international business environment

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MBA III International Business Environment

UNIT I

INTERNATIONAL BUSINESS AN OVERVIEW International Business means carrying on business activities beyond national

boundaries. These activities normally include the transaction of economic resources such as goods, capital, services 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 and services but also foreign investment, especially foreign direct investment.

International business differs from domestic business in that the former involves across the country transactions or across the country production or provision of services, whereas, in the case of domestic business such activities are limited to the length and breadth of the country.

Again, there are many complexities in international business that are not found in case of domestic business. First of all, transactions in international business are mostly intra-firm. Final goods, intermediate goods, and raw material flow between the parent company and the subsidiary, or among different subsidiaries of the same firm.

Secondly, international business transactions are carried out in unfamiliar conditions prevailing in the host countries. The political and legal environment in the host country may be different, manifesting in different sets of policies, rules and regulations. The economic environment may be different, manifesting in different levels of income, lifestyle and consumption patterns. Firms involved in international business have to take care of all these factors and chalk out strategy accordingly.

Thirdly, international business is prone to various kinds of risks. Political risk is one of them. Nationalization of foreign firms’ without providing adequate compensation is common in international business, if the host country government prefers state-run enterprises, the chances for nationalization are more.

Besides the political risk, international transactions-export and import, borrowing and lending, and other forms of receipts and payments- are subject to exchange rate risk.

Fourthly, the management function in international business regarding finance and accounting, personnel, marketing, and production differs from that in domestic business. An international firm takes various

Financial decisions in terms of both domestic currency and host country currency and is more concerned with the hedging of exchange rate risk.

TYPES OF INTERNATIONAL BUSINESS

A firm adopts various modes for its entry into business transaction across borders. Which particular mode a firm should adopt depends, at least, upon four factors. They are:

1. Subservience of the corporate objective 2. Corporate capability 3. Host country environment

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4. Perceived risk When the objective of a firm spreading internationally is simple to earn profits and not necessarily to maintain control over the entire operation, only trading activities will serve its purpose. But if control is the primary objective, the investment mode, and especially investment in a wholly owned foreign subsidiary, will be the best course of action. Thus, a particular mode is selected in tune with the very objective of the firm behind international business. The corporate objective shaping the entry mode must be supported by the company’s capability to select a particular entry mode. For example, if the company’s financial position is not strong enough to make large investment abroad; it will be difficult for the company to make such investment even if it is desirable on the grounds of fulfilling corporate objectives. Thus, the choice of the entry mode depends, to a considerable extent, on the capability of the company going international. The host country environment too influences the entry mode. It includes many aspects, such as the regulatory environment; cultural environment; political and legal environment; economic environment, especially the size of the market and the production; the shipping cost, and so on. Besides these factors, it is risk involved in the different modes of entry that influences the decision of a firm in this respect. Different modes involve varying degrees of risk. The lesser the amount of control in a particular mode, the lower the risk. Thus, the choice of the entry mode depends, among other things, upon the control-risk consideration of the firm. I.TRADE MODE 1. DIRECT AND INDIRECT EXPORT The trade mode presents the first step in international business. It includes export and import. Export may be either direct or indirect. In case of direct export, a company takes full responsibility for making its goods available in the target market by selling directly to the end users, normally through its own agents. Direct export is feasible when the exporter desires to involve itself greatly in international business; and at the same time possesses the capacity to do so. There are also some commodities where direct export is more convenient. They are, for example, air crafts and similar industrial products. When the exporting company does not possess the necessary infrastructure to involve itself in direct exporting, indirect export takes place. It takes place when the exporting company sells its products to intermediaries, who in turn sell the same products to the end-users in the target market. It is a fact that the nature of intermediary differs in direct export or import from that in an indirect export and import. Export management companies (EMCs) and trading companies can not be ignored in this context. When an EMC functions as a distributor, it takes title to goods, sells them on its own account, and assumes the trading risks. Trading companies, on the other hand, provide services to exporters, in addition to exporting activities, such as storage facilities, financing services, and so on. 2. COUNTER-TRADE Counter-trade is a sort of bilateral trade where one set of goods is exchanged for another set of goods. In this type of external trade, a seller provides a buyer with

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deliveries and contractually agrees to purchase goods from the buyer equal to the agreed percentage of the original sale contract value. Counter-trade is classified broadly as:

1. Commercial counter-trade such as classical barter, counter-purchase and pre-compensation

2. Industrial counter-trade such as buy-back agreements, develop for import arrangements, and framework agreements.

Commercial Counter-trade: Classical barter is one of the oldest modes of commercial counter-trade. It involves a once-only exchange of goods on the terms agreed upon between the buyer and the seller. The quantum, quality, and value of goods to be exchanged are well defined. Naturally, the trade flows in one direction are fully compensated by those in the reverse direction. There is no need for bridging finance. Negotiating parties are often governments. The exchange of Iranian oil for New Zealand’s lamb or the exchange of Argentine wheat for Peruvian iron pillets are examples of classical barter. In case of counter-purchase, which is also known as parallel barter, the contracts are often separate for import and export. The type and price of goods traded are generally not specified at the time of signing of the contract. The exporter of goods agrees to accept, in return, a wide range of goods from the importer. Balancing of the value of export and import is done every three to five years. If the two sides are not equal, the balance is paid in cash. Industrial Counter-trade: Being a form of industrial counter-trade, buy back agreements normally involve a larger amount corresponding to the sale of industrial equipment or turnkey plants in exchange for the products manufactured by these industrial plants. Naturally, the contract period is longer, varying from 10 to 20 years. Develop-for-import arrangements are also a variant of the buy-back agreement where the exporter of the plant and machinery participates in the capital of the importing firm and, thereby, takes a share in the profits thereof. This means the involvement of the exporting firm is deeper than in a general buy-back arrangement. Japanese investment in an Australian firm developing gunpowder copper mine is an opposite example. Merits of counter-trade:

• It is a good option for meeting import requirements, especially in case of developing countries whose export faces high barriers.

• It helps stabilize export earnings because it pre-determines the size of export and import. It also helps stabilize the terms of trade as the ratio between export and import prices is predetermined.

• It helps in trade diversification and, thereby, reduces the risk of geopolitical chaos.

• It augments the flow of technology to developing countries, especially when they suffer from a serious technology gap. Buy-back agreements are particularly helpful in such cases.

• When the counter-trade agreement is long term, the importing country gets the same advantage as it gets from the loans.

• Despite the fact that balancing of trade sometimes poses a problem, it reduces the net currency outflow and, thus, helps avoid foreign exchange problems.

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• Developing countries often face distortions caused by unsuitable exchange rate policies. Counter-trade helps correct such distortions. Goods can be exported at less than the quoted price and this can act as an export subsidy.

Demerits of Counter-trade: • It is maintained that counter-trade goes against the norms of multilateral trade

and so countries opting for it, abstain from reaping gains, from the multilateral trading system. There is always the possibility of market distortions because of the lack of multilateral surveillance. Once caught in counter-trade, the weak trading partner is coerced by the strong counterpart.

• Again, difficult to sell products are sometimes traded. This means the country exporting such goods never tries to improve its efficiency. This negatively influences the export performance in the long run.

• Last but not least, the balancing of trade poses a serious problem both at the micro level and at the macro level.

II. Contractual Entry Mode: Contractual entry modes are found in case of intangible products such as technology, patents, and so on. When a company develops a particular technology through its own research and development programme, it likes to recover the cost of research and development. To this end, it sells the technology either to a domestic firm or to a foreign firm. In order to maintain the ownership advantage, a firm passes on the technology only to its own subsidiary located abroad. But if the host government does not permit any foreign investment, the subsidiary of the firm in that host country cannot exist. Transfer of technology through contractual deals is the only way out. The contractual entry mode, often known as technical collaboration or technical joint-venture, is very common. It is preferred in many cases where:

1. The licensor does not possess enough capital for investment, nor does it possesses the requisite knowledge of the foreign market for the purpose of export.

2. The licensor wishes to exploit its technology in the foreign market. 3. The licensor finds the host country market too small to make any investment for

reaping economies of scale. 4. Nationalization is feared in the host country. 5. Foreign investment in the host country is restricted.

Technical collaboration normally takes four forms. They are: 1. Licensing 2. Franchising 3. Management Contracts 4. Turnkey Projects

1. Licensing: it is an arrangement by which a firm transfers its intangible property such as expertise, know-how, blueprints, technology, and manufacturing design to its own unit, or to a firm, located abroad. It is also known as technical collaboration. The firm transferring technology, and so on is known as licensor. The firm receiving technology, at the other end, and so on is known as licensee. The arrangement is meant for a specific period. The licensor gets technical service fee from the licensee. The licensee,

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on the other end, does not have to make a huge investment on research and development. Thus both the parties reap the benefits of licensing. A license can be exclusive, non exclusive, or cross. In an exclusive license, the arrangement provides exclusive rights to produce and market an intangible property in a specific geographic region. A non exclusive license does not grant a firm sole access to the market. The licensor can grant even more companies the right to use the property in the same region. Cross licensing is reciprocal where intangible property is transferred between two firms, both of them being the licensor and the licensee at the same time. Advantages:

• A licensor can expand its operation in different countries by exploiting its innovative technology, without making investment.

• It is less risky than the investment mode because it does not commit any investment. Even if there is an unfavorable political climate in the host country, the licensor is not going to lose anything except for some amount of technical fees.

• Licensing can be advantageous to the license too as it is able to upgrade its production technology and can develop its competitiveness in the international market.

Disadvantages: • There is fear that licensing can reduce the global consistency of the quality and

marketing of a licensor’s product in different national markets, especially if different licensees operate in their own way. Again.

• Again, the secrecy of technology is known to the licensee the moment the licensing agreement is made. In this way, a licensing arrangement hampers the very competitive advantage possessed by the licensor.

2. Franchising: In this form of technical collaboration, the franchiser is the entrant and the franchisee is the host country entity. The franchisee makes use of intellectual property rights, like trademarks, copyrights, and business know how, managerial assistance, geographic exclusivity, or of specific set of procedures of the franchiser for creating the product in question. Franchising differs from licensing in that the former gives a company greater control over the sale of product in the target market. When the franchisee fails to abide by the set of procedures, the franchiser takes back the franchise. Franchising may take different forms.

• In direct franchising, the franchiser frames policy and monitors and directs the activities in each host country from its home-country base.

• In case of indirect franchising, there are sub-franchisers between the original franchiser and the host country units. The sub-franchiser possesses the exclusive right to exploit the original franchiser’s business package within a defined geographic area.

Advantages: • The merit of franchising is that it allows the franchiser to maintain consistency

of its standard products in different target markets. • It is a very low-risk mode of entry in different markets.

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Disadvantages: • Franchising is not cost-free. There are different types of costs involved in it.

The costs are search costs, servicing costs, property right protection costs and monitoring costs etc.

Management Contracts: In a management contract, one company supplies the other with managerial expertise. Such agreements are normally signed in case of turnkey projects where the host country firm is not able to manage day to day affairs of the project or in other cases where the desired managerial capabilities are not available in the host country. The transfer includes both technical expertise and managerial expertise. Merits:

• It is through management contracts that many developing countries are able to utilize specialized expertise in different areas of their economy.

• Management contracts often supplement the licensing agreement insofar as they help the firm reap the advantage of licensing.

Demerits: • The transfer of managerial know-how is very easy as the licensor has to simply

overstretch its management resources and make them available to the licensee. But the problem is that there is often misunderstanding between the foreign managers and the local managers, ultimately effecting productivity.

• Again, if foreign managers work only for a short period and do not train the l9cal personnel, managerial efficiency will not be up to the mark. This will lead to problems when they go back to their home country.

Turnkey Projects: In a turnkey project agreement, a firm agrees to construct an entire plant in a foreign country and make it fully operational. It is known as turnkey because the licensor starts the operation and hands over the key of the operating plant to the licensee. Agreements for turnkey projects normally take place where the initial construction part of the plant is more complex than the operational part. Such projects are either self-engineered or made to specifications. In case of former, it is the licensor who decides the design of the project. In the latter, it is the licensee who takes such decision. In both cases, the contract involves either a fixed price or a cost-plus price. In a fixed-price contract, the risk of cost over-runs lies with the licensor. Advantages:

• Turnkey projects allow firms to specialize in their core competencies, which they could not have done in the absence of such contracts.

• Such contracts allow the host government to obtain world class designs for its infrastructure projects.

• Also advantageous in cases where the host government restrict the inflow of capital.

III. Foreign Investment: Foreign investment takes two forms: One is portfolio investment, which does not involve the production and distribution

of goods and services. It is not concerned with the control of the host country enterprise. It simply gives the investor, a non-controlling interest in the

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company. Investment in securities on the stock exchanges of a foreign country or under the global depository receipt mechanism is an example of foreign portfolio investment.

The other is foreign direct investment, which is very much concerned with the operation and ownership of the host country firm. In case of FDI, if a company acquires around 10 percent of the equity in a foreign firm, it should be treated as foreign portfolio investment as he investing or the acquiring firm does not have a say in the affairs of the target company.

FDI is either horizontal or vertical. • Horizontal FDI is said to exist when a firm invests abroad in the same

operation/industry. Suzuki’s investment in India to manufacture cars is an example of horizontal FDI.

• Vertical FDI is found when a firm invests abroad in other operations either with a view to have control over the supply of inputs or to have control over marketing of its product. It may be further backward or forward:

In backward vertical FDI, it assures the supply of inputs for its production at home. For example- British Petroleum and Royal Dutch Shell have invested abroad in the production of oil. In forward vertical FDI, it helps the sale of domestically produced goods in the host country. For example Volkswagen has acquired a number of US dealers in order to sell its cars to consumers in the USA.

Further based on the motives of the MNCs, FDI may be classified as: 1. Market-seeking- it moves to a country where per capita income and size of

the market are large. 2. Resource-seeking- it flows to a host country where raw material and

manpower are available in abundance. 3. Efficiency-seeking-it moves to a country where the abundance of resources

and presence of large market help MNCs improve their efficiency. Mergers and Acquisitions (M&As) FDI takes place also through mergers and acquisitions (M&As) that are not a

start-from-scratch mode or a Greenfield investment. Broadly speaking, M&As take two forms:

One is the acquisition where one firm acquires or purchases another firm. The former is known as acquiring company and the latter is known as Target Company. No new firm comes into existence after the merger.

The other form manifests in consolidation or amalgamation where two merging firm lose their identity into a new firm that comes to exist representing the interest of the two.

The M&As are either horizontal, or vertical, or conglomerate. Horizontal M&As are found where two or more firms engaged in similar lines

of activities join hands. For example, if two firms manufacturing automobiles merge, it will be called a horizontal merger. This merger help create economies of scale because the size of the firm becomes large to reap such gains.

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Vertical M&As occur among firms involved in different stages of the production of a single final product. If an oil exploration firm and refinery unit merges, it will be called a vertical integration.

Conglomerate merger or consolidation involves two or more firms in unrelated activities. Three types of conglomerate M&As are often found. Product extension combination broadens the product lines of the firm. Similarly, a geographic extension merger involves two firms operating in different and non-overlapping geographic areas. The size of the market expands after the merger. Lastly, conglomerates representing neither of the two are known as pure conglomerate mergers.

There are financial conglomerates where a financial company manages the financial functions of other companies in the group. Similarly, there are managerial conglomerates combining the management of several companies under one roof.

ECONOMIC ENVIRONMENT Economic environment influences international business decisions a lot. This is because the decision to trade or to locate manufacturing operations varies from one host country to the other, depending on the form of the economic system existing there and on the various economic parameters prevailing there, for example, level of income and inflation; health of industrial, financial and external sectors; fiscal and monetary policies; and many others. Forms of Economic System There are primarily two forms of economic systems, that is, the centrally planned economy (CPE) and the market based economy. The two forms lie on the two extremes and so the third form, known as the mixed economy, is a compromise between the two. In other words, the system of mixed economy possesses the features of the first two systems. A CPE is defined as an economy where decisions’ regarding production and distribution of goods is taken by a central authority, depending upon the fulfillment of a particular economic, social and political objective. The government designs the investment and coordinates the activities of the different economic sectors. Ownership of the means of production and the whole process of production lies in the hands of the government. The former USSR and East European countries were apposite examples of this type of economic system. In the market based economic system, the decision to produce and distribute goods is taken by individual firms based on the forces of demand and supply. The means and factors of production are owned by individuals and firms and they behave according to the market forces. The firms are free to take economic decisions. They take such decisions for the purpose of maximizing their profit or wealth. Consumers are sovereign; they are free to decide what they want to buy. The United States of America and West European countries are example of the market based economic system. Between the two extremes, there is the mixed economic system. As mentioned above, there is no country that represents any of the two systems in its purest

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form. In China, which is a CPE, the government has demarcated an area, known as special economic zone where private initiatives are allowed. On the other hand, in the United States of America, which has been a staunch advocate of the free-market economy, some economic activities are owned and regulated by the government. Thus, mixed economy, which represents a mixture of state control on one hand and the economic freedom of entrepreneurs and consumers on the other, is the natural outcome. It is a system that involves greater governmental intervention than found in a market based economy or that relies more on market forces than experienced in a centrally planned economy. To cite an example, the Indian economy represents a mixed economic system. The nature of doing business with these different sets of countries is naturally different. In case of a CPE, it is normally the state trading corporation that participates in international trade. On the other hand, in a market based economy, trade is handled by individual firms. In a mixed economy, both the trading systems are found. Thus, the trade process and the involved procedural formalities differ widely in these cases. The procedural formalities also differ in case of manufacturing of a product or providing services in these different sets of countries. Whenever a firm trades with any other country, or when it tries to locate its manufacturing operations there, it takes into account the existing economic system in the host country and accordingly shapes its trade and foreign operation policies. It also takes into account some preliminary economic indicators of the host country at a particular point of time, as well as over a particular period. These economic indicators help the firm know, among other things,

• The size of demand for its products, • The expected cost of production and the net earning, so as to

ascertain its competitive edge, and • Whether it will be able to smoothly repatriate its earning back to its

home country. The size of demand depends inter alia upon the level of income and its distribution, the propensity to consume, and rate of inflation. The cost of production depends upon the availability of human and physical resources; development of infrastructure; and on fiscal, monetary, and industrial policies. Similarly, smooth repatriation of income and profit depends upon the strength of the external sector.

• Level of Income and its Distribution The size of demand for a product is dependent upon the size of income of its buyer. This is why a firm doing business with a foreign country evaluates the income level existing in that foreign country. The level of income is normally represented by the gross national product (GNP) or gross domestic product (GDP). GDP is the aggregate of the total output of goods and services provided during a year. If one adds to it the income from abroad, the sum is known as GNP. Thus income level in a particular country should be evaluated in terms of per capita income. It is on this basis that the World Bank (2003) has classified different countries as: 1. Low income country

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2. Middle income country 3. High income country Based on the level of income and some other economic and socio-economic indicators, one can group the countries into: (1). developed and (2) developing. The industrialized countries of North America, Western Europe, and the Australian continent are designated as developed countries. In the developing world, some of the countries have made fast strides towards industrialization and have witnessed a high growth rate. They are known as newly industrializing countries (NICs) or emerging market economies. The others are the less developed countries in general. Low income level means low purchasing power. Thus, multinational firms market or manufacture low price goods in such countries. The scope for a costly product in such countries is very limited. However, on the basis of experience, it can be said that multinational firms also often move to low income countries for manufacturing high price goods. There are two reasons for this. First, when the population is quite large and the wage level in general is very low in view of the large supply of labour. In other words, MNCs move to such

POLITICAL ENVIRONMENT Besides the regulation of trade and investment at the national, regional and international levels, it is also the political and legal environment that plays a crucial role international business. A firm can not ignore the political situation and legal formalities existing either in the home country or in the host country if it has to operate successfully abroad.

Concept of Political Environment: -

The political scenario in a country is the outcome of the interacting influence of various interest groups such as individual households, firms, politicians, bureaucrats and many others. The stronger a particular interest group the more prominent its ideology will manifest in the overall political scenario.

As opposed to diverse political environment in a particular country, a particular political ideology may be found in more than one country. It is because the ethnic background, language, religion and so on bring many countries within the fold of one common political ideology. Thus political environment is marked by, both, diversity and uniformity.

Democracy verses Totalitarianism: - The political scenario often varies between the two extremes- democracy on the one hand and totalitarianism on the other. The purest form of democracy represents direct involvement of citizens in policy making. With growing time and distance barrier over time, it turned into a representative democracy where only the elected representatives have a say in political decisions.

Totalitarianism, at the other extreme, represents monopolization of political power in the hands of an individual or a group of individuals with virtually no opposition. The policy is simply the dictates of the ruler.

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Totalitarianism may represent either a theocratic government or a secular government. In the former it is the religion that dictates the political philosophy. For example: - Iran and a large part of Afghanistan controlled by pro-theocracy clergymen come under this group.

On the contrary, in secular totalitarianism, political leaders rely on either on military power or bureaucratic power.

One form of secular totalitarianism is communism which does not differentiate between the economic and political base of the government. In real life, neither the purest form of democracy nor the purest form of totalitarianism is found.

Legal system: - A country’s legal system, which embraces its law and regulations, is closely related to its political system. For example: -

In a totalitarianism political set up, the laws favour state ownership of industries.

In a free political set p, on the other hand law tends to encourage private initiatives. Again in free countries, laws are quite independent of political control.

In totalitarian and semi-totalitarian regimes laws are a part of the political policy.

It is clear that legal environment influences international business and strategy of a firm will be different in a country with no restrictive regulations as compared to that in a country with too many restrictive regulations.

On the global level, there are broadly three types of legal systems: -

i) Civil Law: - It is marked with a detailed set of written rules and regulations, with the result that there is seldom any interpretation of the law by the court. It is found in Central and South America, some Asian countries and African countries and some West European countries.

ii) Common Law: - Originated in England- In this case, there is ample scope for the interpretation of law by the court. Interpretation is based on tradition and precedence. Common Law is found usually in the United Kingdom, The United States of America, Australia, Canada and in some parts of Asia and Africa.

iii) Theocratic legal system:- In this case, law is based on religious teachings. The most important example of theocratic law is Islamic law, which is based on the Koran or the sayings of Prophet Mohammad.

Home Country Perspective: - It is true that firms move to a country with a stable political and less restrictive legal environment. So the political and legal environment prevailing in the host country is much more significant. Such environment is also important in the home country.

If environment is encouraging in the home country, it will have a positive impact of the internationalization of the firms. For example- the Indian

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government has announced incentives and has eased procedural formalities for the overseas operations and domestic firms.

However, the political and legal environment in the home country is not always encouraging. It is often restrictive. The restrictions are manifested in various types of curbs on export and other forms of business.

(Curbs like: - Embargo- complete prohibition of trade, Sanctions- negation of trade financing or prohibition of high technology trade and so on.)

Further the home government; sometimes impose restrictions on other forms of business too. In some countries, anti-trust laws are strictly implemented. The government does not allow national firm to move abroad if they lead to thwart competition and many other like this.

Host Country Perspective: - There is always some risk involved in international business on account of differing political scenarios in host countries. This is known as political risk, which needs proper management for a successful international business operation.

Meaning and Forms of Political Risk: - Political risk is said to exist when sudden and unanticipated changes in political set-up in the host country lead to unexpected discontinuities and corporate performance.

For a long period, political risk was narrowly interpreted in terms of expropriation of assets. But for the past few decades, the coverage of political risk has come to be wider also including risk from racial religious or civil strife, political corruption and blackmail.

Political risks are classified as: -

i) Ownership risk: - Such risk exposes property and life.

ii) Operating risk: - This includes interference of the host government with the ongoing operations of the firm.

iii) Transfer risk: - Concerns the transfer of funds, either to home country or to any other country.

Stephen classifies political risk as: -

1. Macro risk or country specific risk: - Affecting all foreign firms in a country emerges on account of expropriation ethnic and other strife, currency inconvertibility, refusal of debt and so on.

2. Micro risk or firm specific risk: - Such risk affecting a particular industry or firm emerges on account of conflict between the bonafied objectives of the host government and the operation of the MNC or on account of corruption which has become a way of life in many countries.

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SOCIO CULTURAL ENVIRONMENT The socio-cultural environment is an important factor that needs to be taken into account by an international manager. Since culture or human behavior influences to a great extent, international business decision, while planning overseas operations, a multinational enterprise, takes into account the socio cultural environment of the host country. If this environment is similar in both the host and home countries, the manager will try to take the maximum advantage of the similarity for strategy formulation. If it is different, the manager will try to understand the differences and shape the strategy according to the changed environment.

MEANING OF CULTURE- Culture represents the entire set of social norms and responses that dominate the behavior of persons living in a particular geographic or political boundary. It is a fact that cultural boundaries may differ from national/political boundaries because individuals with varying cultural back-grounds may reside in a particular nation. For example, Islamic culture is shared by the citizens of many countries in the Middle East, Asia, and Africa. Yet cultural boundaries and national boundaries are often equated.

Culture, as noted earlier, represents the whole set of social norms and response that shape the knowledge, belief, morals, attitude, behavior, and the very way of life of a person or a group of persons. Culture is not in-born. It is acquired and inculcated. The inculcation of culture begins at the very birth of a person and lies below the level of conscious thought. It may be mentioned that culture is not specific to a single individual; rather it is shared by a group of persons. In fact, it is culture that enables persons to communicate with others and to distinguish between what should be done and what should not be done.

ELEMENTS OF CULTURE- Based on the definition of culture, there are a few basic elements of culture. These elements are universal; meaning that they form the cultural environment of all societies. These elements are as follows:-

• Language

• Religion

• Education

• Attitudes and value

• Customs

• Aesthetics

• Social institutions

• Material elements

LANGUAGE- Language is the medium through which message is conveyed. It may be verbal or non-verbal. The former includes the use of a particular words or how the words are pronounced. The latter embraces the gestures through which feelings are expressed. When an international manager gives the instruction to his subordinates, who normally come from the host country, the instructions must be understood properly

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by the latter; or when the firm’s salesmen tries to convince the consumers, the latter should follow the language of the former well.

Again, if the language is the same in the two countries, it is possible that the same word or the same phrase carries different meanings in different countries. For example, the word, homely means friendly and comfortable in England but plain or even ugly in the United States. American brand names sometimes carry strange meanings when translated into other languages. American Motors’ Matador became ‘killer’ in Spanish.

Even if the international managers make themselves acquainted with the principal language spoken in the host country, the problem is not over. There are many dialects spoken there and it would not be very convenient for the less educated employees to follow the instructions because they may be better versed with a regional dialect rather than with the principal language.

As far as the non-verbal language is concerned, it is also different in different countries. For example, Latin Americans prefer standing close to a person with whom they are talking, but this is not liked by the Americans or by Britons. Thus, multinational managers must also be acquainted with the non-verbal language of the host country.

RELIGION- Religion is another element of culture. Irrespective of forms, religion believes in a higher power. It sets the ideals of life and thereby the values and attitude of individuals living in a society. These values manifest in individuals’ behavior and performance. Since different forms of religions differ in details, the attitude towards entrepreneurship or consumption, and so on varies among different societies practising different forms of religion or among different schools of the same religion. For example, Protestants and Catholics, both represent Christianity, but the former give weightage to accumulation of wealth, while the latter oppose it. Similarly, in Islam, prayers five times a day and fasting during Ramzan are emphasized upon, which in turn, affects productivity.

EDUCATION- The level of education in a particular culture depends primarily on the literacy rate and on enrolment in schools and colleges. This element has a close relationship with the availability of skilled manpower, availability of workers and managers who can be sent to the home country for training, production of sophisticated products, and with the adaptation of imported technology. If the level of education is high in a particular society, it is easy for multinational firms to operate there. It is because skilled manpower will be easily available, it’s training will be easy and the firm will be able to produce sophisticated goods. However, it is not only the level of education but also the pattern of education is important. If the majority of persons in the host country are educated in the area of humanities or languages, they cannot be of as much use as those educated in the area of business studies or engineering.

ATTITUDE AND VALUES- Values are the belief and norms prevalent in a particular society. They determine largely the attitude and behavior of individuals towards work, status, change, and so on. In some societies, where income and wealth are emphasized upon, people work for more hours in order to earn more. On the contrary, in societies where leisure is preferred, people work only for limited hours, just to meet their essential wants necessary for survival.

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Again, the attitude towards social status is an important factor. Those who believe in higher social status spend even more; and to this end, they work more and earn more.

Yet again, in some societies, the attitude of the individuals does not favor change. To this end, they like to protect their own culture with elaborate sets of sanctions and laws. This means that individuals who deviate from their own culture are punished under the law. In such cases, the international manager tries to find out a way that does not deviate widely from existing culture in the host country.

CUSTOMS- Customs and manners vary from one society to another. In the United States of America, silence is taken as negation, while it is not so in Japan. Similarly, Britons prefer instant coffee, while in the USA, ground coffee and instant coffee are both popular. Campbell’s sells large cans of soup in Mexico in order to cater to the needs of large families, while, in Britain, it is not so. In view of such differences, it is imperative for international managers to be aware of varying manners and customs.

AESTHETICS – Aesthetics is concerned with the sense of beauty, good taste, and with the particular symbolism of colours. Colour symbolism, for example, is very important in international business. Black is the symbol of mourning in the United States of America and the United Kingdom, while it is white in Japan and some other Far Eastern countries. Green is popular in Islamic countries. Thus, while designing the advertisement programme or while packaging products, an international manager must take into account these facts so that the aesthetic sensibilities of the host country people are not marginalized and product marketing is smooth.

SOCIAL INSTITUTIONS – Social institutions fro an integral part of culture. They are concerned mainly with the size of the family and social stratification. In the United States of America and the United Kingdom and most other developed countries, the size of the family is small, comprising of a husband, wife, and children. But in many other countries, especially in developing ones, grand parents too are a part of the family. In yet another group of countries, the family is larger, comprising of cousins, aunts, and uncles. In India, the joint family system is still prevalent.

Similarly, in some societies, social stratification is very much apparent. Persons of different strata may be in a single office, enjoy different facilities. Social stratification is also apparent in people’s buying habits. Low income persons use low price products, while the same need of the affluent class is catered with a sophisticated variety of goods. Thus, when an international manager operates in a foreign land, he or she takes into account which segment of the society is the major buyer of the product or whether the persons employed in the firm believe in equality or unequal status.

MATERIAL ELEMENTS – Last but not least, this aspect of material culture cannot be ignored. Material culture is related to the economic, financial, and social infrastructure and to objects and things enjoyed by people. For example, Germans like beer, while the French like wine. So marketing of wine in Germany will be a bad proposal. In Japan, due to lack of space and the prevalence of small homes and apartments, marketing of lawn mowers will be a futile attempt.

Similarly, in less developed countries, where power shortage is common, power generating machines can easily be marketed. But in developed countries, where the

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economic infrastructure is developed, marketing of time saving home appliances will turn out t be a good proposal. If the consumers are uneducated, their consumption pattern will be different. In such cases, computer marketing will not be successful. Again, in cases where financial infrastructure is lacking, foreign companies will have to arrange funds, not from the host country financial market, but, from elsewhere. Thus, these varying elements of culture lead to cultural diversity among different societies, which need to be taken care of by international managers.

CULTURAL DIVERSITY: - Various elements of culture vary in different societies. In some societies, individualism motivates personal accomplishment, while in others; the concept of the group is prominent. American culture comes under the former, while the Chinese and Japanese case conforms to the latter. In some societies, tradition, ceremony, and social rule do not figure, while they are maintained in other societies. Latin American managers, thus, differ from American managers who do not believe in traditions. Western culture encourages innovation in product and technology, while in some parts of the world where culture is highly rigid; people resist new products and technology. In some societies, decisions are taken only by managers

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UNIT II

Balance of Payments

The Balance of Payments of a country is a systematic accounting record of all economic transactions during a given period of time between the residents of the country and residents of foreign countries.

The definition refers to economic transactions. By this we mean transfer of economic value from one economic agent (individual, business, government, etc.) to another. The transfer may be a requited transfer, i.e. the transferee gives something of economic value to the transferor in return or an unrequited transfer, i.e. a unilateral gift. The following basic types of economic transactions can be identified:

• Purchase or sale of goods or services with a financial qui pro quo- or a promise to pay. One real and one financial transfer.

• Purchase or sale of goods or services or a barter transaction. Two real transfers.

• An exchange of financial items e.g. purchase of foreign securities with payment in cash or by a cheque drawn on a foreign deposit. Two financial transfers.

• A unilateral gift in kind. One real transfer.

• A unilateral financial gift. One financial transfer.

Of course there is nothing specifically “international” about any of the above transactions: they become so when they take place between a resident and a non-resident.

Components of the Balance of Payments:-

The BOP is a collection of accounts conventionally grouped into three main categories with subdivisions in each. The three main categories are:-

a) The Current Account: Under this are included imports and exports of goods and services and unilateral transfers of goods and services.

b) The Capital Account: Under this are grouped transactions leading to changes in foreign financial assets and liabilities of the country.

c) The Reserve Account: In principle this is no different from the capital account in as much as it also relates to financial assets and liabilities. However, in this category only “reserve assets” are included. These are the assets which the monetary authority

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of the country uses to settle the deficits and surpluses that arise on the other two categories taken together.

Overall structure of the BOP account and the nature of relationships between the different sub-groups:

The Current Account

Structure of the Current Account in India’s BOP Statement

A. Current Account Credits Debits Net

I. Merchandise

II. Invisibles (a + b + c)

(a) Services

1. Travel

2. Transportation

3. Insurance

4. Government not elsewhere Classified

5. Miscellaneous

(b) Transfers

6. Official

7. Private

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(c) Income (i) Investment Income

(ii) Compensation to Employees

Total Current Account (I + II)

I. Merchandise:

In principle, merchandise trade should cover all transactions relating to movable goods, with a few exceptions, where the ownership of goods changes from residents to non-residents (exports) and from non-residents to residents (imports0. The valuation should be on f.o.b. basis so that international freight and insurance are treated as district services and not merged with the value of the goods themselves.

Exports, valued on f.o.b. basis, are credit entries. Data for these items are obtained from the various forms exporters have to fill and submit to designated authorities.

Imports valued at c.i.f. are the debit entries

The difference between the total of credits and debits appears in the “Net” column. This is the Balance on Merchandise Trade Account, a deficit if negative and a surplus if positive.

II. Invisibles

Conventionally, trade in physical goods is distinguished from trade in services. The invisible account includes services such as transportation and insurance, income payments and receipts for factor services- labor and capital- and unilateral transfers.

Credits under invisible consist of services rendered by residents to non-residents, income earned by residents from their ownership of foreign financial assets (interest, dividends), income earned from the use, by non-residents, of non-financial assets such as patents and copyrights owned by residents and the offset entries to the cash and in-kind gifts received by the residents from non-residents. Debits consist of same items with the roles of residents and non-residents reversed.

The net balance between the credit and debit entries under the heads-merchandise, non-monetary gold movements and invisible taken together is the Current Account

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Balance. The net balance is taken as deficit if negative (debit exceeds credits), a surplus if positive (credit exceeds debits).

The Capital Account:-

Structure of the Capital Account

B. Capital Account (1 to 5) Credit Debit Net

1. Foreign Investment (a +b)

(a) In India

i) Direct

ii) Portfolio

(b) Abroad

2. Loans (a +b-c)

(a) External assistance

i) By India

ii) To India

(b) Commercial Borrowings

(MT and LT)

i) By India

ii) To India

(c) Short-term

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To India

3. Banking Capital (a + b)

(a) Commercial Banks

i) Assets

ii) Liabilities

iii) Non-resident Deposits

(b) Others

4. Rupee debt service

5. Other Capital

Total Capital Account (1 to 5)

The capital account consists of three major subgroups. The first relates to foreign equity investments in India either in the form of direct investments portfolio investments such as purchase of Indian companies’ stock by foreign institutional investors, or subscriptions by non-resident investors to GDR and ADR issues by Indian companies.

The next group is loans. Under this are included concessional loans received by the government or public sector bodies, long and medium term borrowings from the commercial capital market in the form of loans, bond issues, etc. and short term credits.

Disbursements received by Indian resident entities are credit items while repayments and loans made by Indian are debits.

The third group separates out the changes in foreign assets and liabilities of the banking sector. Increases (decrease) in assets are debits (credits) while increases (decrease) in liabilities are credits (debits). Non-resident deposits with Indian banks are shown separately.

The total Capital Account consists of these three major groups and two other minor items shown under ‘rupee debt service” and “other capital”.

The remaining accounts in India’s BOP are;-

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Other Accounts Credits Debits Net

C. Errors and Omissions

D. Overall Balance (Total of Capital and Current Accounts and Errors

and Omission)

E. Monetary Movements

i) IMF

ii) Foreign Exchange Reserves ( Increase-/ Decrease +)

The IMF account contains purchases (credits) and repurchases (debits) from the IMF. The foreign Exchange Reserves account records increases (debits) and decreases (credits) in reserve assets. Reserve assets consist of RBI’s holdings of gold and foreign exchange (in the form of balances with foreign central banks and investments in foreign government securities) and holdings of SDRs. SDRs- Special Drawing Rights- are a reserve asset created by the IMF and allocated from time to time to member countries. A nation’s international balance of payment is in equilibrium when the autonomous supply of the autonomous demand for foreign exchange is equal. This is an equilibrium situation. Whether there is a monetary authority committed to maintain the exchange rate stability without having to interfere as a residuary buyer or seller of gold and/or foreign currencies in the foreign exchange market to achieve this or whether exchange rates are flexible and their movement assures the equality. Disequilibrium in a country’s external balance of payments appears either as a surplus or a deficit. The balance of payments disequilibrium is favorable (surplus) when the difference between the autonomous supply of and the autonomous demand for foreign exchange is positive. When this difference is negative, the disequilibrium is unfavorable (deficit).

THEORIES OF INTERNATIONAL TRADE

These theories explain regarding what, how much and with whom a country should trade. These explanations are given by different economists during different periods.

1. Mercantilist’s Version: - Increasing gold holding through export augmentation and import restriction lay at the root of the mercantilist theory of international trade.

2. Classical Approach: - Classical economist refuted the mercantilist notion of precious metals being the source of wealth. They thought domestic production

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was the prime source of wealth, thereby assumed productive efficiency to be the motivating factor behind trade.

Two of the classical theories have been discussed here; one propounded by Adam Smith and the other propounded by David Ricardo. i) Theory of Absolute Cost Advantage; Adam Smith: - According to this theory the productive efficiency differed among different countries because of diversity in the natural and acquired resources possessed by them.

The difference in natural advantage manifests in varying climate, quality of land, availability of minerals, water and other natural resources; while the difference in acquired resources manifests in different levels of technology and skills available.

So a particular country should specialize in producing only those goods that it is able to produce with greater efficiency or at lower cost; and exchange those goods with other goods of their requirement from a country that produces those other goods with greater efficiency or at lower cost.

This will lead to optimal utilization of resources in both the countries. Both the countries will gain from trade in so far as both of them will get the two sets of goods at the least cost.

Adam Smith explains the concept of absolute advantage in a two-commodity, two-country framework.

Suppose: - Bangladesh produces 1 kg of rice with 10 units of labour or it produces 1 kg of wheat with 20 units of labour.

On the other hand: - Pakistan produces the same amount of rice with 20 units of labour and produces the same amount of wheat with 10 units of labour.

Each of the country has 100 units of labour. Equal amount of labour is used for the production of two goods in the absence of trade between the two countries.

Amount of Production in Absence of Trade

Rice

Wheat

Amount of production after trade

Rice

Wheat

Bangladesh

Pakistan

5 kg

2.5 kg

2.5kg

5 kg

Bangladesh

Pakistan

10kg

Nil

Nil

10kg

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Total output in

two countries

:- 15kg Total output in two countries

: - 20 kg

In the absence of trade: - Bangladesh will be able to produce 5 kg of rice and 2.5 kg of wheat. Pakistan will produce 5 kg of wheat and 2.5 kg of rice. But when trade is possible between the two countries: - Bangladesh will produce only rice and exchange a part of rice output with wheat from Pakistan. Pakistan will produce only wheat and exchange a part of the wheat output with rice from Bangladesh which was producing7.5 of food grains in the absence of trade, will now produce 10 kg of food grains. Similarly in Pakistan 10 kg of food grains will be produced instead of 7.5 kg. This theory of absolute cost advantage explains how trade helps increase the total output in the two countries. (Though it fails to explain whether trade will exist if any of the two countries produces both the goods at lower cost).

ii) Theory of Comparative Cost Advantage: - This theory explains that a country should specialize in the production and export of a commodity in which it possess greatest relative advantage.

Ricardo focuses not on absolute efficiency but on relative efficiency of the country for producing goods. This is why his theory is known as theory of comparative cost advantage.

In a two-country, two-commodity model, he explains that a country will produce only that product which it is able to produce efficiently.

Suppose: - Bangladesh and India, each of has 100 units of labour. One half of the labour force is used for the production of rice and the other half for the production of wheat,

In Bangladesh: -

10 units of labour are required to produce either 1 kg of rice or 1 kg of wheat.

In India: -

5 units of labour are required to produce 1 kg of wheat and 8 units of labour are required to produce 1 kg of rice.

Amount of output in absence of trade Rice Wheat

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1. Bangladesh

2. India

5 kg

6.25 kg

5 kg

10 kg

Total output: -26.25 kg

(If we view according to absolute cost advantage theory, there will be no trade as India possess absolute cost advantage in the production of both commodities)

But from the viewpoint of Ricardo’s comparative cost advantage, there will be trade because India possesses comparative cost advantage in the production of wheat.

Amount of output after trade Rice Wheat

1. Bangladesh

2. India

10 kg

Nil

Nil

20 kg

Total output: - 30 kg

This is because the ratio cost between Bangladesh and India is 2: 1 in case of wheat while it is 1.25:1 in case of rice.

Because of this comparative cost advantage, India will produce only 20 kg of wheat with 100 units of labour and export a part of wheat to Bangladesh.

On the other hand Bangladesh will produce only 10 kg of rice with 100 units of labour and export a part of rice to India. The total output of food grains in the two countries, which was equal to 26.25 kg prior to trade, rises to 30 kg after trade. Thus, it is the comparative cost advantage that leads to trade and so specialization in production and thereby, to increase in the total output of the two countries.

Though theory seems to be simple, yet it suffers from a few limitations: -

• It takes into consideration only one factor of production, does not take into account transportation cost.

• It assumes the existence of full employment.

• Stresses too much on specialization that is expected to improve efficiency that is not always the case in real life.

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• Economists feel that resources are mobile domestically and immobile internationally.

Neither of the assumptions is correct. It is difficult for labour to move from one occupation to another within the country. On the contrary, labour and capital move easily across nations.

3.) Factor Proportions Theory: - This theory explains that in a two-country, two-factor and two-commodity framework different countries are endowed with varying proportions of different factors of production.

Some countries have large populations and large labour resources. Others have abundance of capital but are short of labour resources.

Thus: -

• A country with a large labour force will be able to produce the goods at a lower cost using a labour intensive mode of production.

• Countries with a large supply of capital will specialize in goods that involve a capital intensive mode of production.

The former will export its labour intensive goods to the latter and import capital intensive goods from the latter.

After the trade both the countries will have two types of goods at the least cost.

4. Neo-Factor Proportions Theories: - Some of the economists emphasis on the [point that it is not only the abundance (scarcity) of a particular factor, but also the quality of that factor of production that influences the pattern of international trade. The quality is so important in their view that they analyze the trade theory in a three factor framework. The third factor manifests in the form of: -

• Human Capital: - A country with improved human capital (which is the result of better education and training).

• Skill-intensity: - Labour is a non-homogeneous factor and it is the differing quality of labour in terms of skills that determines the pattern of international trade.

• Economies of scale: - This hypothesis explains that with rising output, unit cost decreases. The producer achieves internal economies of scale. A country with large production possesses an edge over other countries with regards to export.

• Research and Development including technological innovation: - R & D activity is positively associated with the competitive ability of manufacturing industries. A country with large expenditure on R & D possesses a comparative trade advantage. A technologically advanced country exports newly innovated goods where its innovation continues to remain its monopoly.

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THEORY OF FOREIGN DIRECT INVESTMENT

FDI

1. Mac Dougall-Kemp Hypothesis: - Assuming a two country model- one being the investing country and the other being the host country- and the price of capital being equal to its marginal productivity, they explain that capital moves freely from a capital abundant country to a capital scarce country and in this way the marginal productivity of capital tends to equalize between the two-countries.

This leads to improvement in efficiency in the use of resources that leads ultimately to an increase in welfare. Despite the fact that the output in the investing country decreases in the wake of foreign investment outflow, national income does not fall in so far as the country receives returns on capital invested abroad, which is equal to marginal productivity of capital times the amount of foreign investment.

So long as the income from foreign investment is greater than the loss of output, the investing country continues to invest abroad because it enjoys greater national income than prior to foreign investment.

The host country too witnesses increase in national income as a sequel to greater magnitude of investment, which is not possible in the absence of foreign investment inflow.

2. Industrial Organization Theory (Explaining why investment takes place?): - This theory is based on an oligopolistic or imperfect market in which the investing firm operates.

(Market imperfections arise in many cases such as product differentiated marketing skills, proprietary technology, managerial skills etc.)

According to Hymer a MNC is a typical oligopolistic firm that possesses some sort of superiority and that looks for a control in an imperfect market with a view of maximizing profits.

Though the international firm has disadvantage of being posted in a foreign host country where it has no intimate knowledge of language, culture, legal system and consumer’s preferences.

It has specific advantages in new technology to make a new product that differs from the existing ones. This possession of knowledge also helps in developing special marketing skills, superior organizational and management set-up and improved processing. This outweighs the disadvantage and international firm harvests huge profits.

3. Product Cycle Theory (Explains when to why and where?): - According to Raymon Vernon- most products follow a life cycle that is divided into three stages: -

i) Innovation Stage: - In order to compete with other firms and to have a lead in the market, the firm innovates a product with the help of research and development. The product is manufactured in the home country to meet the domestic demand, but a portion of the output is also exported to other developed countries.

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The quality of the product, and not the price, forms the basis of demand because the demand is price inelastic at this stage.

ii) Maturing Product Stage: - At this stage, the demand for the new product in other developed countries grows substantiality and it turns price-elastic.

Rival firms in the host country itself begin to appear at this stage to supply similar products at a lower price owing to lower distribution cost, whereas the product of the innovator is often costlier, as it involves the transportation cost and tariff that is imposed by the importing government.

In order to compete with rival firms, the innovator decides to set up a production unit in the host country itself, which would eliminate transportation cost and tariff. This leads to internationalization of production.

iii) Standardized Product Stage: - At this stage a standardized product and its production techniques are no longer the exclusive possession of the innovating firm, rival firms from the home country itself or from some other developed countries, put stiff competition.

At this stage, price competitiveness becomes more important; and in view of this fact, the innovator shifts the production to a low cost location, preferably a developing country where labour is cheap. The product manufactured in low cost location is exported back to home country or to other developed countries.

One more stage in the product’s life cycle known as “dematuring stage” – when development in technology or in consumer’s preference breaks down product standardization.

Sophisticated models of the product are manufactured again in technology advanced, high income countries so that the firm can have a close linkage with consumer’s tastes and with the basic infrastructure required for production.

4. Location Specific Theory: - Since real wage cost varies among countries, firms with low technology move to low wage countries.

In some countries, trade barriers are created to restrict import. MNCs invest in such countries in order to start manufacturing there and evade trade barriers.

Sometimes it is the availability of cheap and abundant raw material that encourages the MNCs to invest in the country with abundant raw material.

5. Internationalization Approach: - Transfer of technology and knowledge or expertise developed at one unit is normally passed on to other units free of charge. This means that transaction cost in respect of intra-firm transfer of technology is almost zero. Whereas such costs in respect of technology transfer to other firms are usually higher putting those firms at a disadvantage.

This internationalization benefits; manifesting in the cost-free intra firm flow of technology motivates a firm to go international.

6. Eclectic Paradigm: - Dunning’s Eclectic Paradigm postulates that, at any given time, the stock of foreign assets owned by a multinational firm is determined by a combination of firm specific or ownership advantage (O), the extent of location bound

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endowments (L), and the extent to which these advantages are marketed within the various units of the firm (I).

Dunning is conscious that configuration of O-L-I advantages varies from one country to another. Foreign investment will be greater where the configuration is more pronounced

7. Currency Based Approaches: - This theory postulates that internationalization of firms can best be explained in terms of the relative strength of different currencies, Firms from a strong currency country move out to a weak currency country.

8. Politico-Economic Theories: - These theories concentrate on political risk. Political stability in the host countries leads to foreign investment therein. Similarly political instability in the home country encourages investment in foreign countries.

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UNIT III

WORLD FINANACIAL ENVIRONMENT

TARIFF AND NON TARIFF BARIERS Tariffs have been one of the classical methods of regulating international

trade. They may be referred to as taxes levied on imports. They aim at restricting the inward flow of goods from other countries to protect the country’s own industries by making the goods costlier in that country. Sometimes the duty on the product is do steep that it does not become worthwhile to import it. In addition, the duties so imposed provide a substantial source of revenue to the importing country. In India, custom duty forms a significant part of total revenue and, therefore is an important element in preparing the budget. Some countries use this method of imposing tariffs and customs to balance their balance of trade. A nation may also use this method to influence the political and economic policies of other countries. It may impose tariffs on certain imports from a particular country as a protest against tariffs imposed by that country on its goods.

KINDS OF TARIFFS:- Tariffs may be classified according to: - the purpose of taxes, and how they are levied. 1. As far as purpose of taxes is concerned, tariffs may be classified into two categories- a) Revenue Tariffs – These are basically intended to raise government revenue without intending to protect any industry in the country. It is levied at a fairly low rate and does not obstruct the free flow of imports. b) Protective Tariffs- These tariffs on the other hand, aim at protecting the domestic industries and are generally levied at a very high rate and, therefore obstruct the free flow of imports. Its main purpose is not to increase revenue but to provide a safeguard to the domestic industries against foreign competition in the local market. Tariffs, sometimes, are levied to discriminate between countries, e.g., tariffs are imposed on certain goods having certain specifications, which are imported, from a particular country. 2. On the basis of how tariffs are computed, tariffs may be put into two categories- a) Specific Duties or Tariffs are imposed on the basis of per unit of any identifiable characteristics of merchandise such as per unit of weight, volume, length, number or any other unit of quality of goods. The duty schedules so specified must specify the rate of duty as well as the determining factor such as weight, number, etc. and the basis of arriving at determining factor such as gross weight, net weight or fair weight, etc. b) Ad valorem Tariffs are based on the value of imports and are charged in the form of a specific percentage of the value of goods. The schedule should specify how the value of imported goods would be arrived at. Most of the countries follow the practice of charging tariffs on the basis of c.i.f cost of a product of f.o.b. cost mentioned in the invoice. As tariffs under this method, are levied on c.i.f. or f.o.b.

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prices, sometimes unethical practices of under invoicing are adopted whereby the custom revenue is affected. In order to eliminate such malpractices, some countries adopt a fair value or the current domestic value of the goods as the basis for the computation of custom duty. In order to protect the domestic industries against competition, some other tariffs are also imposed. Among them, two are important- a) Anti dumping duties- Very often, exporters from developed countries are eager to sell their products in foreign markets with a view to capture a large market, at a very low price not proportionate to their cost of production. This attempt to introduce their products I a large quantity into foreign market at a very lower price, even lower than cost, is called ‘dumping’. This naturally will adversely affect the domestic industries. The government of importing country, therefore, imposed customs duty on such goods at a very high rate to counteract this unfair competition. This duty is known as ‘anti dumping duty’. Such duties are charged in addition to the normal custom duty on the product. This additional charge would cover at least the difference between the export price and the normal price or market price in the exporting country. b) Counteracting duties:- These are similar to the anti dumping duties and are charged on goods imported from countries where the manufacturer exporter is paid, directly or indirectly, a subsidy as an incentive for export. The amount of duty normally does not exceed the estimated amount of subsidy. NON TARIFF BARRIERS:- Over the last few years, GATT has been endeavoring to achieve a reduced and rationalized tariff structure for trade among its member countries. As per terms GATT, every member country will accord MFN treatment to all other member countries while importing goods from them. At the same time, importing countries are also concerned with the development of their own industries and trade. They will have to protect them against unfair competition with a view to giving the domestic industry a fair chance for survival. To meet the challenges, more and more countries are adopting non-tariff measures to regulate their imports. Such measures may be called ‘non-tariff barriers’. Some of these non-tariff measures are:- a) Quantitative (QR) restrictions, quotas and licensing procedures- Under QR, the maximum quantities of different commodities, which would be allowed to be imported over a period of time from various countries, is fixed in advance. The quantity to be imported or quota fixed normally depends upon the relations of the two countries and need of the importing country. There is, therefore no effect of price level changes in foreign or domestic markets and the government is in a position to restrict the imports to a desired level. Quotas are very often combined with licensing system to regulate the flow of imports over the quota period as also to allocate them between various importers and supplying countries. Under this system, a license or a permit is to be obtained from the govt. to import the goods specifying the quantity and the country from which to import, before concluding the contract with the supplier. b) Foreign Exchange restrictions- Exchange control measures have been widely used by a number of developing countries in the post-war period to regulate their imports and to keep their balance of payments in controllable limits. Under this system, the importer must be sure that adequate foreign exchange would be made

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available to him for the imports of goods by obtaining a clearance from the exchange control authorities of the country before concluding the contract with the supplier. c) Technical and administrative regulations- Another measure to regulate imports is the imposition of certain standards of technical production, technical specifications, etc. and the importing commodity must conform. Such types of technical restrictions are impressed in case of pharmaceutical products, etc. and the importing commodities must satisfy them before their import is permitted. Besides technical restrictions, administrative restrictions such as adherence to certain documentary procedure are adopted to regulate imports. These technical and administrative measures impede the free flow of trade to a large extent. d) Consular Formalities- A number of countries demands that shipping documents must accompany the consular documents such as certificate of origin, certified invoices, import certificates, etc. Sometimes, it is also insisted that such documents should be drawn in the language of importing countries. In case the documentation is faulty or not drawn in the language of importing country, heavy penalties are imposed. Fees charged for such documentation are quite heavy. e) State Trading- In most socialistic countries, foreign trade, i.e., import and export transactions are exclusively handled or canalized by certain state agencies. Separate state agencies are set up for each class of products. These agencies carry on international trade strictly according to the govt. policies. A few other countries of the world follow state trading in a restricted sense to achieve certain desired results especially where bulk imports are needed and the govt. wants to maintain price stability. India is a good example where state trading is followed in a restricted sense. Some articles, are decided by the govt., are imported only through the State Trading Corporation (STC). Likewise, exports of raw materials such as iron ore, mica, etc. are canalized only through Minerals and Metals Trading Corporation (MMTC). f) Preferential arrangements- With due evolvement of the multilateral trading system, a few member countries agree to a small advantageous group for their mutual benefit. The member countries of the group negotiate and arrive at a settlement of preferential tariff rate to carry on trade amongst them. These rates are much lower than ordinary tariff rates and applicable only to the member nations of the small group. Such types of preferential arrangements are outside the purview of the GATT, Some of the small groups are EEC, ASEAN, and LAFTA etc.

EUROCURRENCY (EURODOLLAR) MARKET The term ‘Eurocurrency market’, also synonymous with the Eurodollar

market, is a broad catch-all for a number of specific markets separated by the type of transactions, institutional arrangements, by the use of various instruments for financial dealings, sometimes geographical location and even by the lack of standardization on the part of European central banks in their use of terminology.

The Eurocurrency market is an international banking market whose major location is in London and which specializes in the borrowing and lending of currencies outside their countries of issue. Besides the US dollar, this dominates the market in transactions; transactions take place in other Eurocurrencies whose share in the total assets and liabilities of the Euro banks has tended to increase over the years. Those who participate in the Eurocurrency market include the commercial banks,

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monetary authorities, business firms (particularly large multinational corporations), government agencies and semi-governmental entities, including central and international organizations. Since the major part of the market is located in Europe and since transactions are mostly in dollars, the market is commonly called the ‘Eurodollar market’. However with the increasing use of non dollar currencies, for example, the deutsche mark and the Swiss franc, the market is more appropriately labeled as the ‘Eurocurrency market’.

General Features of the Market- In the Eurocurrency market, the Euro banks have developed certain

characteristic lending and borrowing practices which have in a way become the general features of Eurocurrency market. These practices or techniques were largely the result of the particular structure of the market and the change in this structure over time. The Eurocurrency market has the following general features:- 1. The Eurocurrency market is a wholesale market in so far as most final borrowers are large companies or official entities and the average unit size of transaction is large. Consequently, the overhead expenses of banks are relatively low. 2. The largest segment of the Eurocurrency market is the interbank market which is essentially short-term in nature. Consequently, more than three-fourths of the foreign currency liabilities and assets of the reporting Euro banks are against other banks. In the last few years, increase in the gross size of the market represents to a very large extent increase in the inter bank deposits. 3. The Eurocurrency market is a highly competitive market with unrestricted entry for the newcomers in the market. Consequently, the margin between interest rate on deposits and loans has tended to decline and the Euro banks have to remain contended with lower rates of return on the Eurocurrency assets than those rates of return which can be had on domestic currency assets in national markets. Although resembling in many ways the national markets, the Eurocurrency market is basically different from them since it is a market without any central monetary authority and free from controls. Loans and Deposits Euro market loans are almost similar to the loans that are made in the domestic or onshore market. One important difference; however is that borrowers in the Eurodollar market are typically large, well-known firms with high credit standing. Consequently, credit evaluation and documentation are less rigorous. Loan maturities range from short-term trade financing to 10-year commitments. With a view to spreading the default risk generally inherent in large-scale loans over a large number of banks, the Euro banks have increasingly resorted to the technique of syndicating the medium-term loans extended outside the interbank market. There are different methods for syndicating a loan. The common characteristic of all methods is to involve a large number of participating banks (as many as 95 banks in one case) with only one bank- the lead bank-managing the loan. In order to limit the default risk resulting from indirect loan relationship often involving many banks, Euro banks typically place limits on the amount outstanding advances which they will extend to any single borrowers in any single country. The syndicated credit market developed during the late 1960s and was a major factor in facilitating the access of developing countries to Eurocurrencies funds.

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Yet another feature of Eurocurrency dealings outside the interbank market is the use of ‘floating rate’ medium-term credit arrangements which represent a type of roll-over credit with interest rates determined periodically, usually every three or six-monthly, on the basis of interest rates prevailing in the interbank part of the Eurocurrency market. In a way, resorting to the use of ‘floating rate’ medium-term credit arrangements, Eurobank try to reduce the interest rate risk which is inherent in unmatched maturities of assets and liabilities. In many loan agreements, a multi currency clause is also incorporated in order to avoid the risk of loss resulting from exchange rate fluctuations. This clause provides an important element of flexibility in this respect by offering a choice of currencies in which the whole or parts of a loan may be drawn upon. A very significant development in the Eurocurrency market is the emergence of SDR-linked certificates of deposits and bonds. In terms of volume, the most important SDR market is the deposit market in which bank index the value of deposits to the SDR. The SDR market is the wholesale market with a typical deposit of approximately SDR 12 million. The principal depositors are the central banks, Middle East countries’ governments or agencies and institutions in the international oil business. Eurocurrency Market and Developing Countries During the past two decades, a growing number of developing countries have borrowed increasing amount of funds from the Eurocurrency market. This is, however, far from suggesting that either the access for the developing countries to the market funds has been easy or that the funds have been obtained from the market at cheap cost or have always been suitable for purposes of economic development. While some developing countries have had access to international and foreign bond markets as well as bank loans, borrowings have been largely made through medium-term syndicated loans with maturities ranging between 3 to 10 years with floating interest rates. According to the conservative estimate made by the bank for international Settlements, the medium and long-term lending from banks in the Group of Ten countries and Switzerland to developing countries rose from about US $2 billion in 1971to US $10 billion in 1976 and to over US $40 billion in1995. The importance of the Eurocurrency market in international economy has increased so overwhelmingly that its future is linked with the future of the world economy as a whole. Indeed so much amazingly rapid has been the development of the market that the Eurocurrency has now become the focus of considerable and at times of diffused controversy. Its size, rapid growth and freedom from national regulations have attracted interest in the macroeconomic implication of this market and its impact on the policies of individual countries. The extent of development of Eurocurrency market is also an indicator of the extent of monetary interdependence of the economies of the world. The degree of the development of the Eurocurrency market is such that for the proper management and monitoring for the world economy effective coordination between the monetary and other policies of, at least, the major countries of the world is essential. To bring this about, agreement on some form of coordinated surveillance and official intervention in the Eurocurrency market may well prove the beginning of laying the foundation for further cooperation in economic policies of the countries of

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world. There is, however, little chance of progressing in the direction of formulating specific regulatory measures for the market until there is some consensus agreement among the concerned countries regarding the overall role of the Eurocurrency market as an international capital market.

FOREX MARKET MECHANISM

The foreign exchange market is the market in which currencies are bought and sold against each other. It is the largest market in the world. The foreign exchange market is an over-the-counter market. This means that there is no single physical or electronic market place or an organized exchange (like a stock exchange) with a central clearing mechanism where traders meet and exchange currencies. The market itself is actually a worldwide network of inter-bank traders, consisting primarily of banks, connected by telephone lines and computers. While a large part of inter-bank trading takes place with electronic trading systems such as Reuters Dealing 2000 and Electronic Broking Systems, bank and large commercial i.e. corporate customers still use the telephone to negotiate prices and consummate the deal. After the transaction, the resulting market bid/ask price is then fed into computer terminals provided by official market reporting service companies. The prices displayed on official quote screen reflects one of may be dozens of simultaneous ‘deals’ that took place at any given moment. Online trading systems have also been devised and may become the norm in the future. However, for corporate customers of banks, dealing on the telephone will continue to be an important channel. Structure of the Foreign Exchange Market • Retail market in foreign exchange is the market in which travelers and tourists

exchange one currency for another in the form of currency notes or travelers’ cheques. The total turnover and average transaction size are very small. The spread between buying and selling prices is large.

• Whole sale market is often called the inter bank market. The major categories of participants in this market are commercial banks, investment institutions, non-financial corporations and central banks. The average transaction size is very large. Among the participants in this market, primary price makers or professional dealers make a two-way market to each other and to their clients i.e. on request they will quote a two-way price- a price to buy currency X against Y and a price to sell X against Y- and be prepared to take either buy or the sell side. This group includes mainly commercial banks but some large investment dealers and a few large corporations have also assumed the role of primary dealers. Primary price makers perform an important role in taking position off the hands of another dealer or corporate customer and then offsetting these by doing an opposite deal with another entity which has a matching requirement. Among the primary price makers there is a kind of layering or a pyramid. A few giant multinational banks which deal in a large number of currencies, in large amounts and often deal directly with each other without using brokers. Their transactions can have significant influence on the market. In the second tier are large banks which deal in a smaller number of currencies and use

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the services of brokers more often. Lastly there are small local institutions which make market in very small numberof major currencies against their home currency. In the retail market there are entities that quote foreign exchange rates but do not make a two way market. They are secondary price makers. Restaurants, hotels, shops catering to tourists buy foreign currency in payment of bills; some entities specialize in retail business for travelers and buy and sell foreign currencies and travels’ cheques. Typically their bid-ask spreads are much wider than those of primary price makers. Finally, there are price takers who take the prices quoted by primary price makers and buy or sell currencies for their own purposes but do not make a market themselves. Corporations use the foreign exchange market for a variety of purposes related to their operations. Among these are payments for imports, conversion of export receipts, hedging of receivables and payables, payment of interest on foreign currency loans, placement of surplus funds and so forth. Many companies, as a matter of policy, restrict their participation in the market to transactions arising out of their business of producing and selling goods and services. They do not take active positions in the market to profit from exchange rate fluctuations. Others, mainly giant multinationals, utilize their considerable financial expertise to take positions purely with the intention of generating financial profits from exchange rate movements. Central banks intervene in the market from time to time to attempt to move exchange rates in a particular direction or moderate excessive fluctuations in the exchange rate. Types of Transactions and Settlement Dates Settlement of transaction takes place by transfers of deposits between the two parties. The day on which these transfers are affected is called the settlement date or the value date. Obviously, to effect the transfers, banks in the countries of the two currencies involved must be open for business. The relevant countries are called settlement locations. The locations of two banks involved in the trade are dealing locations which need not be the same as settlement locations. Depending upon the time elapsed between the transaction date and the settlement date, foreign exchange transactions can be categorized into spot and forward transactions. Third categories called swaps are combination of a spot and a forward transaction (or a forward-forward swap i.e. a combination of two forward transactions). In a spot transaction the settlement or value date is usually two business days ahead for European currencies and Asian currencies traded against dollar. Thus if a London bank sells yen against dollar to a Paris bank on Monday, the London bank will turn over a yen deposit to the Paris bank on Wednesday and the Paris bank will transfer a dollar deposit to the London bank on the same day. The time gap is necessary for confirming and clearing the deal through the communication network such as SWIFT. (Note that by the two business days ahead rule, deals done on a Thursday will be cleared the following Monday, while deal done on Friday will have Tuesday of the following week as the value date if, Saturday and Sunday are bank holidays as they are in most financial centers). To

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reduce credit risk both transfer should take place on the same day. The settlement time is reduced to one business day for trades between currency pairs such as the US dollar and Canadian dollar and US dollar and Mexican peso. Value dates for forward transactions- In a 1-month (or 30 days) forward purchase of say pound against rupees, the rate of exchange is fixed on the transaction date; the value date is arrived at as follows: first find the value date for a spot transaction between the same currencies done on the same day and then add one calendar month to arrive at the value date. Thus for a one month forward transaction entered into on say June 20, the corresponding spot value date is June 22 and one month forward value date is July 22, two months forward would be August 22 and so on. Standard forward contract maturities are 1 week, 2 weeks, 1, 2,3,6,9 and 12 months. The value dates are obtained by adding the relevant number of calendar months to the appropriate spot value date. If the value date arrived at in such a manner is ineligible because of bank holidays, then like in a spot deal, it is shifted forward to the next eligible business day. However, there is one important difference viz. rolling forward must not take you into the next calendar month, in which case you must shift backward. Thus suppose a 3-month forward deal is done on November 26. The spot date is November 28. Adding three calendar months takes you to February 28. If February 28 is ineligible, you can not shift forward because that goes into March (assuming it is not a leap year). It must be rolled back to February 27. Though standard maturities are in whole number of months, banks routinely offer forward contracts for maturities are in whole number of months. Thus a corporation can enter into a forward contract for deliver say 73 days from the date of transaction. Such contracts are called “broken date” or “odd date” contracts. For some currency pairs, long dated forward contracts with maturities extending out to five years are available. A swap transaction in the foreign exchange market is a combination of a spot and a forward in the opposite direction. A spot 60-day Dollar-Euro swap will consist of a spot purchase (sale) of dollars against the Euro coupled with a 60 day forward sale (purchase) of dollar against euro. When both the transactions are forward transactions we have a forward-forward swap. Short date transactions are transactions which call for settlement before the spot date. “Cash” transactions are for settlement same day while some deals will involve settlements “tomorrow” i.e. one business day ahead when a spot deal would be settled two business days later.

International Stock (Capital) Market

The twentieth century has seen massive cross-border flows of capital. The initial thrust to cross-border flows of equity investment came from the desire on the part of institutional investors to diversify their portfolios globally in search of both higher return and risk reduction. Financial deregulation and elimination of exchange controls

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in a number of developed countries at the beginning of eighties permitted large institutional investors to increase their exposure to foreign equities. The decade of 1990’s witnessed opening up of equity markets of developing countries like South Korea, Taiwan, Indonesia and India to foreign investors though with some restrictions. A number of companies from these countries have raised equity financing in developed country stock markets. The trend towards global integration of equity markets is unmistakable though it is punctuated by intermittent crises and consequent investor retreat. Equity capital can flow to a developing country in one or more of three ways.

• Developed country investor can directly purchase shares in the stock market of a developing country.

• Or, companies from developing countries can issue share (or depository receipts) in the stock markets of developed countries.

• Finally, indirect purchases can be made through a mutual fund which may be a specific country fund or a multi-country regional fund.

While stock markets in developing countries are quite small in size compared to the major developed country markets- the US, Japan and the UK- turnover ratios of many of them are comparable to those in the latter. Since many companies have accessed the global equity market primarily for establishing their image as global companies, the major consideration has been visibility and post issue consideration related to investor relations, liquidity of the stock in the secondary market and regulatory matters pertaining to reporting and disclosure. Other relevant considerations are the price at which the issue can be placed, costs of issue and factors related to taxation.

If the international markets were integrated, a given stock would be priced identically by all investors and there would be no advantage in choosing one market over another apart from cost-of-issue considerations. However, with segmented markets, the price that can be obtained would vary from one market to another. Countries with high saving rates such as Japan (and those like Switzerland with access to others’ investible funds) would normally have low cost of equity. However, some of these markets may not be readily accessible except to very high quality issuers. When the issue size is large, the issuer may consider a simultaneous offering in two or more markets. Such issues are known as Euroequities.

Issue costs are an important consideration. In addition to the underwriting fees ( which may be in the 3-5% range), there are substantial costs involved in preparing for an equity issue particularly for issuers from developing countries who are not very well known to developed country investors. Generally speaking, issue costs tend to be lower in large domestic markets such as the US and Japan.

Starting way back in 1970s, a number of European and Japanese companies have got themselves listed on foreign stock exchange such as New York and London. Shares of many firms are traded indirectly in the form of depository receipts. In this mechanism the shares issued by a firm are held by a depository, usually a large international bank, which receives dividends, reports etc. and issues claims against these shares. These claims are called depository receipts with each receipt being a

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claim on a specified number of shares. The depository receipts are denominated in a convertible currency- usually US dollars. The depository receipts may be listed and traded on major stock exchanges or may trade in the OTC market. The issuer firm pays dividends in its home currency which is converted into dollars by the depository and distributed to the holders of depository receipts. This mechanism originated in US-the so-called American Depository Receipts or ADRs. Recent years have seen the emergence of European Depository Receipts (EDRs) and Global Depository Receipts (GDRs) which can be used to tap multiple markets with a single instrument.

The early Indian issuers such as Reliance preferred the GDR route since listing and disclosure requirements are less onerous. In recent years, many Indian IT companies have preferred to use the ADR route with listing on major US exchanges such as NASDAQ and NYSE. The main reason for this is that their mergers and acquisition activity and foreign subsidiaries are mostly in US. Hence it was crucial for them to get listed on US exchange and use the dollar-denominated instruments as “currency” for acquisitions in US and grant of ESOPs. Also, the US capital markets are the largest and most prestigious and a listing on US exchange gives the company a highly visible global image. The strict US standards pertaining to disclosure and reporting are also said to improve corporate governance. Transactions in depository receipts are settled by means of computerized book transfers in international clearing systems such as EUROCLEAR and CEDEL.

Moreover GDR/ADR holders have the right to subscribe to new shares and the right to bonus shares. All these rights are exercised through the depository. The depository converts the dividends from rupees to foreign currency. DR holders have no voting rights. The depository may vote if necessary as per the provisions in the Depository Agreement.

International Institutions

International Monetary Fund (IMF)

The International Monetary Fund (IMF) was established for promoting international economic stability by promoting the balanced growth of free international trade and the multiconvertibility of national currencies. The Fund is a pool of the central bank reserves and national currencies which are made available to the Fund members under certain conditions. In a way, pool may be regarded as an extension of member countries’ central bank reserves.

AIMS:-

The International Monetary Fund has been the centerpiece of the world monetary order since its creation in 1944 though its supervisory role in exchange rate arrangements has been considerably weakened after the advent of floating rates in 1973.

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As mentioned above, restoration of monetary order after the Second World War was to be achieved within the framework of the Articles of Agreement adopted at Bretton Woods. These articles required the member countries to cooperate towards:

• Increasing international monetary cooperation

• Promoting the growth of trade promoting exchange rate stability

• Establishing a system of multilateral payments, eliminating exchange restrictions which hamper growth of world trade and encouraging progress toward convertibility of member currencies.

• Building a reserve base.

The responsibility for collection and allocation of reserves was given to the IMF. It was also given the role of supervising the adjustable peg system, rendering advice to member countries on their international monetary affairs, promoting research in various areas of international economics and monetary economics and provide a forum for discussion and consultations among member nations.

ACTIVITIES:-Each member of the IMF undertakes a broad obligation to collaborate with the IMF and other members to ensure orderly exchange arrangements and to promote a system of stable exchange rates. In addition, members are subject to certain obligations relating to domestic and external policies that can affect the balance of payments and the exchange rates. The IMF makes its resources available, under proper safeguards, to its members to meet short-term or medium-term payment difficulties.

To enhance the balance of payments assistance to its members, the IMF established a Compensatory Financing Facility on February27, 1963; temporary oil facilities in 1974 and 1975; a Trust Fund in 1976; and an Extended Fund Facility (EFF) for medium-term assistance to members with special balance of payments problems on September13, 1974. In March 1986, it established the Structural Adjustment Facility (SAF) to provide assistance to low income countries. In December1987 it established the Enhanced Structural Adjustment Facility (ESAF) to provide further assistance to low-income countries facing high level of indebtedness. In August 1988, the Compensatory and Contingency Financing Facility was established, succeeding the Compensatory Financing Facility. The new facility provides broader protection to members pursuing IMF-supported adjustment programmes.

In December 1997, the Supplemental Reserve Facility (SRF) was established to provide short-term assistance to countries experiencing exceptional balance of payments problem owing to a large short-term financing need resulting from a sudden disruptive loss of market confidence, reflected in pressure on the capital account and the members’ reserves.

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Contingent Credit Lines (CCL) were established in April 1999 as instruments of crisis prevention to counter problems of international financial contagion.

CAPITAL RESOURCES:-

In April 1997, the Interim Committee of the Fund’s Board of Governors endorsed the concept of an amendment that would make the promotion of capital account liberalization one of the Fund’s purposes and would give the Fund the appropriate jurisdiction over capital movements. The capital resources of the IMF comprise SDRs and currencies that the members pay under quotas calculated for them when they join the IMF. Every IMF member is required to subscribe to the IMF an amount equal to its quota. An amount not exceeding 25 percent of the quota has to be paid in reserve assets, the balance in the member’s own currency. The members with the largest quota are: 1st, the USA; joint 2nd, Germany and Japan; joint 4th, France and the UK.

An increase of almost 60percent in IMF quotas became effective in November1992 as a result of the 9th General Review of Quotas.

BORROWING RESOURCES:-

The IMF is authorized, under its Articles of Agreement, to supplement its resources by borrowing. In January 1962, a 4 year agreement was concluded with 10 industrial members (Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, UK, and USA) who undertook to lend the IMF up to US$6,000 m in their own currencies, if this should be needed to forestall or cope with an impairment of the international monetary system. Switzerland subsequently joined the group. These arrangements, known as the General Arrangements to Borrow (GAB), have been extended several times.

In order to oversee the compliance of members with their obligations under the Articles of Agreement, the IMF is required to exercise firm surveillance over members’ exchange rate policies. The IMF works with the IBRD (World Bank) to address the problems of the most heavily indebted poor countries (most in sub-Saharan Africa) through their Initiative for the Heavily Indebted Poor countries (HIPCs). It is designed to ensure that HIPCs with a sound track record of economic adjustment receive debt relief sufficient to help them attain a sustainable debt situation over the medium-term.

ORGANISATION:-

The highest authority is the Board of Governors, on which each member government is represented. Normally the governors meet once a year, and may take votes by mail or other means between meetings. The board of governors has delegated many of its powers to the 24 executive directors in Washington, who are appointed or elected by individual member countries or group of countries. Each appointed director has voting power proportionate to the quota of the government he or she represents, while each elected director casts all the votes of

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the countries represented. The managing director is selected by the executive directors and serves as chairman of the executive board, but may not vote except in case of a tie. The term of office is for five years, but may be extended or terminated at the discretion of the executive directors. The managing director is responsible for the ordinary business of the IMF, under the direction of the executive directors, and supervises a staff of about 2,200. Under a long-standing, informal agreement, the managing director is European (while the President of the World Bank is a US national). There are three deputy-managing directors. In December, 1998 the IMF had 182 members.

International Bank for Reconstruction and Development

(IBRD)- The World Bank

ORIGIN:_

Conceived at the UN Monetary and Financial Conference at Bretton Woods (New Hampshire, USA) in July 1944, the IBRD, frequently called the World Bank, began operations in June 1946, its purpose being to provide funds, policy guidance and technical assistance to facilitate economic development in its poorer member countries. The Group comprises four other organizations.

ACTIVITIES:_

The Bank obtains its funds from the following sources:-capital paid in by member countries; sales of its own securities; sales of parts of its loans; repayments; and net earnings.

The Bank is self-supporting, raising most of its money on the world’s financial markets. In the fiscal year ending June 30, 1997, it achieved a net income of US $1,285 m; medium band long-term borrowing equivalent of US $15,100 m in 18 currencies; average medium to long-term borrowing costs, after swaps, of 5.01 percent; financial returns on its investment folio of 5 percent; a reserves-to-loan ratio of14 percent; and decline in its net administrative expenditure in real terms to a figure set at $1,177m.

In order to eliminate wasteful overlapping of development assistance and to ensure that the funds available are used to the best possible effect, the Bank has organized consortia or consultative groups of aid-giving nations for many countries. For the purposes of its analytical and operational work, in 1996, the IBRD characterized economies as follows: low-income (average annual per capita GNP of $785 or less); middle-income (between $786 to $9,635); and high income ($9636 or more).

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A wide variety of technical assistance is at the core of IBRD’s activities. It acts as executing agency for a number of pre-investment surveys financed by the UN Development Programme (UNDP).The Bank maintains a staff college, the Economic Development Institute in Washington, DC, for senior officials of member countries. In 1997 the institute held training workshops on anti-corruption strategies and public integrity in more than 10 countries as part of IBRD’s initiative to combat corruption.

ORGANISATION:-

As of July 1997, the Bank had 180 members, each with voting powering the institution, based on shareholding, which, in turn, is based on a country’s economic growth. The Bank’s board of executive directors selects the president. The Articles of Agreement do not specify the nationality of the president but by custom the US executive director makes a nomination, and by a long-standing, informal agreement, the president is a US national (while the managing director of the IMF is European). The initial term is 5 years, with a second of 5 years or less.

International Development Association (IDA)

The IBRD unanimously adopted a proposal on October1, 1959 for setting up in principle the International Development Association. The IDA, nicknamed as the ‘soft loan window’ at which the underdeveloped countries can borrow in hard currencies without worry to repay in the same currencies, formally commented its operation on November 8, 1960. The IDA gives development credits more generously to the poorer developing countries and its loans are more flexible than the IBRD loans, being for 15 years at least. The IDA finances a certain percentage of the cost of a project that is meant not only for meeting the foreign exchange component of the project but also a part of the cost of local currency. Many countries which can not borrow from the IBRD for projects because these are not regarded creditworthy by the Bank are able to secure credit from the IDA. The credits granted by the IDA are free of interest and only an administrative charge is levied on the IDA credit. The IDA has financed wider range of projects than the World Bank has been able to finance. The only criterion for the IDA to grant credit for a project is that the project to be financed should be of a “high development priority”. The other salient feature of the IDA credits is that these credits can also be repaid in local currencies of the borrowing countries. Consequently, borrowers have not to worry about finding the scarce foreign exchange at the same time of repayment of credits. In short, the IDA provides loans on terms which do not bear heavily on the external balance of payment position of the borrower members.

IDA’s RESOURCES:-

IDA’s internal resources including repayment of principal from past credits and service charges of the order of SDR 7.3 billion ( about $9 billion); IBRD net income transfers of SDR 0.7 billion (about $0.9billion) and a small carryover of donor resources from the previous replenishment.

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LENDING OPERATIONS:-

In 1997, the IDA lent a total of US$101,600 m for 2,780 development projects in around 100 countries. The same year, however saw overall loan commitment for the poorest countries fall by almost a third, to US$4,600m, with commitments 15percent down on the lower end of its US$5,300-6,600 m planning range for that year. The biggest shortfall has been in lending to Africa. Up to the end of June 2004, the total cumulative amount of development credits extended by IDA aggregated US $151,390.6 million in the form of 3,745 development credits for various development projects in 112 member countries. India has immensely benefited from the credits granted to her by the IDA. Up to June30, 1999, India has received massive credit assistance of US $26, 16.3 million in the form of 229 credits to finance her various development projects.

Officers and staff of the IBRD serve concurrently as officers and staff of the IDA at the World Bank headquarters.

International Finance Corporation (IFC)

It was established in July 1956 to help strengthen the private sector in developing countries, through the provision of long-term loans, equity investments, guarantees, standby financing risk management and quasi equity instruments such as subordinated loans, preferred stock and income notes. It helps to finance new subordinated loans, preferred stock and income notes. It helps to finance new ventures and assist established enterprises to expand, improve or diversify, and provides a variety of advisory services to public and private sector clients. To be eligible for financing, project must be profitable for investors, must benefit the economy of the country concerned, and must comply with IFC’s environment guidelines.

About 80 percent of its funds are borrowed from the international financial markets through public bond issues or private placements and 20 percent from the IBRD. Its authorized capital is US$2,450 m and paid- in capital at 30 June 1996 was US$2,076 m. The IFC invested US$6,700 m in project financing in 1997 and approved 276 private sector projects in around 80 countries. It has 172 members.

Multilateral Investment Guarantee Agency (MIGA) Established in 1998 to encourage the flow of foreign direct investment to, and among, developing member countries, MIGA is the insurance arm of the World Bank. It provides investors with investment guarantees against non-commercial risk, such as expropriation and war,

and gives advice to governments on improving climate for foreign investment. It may insure up to 90 percent of an investment, with a current limit of US$50m per project. In March 1999 the council of governors adopted a resolution for a capital increase for

the Agency of approximately US$850 m. in addition US$150m was transferred to MIGA by the World Bank as operating capital. By 1999, it had 151 member countries

and a further 15 countries in the process of fulfilling membership requirements.

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UNIT IVRegional Trading Block

A trading block is an association of countries that reduces intra regional barriers

to trade in goods. The purpose is to give smaller economies the larger region and market they need to create the “critical mass” of production and sales needed to be competitive. Trading block seeks to generate welfare gains through income and efficiency effects and trade creation; augment negotiation leverage with third countries; and sometimes promote regional political co-operation.

The effect of block formation can be either trade- creating or trade diverting. The liberalization of trade barriers reduces transaction costs and trade policy within the block, thus encouraging intra and inter-industry specialization and promoting economic efficiency and growth.

Main Trading Blocks

1. The European Union (EU):- The concept of European trading bloc is the easiest to explore since it has been in existence since the Treaty of Rome of 1957. The enlargement of the Union to 15 countries, along with the internal reforms that are being implemented pursuant to the single European Act of 1987, has created a cohesive and continental trading regime. The growth of intra EU trade has far outpaced the growth of exports to third markets.

The EU has also strengthened its trade ties with its proximate neighbors in Europe, the members of EFTA, with which it has industrial FTA’s since the 1970s.

EU bloc is both broadening its geographic scope and deepening its level of integration toward the creation of a continent wide European space. This process has proceeded in several steps during the past 20 years; the enlargement of the EU to 15 members; the growth of the network of association and preferential trading arrangements with 66 countries in Africa and further expansion during the 1990s and the elaboration of association arrangements with emerging democracies in Eastern Europe (reunification of West and East Germany).

The EU’s internal market reforms are contributing to the further integration of the European market and the evolution of a strong regional trading bloc.

2. The North America:- In North America there has also long been a trading bloc that encompasses the world’s largest integrated market; the United States of America, it too, is expanding during the past five years, the US has negotiated a series of bilateral agreement with Canada and Mexico, its largest and third largest trading partners. Respectively both Canada and Mexico conduct about two- thirds of their trade with the US, and each benefits from substantial US direct investment in their economies, US trade with its North American neighbors accounts for about 26percent of total US trade, but is more diversified than that of its neighbors.

Political interest and support for a prospective North America block derives from the fact that the three economies are already integrated to a significant extent. Closer economic integration of the three economies could help promote economies of scales of production, increase productivity, and thus enable

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regional industries to compete more effectively in world markets. This is practically important for these countries as each need to increase its exports to help redress their large current account imbalances- which effectively means that total regional exports to third market need to increase substantially. This is particularly important for Mexico and Canada, which benefit more than the US from the income effects of market integration.

Despite the disparity in the level of economic development between Mexico and its Northern neighbors, the North American trading bloc exhibits most of the basic characteristics of a successful trading bloc. The members meet the geographical proximate test; have a strong political commitment to regionalization and because of the rapid pace of Mexican reform differences in trade regulatory systems are rapidly fading.

The evolution of a North American block is unlikely to diminish support in the region for the multilateral trading system. All three countries regard the regional relationship as complement to their multilateral trade relations. Each country has an important stake in the multilateral system.

The three countries in the region maintain their outward orientation and dependence on a strong multilateral trading system.

3. The East Asia:- The East Asian economies increased their share of world GDP from 5 percent to 20 percent and of world manufacture exports from 23 percent between 1965 and 1988. Japan has emerged as the second largest economy in the world, whereas numbers of developing economies in the region have joined the ranks of the high income economies. During the 1980’s, East Asia experienced the strongest export growth of the three regions.

As Japan has emerged as the second largest economy in the world- Japan’s export might growing faster in South East Asia. In Taiwan,

Thailand and Malaysia, Japan is selling everything from VCR’s to complete factories. Japan’s trade surplus with spirited tigers such as Taiwan and South Korea, are widening. Japan’s export machine has become much more sophisticated over the last decade. Besides mastering hot new technologies, Japanese companies have invested $ 200 billion offshore as of 1990, giving them platforms to make many lower technology, older products. Meanwhile, at home, they have concentrated on developing more technology intensive products, in strong demand overseas.

Most developed countries, influenced by the export pessimism of the 1950s and 1960s adopted inward-looking strategies aimed at developing a modern industrial sector through protectionism, government planning and other direct incentives whose combined effect was a strong anti-export bias. But this ended in the 1960s, and many countries faced serious problems including inefficient industries, foreign exchange shortages and bias against agriculture.

A few countries- notably South Korea and Taiwan- switched to outward strategies. The more outward-oriented NICs grew at a faster rate than the ASEAN-4(Association of South East Asian Nation) and the latter in turn, grew faster than the strongly inward oriented South Asian Countries.

The Republic of Korea and Thailand remain at the man guard of success stories for market oriented reforms. In recent years, like Korea, Taiwan has emerged as a

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major exporter to relatively capital and skill- intensive products as well as a major overseas investor in the region.

By the early 1980’s Singapore had a highly open trade and exchange regime comparable to that of Hong Kong with an average tariff rate of only about 5-6 percent. In addition, through a system of compulsory contractual savings, Singapore had also attained exceptionally high domestic savings rate of over 40 percent, the highest saving rate among NICs (Newly Industrialized Countries).

The prospects of intraregional trade expansion in Asia and the Pacific will depend on the extent to which linkages can be developed through mutual co-operation within the three –tier structure in which the trade sector of the region’s developing economies may be defined.

At the one end are the NIE which have become an example of a successful transformation of their economies through the path of export led growth.

Next comes a broad cluster of more heterogeneous economies consisting of the ASEAN-4, South Asian countries other than the least developed countries and China, which have many commonalities in the infrastructure of foreign trade although the ASEAN-4 are distinctly more export oriented.

The third group consists of countries which have lagged behind in both outward orientations as well as infrastructural support; these would include the least developed countries, the Pacific Islands, Indochina and the transition economies, the problems with each subgroup are largely unique.

Further, in all Asian countries it was necessary to encourage direct investment in order to reduce the dependence on foreign locus, and also to improve and expand capital markets in order to direct savings to domestic industrial growth. Government in most NIEs and the ASEAN-4 has played a decisive role in economic development and has contributed to rapid industrial growth in the economies. This observed association between the phenomenal growth of the Republic of Korea, Singapore and Thailand, for example, and the active roles that their Government has played in their economies differs from the heavy handed approach often used elsewhere; Government in Asia have played a facilitating role.

The concept of potential East Asian trading bloc has been advanced in two somewhat related forms. Some feel that such a block is emerging because the countries of region seem to be come together around the region’s dominant economy, Japan. Other regard the growing interest in Pacific Basin initiates as the catalyst for a new trading block, with the US and Japan at the core.

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UNIT IV

World Economy Growth and Physical Environment The macro dimensions of the environment are economic, social and cultural,

political and legal, and technological. Each is important, but perhaps the single most important characteristic of the international market environment is economic dimension.

Today, there is global economic growth. For the first time in the history of international marketing, markets in every region of the world are potential targets for almost every company from high tech to low tech, across the spectrum of products from basic to luxury. Fastest growing markets are in countries at the earlier stages of development. The economic dimensions of this world market environment are of vital importance.

The world economy has changed profoundly since World War II. Within the past decade, there have been several remarkable changes in the world economy that hold important implications for business. The likelihood of business success is much greater when plans and strategies are based on the new reality of the changing world economy like:-

• Capital movements rather than trade have become the driving force of the world economy.

• Production has become uncoupled from employment • The world economy dominates the scene. The macroeconomics of

industrial countries no longer controls economic outcomes. • The 75 years struggle between capitalism and socialism is over.

The first change is the increased volume of capital movements far exceeds the volume of international merchandise and service trade. This explains the bizarre combination of US trade deficits and continually rising dollar during the first half of the 1980s. Previously when the country ran a deficit on its trade accounts, its currency would depreciate in value- Today; it is capital movements and trade that determine currency value.

The second change concerns the relationship between productivity and employment. Although employment in manufacturing remains steady or has declined, productivity continues to grow. Manufacturing is not in decline it is employment in manufacturing that is in decline.

The third change is the emergence of the world economy as the dominant economic unit. The real secret of the economic success of Germany and Japan is the fact that business leaders and policymakers focus on the world economy and world markets.

The last change is the end of the cold war. The success of the capitalist market system has caused the overthrow of communism as an economic and political system. The overwhelmingly superior performance of the world’s market economies has led socialist countries to renounce their ideology.

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There are three types of economic systems:_ capitalist, socialist and mixed. This classification is based on the dominant method of resource allocation; market allocation, command or central plan allocation and mixes allocation respectively.

• Market Allocation:- This is a system in one that relies on consumers to allocate resources. Consumers “write” the economic plan by deciding what will be produced by whom. The market system is economic democracy. The role of the state in a market economy is to promote competition and ensure consumer protection. The United States, most Western European Countries and Japan- are examples of predominantly market economy.

• Command Allocation:- In such system, the state has broad powers to serve the serve the public interest. These include deciding which products to make and how to make them. Consumers are free to spend their money on what is available, but state planners make decisions about what is produced, and there, what is available. Three of the most populous countries in the world- China, the former USSR and India relied on command allocation systems for decades. All three countries are now engaged in economic reforms directed at shifting to market allocation system.

• Mixed System:- There are, in reality, no pure market or command allocation systems among the world’s economies. All market systems have a command sector and all command systems have a market sector; in other words they are “mixed”.

In a market economy, the command allocation sector is the proportion of gross domestic product (GDP) that is taxed and spent by government. For example- In Sweden, 64percent of all expenditures are controlled by the government, the economic system is more “command” than “market”. The reverse is true in the United States. Similarly, farmers in most socialist countries were traditionally permitted to offer part of their production in a free market. China has given considerable freedom to business and individuals. Market Development Stages:-

International country markets are at different stages of development. Using GNP as a base, international markets have been divided into four categories:- • Low Income Countries:- Low income countries, also known as pre

industrial countries, are those with incomes of less than $766 per capita. Countries at this income level share the following characteristics:-

1. Limited industrialization and high percentage of the population engaged in agriculture and subsistence farming.

2. High birth rates 3. Low literacy rates Heavy reliance on foreign and 4. Political instability and unrest 5. Concentration in Africa, South of the Sahara

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In general these countries represent limited markets for all products and are not significant location for competitive threats. Though Bangladesh is an exception. Here per capita income is about $250; a growing garment industry has enjoyed exports. The dollar value of finished clothing exports surpasses that of jute, tea and other agricultural exports.

• Lower Middle Income Countries(Less Developed Countries LDC):- These are those countries with a GNP per capita of more than $766 and less than $3,036. These countries are at the early stages of industrialization. Factories supply a growing domestic market with such items such as clothing, tires, building materials and packaged foods. These countries are also locations for the production standardized or mature products such as clothing for export markets. Consumer markets in these countries are expanding. LDCs represent an increasing competitive threat. LDCs have a major competitive advantage in mature, standardized, labor intensive products such as athletic shoes. Indonesia, the largest non-communist country in South-East Asia, is a good example of an LDC on the move. Several factories there produce athletic shoes under contract for Nike.

• Upper Middle Income Countries:- These countries also known as industrializing countries are those with GNP per capita between$3,035 and $9,386. In these countries, the percentage of population engaged in agriculture drops sharply as people move to the industrial sector and the degree of urbanization increases. Many of the countries in this state- Malaysia, for example are rapidly industrializing. They have rising wages and high rates of literacy and advanced education, but they still have significantly lower wage costs than the advanced countries.

• High Income Countries:- High income countries, also known as advanced, industrialized, post-industrial, or first world countries, are those with GNP per capita above $9386. With the exception of few oil rich nations, the countries in this category reached their presence income level through a process of sustained economic growth. United States, Sweden and Japan are considered as advanced high income societies as post industrial countries. In such societies the sources of innovation are derived increasingly from the codification of theoretical knowledge. There is an orientation toward the future and the importance of interpersonal relationships in the functioning of society.

• Mixed Basket Economies:- A basket case is a country with economic, social and political problems that are so serious they make the country unattractive for investment and operations. Some basket cases are low income, no growth countries, such as Ethiopia and Mozambique that lurch from one disaster to the next.

Others are one time growing and successful countries that have become divided by political struggles. The result is civil strife,

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declining income, and often, considerable danger to residents. In the mid-1990s, the former Yugoslavia is a case in point. The stages of market development based on GNP per capita correspond with the stages of economic development. Low and lower middle income countries are also referred to as less developed countries or LDCs. The upper middle income countries are also called industrializing countries, and high-income countries are referred to as advanced industrialized and post industrial. Actually the shares of world GNP and the GNP per capita are based on income in national currency translated into US dollars at year end exchange rates. They do not reflect the actual purchasing power and standard of living in the different countries. This tends to exaggerate differences in real income between countries at different stages of economic development. The focus of more recent efforts to link economic and environmental concerns has been on determining changes in wealth (adjusted net savings) as an indicator of sustainability. Measures of adjusted net savings would take into account human capital, natural assets, knowledge and social assets. This measure is a useful “headline” indicator for the economy. Like all national accounts or monetary based indicators, it employs an integrating framework that permits weighing and aggregating disparate elements of the economy and the environment. Still being potentially useful headline indicators, for policy purposes, these indexes need to be disaggregated and complemented by such biophysical measures as pressure response indicators. Not only can the latter be disaggregated to a much greater extent, but they also have the added advantage that they can be used to identify the source of the problem. The concentration of wealth in a handful of large, industrialized countries is the most striking characteristic of global economic environment. The United States is, of course, a colossus in North America, as is the former Soviet Union in Central and Eastern Europe. In 1992, these countries accounted for 91 percent respectively of their region’s GDP. In Western Europe three countries- France, Germany, and the United Kingdom- accounted for almost 65 percent of that region’s GDP. Japan accounted for 62 percent of Asia’s GDP; in fact, Japan’s GDP alone is nearly twice the size of all other Asia Pacific countries GDPs combined. In Latin America, Argentina, Brazil and Mexico accounted for 73 percent of LAFTA (Latin America Free Trade Area) GDP. The actual condition of life for the masses in the richest and the poorest countries were not significantly different in the 1850s. This is in sharp contrast to the condition today in which the gap of the living standard of the majority in thigh income country is vastly different than that of the majority in the low income countries. This growing gap between the richest and the poorest country is a tremendous incentive to people in poor country to move to a high income country to seek economic opportunity and a higher standard of living.

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Helpline : 93124 06425

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SouthExtn

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PunjabiBagh

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aon

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WEBUNIVStu

dentsOnly

Now Also at VIVEK

VIHAR

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Helpline : 93124 06425

Compiled for



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international business environment

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