS: Mobility of different factors of production is less as between nations than in the country itself. However, with the advent of air transport, the mobility of labor has increased manifold. Similarly mobility of capital has increased with the development of international banking. Inspire of these developments, mobility of labor, capital is not as much as it is within the country itself.

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ii. DIFFERENCES IN NATURAL ENDOWMENTS: Natural resources like availability of raw materials, composition of soil, fertility of soil, rainfall, temperature etc. differ widely from country to country. On the basis of this specialty, countries specialize themselves in the production of certain selected commodities & therefore they produce better quality of goods at lower rates & sell them in international market. It causes difference in domestic & foreign trade

iii. DIFFERENT CURRENCIES: There is only one currency acceptable all over the country & therefore there is no difficulty in making payments in internal trade. But, each country has its own monetary system which differs from others .Exchange rate between the two currencies are fixed by the monetary authorities under the rules framed by the INTERNATIONAL MONETARY FUND. All payments for imports are to be made in the exporting country’s currency which is not freely available in importers country.

iv. BALANCE OF PAYMENT PROBLEM

v. MARKET CONDITIONS

PRODUCT MOBILITY

vii. HIGH TRANSPORT COST: Means & costs of transportation also contribute to the difference.

viii. SHARING OF GAINS OF TRADE

ix. DIFFERENT TRADE POLICIES

x. DIFFERENT ECONOMIC ENVIRONMENT

xi. LINGUISTIC & CULTURAL DIFFERENCES

xii. SOVEREIGN POLITICAL ENTITIES: Each country is an independent sovereign political entity. Different countries impose different types of restrictions on imports & exports in the national interest. These restrictions may be: imposition of tariffs & customs duties on imports & exports, quantitative restrictions like quota, Exchange control, imposition of more local taxes etc.

xiii. DIFFERENT LEGAL SYSTEMS: Different legal systems are operated by different countries & they all widely differ from each other. The existence of different legal systems makes the task of business more difficult as they have to follow legal provisions of the two countries as regards the particular trade.

SCOPE OF INTERNATIONAL BUSINESS:

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Scope: (i) Products/Market offered

(ii) Capabilities

(iii) Results

xiv. CATEGORY STRATEGIC AREA

Products/Market Products offered

Market needs

Capabilities Technology

Production capability

Method of sale

Method of distribution

Natural resources

Results Size/growth

Return/profit

STRATEGIC PLANNING PROCESS

H.O. activities Primary flow of Information

Corporate Guiding Principle ______________________ Subsidiaries

Corporate objective ________________________ Subsidiaries

Analyze Environment ________________________ Subsidiaries

Evaluate Corporate Strengths & Weaknesses ___________ Subsidiaries

Specify alternative strategies________________________ Subsidiaries

Evaluate, select & implement Strategy ________________ Subsidiaries

Monitor Strategy ___________________________ Subsidiaries

Corporate Guiding Principle

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Provides a long-term view of what the firm is striving to become & provide direction to divisional & subsidiary managers, some firms use” the decision circle” which is an interrelated set of strategic choices of an international firm.

Input Strategies: labor, management, ownership & financial. They answer the question of where will we find the right people, willingness to carry the risk & the necessary funds.

Marketing & Sourcing: Constitute the basic strategies. They answer the questions to whom are we going to sell what & from where and how will we supply that market.

A third set of strategies: legal & control respond to the problem of how the firm is to structure itself to implement the basic strategies given the resources it can muster. A final strategic area, public affairs is shown as a basic strategy simply because it places a restraint on all other strategy choices.

These strategies influence each other. Although these strategy areas are shown separately in the decision circle & are treated separately, these strategies must be in constant reiteration as one move around the decision circle.

LECTURE-2

INTERNATIONAL BUSINESS: CHALLENGES & OPPORTUNITIES: The different political, LEGAL, SOCIAL, ECONOMIC AND GEOGRAPHICAL environments affect the way a company operates and poses challenges in the form of adjustments one must make to its operations (E.G. how it produces & markets its products abroad, staff its operations and maintains its accounts in a particular country)

1. DIFFERENT POLITICAL ENVIRONMENT : Politics often determines where & how international business can take place. Political disputes, particularly those that result in military conflicts can disrupt trade & investment. To operate abroad organizations should be aware and sensitive to different political regime. E.g. disallowing American nationals to do business in Cuba, because of bombing of a hotel in Indonesia, international investors considered Indonesia to be a riskier place to put funds etc.

2. LEGAL POLICIES : Each country has its own laws regulating business. Domestic & international laws determine largely what the managers of a company operating internationally can do. Domestic laws includes regulations in both the home & host countries on such matters as taxation, employment & foreign exchange transactions. International law in the form of legal agreements between two countries governs how the earnings are taxed by both.

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International law may also determine how & whether companies can operate in certain locales. Companies should understand the treaties amongst the countries and the laws of each country in which they want to operate, as well as how the laws are enforced, to operate profitably abroad.

3. BEHAVIORAL FACTORS: The interpersonal norms of a country may necessitate a company’s alterations of operations. Managers should understand societal values, attitudes & beliefs concerning themselves and others.

4. ECONOMIC FORCES: Economics explains why countries exchange goods & services with each other, why capital and people travel among countries in the course of business and why one country’s currency has a certain value compared to another’s. Economics explains country differences in costs, economic values and market size. Further economics helps explain why, where and when one country can produce goods or services less expensively than another. In addition a manager needs to have knowledge of different analytical tools to determine the impact of an international company on the economies of the host and home countries and the effect of a country’s economic policies & conditions on the company.

5. DIFFERENT GEOGRAPHICAL INFLUENCES: Managers need to know geography to better determine the location, quantity, quality and the availability of the world’s resources, as well as the best way to exploit them. The uneven distribution of resources results in different products and services being produced or offered in different parts of the world. The probability of natural disasters and adverse climatic conditions such as floods, hurricanes, earthquakes, tsunamis or freezing weather make it riskier to invest in some areas than in others.

6. COMPETITIVE ENVIRONMENT: Companies face different competitive situations depending on products, strategies and countries where they operate. As the competitive environment varies at an international level so do the international strategies. In addition companies face international or local competitors at home and in foreign markets. Therefore they must learn about each other in one country for predicting the strategies and actions in other countries.

7. CULTURE: Culture poses challenge for managers as they have to handle different values, attitudes and behavior. Managers have to understand cultural differences and the ways they manifest themselves and to determine similarities across cultures and exploit them in strategy formulation. To achieve success in International business a manger/organization has to show cultural adaptability, patience, flexibility and appreciation of others beliefs.

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8. CROSS-NATIONAL COOPERATION & AGREEMENTS: Trading groups whether bilateral or regional are an important influence on MNEs strategies. Companies must be aware of the regional economic groupings that encompass countries and they must change their organizational structure and operating strategies to take advantage of regional trading groups.

9. LANGUAGE: English is a major language; there are still a large number of ‘non-English’ speaking countries. IB employers should train their employees in the local language of host country.

10. NATIONALISM & BUSINESS POLICY : Nationalism is a dominating factor of the social life of the people of the host countries. Nationalism also affects the business operations of the MNCs dramatically and drastically.US used “Be American, Buy American for automobiles against Japanese cars. Therefore IB companies should be cautious of nationalism and its affects.

11. NATIONAL SECURITY POLICIES OF THE HOST COUNTRIES: MNCs should abide by the national security policies of the host country. Sovereign governments enact and implement laws and formulate and implement policies and regulations. The international business houses should follow these to do business successfully.

OPPORTUNITIES:

1. IMPROVED COMMUNICATION & TRANSPORTATION: Conducting business on an international level usually involves greater distances which increases operating costs and makes control of a company’s foreign operations more difficult. But improved communication and transportation have speeded up interactions and have improved a manager’s ability to control foreign operations.

2. LIBERALIZATION OF CROSS-BORDER TRADE & RESOURCE MOVEMENTS: To protect its own industries, every company restricts the movement across its borders of goods & services and other resources, such as workers & capital. Such restrictions make international business more expensive. Because the regulations may change at any time, international business is also riskier. However, over time most governments have lowered some restrictions on trade because:

a. Their citizens expressed the desire for easier access to a greater variety of goods and services at lower prices

b. They reason that their domestic producers will become more efficient as a result of foreign competition.

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c. The hope to induce other countries to lower their barriers in turn. Fewer restrictions enables companies and individuals to take better advantage of international opportunities.

3. DEVELOPMENT OF SERVICES THAT SUPPORT INTERNATIONAL BUSINESS: Companies and governments have developed services that ease the conduct of international business e.g. Banks have developed efficient means for companies to receive payment in their home-country currencies. Nike sells sportswear to french soccer team as soon as the shipment arrives in French customs a bank in Paris can collect in Euros and pay Nike in U.S. dollars at a bank in the United States. International postal agreements allow you to send letters and packages in any place of the world by conveniently paying postage only in the country and in the currency from which you mail them, regardless of whether they pass through other countries or fly on the airlines.

4. CHANGING POLITICAL SITUATIONS: A major reason for the growth in International business has been the end of the divide between Communist & non-Communist countries. For nearly half a century after World War II, business between the two groups was minimal. Further even within the Communist bloc, countries strove to as much self sufficiency as possible. With the transformation of political and economic policies in the former Soviet Union, most of Eastern Europe, China and Vietnam trade now flourishes between those countries and the rest of the world. A further political factor relates to governments abilities to respond to pressures, to enhance world trade. As incomes have grown so have the tax revenues. Much of the revenue has gone to programs and projects like improving airport and seaport facilities, building efficient highways that connect with those in neighboring countries. All these factors have created opportunities to do business abroad.

5. GROWING CONSUMER PRESSURES: Global discretionary income has risen and now there is a widespread demand for products and services that would have been considered luxuries in past. In the last half of the twentieth century, global consumption grew six fold. The greater demand has created favorable opportunities for increase in International business.

LECTURE-3

Competitive Advantage Meaning:

What a firm has that allows it to make more profit than its rivals. A competitive advantage arises when a firm is able to give its customers the same thing as its rivals but with more benefits, the same thing but at lower cost, or both.

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There are many ways a firm can gain the ability to give customers more benefits, the same benefits at lower cost, or both: access to cheaper raw materials; better staff; cheaper labor; better brand recognition; proprietary technology, and so on. Coca-Cola’s competitive advantage, for example, could be said to arise due to its supreme brand recognition.

Competitive advantage can be created or, at the very least, raised significantly. The improvement of competitiveness within an economy should be a key element of

national export strategy

International competitive advantage:

1. HIGH LIVING STANDARDS: Countries which have the advantage of raw materials, human resources, natural resources & climatic conditions, it can produce products at low cost and also of high quality. Customers can buy more products with the same money. In turn, it can also enhance living standards of the people through enhanced purchasing power .E.g. if country has large uneducated work force it should export labor intensive products.

2. INCREASED SOCIO-ECONOMIC WELFARE : International business enhances consumption level & economic welfare of the people of the trading countries e.g. electronic products of Japan and coffee from Brazil.

3. WIDER MARKET : International business widens market and increases the market size. Therefore companies need not depend on demand for the product in a single country.

4. REDUCED EFFECTS OF BUSINESS CYCLES: Stages of business cycles vary from country to country. Therefore MNC’s can shift from the country, experiencing recession to the country experiencing ‘boom’ conditions.

5. REDUCED RISKS: Both commercial & political risks are reduced for the countries engaged in international business due to their spread in different countries.

6. LARGE SCALE ECONOMIES: MNC’s due to wider & larger markets produce larger quantities. It provides benefits of large-scale economies.

7. POTENTIAL UNTAPPED MARKETS: International business provides chances of exploring &exploiting potential markets which are untapped so far.

8. PROVIDE OPPORTUNITY for &CHALLENGE TO DOMESTIC BUSINESS: Opportunities to domestic business include latest technology, management expertise, market intelligence, product development etc.

9. DIVISION OF LABOUR & SPECIALIAZATION: Brazil specializes in coffee, Kenya in tea, Japan in automobiles.

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10. ECONOMIC GROWTH OF THE WORLD: Specialization, division of labor, enhancement of productivity, innovations to meet competition lead to the overall economic growth of world nations.

11. OPTIMUM & PROPER UTILIZATION OF WORLD RESOURCES : International business provides for the flow of raw materials’, natural resources and human resources from the countries where they are in excess supply to those countries which are in short supply or need most e.g. Flow of human resources from India, consumer goods from U.K. , France , Italy and Germany to developing countries. This helps for the optimum and proper utilization of world resources.

12. CULTURAL TRANSFORMATION: International business benefits are not purely economical or commercial, they are even social & cultural .Good cultural values and factors of the East are acquired by the West & vice versa. Thus, there is a close cultural transformation & integration.

13. KNITTING THE WORLD INTO A CLOSELY INTERACTIVE TRADITIONAL VILLAGE: International business ultimately knits the global economies, societies and countries into a closely interactive village where one is for all and all are for one.

LECTURE-4

INTERNATIONAL COMPETITIVE ADVANTAGE OF NATIONS

MULTIDIMENSIONAL VIEW OF COMPETITIVENESS

Porter introduced what has become known as the ‘diamond of national competitiveness’ with four ‘facets’ determining the competitive strengths and weaknesses of countries and their major sectors. According to Michael E. Porter, four broad attributes, individually and interactively determine national competitive advantage. These 4 broad attributes of a nation shape the environment in which local firms compete, promote or impede the creation of competitive advantage. These factors are:

FACTOR CONDITIONS

DEMAND CONDITIONS

RELATED & SUPPORTING INDUSTRIES

FIRM STRATEGY, STRUCTURE & RIVALRY

Porter represents these elements as the four corners of a diamond.

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1. FACTOR CONDITIONS: include land, labor, natural resources and infrastructure.

Sustained competitive advantage comes from advanced or specialized factors like skilled labor, capital and infrastructure.

These are created not just inherited.

Competitive advantage from factors depends on how effectively & efficiently they are employed. ADVANCED FACTORS (e.g. highly educated personnel and research industries in sophisticated disciplines. SPECIALIZED FACTORS - knowledge based in particular fields are more critical in determining competitive advantage than basic factors (such as highway systems, supply of debt capital or a pool of well motivated educated employees. It’s also important to note that selective disadvantages in the more basic factors can prod a country to innovate and upgrade e.g.in Japan –poor position in natural resources spurred competitive innovation.

Denmark has hospitals that specialize in studying and treating diabetes; Denmark also is a world leading exporter of insulin. By creating specialized factors and then working to upgrade them, country has maintained its premier position in health care field.

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2. DEMAND CONDITIONS: includes size and sophistication of its market.

Nations gain competitive advantage in industries where the home demand gives their companies an earlier picture of emerging buyer needs & where demanding buyers pressurize companies to innovate faster & achieve sophisticated competitive advantage than their foreign rivals.

The size & pattern of growth of home demand can reinforce national advantage in an industry. Large home market size can lead to competitive advantage in industries where there are economies of scale.

Sweden long concerned with helping the disabled, has now spawned a competitive industry that focuses on the special needs of these people.

Denmark’s environmental concern has resulted in Danish companies developing highly effective water pollution control equipment and windmills.

3. RELATED & SUPPORTING INDUSTRIES: these enhance competitive advantage thru working relationships, joint research and problem solving, close proximity and sharing of knowledge and experience.

4. FIRM STRATEGY, STRUCTURE & RIVALRY: Vigorous domestic competition compels the firm to become vibrant n proactive. Structure refers to mgmt. style being practiced by the firm. National policies tend to affect the firm’s international strategies.

In Italy, successful firms typically are small or medium sized; operate in fragmented industries such as furniture, lighting, footwear etc. are managed like extended families and employ a focus strategy geared towards meeting the needs of small market niches.

Germany tends to have hierarchical organizations that emphasize technical or engineering content (optics, chemicals , complicated machinery and demand precision manufacturing).

Competitors: Switzerland: pharmaceuticals firms of Hoffman-La Roche, Ciba-Geigy & Sandoz help the country to maintain its internationally competitive edge.Germany-BASF, Hoechst & Bayer, help the country to keep ahead in chemicals.

Along with 4 elements in the diamond, Porter brings 2 more elements: role of govt. and role of chance (random events such as major technological breakthroughs, political decisions by governments, war & destruction, fluctuation in exchange rates etc.) that enhances or impedes a firm’s competitiveness.

Limitations:

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1.

2. Focus more on developed countries.

3. Natural resources are too important.

4. Govt. has a role in determining competitiveness.

5. Chance factors play their role in promoting or hampering competitive strengths of firms.

PORTER’S DETERMINANTS AS A SYSTEM:

Each of the determinants often depend on the others e.g. even if a country has sophisticated buyers that can provide a company with feedback about how to modify or improve its products (demand conditions) , this information will not be useful if the firm lacks personnel with the skills to carry out these functions (factor conditions) . Similarly, if suppliers can provide the company with low-cost inputs & fresh ideas for innovation (related & supporting industries) but the firm clearly & easily dominates the industry (firm strategy, structure & rivalry) and does not feel a need to upgrade the quality of its products and services, it will eventually loose this competitive advantage.

LECTURE-5

INTERNATIONAL MONETARY SYSTEMS: The international monetary system discusses, among other things, the system of exchange rate or the relationship between the value of any two currencies.

EARLY SYSTEM: Centuries ago, when there was no established system & when the coins were made of valuable metal, the exchange rate was determined on the basis of the value of metal contained in the two currencies. This system was followed by the gold standard, which was considered of vital importance between 1870s and 1914.

GOLD STANDARD: Gold standard is a monetary system wherein the government holds gold coins in reserve against bank currency notes that are in circulation. The bank notes can be exchanged for gold on demand.

The gold standard was suspended during the Great War I, after which it was readopted. But with substantial changes in the international economic scenario, it did not remain tenable; and by 1930s, it was finally abandoned.

THE Gold standard possessed some inherent merits. Since the fixed weight of gold had formed the basis for a unit of the currency and since the free flow of gold was allowed among countries,

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the gold standard had provided for domestic price stability and for automatic adjustment in exchange rates and in the balance of payments.

The supply of gold was fixed and so was the money supply. As a result, the domestic price level was stable. Any deficit in Balance of trade, consequent outflow of gold led to shrinkage in money supply and to a lower price level. The lower price level made the exports competitive, which in turn wiped out the trade deficit. Yet again, any deviation from mint parity could be avoided through the free flow of gold from one country to the other.

BRETTON WOODS SYSTEM OF EXCHANGE RATES

The demise of the gold standard led to large scale oscillation in the exchange rate. It required the creation of an international body that could help create an orderly exchange rate regime and could have surveillance over it. The Bretton Woods Conference of July 1944 resolved to create the International Monetary Fund (IMF) for this purpose. The IMF was established in 1945. A new system of exchange rate evolved. Since this new system was the aftermath of the Bretton Woods Conference, it was known as the Bretton Woods system of exchange rates.

The Bretton woods system of exchange rates represented a fixed parity system with adjustable pegs. Each member country was to set a fixed value, called the par value, of its currency in terms of gold or US dollar. It was the par value that determined the exchange rate between any two currencies. Minor fluctuations, if any, within a band of +1.0 or – 1.0 were expected to be corrected through the active intervention of the monetary authorities. But if a country faced a fundamental disequilibrium in its balance of payments, it could devalue its currency. It did not require approval of IMF for the changes up to 5.0 % in the value of the currency, but beyond this percentage, the IMF’s approval was necessary.

The Bretton Woods system did bring about stability in the exchange rate, but it could not go a long way. It was primarily the loss of confidence in the US dollar following deterioration in the US balance of payments since the late 1950s that hindered the smooth functioning of this system & led to its collapse by 1973.Since the US dollar was the strongest currency in the post-war years and since it was convertible into gold, a number of central banks held a large amount of dollar denominated securities as reserves. When the US Balance of payment began deteriorating in the late 1950s & the real value of dollar was expected to be lower, the central banks started converting these securities into gold. This caused a huge outflow of gold from the US Treasury, which in turn weakened the dollar. The weakening of the dollar led to further conversion of dollar denominated securities into gold. Barring US citizens from buying gold eroded their confidence further. Expectations of a record deficit in 1971 in the US balance of payments resulted in massive selling of dollar in the international financial market. The gold price in the free market rose, disturbing the relationship between the dollar & gold. By August 1971, a full-

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blown crisis appeared against the dollar. The Nixon administration suspended the convertibility of the dollar into gold and this was a serious blow to the fixed parity system.

In December 1971, the Smithsonian Arrangement helped realign the par value of major currencies .For example, US dollar was depreciated, on the other hand the currencies of the surplus countries were appreciated. The fluctuation band of the par values was raised from =/- 1.0% to =/- 2.25% in order to provide greater room to member countries to manage their exchange rates. But this arrangement too could not go far. There was a tide of speculation against the dollar. The US government devalued dollar further by 10% in February 1973, but it failed to improve the situation. The foreign exchange markets were closed in 1973 to avert a crisis. But when they reopened, major currencies came on to float, thus delivering a death blow to the |Bretton Woods system of exchange rates.

EXCHANGE RATE REGIME SINCE 1973

The IMF appointed the Committee of Twenty which suggested various options for the exchange rate arrangement. These suggestions were approved at Jamaica during February 1976 and were formally incorporated into text of Second Amendment to the Articles of Agreement.

In a floating rate system, it is the market forces that determine the exchange rate between two currencies. Exchange rate is automatically adjusted according to the changes in macroeconomic variables. Exchange rate is almost stable around the equilibrium in the long run.

Developing countries in particular do not find floating rates suitable to their needs. Since their economy is not diversified and since their export is subject to frequent changes in demand & supply, they face frequent changes in exchange rates.

The floating rate system may be either INDEPENDENT or MANAGED FLOATING. The system of managed floating involves intervention by the monetary authorities of the country for the purpose of exchange rate stabilization. The process of intervention interferes with the market forces and so it is known as “dirty floating” as against independent floating, which is known as “clean” floating.

INTERVENTION is direct as well indirect. When the monetary authorities stabilize the exchange rate through changing interest rates, it is indirect intervention. On the other hand, in case of direct intervention, the monetary authorities purchase and sell foreign currency in the domestic market.

CURRENT EXCHNAGE RATE REGIMES:

1.EXCHANGE ARRANGEMENT WITH NO SEPARATE LEGAL TENDER(9): Under the arrangement the currency of another country circulates as the sole legal tender e.g. Ecuador, El Salvador & Panama have US dollar as the legal tender.

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2. EXCHANGE RATE ARRANGEMENTS WHERE MEMBERS OF THE CURRENCY UNION SHARE THE SAME LEGAL TENDER (32)

Central African Economic & Monetary Community: Cameroon, Central African Republic, Chad, Republic of Congo, Equatorial Guinea, Gabon

EU (European Union) with Euro as the legal tender .Adopting such regimes implies the complete surrender of the monetary authorities independent control over domestic monetary policy.

3. CURRENCY BOARD ARRANGEMENT (7) : This is a monetary regime based on legislative commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate. To fulfill this legal obligation, currency board, which is the issuing authority is empowered to issue currency only to the extent of foreign exchange reserves of the country. In its classification referred to above, IMF has classified eight countries – Argentina, Bosnia, Brunei, Bulgaria, Djibouti, Estonia, Hong Kong, and Lithuania – as having a currency board system.

4. CONVENTIONAL FIXED PEG ARRANGEMENTS(52) : Pegging of a currency means fixing its value in terms of another currency. The external value of a pegged currency is not dependent upon any independent factor. It changes with the changes in the value of the currency or currencies to which it is pegged. Pegging can be done in any of the following ways:

Pegging to a major currency e.g. Chinese Yuan is pegged to US dollar. Pegging to a basket of currencies, the basket is formed from the currencies of major trading or financial partners and the weights reflect the geographical distribution of trade, services or capital flows.

Pegging to a standardized currency composite such as SDR. The exchange rate is allowed to fluctuate within the narrow margin of less than +/- 1% around central rate for at least 3 months. The monetary authority stands ready to maintain fixed parity through direct or indirect intervention.

Direct intervention takes the form of sale or purchase of foreign currency in the market. Indirect intervention is done through aggressive use of interest rate policy, imposition of foreign exchange regulations, moral sanction to constrain foreign exchange activity.

This is identical to the Bretton Woods system where a country pegs its currency to another or to a basket of currencies with a band of variation not exceeding +1% around the central parity. The peg is adjustable at the discretion of the domestic authorities. 39 IMF members had adopted this regime as of 1999.

CRAWLING PEG (5): The uncertainty associated with following fixed peg where the devaluation or revaluation occurs at long intervals, at uncertain times & in very large doses.

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Under crawling peg adjustments take place periodically & therefore adjustment is smaller. The currency is adjusted periodically in small amounts at a fixed rate in response to changes in selective quantitative indicators, such as past inflation etc. Iran , Azerbaijan, Costa Rica, Nicargua.

EXCHANGE RATES WITHIN HORIZONTAL BANDS : This system combines the features of horizontal bands with crawling pegs. The currency is maintained within a certain fluctuation margins of at least +\- 1% around the central rate or the margin between maximum and minimum value of the exchange rate exceeds 2%. The central rate or margins are adjusted periodically at a fixed rate or in response to changes in selective quantitative indicators Israel (+/- 22%), (+/- 7%) Honduras, Hungary (+/-2.25%)

MANAGED FLOATING(51) : Managed floating or dirty float is a system in which currency is normally floating but monetary authority intervenes when the market fluctuations are violent, to bring some order in the market. The monetary authority influences the exchange rate through direct or indirect intervention. Bangladesh, Thailand, Pakistan are countries following managed float. IMF classifies India also under this currency.

INDEPENDENTLY FLOATING : When the currency is independently floating, its exchange rate is market determined. However, no country is following the system in pure form. There may be occasional official foreign exchange market intervention. Such intervention is aimed at moderating the rate of change & prevents undue fluctuations in the exchange rate, rather than establishing a level for it. USA, UK, Switzerland & Sri Lanka are some countries whose currencies are floating independently.

GLOBAL SCENARIO OF EXCHANGE RATE ARRANGEMENTS:

Firms engaged in international business must have an idea about the exchange rate arrangement prevailing in different countries as this will facilitate their financial decisions.

At present, as many as 25% of a total of 187 countries have an independent float while the other 51 countries have managed floating system. The other 7 countries have a crawling peg, while 53 countries have pegs of different kinds. The EMU and other 20 countries of Africa and the Caribbean region come under some kind of economic and monetary integration scheme in which they have a common currency. Lastly 9 countries do not have their own currency as legal tender.

Post-World war II, countries realized that planned international cooperation fostered economic development & prosperity. Thus, immediately after the war, they agreed to a framework of international rules – a code of behavior –to maintain monetary discipline

INTERNATIONAL FINANCIAL MARKETS:

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International financial market can be compartmentalized into 2 segments. One is the international money market represented by the flow of short term funds.

International capital market forms the other segment where medium and long term funds flow. There are a number of agencies & instruments through which funds move to resource needy institutions or firms.

A) Official Sources:

1. Multilateral Agencies:

(i) International Development Banks such as World Bank, IFC, and others

(ii) Regional Development Banks such as Asian Development Bank etc.

B) Non-Governmental Agencies:

1. Borrowing and Lending Market Involving International Banks

2. Securities market : a) Debt Securities b) Equities)

in which the euro equities and debt instruments such as international bonds, medium term euro notes, short term euro notes and euro commercial papers are sold & purchased.

Multilateral Agencies: IBRD & IDA- together came to be known as the World Bank. IBRD, IDA, IFC and MIGA – together are known as the World Bank Group.

The 1960s were marked with the establishment of regional development banks in Latin America, Africa, and Asia. The Asian Development Bank, meant for the development of the Asian region, began operations from 1967.

Bilateral Agencies: Different governments joined hands with private agencies & the export credits came to form a sizeable part of the bilateral assistance programme.

International Banks:

Euro Banks: Euro banks deal with both residents and non-residents. They essentially deal in any currency other than the currency of the host country. For example, if a Euro bank is located in London, it will deal in any currency other than the British Pound.

The deposits and loans of the Euro bank are remunerated at the interest rate set by the market forces operating in the euro currency market and not by the interest rate prevailing among the domestic banks in the host country. Euro banks are free from the rules and regulations of the host government as they are concerned with the movement of funds of the foreign currency.

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Offshore Banking centers: OBC’s deal with non-residents only, although like the Euro Banks, they did not deal in the currency of the host country. OBC’s came to cluster at places & in countries where the:

The Governmental control & regulations were the least interfering.

Tax rate were very low

Political & economic stability was found

Necessary infrastructure for their smooth operation such as an improved system of communication, financial community and so on was available.

Syndicated Lending: is when banks join hands to provide large loans. One of the lending banks is the lead manager who originates the transaction, structures it, selects the lending members, and supervises documentation & services loans after the agreement is complete in lieu of that it charges an additional fee.

Non-bank depositors/ borrowers are mainly corporate bodies & governments. Deposits in Euro Banks & off shore banking centers are not subject to national regulations such as CRR. As a result, they are able to pay a higher rate on deposits.

INTERNATIONAL SECURITIES MARKET:

International equities: do not represent FDI as holders do not enjoy voting rights. Euro equities are not debts as holders are paid dividend. They are issued when domestic markets are already flooded with shares & the issuing company would not like to add further stress to the domestic stock of shares. Since such additions may cause a fall in share prices.

Companies issue such shares for gaining international recognition, Such issues bring in scarce foreign exchange, Capital is available at lower cost, funds raised this way do not add to foreign exchange exposure.

INTERNATIONAL BONDS:

Foreign bond: A bond issued in a foreign country’s financial market & denominated in the currency of that country is known as a foreign bond.

Euro bond: issued in a foreign country is denominated in any currency other than the currency of the country where it is issued.

Global bonds, cocktail bonds ( denominated in SDRs), convertible bonds ( convertible into equities after a specific period)

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Euro Notes: are promissory notes issued by companies for raising short term funds. They are denominated in any currency other than the currency of the country where they are issued.

Euro Commercial paper (ECP) : ECP is a promissory note like the euro note. It is not underwritten & also it is issued only by highly creditworthy borrowers.

LECTURE-7

WORLD BANK/INTERNATIONAL BANK FOR RECONSTRUCTION & DEVELOPMENT (IBRD)

World Bank is a multilateral development institution whose purpose is to assist its developing member-countries further their economic and social progress so that their people may live better and fuller lives. World Bank is a vital source of financial & technical assistance to developing countries around the world.

The International Bank for Reconstruction and Development (IBRD), better known as the World Bank, was established in 1944 to help Europe recover from the devastation of World War II. The success of that enterprise led the Bank, within a few years, to turn its attention to the developing countries. World Bank is headquartered in Washington, D.C.

By tradition, the Bank president is a U.S. national and is nominated by the United States, the Bank's largest shareholder. The President is selected by the Board of Executive Directors for a five-year, renewable term. By the 1950s, it became clear that the poorest developing countries needed softer terms than those that could be offered by the Bank, so they could afford to borrow the capital they needed to grow.

With the United States taking the initiative, a group of the Bank’s member countries decided to set up an agency that could lend to the poorest countries on the most favorable terms possible. They called the agency the "International Development Association."

IDA's Articles of Agreement became effective in 1960. The first IDA loans, known as credits, were approved in 1961 to Chile, Honduras, India and Sudan.

As its mission has expanded, the World Bank has created affiliated organizations:

IDA,

IFC (INTERNATIONAL FINANCE CORPORATION)

MULTILATERAL INVESTMENT GUARANTEE AGENCY (MIGA)

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ICSID (INTERNATIONAL CENTER FOR SETTLEMENT OF INVESTMENT DISPUTES)

MEMBERSHIP

Total member countries in each institution  The International Bank for Reconstruction and Development (IBRD) 187The International Development Association (IDA) 170The International Finance Corporation (IFC) 182The Multilateral Investment Guarantee Agency (MIGA) 175The International Centre for Settlement of Investment Disputes (ICSID) 144

 The main function of the World Bank is now to provide loans to the developing countries for development projects and programs. Since the credit rating of many developing countries is poor, they find it difficult to raise resources in international capital markets.

Organization: The member countries are represented by a Board of Governors, who are the policy makers at the World Bank. The governors are member countries’ ministers of finance or ministers of development.

Governors meet annually, they delegate duties to 25 Executive Directors, who work on site at bank. The five largest shareholders, France, Germany, Japan, the United Kingdom and the United States appoint an executive director, while other member countries are represented by 20 executive directors.

Fund Generation

IBRD lending to developing countries is primarily financed by selling AAA-rated bonds in the world’s financial markets. While IBRD earns a small margin on this lending, the greater proportion of its income comes from lending out its own capital. This capital consists of reserves built up over the years and money paid in from the bank’s member country shareholders. IBRD’s income also pays for World Bank operating expenses and has contributed to IDA & debt relief.

IDA is the world’s largest source of interest free loans & grants assistance to the poorest countries, is replenished every three years by 40 donor countries. Additional funds are regenerated through repayments of loan principal on 35-to-40 year, no-interest loans, which are then available for re-lending.

Loans

Through the IBRD & IDA, the World Bank offers two basic types of loans & credits:

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Investment loans: are made to countries for goods, works & services in support of economic and social development projects in a broad range of economic & social sectors.

Development policy loans (formerly known as adjustment loans) provide quick-disbursing financing to support countries policy & institutional reforms.

Each borrower’s project proposal is assessed to ensure that the project is economically, financially, socially & environmentally sound.

Analytic and Advisory Services

Conditions for loans:

It must lend only for productive purposes & must stimulate economic growth in the developing countries where it lends.

It must give due regard to the prospects of repayment.

Each loan is made to a government or must be guaranteed by the government concerned.

The Bank’s decisions to lend must be based on economic considerations.

Loans must be used to meet the foreign exchange component of the projects.

The rate of interest is somewhat lower but related to market rates.

The use of loans cannot be restricted to purchases in any particular member-country. In other words, loans are not ‘tied’.

Capital:

The IBRD finances its lending operations primarily from borrowings in the world capital markets.

Funds from such other sources as governments, commercial banks, export-credit agencies, & other multilateral institutions are increasingly being paired with World Bank funds to co finance projects.

The authorized capital of the bank is divided into shares, these shares are only available to the member countries. Of each share (a)2% is payable in gold or USD (b) 18% to be paid in the currency of the member country; and (c) remaining 80% is callable fund i.e. , it is liable to be called if and when needed to meet obligation to lenders from whom the Bank has borrowed or to private investors whose loans the Bank has guaranteed. Thus,

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only 20% of the total capital is called up by the Bank and is available for lending purposes.

LECTURE-8

IDA (International Development Association)

For extending loans on concessional terms to the developing countries whose repayment capacity is limited, IDA in 1960 was established & has 170 members.

The IDA offers credit to the eligible developing countries on extremely favorable terms largely from resources provided by its wealthier members. IDA complements the World Bank’s other lending branch IBRD which serves middle-income countries with capital investment and advisory services.

IBRD and IDA share the same staff and headquarters and evaluate projects with the same rigorous standards. IDA is one of the largest sources of assistance for the world’s 78 poorest countries, 39 of which are in Africa. It is the single largest source of donor funds for basic social services in the poorest countries.

IDA lends money (known as credits) on concessional terms. This means that IDA credits have no interest charge and repayments are stretched over 35 to 40 years, including a 10-year grace period. Eligibility for IDA support depends first and foremost on a country’s relative poverty, defined as GNI per capita below an established threshold and updated annually. IDA also supports some countries, including several small island economies, which are above the operational cutoff but lack the creditworthiness needed to borrow from IBRD.

Some countries, such as India, Indonesia and Pakistan, are IDA-eligible based on per capita income levels, but are also creditworthy for some IBRD borrowing. They are referred to as “blend” countries.

There is no interest charge, but credits do carry a small service charge, currently 0.75 percent on funds paid out. Loans address primary education, basic health services, clean water and sanitation, environmental safeguards, business climate improvements, infrastructure and institutional reforms. These projects pave the way toward economic growth, job creation, higher incomes and better living conditions.

IDA emphasizes broad-based growth, including: (1) Sound economic policies, rural development, private business and sustainable environmental practices (2) Investment in people, in education and health, especially in the struggle against HIV/AIDS, malaria and TB (3) Expansion of borrower capacity to provide basic services and ensure accountability for public resources (4) Recovery from civil strife, armed conflict and natural disaster (5) Promotion of trade and regional integration

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IDA carries out analytical studies to build the knowledge base that allows intelligent design of policies to reduce poverty. IDA advises governments on ways to broaden the base of economic growth and protect the poor from economic shocks.

IDA also coordinates donor assistance to provide relief for poor countries that cannot manage their debt-service burden. IDA has developed a system for allocating grants based on countries’ risk of debt distress, designed to help countries ensure debt sustainability.

While the IBRD raises most of its funds on the world's financial markets, IDA is funded largely by contributions from the governments of the richer member countries. Additional funds come from IBRD's income and from borrowers' repayments of earlier IDA credits.

IDA ReplenishmentsDonors get together every three years to replenish IDA funds. Donor contributions account for about 60% of the US$41.6 billion in the IDA15 replenishment, which finances projects over the three-year period ending June 30, 2011.

The largest pledges to IDA15 were made by the United Kingdom, the United States, Japan, Germany, France, Canada, Italy and Spain, but less wealthy nations also contribute to IDA.

IFC, founded in 1956, is legally a separate entity from the bank although membership in the IFC is not open to non members of the IBRD. The Board of Governors and the Executive Directors of the World Bank also function as the Board of Governors & the Executive Directors of the IFC. The subscription quota of each member is proportionate to its share of subscription to the capital of the World Bank.

The IFC has its own legal and operating staff but draws on the bank for administration and other services. The IFC functions like an investment bank. It participates directly in equity as well as loan investments. It participates only in private ventures and its loans are not dependent on government guarantees.

Investment Policy

(i) The IFC considers only those enterprises which are predominantly industrial & contribute to economic development of the country.

(ii) The project to be financed by the IFC must be in private sector and must be productive in nature.

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(iii) Before making any investment , the Corporation satisfies itself that the enterprise has experienced and competent management.

(iv) The IFC’s loan will not be more than half of the capital needed for an enterprise.

(v) The rate of interest for the IFC loan is determined by mutual negotiation, depending upon the degree of risk involved & other terms of investment.

(vi) The IFC’s loan are disbursed in lump-sum or in installments and are repayable in a period of 5 to 15 years.

The important industries financed by IFC iron & steel , mining , fertilizers, paper, cement, textiles, chemicals etc.

MIGA (Multilateral Investment Guarantee Agency)

As a member of the World Bank Group, MIGA's mission is to promote foreign direct investment (FDI) into developing countries to help support economic growth, reduce poverty, and improve people's lives. It does this by providing political risk insurance (guarantees) to the private sector.

MIGA guarantees cover projects in a broad range of sectors and subsectors, with projects in the financial sector accounting for the largest share (52 percent) of the agency’s outstanding portfolio at the close of fiscal year 2010. The high exposure in the sector is largely the result of MIGA’s support to the banking sector in the wake of the international financial crisis.

At 30 percent of MIGA’s outstanding gross portfolio, the infrastructure sector is a priority focus for the agency. MIGA has a comparative advantage in supporting complex infrastructure investments, particularly when it comes to cash-intensive investments that involve municipal governments, and when it comes to securing financing at better rates and for longer periods.

In fiscal year 2010, the agribusiness, manufacturing, and services sector accounted for 11 percent, while the oil, gas and mining sector accounted for 7 percent of the agency’s gross exposure.

ICSID (INTERNATIONAL CENTRE FOR SETTLEMENT OF INVESTMENT CISPUTES)

ICSID is an autonomous international institution established under the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (the ICSID or

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the Washington Convention) with over one hundred and forty member States. The primary purpose of ICSID is to provide facilities for conciliation and arbitration of international investment disputes.

The ICSID Convention is a multilateral treaty formulated by the Executive Directors of the International Bank for Reconstruction and Development (the World Bank). It was opened for signature on March 18, 1965 and entered into force on October 14, 1966.

The Convention sought to remove major impediments to the free international flows of private investment posed by non-commercial risks and the absence of specialized international methods for investment dispute settlement. ICSID was created by the Convention as an impartial international forum providing facilities for the resolution of legal disputes between eligible parties, through conciliation or arbitration procedures. Recourse to the ICSID facilities is always subject to the parties' consent.

As evidenced by its large membership, considerable caseload, and by the numerous references to its arbitration facilities in investment treaties and laws, ICSID plays an important role in the field of international investment and economic development.

Today, ICSID is considered to be the leading international arbitration institution devoted to investor-State dispute settlement.

LECTURE-6

INTERNATIONAL MONETARY FUND (IMF)

Experts in the U.S.A. & U.K. began planning to solve the monetary problems to be faced after the war. Keynes Plan & the White Plan, were the basis for the Bretton Woods Conference which decided to set up IMF & the IBRD.

The creation of the Fund represents a major effort at international monetary co-operation.

The International Monetary Fund (IMF) is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world. Through its economic surveillance, the IMF keeps track of the economic health of its member countries, alerting them to risks on the horizon and providing policy advice. It also lends to countries in difficulty, and provides technical assistance and training to help countries improve economic management. This work is backed by IMF research and statistics.

OBJECTIVES

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1. To promote exchange stability & orderly exchange arrangements.

2. To help re-establish multilateral system of trade & payments & to eliminate foreign exchange restrictions.

3. To provide for international adjustment, superior to deflation, by making available increased international reserves.

4. To facilitate the expansion & balanced growth of international trade.

RESOURCES

Upon joining, each member of the IMF is assigned a quota, based broadly on its national income & its position in the international trade. Each member’s quota in the Fund determines its subscriptions to the fund, its drawing rights, voting power & share of any allocation of SDR’s

Subscriptions: A member's quota subscription determines the maximum amount of financial resources the member is obliged to provide to the IMF. A member must pay its subscription in full upon joining the IMF: up to 25 percent must be paid in the IMF's own currency, called Special Drawing Rights (SDRs) or widely accepted currencies (such as the dollar, the euro, the yen, or pound sterling), while the rest is paid in the member's own currency.

Voting power. The quota largely determines a member's voting power in IMF decisions. Each IMF member has 250 basic votes plus one additional vote for each SDR 100,000 of quota. Accordingly, the United States has 371,743 votes (16.77 percent of the total), and Palau has 281 votes (0.01 percent of the total).

Access to financing: The amount of financing a member can obtain from the IMF (its access limit) is based on its quota. Under Stand-By and Extended Arrangements, which are types of loans, a member can borrow up to 200 percent of its quota annually and 600 percent cumulatively. However, access may be higher in exceptional circumstances.

ORGANISATION OF IMF:

The management of the fund is under the control of two bodies: (a) Board of Governors (b) Board of Executive Directors

Highest authority of fund is the Board of Governors, in which each of the member countries is represented by a Governor & an alternate Governor.

Board of Governors has delegated many of its powers to the Board of executive directors. Executive Board deals regularly with a wide variety of administrative & policy matters &

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elects the managing director who is the chairperson of the Executive Board & Chief of the operating staff of the fund.

FUNCTIONS OF IMF:

The basic functions of IMF are:

1. To lay down ground rules for the conduct of international finance.

2. To provide short & medium –term assistance for overcoming short-term balance of payment deficits.

3. Creation & distribution of reserves in the form of SDRs.

4. Technical Assistance: IMF also provides technical assistance to member countries on financial matters.

5. Structural Adjustment Facility: The IMF established in March 1986 Structural Adjustment Facility (SAF) to provide additional balance of payments assistance on concessional terms to the poorer member countries.

Under IMF member countries agreed to control the limits of their exchange rates in a predetermined way. Under the original agreement, exchange rates were permitted to vary by 1% above or below par.

As a country’s rate of exchange attained or approached either limit, called arbitrage support points, its central bank intervened in the market to prevent the rate from passing the limit.

MAIN FEATURES OF THE IMF AS IT EXISTED UP TO 1973

PAR VALUE SYSTEM: The exchange value of a member’s currency was fixed in terms of gold. Since the price of gold was officially fixed at U.S. $ 35 per ounce, it also meant that par values were fixed in terms of dollar. Dollar was used as the intervention currency as at that time dollar was as good as gold. In fact, members preferred to keep dollars in reserve, in as much as dollars earned interest while gold reserves did not.

Change in par Value. In order to achieve short-term balance of payments equilibrium, members could borrow funds from the IMF.

If a member proposed a change up to 10%, no prior approval from the IMF was required. If the proposed change was greater than 10%, it could be allowed provided (i) there was a fundamental disequilibrium, and (ii) devaluation would be the right remedy for fundamental disequilibrium.

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CHANGES MADE AFTER 1973

A member can peg its currency to (i) either a single major currency, or (ii) a basket of currencies, or (iii) allow it to float independently, (iv) adjust it to a set of indicators. A reduction in role of gold in International Monetary System: S.D.R. is now the unit of account for Fund’s transaction.

SDR (Special drawing rights): The fund created SDR’s in 1969.Sometimes called paper gold, SDRs special account entries on the IMF books designed to provide additional liquidity to support growing world commerce. Initially SDR’s worth $9.5billion were created.

The value of the SDR is determined daily on the basis of 4 currencies-US dollar, Euro dollar, Japanese Yen & British Pound sterling. The SDR valuation is revised every 5 years.

CRITICAL APPRAISAL OF IMF

Expansion of Fund: Since its inception, the IMF has progressed both in membership & resources.

Provision of credit: The performance of IMF has been satisfactory in respect of the provision of financial assistance to its member countries.

Exchange Stability: The IMF has been making sincere efforts to promote exchange stability among the member countries. The exchange stability as experienced during the IMF era is definitely superior to the chaotic condition of fluctuating exchange rates.

Machinery for Consultation: The IMF machinery set up for providing expert guidance to the member countries in monetary matters has proved very useful. The fiscal and financial policies of the member countries are formulated keeping in view the guidelines suggested by the fund.

Increase in International Liquidity: With the establishment of the scheme of SDRs, the IMF has increased the international liquidity. It provides credit to the needy countries through its account.

LECTURE-9

GLOBALISATION & FDI :

GLOBALISATION is the growing interdependence of countries worldwide through increasing volume and variety of cross-border transactions in goods and services and of international capital flows and also through more rapid and widespread diffusion of technology.

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It is “The shift towards a more integrated and interdependent world economy”.

Globalization of investment refers to investment of capital by a global company in any part of the world. A global company conducts the assessment of the financial feasibility of new projects in different countries of the world and invests capital in that country where it is relatively more profitable.

Globalization of investment is also known as foreign direct investment. FDI occurs when a firm invests directly in new facilities to produce and/or market a product or service in a foreign country. Coca-Cola acquired a number of bottling companies throughout India by investing the capital directly.

REASONS FOR GLOBALISATION OF INVESTMENT:

There has been a rapid increase in the volume of global trade. Many countries provide more favorable environment for direct investment. For example Government of India provided for automatic approval for FDI up to 51% of capital of a company.

Many countries before 1930s created barriers relating to exports, imports & foreign investment. The establishment of WTO has contributed to the elimination of investment barriers phenomenally.

A significant amount of FDI is directed to the developing countries in ASIA & EASTERN EUROPE. Small & medium sized companies have begun investing in various countries.

In addition to increase in the volume of FDI, its composition has also been changing. Initially FDI was directed mostly towards the USA. FDI, recently has been directed towards other countries especially the developing countries of the world.

Liberalization of flow of capital across the borders by various countries.

Global companies in order to have control over manufacturing & marketing activities invest in the foreign countries.

International firms go for FDI in order to avoid the restrictions imposed by the host country on exports. For example, Toyota, a Japanese automobile company increased its investment in the USA, the UK consequent upon imposition of restrictions on exports of automobiles by the host countries.

Sourcing funds globally: The other factor which contributes for the increase in global investment in the sourcing of funds globally. Most of the MNC’s procure funds from any source in the globe, wherever the cost of capital is low with feasible terms and conditions.

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Important sources of funds:

o IBRD, IFC (soft loan window) , IDA, Asian Development bank, African development Bank

o Investors have also started investing in shares of foreign companies.

Modes of Globalization of investment

Acquisition of foreign companies, Joint ventures ,Long term loans, Issuing Equity Shares, Debentures, Bonds etc. are the various sources of finance.

LECTURE-10 FOREIGN DIRECT INVESTMENTFDI as a mode of foreign entry involves ownership of property, assets, projects & businesses invested in a host country.

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Green-field investment: This involves the establishment of a wholly new operation in a foreign country.

Brown-field investment: When a company or government entity purchases or leases existing production facilities to launch a new production activity.

Acquiring or merging with an existing firm in the foreign country. Acquisitions can be minority (where the foreign firm takes a 10% to 49% interest in the firms voting stock) or majority (foreign interest of 50%-99%) or full outright stake (100%)

Foreign portfolio investment (FPI): investment by individuals, firms or public bodies (e.g. government bonds, foreign stocks). FPI does not involve taking a significant equity stake in a foreign business entity (i.e., the equity stake is less than 10%).

It is a non-controlling interest in a company or grant of loan to another party. A portfolio investment takes one of the two forms: Share investment in a company or loans to a company or country in the form of bonds, bills or notes that the investor purchases.

Companies use portfolio investment for short-term financial gain which allows a company to earn money on its money with relative safety. Company treasurers routinely move funds among countries to earn higher yield on short-term investments.

Horizontal FDI: is FDI in the same industry in which a firm operates at home.

Vertical FDI: is investment in an industry that provides inputs for a firms domestic operations, or it may be FDI in an industry abroad that sells the output of a firms domestic operations. Backward vertical FDI occurs when the firm establishes/acquires the firm abroad to manufacture intermediaries which can be used in the domestic firm or by other subsidiaries. For instance, a computer manufacturer may establish a hard disk manufacturing firm abroad. Forward vertical FDI occurs when the firm invests in a foreign firm to distribute its products there.

Conglomerate FDI: It occurs when the investor firm invests in a venture in the host country to manufacture a product unrelated to its product line. The purpose may be to utilize the opportunity abroad by using its managerial or capital resources.

Efficiency Seeking FDI: A firm may decide to invest abroad when it finds that it can produce there with better cost efficiency than in the domestic market. The efficiency may be achieved through (a) low cost of raw materials available in the host country (b) other input costs, e.g., transport and communication costs, and cost of other intermediate products being cheaper in the host country, and (c) membership of a regional integration agreement conducive to the establishment of regional corporate network.

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Market Seeking FDI: Firms take the route of FDI when they recognize the need to expand their market to grow or stay competitive. A country with favorable conditions of market size and per capita income, market growth, access to regional & global markets will attract FDI.

Resources Seeking FDI : Historically availability of natural resources has been important factor in attracting resource seeking FDIs into the host country. However, presence of natural resources usually gives rise to trade rather than to FDI. Investment took place when the resources abundant country lacked the required capital to exploit them or did not have the technical expertise or infrastructure to extract & trade in them.

Created assets seeking FDI: Created assets are man made. Like communication infrastructure or marketing network.

EFFECTS OF FDI/HOST COUNTRY

1. Spillover effects: large MNEs have access to financial resources which supplement the domestic capital available.

Benefit of Technology

FDIs tend to create innovation & knowledge, which are dispersed throughout many levels of local economy.

Foreign managers trained in latest management techniques can help improve efficiency of operations in host country.

2. Employment effects: FDI facilitates creation of jobs .Direct employment is result of foreign MNE offering jobs to locals. Indirect employment arises as a result of increased investment as a result of increase in consumption expenditure.

3. Balance of payments effect: FDI can affect the balance of payment position of a country.

4. Competition and Economic growth:

Competition drives down prices & increases consumer welfare.

Stimulates capital investment by firms in the domestic markets in form of R& D, plant, equipment as they struggle to gain an edge over their rivals.

Long term results include increased productivity, product & process innovation & greater growth.

EFFECTS OF FDI/HOME COUNTRY PERSPECTIVE34

1. Increased foreign earnings: repatriated dividends, license fee etc.

2. Employment effect: in the form of home-country exports of capital equipment, intermediate goods & complementary products.

3. Acquisition of skills: reverse resource transfer affect

4. Ensuring growth from organizational learning

5. Advances of differences in factor endowments: firms are prompted to invest abroad to acquire particular resources at lower costs than could be obtained in their home-country e.g. PepsiCo’s investment in Brazil, Argentina, and Mexico.

6. Increasing return from ownership advantages.

GLOBAL FDI PATTERNS

• Past 20 years have seen a marked increase in both flow & stock of FDI in the world economy. Firms fearing protectionist measures see FDI as a way of circumventing trade barriers.

• Although developed nations, U.S. in particular still account for largest share of FDI inflows, there has been increase flow of FDI in developing countries.

• Most recent inflows into developing nations have been targeted at emerging economies of South, East & South East Asia followed by Latin America especially Brazil & Mexico.

• Growing importance of China as a recipient of FDI. Africa received smallest amount of inward investment.

• USA top recipient, EU remained the largest host region, with 41% of total FDI inflows.

FDI OUTFLOWS

• Triad countries (US, Europe & Japan) accounted for 85% of FDI outflow.

• Developing countries remain a secondary yet growing source of FDI.

• MNE’s from developed countries more likely possess ownership or monopolistic advantages, more likely to be innovators, more likely to possess capabilities to venture abroad.

• The largest investors USA, UK, France, Germany & Spain accounted for 64% of the total outflow.

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• From 1980 to 1990 share of developing countries in outflows grew from 3 to 8%, contributing to this flow were mostly Asian firms although Latin American firms also increased their FDI outflows.

FDI IN INDIA

• Until 1991, there was very little FDI activity in India. Inflow was limited & government policy constrained potential of Indian companies to make foray into foreign countries.

• In last few years India has seen an astounding growth in outward FDI while inward FDI doubled.

• Indian firms are moving massively into IT & Services in developed countries. Indian firms are diversifying into knowledge industry and/or acquiring crown jewels of European & US manufacturing industry. In industries such as pharmaceuticals, software, IT, telecommunications, and transport, Indian MNC’s base their investment on advanced technology, high knowledge intensity & on cutting edge strategies.

LECTURE-11

FOREIGN INVESTMENT POLICY

Prior to economic reforms, foreign investment into India was at a very low level due to restrictive policies followed. Since the launching of the reform, the annual quantum of foreign direct investment increased from USD 129 million in 1991-92 to USD 7.2 billion in 2005-06. Investments by foreign institutional investors (FII) in the Indian capital market has also increased to USD 45.3 billion at March2006 from USD 827 million at December 1993.There has been a simultaneous increase in the Indian investments abroad.

The New Policy 1991

The new policy has allowed majority foreign equity with automatic approval in a large number of industries. The new policy has also made the import of capital goods automatic provided the foreign exchange requirement for such import is ensured through foreign equity.

FDI policy

FDI up to 100% is allowed under the automatic route in all activities/sectors except the following which will require approval of the Government :

Activities/items that require an Industrial License;

Proposals in which the foreign collaborator has a previous/existing venture/tie up in India in the same or allied field

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All proposals relating to acquisition of shares in an existing Indian company by a foreign/NRI investor.

All proposals falling outside notified sectoral policy/caps or under sectors in which FDI is not permitted.

An ongoing review of the FDI policy is carried out so as to initiate more liberalization. Change in sectoral policy/sectoral equity cap is notified from time to time by the Secretariat for Industrial Assistance (SIA) in the Department of Industrial Policy & Promotion.

FDI in sectors/activities under automatic route does not require any prior approval either by the Government or the RBI.

The investors are required to notify the Regional office concerned of RBI of receipt of inward remittances within 30 days of such receipt. They will have to file the required documents with that office within 30 days after issue of shares to foreign investors.

Procedure for obtaining Government approval FIPB

The Foreign Investment Promotion Board (FIPB) considers approving all proposals for foreign investment, which requires Government approval. The FIPB also grants composite approvals involving foreign investment/foreign technical collaboration. Other than NRI Investments and 100% EOU, applications seeking approval for FDI in form FC-IL, should be submitted to the Department of Economic Affairs (DEA), Ministry of Finance.

FDI from NRI & for 100% EOU

Applications for FDI with NRI Investments & 100% EOU should be submitted to the Public Relation & Complaint (PR&C) Section of Secretariat of Industrial Assistance (SIA), Department of Industrial Policy & Promotion.

Proposals requiring Government’s approval

Application for proposals requiring prior Government's approval should be submitted to FIPB in FC-IL form. Plain paper applications carrying all relevant details are also accepted. No fee is payable. All the proposals submitted to FIPB seeking FDI approval should include the following information:

Whether the applicant has had or has any previous/existing financial/ technical collaboration or trade mark agreement in India in the same or allied field for which approval has been sought;

If an applicant has any approved proposal earlier, details thereof and the justification for proposing the new venture/ technical collaboration (including trademarks) has to be submitted.

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Applications can also be submitted with Indian Missions abroad who will forward them to the Department of Economic Affairs (DEA) for further processing.

Foreign investment proposals received in the DEA are placed before the Foreign Investment Promotion Board (FIPB) within 15 days of receipt.

The decision of the Government in all cases is usually conveyed by the DEA within 30 days of submission of the FDI proposal.

INDUSTRIAL LICENSING: With progressive liberalization & deregulation of the economy industrial license is required in very few cases. At present industrial license is required for following:

o Alcoholic drinks

o Cigarettes & tobacco products

o Electronic aerospace & defense equipment

o Explosives

o Hazardous chemicals such as isocynates, phosgene etc.

LOCATIONAL RESTRICTIONS: Industrial undertakings to be located within 25 Kms of the standard urban area limit of 23 cities having a population of 1 million as per 1991 census require approval. Industrial license even in these cases is not required if a unit is located in an area designated as an industrial area before 1991 or non-polluting industries such as electronics , computer software , printing.

ITEMS RESERVED for Exclusive manufacture by MICRO & SMALL Enterprise Sector

In 2008 only 35 items are left on the reserved list which once had 873 items. Latest de-reservation means that pastries, hard boiled sugar candy & tooth powder can be manufactured by large units too. Similarly buckets, paper bags, paper cups, envelopes, letter pads, paper napkins have been delisted.

Remaining 35 items: wood, wood products, paper products, plastic products, organic chemicals, drugs, glass, ceramics, mechanical engineering & electrical machines etc.

FDI is prohibited in the following sectors:

Retail trading, Atomic energy, Lottery business, Gambling & Betting, (Excluding Floriculture), Horticulture, development of seeds, Animal Husbandry, Pisciculture & Cultivation of vegetables, mushrooms etc. under controlled conditions & services related to agro & allied sectors) & Plantations (other than tea plantations).

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In sectors other than those prohibited above, investments can be made either with the specific prior approval of the GOI, MOF, FIPB or under Automatic route of Reserve Bank.

Some of the factors that explain the recent spurt in FDI inflows into India are:

Progressive liberalization of FDI policy has strengthened investor confidence opening up of new sectors, removal of FDI caps in most sectors, including advertising, airports, private sector oil refining, drugs & pharmaceuticals etc.

Liberalization of foreign exchange regulations by way of simplification of procedures for making inward & outward remittances.

Sectoral reforms, especially in sectors such as telecom, information technology& automobiles have made them attractive destination for FDI.

Policy to allow foreign companies to set up wholly owned subsidiaries in India has enabled foreign companies to convert their joint ventures into wholly owned subsidiaries. The percentage of FDI through merger & acquisitions route has increased to around 30% ( from around 10% in 1999)

Public sector disinvestment has emerged as an important means to promote FDI.

Liberal policy towards Foreign Venture Capital Investment (FVCI) has given an impetus to investments in technology & infrastructure projects.

Foreign Investment Implementation Authority (FIIA) has been activated & now meets at regular intervals to review & resolve investment related problems.

Beside 100 percent relaxation of FDI in real estate, the government policies on FDI also offer opportunities for foreign investors to invest in different sectors. This includes 100 percent in power trading, processing, development of new airports, laying of natural gas pipelines, petroleum infrastructure and warehousing of coffee and rubber. Limit for telecoms services firms have been raised from 49 per cent to 74 per cent. Another cap to the retailing industry in India is allowing 100% FDI in single brand outlet & 51% FDI in multi-brand retail as well as 51% FDI in aviation industry from other private airlines.

Other measures which encourage foreign investment include the following: ending the government monopoly in insurance; opening up of the banking sector; protection of international trademarks & patents by legislation, conclusion of bilateral investment treaties & double taxation treaties.

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